Author: John Sloman

There have been many analyses of the economic effects of Brexit, both before the referendum and at various times since, including analyses of the effects of the deal negotiated by Theresa May’s government and the EU. But with the prospect of a Boris Johnson government and, with it, a no-deal Brexit on 31 October, attention has turned to the effects of leaving the EU without a deal.

There have been two major analyses recently of the likely effects of a no-deal Brexit – one by the International Monetary Fund (IMF) and one by the Office for Budget Responsibility (OBR).

IMF analysis

The first was in April by the IMF as part of its 6-monthly World Economic Outlook. In Scenario Box 1.1. ‘A No-Deal Brexit’ on page 28 of Chapter 1, the IMF looked at two possible scenarios.

Scenario A assumes no border disruptions and a relatively small increase in UK sovereign and corporate spreads. Scenario B incorporates significant border disruptions that increase import costs for UK firms and households (and to a lesser extent for the European Union) and a more severe tightening in financial conditions.

Under both scenarios, UK exports to the EU and UK imports from the EU revert to WTO rules. As a result, tariffs are imposed by mid-2020 or earlier. Non-tariff barriers rise at first but are gradually reduced over time. Most free-trade arrangements between the EU and other countries are initially unavailable to the UK (see the blog EU strikes major trade deals) but both scenarios assume that ‘new trade agreements are secured after two years, and on terms similar to those currently in place.’

Both scenarios also assume a reduction in net immigration from the EU of 25 000 per year until 2030. Both assume a rise in corporate and government bond rates, reflecting greater uncertainty, with the effect being greater in Scenario B. Both assume a relaxing of monetary and fiscal policy in response to downward pressures on the economy.

The IMF analysis shows a negative impact on UK GDP, with the economy falling into recession in late 2019 and in 2020. This is the result of higher trade costs and reduced business investment caused by a poorer economic outlook and increased uncertainty. By 2021, even under Scenario A, GDP is approximately 3.5% lower than it would have been if the UK had left the EU with the negotiated deal. For the rest of the EU, GDP is around 0.5% lower, although the effect varies considerably from country to country.

The IMF analysis makes optimistic assumptions, such as the UK being able to negotiate new trade deals with non-EU countries to replace those lost by leaving. More pessimistic assumptions would lead to greater costs.

OBR analysis

Building on the analysis of the IMF, the Office for Budget Responsibility considered the effect of a no-deal Brexit on the public finances in its biennial Fiscal risks report, published on 17 July 2019. This argues that, under the relatively benign Scenario A assumptions of the IMF, the lower GDP would result in annual public-sector net borrowing (PSNB) rising. By 2021/22, if the UK had left with the deal negotiated with the EU, PSNB would have been around £18bn. A no-deal Brexit would push this up to around £51bn.


According to the OBR, the contributors to this rise in public-sector net borrowing of around £33bn are:

  • A fall in income tax and national insurance receipts of around £16.5bn per year because of lower incomes.
  • A fall in corporation tax and expenditure taxes, such as VAT, excise duties and stamp duty of around £22.5bn per year because of lower expenditure.
  • A fall in capital taxes, such as inheritance tax and capital gains tax of around £10bn per year because of a fall in asset prices.
  • These are offset to a small degree by a rise in customs duties (around £10bn) because of the imposition of tariffs and by lower debt repayments (of around £6bn) because of the Bank of England having to reduce interest rates.

The rise in PSNB would constrain the government’s ability to use fiscal policy to boost the economy and to engage in the large-scale capital projects advocated by Boris Johnson while making the substantial tax cuts he is proposing. A less optimistic set of assumptions would, of course, lead to a bigger rise in PSNB, which would further constrain fiscal policy.

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Questions

  1. What are the assumptions of the IMF World Economic Outlook forecasts for the effects of a no-deal Brexit? Do you agree with these assumptions? Explain.
  2. What are the assumptions of the analysis of a no-deal Brexit on the public finances in the OBR’s Fiscal risks report? Do you agree with these assumptions? Explain.
  3. What is the difference between forecasts and analyses of outcomes?
  4. For what reasons might growth over the next few years be higher than in the IMF forecasts under either scenario?
  5. For what reasons might growth over the next few years be lower than in the IMF forecasts under either scenario?
  6. For what reasons might public-sector net borrowing (PSNB) over the next few years be lower than in the OBR forecast?
  7. For what reasons might PSNB over the next few years be higher than in the OBR forecast?

