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 no-deal Brexit on 31 October under the new Boris Johnson government, 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
- 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.
- 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.
- What is the difference between forecasts and analyses of outcomes?
- For what reasons might growth over the next few years be higher than in the IMF forecasts under either scenario?
- For what reasons might growth over the next few years be lower than in the IMF forecasts under either scenario?
- For what reasons might public-sector net borrowing (PSNB) over the next few years be lower than in the OBR forecast?
- 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
- 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.
- Distinguish between trade creation and trade diversion from a trade deal with another country or group of countries.
- 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?
- Which sectors in the EU and which sectors in the Mercosur countries and Vietnam are likely to lose from the respective trade deals?
- Are the EU–Mercosur and the EU–Vietnam trade deals likely to lead to net trade creation or net trade diversion?
- 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?
- Will the UK benefit from the EU’s trade deals with Mercosur and Vietnam?
Confidence figures suggest that sentiment weakened across several sectors in June with significant falls recorded in retail and construction. This is consistent with the monthly GDP estimates from the ONS which suggest that output declined in March and April by 0.1 per cent and 0.4 per cent respectively. The confidence data point to further weakness in growth down the line. Furthermore, it poses the risk of fuelling a snowball effect with low growth being amplified and sustained by low confidence.
Chart 1 shows the confidence balances reported by the European Commission each month since 2007. It highlights the collapse in confidence across all sectors around the time of the financial crisis before a strong and sustained recovery in the 2010s. However, in recent months confidence indicators have eased significantly, undoubtedly reflecting the heightened uncertainty around Brexit. (Click here to download a PowerPoint copy of the chart.)
Between June 2016 and June 2019, the confidence balances have fallen by at least 8 percentage points. In the case of the construction the fall is 14 points while in the important service sector, which contributes about 80 per cent of the economy’s national income, the fall is as much as 15 points.
Changes in confidence are thought, in part, to reflect levels of economic uncertainty. In particular, they may reflect the confidence around future income streams with greater uncertainty pulling confidence down. This is pertinent because of the uncertainty around the UK’s future trading relationships following the 2016 referendum which saw the UK vote to leave the EU. In simple terms, uncertainty reduces the confidence people and businesses have when forming expectations of what they can expect to earn in the future.
Greater uncertainty and, hence, lower confidence tend to make people and businesses more prudent. The caution that comes from prudence counteracts the inherent tendency of many of us to be impatient. This impatience generates an impulse to spend now. On the other hand, prudence encourages us to take actions to increase net worth, i.e. wealth. This may be through reducing our exposure to debt, perhaps by looking to repay debts or choosing to borrow smaller sums than we may have otherwise done. Another option may be to increase levels of saving. In either case, the effect of greater prudence is the postponement of spending. Therefore, in times of high uncertainty, like those of present, people and businesses would be expected to want to have greater financial resilience because they are less confident about what the future holds.
To this point, the saving ratio – the proportion of disposable income saved by households – has remained historically low. In Q1 2019 the saving ratio was 4.4 per cent, well below its 60-year average of 8.5 per cent. This appears to contradict the idea that households respond to uncertainty by increasing saving. However, at least in part, the squeeze seen over many years following the financial crisis on real earnings, i.e. inflation-adjusted earnings, restricted the ability of many to increase saving. With real earnings having risen again over the past year or so, though still below pre-crisis levels, households may have taken this opportunity to use earnings growth to support spending levels rather than, as we shall see shortly, looking to borrow.
Another way in which the desire for greater financial resilience can affect behaviour is through the appetite to borrow. In the case of consumers, it could reduce borrowing for consumption, while in the case of firms it could reduce borrowing for investment, i.e. spending on capital, such as that on buildings and machinery. The reduced appetite for borrowing may also be mirrored by a tightening of credit conditions by financial institutions if they perceive lending to be riskier or want to increase their own financial capacity to absorb future shocks.
