Paul Dundon’s Weblog


A little cheese and a little whine

Some Thoughts on the Economics of Brexit

I have no special expertise in economics, but my reasons for voting Remain were economic ones, so I thought it was worth setting them out in the unlikely event that anyone cares about why I voted as I did.

Letting the Dust Settle

Once Article 50 is invoked, two processes begin. The EU decides on what basis they are willing to relate to us moving forward, and the ROW (Rest Of the World) starts positioning itself to do the same. The ROW can’t really decide what to do until the EU has spoken, but some groundwork can be done. At the end of these processes, we have a new trade agreement with the EU and new trade agreements with ROW.

How long will all this take? Trade agreements typically take about eight years to negotiate and there’s a general expectation that Article 50 takes two years to run. Let’s think optimistically, then: let’s say we wrap up Article 50 in one year, and the ROW negotiations go quickly and take just four years, and can start at the same time as Article 50, so we have a four year period of negotiation in total.

Pessimistically, after two years of Article 50 we still don’t have a deal we can live with so we hang in for another year, and the ins-and-outs of those negotiations constantly undermine our negotiations with ROW, so the clock on ROW negotiations doesn’t start until those three years are up, and then it takes the full eight years to negotiate new trade agreements. That gives a pessimistic figure of twelve years before the new set of agreements are in place.

Let’s split the difference and say eight years. No; let’s err on the side of optimism and say six. Now, once the new agreements are in place, businesses have to figure out how to take advantage of them before they really contribute to the economy. That’s probably going to take a year or two, but again, let’s be optimistic and say that this happens right away.

Investor Confidence

Over those six years, British businesses represent a greater investment risk than they did before the vote. An investment isn’t risky because you think it will fail; it’s risky because you don’t know if it will fail or not. Once Article 50 is served, investors will look at British businesses and think “I don’t know if this is a safe place to put my money, and I can’t know until these negotiations are concluded.” Now, I’m not saying that suddenly British businesses are going to become toxic – there will still be people happy to invest in them, but even in the optimistic case, British businesses will become a riskier proposition than they are at present, and remain a riskier proposition for six years.

Now, investors have a choice of where they put their money, and basically there are four relevant options: commodities (eg gold, oil); foreign businesses; British businesses; and government bonds. If British businesses become riskier, then the others, by comparison, become less risky, so money will move away from British businesses to the other three.

British businesses do not have to stand by helpless, of course. What they have to do to get money flowing back is to increase their profitability. The more the potential profits, the greater the risk investors will tolerate, so if you suddenly find you’re a riskier investment, the thing to do is to improve your margins.

How do businesses do this? The easiest thing to do is cut costs, because you have much more control over costs than income; and the easiest cost to cut is labour, because that’s the one you have most control over. So, you lay off staff and you cut wages; you defer recruitment; you demand that your staff work harder. In short, unemployment rises, wages fall, and working conditions get worse. Businesses can, of course, increase their prices; this leads to inflation, with everyone able to afford less. Living standards generally go down and the value of savings is eroded.

As unemployment rises, and wages fall, people have less free cash so the domestic market for goods and services starts to shrink. Businesses lose revenue, and the uncertainty about long term trading prospects makes it difficult for them to compensate for that by exploiting foreign markets (there are no new trade agreements in place at this point, remember). There is a risk, then, that we get caught in a vicious cycle, with rising unemployment leading to falling sales leading to rising unemployment, against a background of increasing prices.

Economic Growth

Thinking optimistically, we might be able to cause just enough unemployment to retain investment without the economy flat out collapsing. If we’re pessimistic, then even retaining a small amount of investment will pull us into recession. Let’s split the difference, and say that the economy flatlines – no recession, but no growth.

No; let’s be optimistic again. Over the last couple of years, UK GPD has grown by about 0.6% every quarter. Let’s assume that, instead of recession, or even flatlining, the reduction in investment just causes a bit of a slowdown and the economy continues to grow at half that rate. We’ve established a period of six years for the dust to settle, that is, before we see the benefit of new trade agreements. Over this time we would see the economy grow by 7%. This compares to it growing by 15% if we continued growing at our current rate. That is, Brexit halves our prospects of economic growth over the next six years, even thinking optimistically.

This is all crystal ball stuff, of course. But, it’s hard to see how there won’t be a reduction in investment in British businesses, given that they become a riskier proposition; and it’s hard to see how that doesn’t cause some reduction in economic growth; so the question is how much reduction it causes. Saying we avoid recession is pretty optimistic; saying we retain a reasonable level of growth, as I have done here, is even more so.


Let’s try to stay positive though; Brexit, we might say, wasn’t meant to be a quick fix. Let’s say this is a ten year project, so we need to allow ourselves four more years to recover that loss. We’ve had six years of higher unemployment, lower wages and worse working conditions, but let’s say we can stomach another four. The end of uncertainty, let’s say, restores investor confidence and money flows back into British businesses. Left to its own devices, GDP growth would return to 0.6% per quarter. If we’d had a steady 0.6% growth over those ten years, the economy would have grown by 27%. To get the same overall growth after six years of limited growth, GDP would have to grow by 1.05% per quarter for those four recovery years.

That growth would have to come from improved trade, ie, selling our goods abroad (because that’s the only positive economic change Brexit gives us). Again, let’s be optimistic and assume we can do this right away – businesses don’t have to spend time marketing, establishing their brand, setting up operations etc. At the end of those six years, GDP would be within a gnat’s of £3tn, compared to the £3.2tn we would expect without those six limited years. Over those four recovery years, we’d expect GDP to total just shy of £12tn, compared to £12.9tn without the limited growth. So, over those four years, increased trade has to pull in a little under £900bn, or about £222bn per year, to compensate for our loss.

Let’s again be optimistic and assume that our trade with Europe remains the same, so all we have to do is boost ROW exports by £222bn (we don’t have to make up any lost trade with Europe). In 2015, our exports to ROW totalled £171bn. In other words, to make up for lost growth, we would have to significantly more than double our exports to ROW. If this doesn’t seem unrealistic, try to consider what it means in terms of individual sales, of actual business people finding actual customers. Imagine you’re a salesperson, and your boss comes to you and says “I need you to sell more than twice as much as you sold last year, and all your additional sales have to come from outside Europe.” With the best will in the world, how do you rise to that challenge?

So, thinking optimistically, with everything going smoothly and no catastrophes, we are looking at six years of increased unemployment, lower wages and worsened working conditions, and even in ten years, we will still be suffering the loss. We’re not talking the end of civilisation here; I don’t expect to see Westminster Bridge in flames or the Four Horsemen galloping across it. But even in the best case, the worst off in this country are going to be even worse off than they are now, for at least ten years. That seems an awfully high price to pay for any other benefits Brexit might bring us.

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The Golden Bough
The Value of Nothing
The Fire
A Wolf at the Table
Devil Bones

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