The EU has recently signed two trade deals after many years of negotiations. The first is with Mercosur, the South American trading and economic co-operation organisation, currently consisting of Brazil, Argentina, Uruguay and Paraguay – a region of over 260m people. The second is with Vietnam, which should result in tariff reductions of 99% of traded goods. This is the first deal of its kind with a developing country in Asia. These deals follow a recent landmark deal with Japan.

At a time when protectionism is on the rise, with the USA involved in trade disputes with a number of countries, such as China and the EU, deals to cut tariffs and other trade restrictions are seen as a positive development by those arguing that freer trade results in a net gain to the participants. The law of comparative advantage suggests that trade allows countries to consume beyond their production possibility curves. What is more, the competition experienced through increased trade can lead to greater efficiency and product development.

It is estimated that the deal with Mercosur could result in a saving of some €4bn per annum in tariffs on EU exports.

But although there is a net economic gain from greater trade, some sectors will lose as consumers switch to cheaper imports. Thus the agricultural sector in many parts of the EU is worried about cheaper food imports from South America. What is more, increased trade could have detrimental environmental impacts. For example, greater imports of beef from Brazil into the EU could result in more Amazonian forest being cut down to graze cattle.

But provided environmental externalities are internalised within trade deals and provided economies are given time to adjust to changing demand patterns, such large-scale trade deals can be of significant benefit to the participants. In the case of the EU–Mercosur agreement, according to the EU Reporter article, it:

…upholds the highest standards of food safety and consumer protection, as well as the precautionary principle for food safety and environmental rules and contains specific commitments on labour rights and environmental protection, including the implementation of the Paris climate agreement and related enforcement rules.

The size of the EU market and its economic power puts it in a strong position to get the best trade deals for its member states. As EU Trade Commissioner, Cecilia Malmström stated:

Over the past few years the EU has consolidated its position as the global leader in open and sustainable trade. Agreements with 15 countries have entered into force since 2014, notably with Canada and Japan. This agreement adds four more countries to our impressive roster of trade allies.

Outside the EU, the UK will have less power to negotiate similar deals.

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Questions

  1. Draw a diagram to illustrate the gains for a previously closed economy from engaging in trade by specialising in products in which it has a comparative advantage.
  2. Distinguish between trade creation and trade diversion from a trade deal with another country or group of countries.
  3. Which sectors in the EU and which sectors in the Mercosur countries and Vietnam are likely to benefit the most from the respective trade deals?
  4. Which sectors in the EU and which sectors in the Mercosur countries and Vietnam are likely to lose from the respective trade deals?
  5. Are the EU–Mercosur and the EU–Vietnam trade deals likely to lead to net trade creation or net trade diversion?
  6. What are the potential environmental dangers from a trade deal between the EU and Mercosur? To what extent have these dangers been addressed in the recent draft agreement?
  7. Will the UK benefit from the EU’s trade deals with Mercosur and Vietnam?

Latest data from the UK banking trade association, UK Finance, show that cash payments have continued to decline, while contactless and mobile payments have risen dramatically. In 2018, cash payments fell 16% to 11.0 billion payments and constituted just 28% of total payments; the compares with 60% in 2008 and a mere 9% projected for 2028. By contrast, in 2018, debit card payments increased 14% to 15.1 billion payments. Credit card payments increased 4% to stand at 3.2 billion payments. Mobile payments though media such as Apple Pay, Google Pay and Samsung Pay, although still a relatively small percentage, have also increased rapidly, with 16% of the adult population registered for mobile payments, compared with just 2% in 2016.

But what are the implications of this ‘dash from cash’? On the plus side, clearly there are advantages to consumers. A contactless payment is often more convenient than cash and does not require periodic visits to a cash machine (ATM) – machines that are diminishing in number and may be some distance away if you live in the countryside. What is more, card payments allow purchasing online – a form of shopping that continues to grow. Also, if a card is stolen or lost, you can cancel it; if cash is stolen or lost, you cannot cancel that.

Then there are benefits to vendors. Cashing up is time consuming and brings little or no benefit in terms of bank charges. These are typically around 0.75% for cash deposits and roughly the same for handling debit card payments (around 0.7%). What is more, with the closure of many bank branches, it is becoming harder for many businesses to deposit cash.

Finally, there is the problem that many illegal activities involve cash payments. What is more, cash payments can be used as a means of avoiding tax as they can be ‘kept off the books’.

But there are also dangers in the dash from cash. Although the majority of people now use cards for at least some of their transactions, many older people and people on low incomes rely on cash and do not use online banking. With bank branches and ATMs closing, this group is becoming further disadvantaged. As the Access to Cash Review, Final Report states:

Millions of people could potentially be left out of the economy, and face increased risks of isolation, exploitation, debt and rising costs.