Chart 2 shows consumer confidence alongside the annual rate of growth of consumer credit (net of repayments) to individuals by banks and building societies. Consumer credit is borrowing by individuals to finance current expenditure on goods and services and it comprises borrowing through credit cards, overdraft facilities and other loans and advances, for example those financing the purchase of cars or other large ticket items. (Click here to download a PowerPoint copy of the chart.)
The chart allows us to view the confidence-borrowing relationship for the past 25 years or so. It suggests a fairly close association between consumer confidence and consumer credit growth. Whether changes in confidence occur ahead of changes in borrowing is debatable. However, the easing of confidence following the outcome of the EU referendum vote in June 2016 does appear to have led subsequently to an easing in the annual growth of consumer credit. From its peak of 10.9 per cent in the autumn of 2016, the annual growth rate of consumer credit dropped to 5.6 per cent in May 2019.
The easing of credit growth helps put something of a brake on consumer spending. It is, however, unlikely to affect all categories of spending equally. Indeed, the ONS figures for May on retail sales shows a mixed picture for the retail sector. Across the sector as a whole, the 3 month-on-3 month growth rate for the volume of purchases stood at 1.6 per cent, having fallen as low as 0.1 percent in December of last year. However, the 3 month-on-3 month growth rate for spending volumes in department stores, which might be especially vulnerable to a slowdown in credit, fell for the ninth consecutive month.
Going forward, the falls in confidence might be expected to lead to further efforts by the household sector, as well as by businesses, to ensure their financial resilience. The vulnerability of households, despite the slowdown in credit growth, so soon after the financial crisis poses a risk for a hard landing for the sector. After falls in national output in March and April, the next monthly GDP figures to be released on 10 July will be eagerly anticipated.
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Questions
- Which of the following statements is likely to be more accurate: (a) Confidence drives economic activity or (b) Economic activity drives confidence?
- Explain the difference between confidence as a source of economic volatility as compared to an amplifier of volatility?
- Discuss the links between confidence, economic uncertainty and financial resilience.
- Discuss the ways in which people and businesses could improve their financial resilience to adverse shocks.
- What are the potential dangers to the economy of various sectors being financially distressed or exposed?
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.
Articles
- Millions choose a cashless lifestyle
BBC News, Kevin Peachey (6/6/19)
- The decline of cash in the UK – in charts
BBC News (7/6/19)
- One in 10 adults in UK have gone ‘cashless’, data shows
The Guardian, Rupert Jones (6/6/19)
- Going contactless is gloriously convenient – for all the wrong people
The Guardian, Peter Ormerod (7/3/19)
- Mobile banking and contactless cards continue to surge in popularity
Financial Times, James Pickford (6/6/19)
- Is a cashless society in Britain near? Banking data suggests just 9% of all payments will be cash by 2028
This is Money, George Nixon (6/6/19)
- Older and poorer communities are left behind by the decline of cash
The Conversation, Daniel Tischer, Jamie Evans and Sara Davies (16/5/19)
- As cash declines, research shows the most deprived communities are left behind
University of Bristol Press Release (16/5/19)
- Do People Really Spend More With Credit Cards?
Forbes, Bill Hardekopf (16/7/18)
- Why Cash Is Quickly Disappearing From China’s Economy—Data Sheet
Fortune, Aaron Pressman and Clay Chandler (5/6/19)
Cashless in China: Why It Matters CNA Insider on YouTube, Joshua Lim (28/10/17)
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Questions
- Summarise the main findings of the UK Payments Market Report 2019
- What are the relative merits of using (a) cash; (b) debit cards; (c) mobile payment?
- 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?
- 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?
- Why and how is China going ‘cashless’? Does this create any problems?
- 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
- What are the main benefits of employee ownership?
- Are there any disadvantages of employee ownership and, if so, what are they?
- What are the main barriers to the adoption of employee ownership?
- What are the main recommendations from The Ownership Effect Inquiry? (See linked report above.)
- 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.)
