Brexit brings with it a new kind of uncertainty

Good afternoon. It was the Autumn Statement in Brexitland this week, and as usual the headlines were consumed by a battle for political narrative around personal taxation and what it all means for the voters’ pocketbooks. 

But there was big actual news for business and not just the permanent extension of ‘full expensing’ of capital investment but also the publication of Lord Richard Harrington’s review of how the UK can do better at attracting foreign direct investment. It was a thinly veiled blueprint for an industrial strategy and his foreword to the report is well worth reading.

Both of these measures shared the common purpose of creating more certainty for business, an absolutely essential commodity for encouraging investment as the turbulence of the post-Brexit years has demonstrated.

That was a point made this week by Dave Ramsden, the deputy governor for markets and banking at the Bank of England, when he told the Treasury select committee that Brexit had clearly “chilled” the UK’s business investment, both foreign and domestic. (Listen from 12h.04m.38s)

“We do know from a large body of analytical evidence that a key driver of business investment decisions is certainty . . . you want certainty around where fiscal policy is going, and certainty about what kind of relationships your economy is going to have,” he said.

Full expensing delivers longer term certainty on fiscal policy, but as for the “kind of relationships” the UK economy is going to have, that continues to be dogged by the structural uncertainties that Brexit creates.

It’s the structural part that is important. Even if the UK gets a stable government (one that doesn’t flip-flop on net zero or repeatedly threaten to legislate in defiance of its international treaty obligations) Brexit creates a permanent state of low-grade uncertainty.

This is because every time its largest trade partner advances new rules and regulations, the UK (and its investors who have links with integrated supply chains and data sharing) are going to have to ask themselves how the UK will, or won’t, respond to those rules.

I’m not sure exactly which “analytical evidence” Ramsden was referring to, but quite possibly it was this 2019 paper by a clutch of Bank of England economists that examined how Brexit causes a different, more nagging, type of uncertainty.

“Brexit is unusual in that it generated persistent uncertainty,” they wrote, differentiating the UK’s decision to leave the EU from other big, one-off shocks such as “the 1973 Opec oil price shock, Gulf Wars I or II, the 9/11 attacks, the collapse of Lehman Brothers”.

(On a more micro level, this November 2023 paper by the Centre for Inclusive Trade Policy looks at the impact of that uncertainty on UK import prices and finds the “referendum outcome raised UK import prices by 11 per cent and consumer prices by 0.6 per cent through trade policy uncertainty alone”.)

A more precarious perch in the world

The question is the extent to which, with the Trade and Cooperation Agreement now in place and functioning, the UK can limit the ongoing uncertainty caused by its new, inherently more precarious, perch in the world.

Industry adapts (small companies stop trading, bigger ones suck up the bureaucracy and cost) but business must manage the drag of a constantly evolving policy environment. 

For example, a new Brexit border on EU imports comes into force in January; questions are pending on how a UK carbon border tax will link with the EU’s; or on how the EU’s move towards data localisation will affect the UK’s data adequacy agreement.

And the wheels grind slowly. The TCA came into force on January 1 2021, but it was only a couple of weeks ago — nearly three years on — that the UK government announced its plans for an “alternative transitional registration model” for chemicals under UK Reach. A consultation on the proposals “will be published in early 2024”. 

Industry groups like the Chemical Industries Association and the British Coatings Federation welcomed the prospect of a lighter touch regime, having warned in May that uncertainty around the regulatory regime for the industry risked causing “irreparable damage” to British businesses.

At the same time environmental and consumer groups, including Chem Trust, the Greener UK coalition and Breast Cancer UK, have all spoken of the need for “robust” regulation and warned against reducing requirements for the amount of data held on chemicals by the regulator.

Ruth Chambers, senior fellow at Greener UK, which represents 10 of the UK largest conservation groups, says: “The forthcoming consultation on chemicals regulation is a chance for ministers to show the environment is at the heart of their policymaking, as pledged.”

Will they? Or given the current polls and the advancing political timeframe of the next election, will a Labour government respond differently to such pressure than a Conservative one? 

I don’t know the answer to that — and nor do industry or investors — which is the point. Ongoing uncertainty.

Brexit challenge

As Harrington said in his FDI review, investment decisions are driven by a panoply of factors, but as the 200 investors he spoke to kept telling him, the UK’s traditional attractiveness has been “offset by recent policy instability, regulatory and policy uncertainty and market access challenges”.

It was notable that the Office for Budget Responsibility did not adjust it’s Brexit impacts forecast this week; while last week the National Institute of Economic and Social Research published an updated estimate of the Brexit hit, which it said “gradually escalates” to some 5-6 per cent of GDP or about £2,300 per capita by 2035. 

NIESR said the effects were down to “the fall in the UK terms of trade” in the EU-UK trade deal and the related fall in UK productivity, each accounting for over 2.5 percentage points of the estimated reduction in real GDP.

The challenge of Brexit is that it makes those issues identified by Harrington inherently harder to address — even if the Labour leader Sir Keir Starmer wins a 150 seat majority, there is no magic wand that will make those structural impediments go away. Only hard graft will do that.

Brexit in numbers

Zooming out slightly, because while Brexit hurts at the margin and creates those structural challenges, they don’t exist in isolation, but are just one element of a much bigger picture.

This is shown by this week’s chart which is taken from a fascinating deep dive into UK trade performance by the Boston Consulting Group’s centre for growth, which is run by Raoul Ruparel, who in a previous life was Europe adviser to Theresa May.

He examines the UK underperformance in goods trade and finds that it’s not confined to EU-UK trade — a fall in UK exports to the US is as worrying — and looks at reasons for why this might be.

The study comes up with three factors: inflation skewing some countries’ trade stats favourably compared to the UK; the fact that globally trade has recently seen a boom in areas like agriculture and fertiliser that aren’t UK strengths (so the UK hasn’t caught much of the updraught); but also persistent UK underperformance in areas where it is strong, like cars and (see chart) chemicals.

It’s a salutary finding that in 2022, the UK exported similar levels of organic chemicals to the US as it did in 1995, while in the same period Ireland exported 31 times and China over 52 times the amount.

Disaggregating the underlying causes is hard. Ruparel suggests a number of possible reasons, including a recent shift in pharmaceutical manufacturing to Ireland, high UK industrial energy prices, a lack of investment (see above) and a potential Brexit factor, since Ireland and China’s exports to the US increase sharply post 2016 while the UK’s flatline, then decrease.

But the wider point is that, looking to the future, the UK’s challenges predate Brexit and are not confined to Brexit. Ruparel’s advice is not to fight old wars, but invest in preparing for future ones.

That means focusing on the industries where future booms might take place, and positioning the UK well to take advantage of these — Harrington’s report is at least a start on that.

---

Britain after Brexit is edited by Gordon Smith. Premium subscribers can sign up here to have it delivered straight to their inbox every Thursday afternoon. Or you can take out a Premium subscription here. Read earlier editions of the newsletter here.