Then there is the danger of fraud. As the Financial Times article below states:

The proliferation of new types of payment method has raised concerns over security. Criminals stole £1.2bn in 2018, according to previous data from UK Finance, up from £967m in 2017. This included a rise in fraudsters illegally accessing customers’ accounts and cards.
 
Complaints about banking scams reached a record high in the past financial year, according to figures in May from the UK’s Financial Ombudsman Service.

One of the biggest dangers, however, of the move to card payments, and especially contactless payments, is that people may be less restrained in their spending. They may be more likely to rack up debt with little concern at the time of spending about repayment. As the Forbes article below states:

Because items purchased with a credit card have been decoupled from emotion, shoppers can focus on the benefits of the purchase instead of the cost. Thus, paying with a credit card makes it more difficult to focus on the cost or complete a more rational cost–benefit analysis. For example, if a person had to count out $0.99 to purchase an app, they might be less inclined to buy it. However, since we can quickly buy apps with our credit card, the cost seems negligible, and we can focus on the momentary happiness of the purchase.

Finally, there is the issue of our privacy. Card payments enable companies, and possibly other agencies, to track our spending. This may have the benefits of allowing us to receive tailored advertising, but it may be used as a way of driving sales and encouraging us to take on more debt as well as giving companies a window on our behaviour.

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Questions

  1. Summarise the main findings of the UK Payments Market Report 2019
  2. What are the relative merits of using (a) cash; (b) debit cards; (c) mobile payment?
  3. Find out what has happened to consumer debt in a country of your choice over the past five years. What are the main determinants of the level of consumer debt?
  4. How has UK money supply changed over the past five years? To what extent does this reflect changes in the ways people access money in their accounts?
  5. Why and how is China going ‘cashless’? Does this create any problems?
  6. Make out a case for and against increasing the £30 limit for contactless payments in the UK.

Firms are increasingly having to take into account the interests of a wide range of stakeholders, such as consumers, workers, the local community and society in general (see the blog, Evolving Economics). However, with many firms, the key stakeholders that influence decisions are shareholders. And because many shareholders are footloose and not committed to any one company, their main interests are short-term profit and share value. This leads to under-investment and too little innovation. It has also led to excessive pay for senior executives, which for many years has grown substantially faster than the pay of their employees. Indeed, executive pay in the UK is now, per pound of turnover, the highest in the world.

So is there an alternative model of capitalism, which better serves the interests of a wider range of stakeholders? One model is that of employee ownership. Perhaps the most famous example of this is the John Lewis Partnership, which owns both the department stores and the Waitrose chain of supermarkets. As the partnership’s site claims, ‘when you’re part of it, you put your heart into it’. Although the John Lewis Partnership is the largest in the UK, there are over 330 employee-owned businesses across the UK, with over 200 000 employee owners contributing some £30bn per year to UK GDP. Again, to quote the John Lewis site:

Businesses range from manufacturers, to community health services, to insurance brokers. Together they deliver 4% of UK GDP annually, with this contribution growing. They are united by an ethos that puts people first, involving the workforce in key decision-making and realising the potential and commitment of their employees.

A recent example of a company moving, at least partly, in this direction is BT, which has announced that that every one of its 100 000 employees will get shares worth £500 every year. Employees will need to hold their shares for at least three years before they can sell them. The aim is to motivate staff and help the company achieve a turnaround from its recent lacklustre performance, which had resulted in its laying off 13 000 of its 100 000-strong workforce.

Another recent example of a company adopting employee ownership is Richer Sounds, the retail TV and hi-fi chain. Its owner and founder, Julian Richer, announced that he had transferred 60% of his shares into a John Lewis-style trust for the chain’s 531 employees. In addition to owning 60% of the company, employees will receive £1000 for every year they have worked for the retailer. A new advisory council, made up of current staff, will advise the management board, which is taking over the running of the firm from Richer.

According to the Employee Ownership Association (EOA), a further 50 businesses are preparing to follow suit and adopt forms of employee ownership. As The Conversation article linked below states:

As a form of stakeholder capitalism, the evidence shows that employee ownership boosts employee commitment and motivation, which leads to greater innovation and productivity.
 
Indeed, a study of employee ownership models in the US published in April found it narrowed gender and racial wealth gaps. Surveying 200 employees from 21 companies with employee ownership plans, Joseph Blasi and his colleagues at Rutgers University found employees had significantly more wealth than the average US worker.
 
The researchers also found that the participatory management practices that accompanied the employee ownership schemes led to employees improving their communication skills and learning management skills, which had helped them make better financial decisions at home.

But, although employee ownership brings benefits, not only to the employees themselves, but also more widely to society, there is no simple mechanism for achieving it when shareholders are unlikely to want to relinquish their shares. Employee buyout schemes require funding; and banks are often cautious about providing such funding. What is more, there needs to be an employee trust overseeing the running of the company which takes a long-term perspective and not just that of current employees, who might otherwise be tempted to sell the company to another seeking to take it over.

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Questions

  1. What are the main benefits of employee ownership?
  2. Are there any disadvantages of employee ownership and, if so, what are they?
  3. What are the main barriers to the adoption of employee ownership?
  4. What are the main recommendations from The Ownership Effect Inquiry? (See linked report above.)
  5. What are the findings of the responses to the employee share ownership questions in the US General Social Survey (GSS)? (See linked Global Banking & Finance Review article above.)

The linked article below, by Evan Davis, assesses the state of economics. He argues that economics has had some major successes over the years in providing a framework for understanding how economies function and how to increase incomes and well-being more generally.

Over the last few decades, economists have …had an influence over every aspect of our lives. …And during this era in which economists have reigned, the world has notched up some marked successes. The reduction in the proportion of human beings living in abject poverty over the last thirty years has been extraordinary.

With the development of concepts such as opportunity cost, the prisoners’ dilemma, comparative advantage and the paradox of thrift, economics has helped to shape the way policymakers perceive economic issues and policies.

These concepts are ‘threshold concepts’. Understanding and being able to relate and apply these core economic concepts helps you to ‘think like an economist’ and to relate the different parts of the subject to each other. Both Economics (10th edition) and Essentials of Economics (8th edition) examine 15 of these threshold concepts. Each time a threshold concept is used in the text, a ‘TC’ icon appears in the margin with the appropriate number. By locating them in this way, you can see their use in a variety of contexts.

But despite the insights provided by traditional economics into the various problems that society faces, the discipline of economics has faced criticism, especially since the financial crisis, which most economists did not foresee.

Even Davis identifies two major shortcomings of the discipline – both beginning with ‘C’. ‘One is complexity, the other is community.’

In terms of complexity, the criticism is that economic models are often based on simplistic assumptions, such as ‘rational maximising behaviour’. This might make it easier to express the models mathematically, but mathematical elegance does not necessarily translate into predictive accuracy. Such models do not capture the ‘messiness’ of the real world.

These models have a certain theoretical elegance but there is now an increasing sense that economies do not evolve along a well-defined mathematical path, but in a far more messy way. The individual players within the economy face radical uncertainty; they adapt and learn as they go; they watch what everybody else does. The economy stumbles along in a process of slow discovery, full of feedback loops.

As far as ‘community’ is concerned, people do not just act as self-interested individuals. Their actions are often governed by how other people behave and also by how their own actions will affect other people, such as family, friends, colleagues or society more generally.

And the same applies to firms. They will be influenced by various other firms, such as competitors, trend setters and suppliers and also by a range of stakeholders – not just shareholders, but also workers, customers, local communities, etc. A firm’s aim is thus unlikely to be simple short-term profit maximisation.

And this broader set of interests translates into policy. The neoliberal free-market, laissez-faire approach to policy is challenged by the desire to take account of broader questions of equity, community and social justice. However privately efficient a free market is, it does not take account of the full social and environmental costs and benefits of firms’ and consumers’ actions or a fair distribution of income and wealth.

It would be wrong, however, to say that economics has not responded to these complexities and concerns. The analysis of externalities, income distribution, incentives, herd behaviour, uncertainty, speculation, cumulative causation and institutional values and biases are increasingly embedded in the economics curriculum and in economic research. What is more, behavioural economics is becoming increasingly mainstream in examining the behaviour of consumers, workers, firms and government. We have tried to reflect these developments in successive editions of our four textbooks.

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Questions

  1. Write a brief defence of traditional economic analysis (i.e. that based on the assumption of ‘rational economic behaviour’).
  2. What are the shortcomings of traditional economic analysis?
  3. What is meant by ‘behavioural economics’ and how does it address the concerns raised in Evan Davis’ article?
  4. How is herd behaviour relevant to explaining macroeconomic fluctuations?
  5. Identify various stakeholder groups of an energy company. What influence are they likely to have on the company’s behaviour?
  6. In an era of social media, web-based information and e-commerce, why might it be necessary to rethink the concept of GDP and its measurement?
  7. What is meant by an efficient stock market? Why may the stock market not be efficient?