In hindsight, who was right?

04 Nov 2016 | Research & Business Knowledge

On June 23rd 2016 the UK referendum resulted in a vote to leave the EU.  Prior to the vote there were both dire warnings and blithe assurances from the two sides about what would happen to the economy in the event of a vote to leave.

So who was right?

Before coming to a view, it is worth considering what shape the economy was in before the Brexit referendum.  And, at least in relative terms, the answer is: not bad.

After being the G7 country with the slowest growth before joining the EU, the UK had seen the fastest growth in prosperity among the G7 countries since joining.

We had also experienced a faster bounce back from the Global Financial Crisis of 2008/9 than the Eurozone countries.  This was due in part to having an independent currency that could be allowed to devalue, and for which new money could be created wholesale.  The euphemism coined for this practice was quantitative easing – and the country saw nearly £400bn of it between 2008 and 2012.

In contrast the Eurozone countries were tied to a single central currency over which they had no individual national control.  Disagreements within the zone about its wisdom meant that the Eurozone was a late starter in quantitative easing, and some would say this has slowed its recovery.

In line with its greater growth and faster recovery from the GFC, unemployment in the UK is lower than in most of the Eurozone: only Germany among the major EU economies has a lower unemployment rate.

In fact, and with timing which may go down in history as somewhat ironic, GDP in the UK actually rose just before the Brexit vote…though we didn’t find out about it until afterwards.

It is also worth remembering what the two sides said would happen to the economy if the country voted to leave the EU on June 23rd.

Let’s start with the Brexiteers, spearheaded by (among others) Nigel Fage, Michael Gove, Boris Johnson and Andrea Leadsom.  Among their more loudly trumpeted claims were:

  • We would stop paying £13bn a year to the EU
  • We would have an extra £350m a week to spend on the NHS
  • GDP would rise by 4% by 2030, as would average disposable income
  • Prices on goods and services would fall by up to 8%.

Looking a little more closely at the first of these claims, we pay about £13bn a year to the EU, and we get back about £4.5bn, so we make a net contribution of £8.5bn.  To put that in context, it is about 7% of what we spend on the NHS, or to put it another way the net EU contribution accounts for £1 out of every £100 the UK government spends.

There was a lot of talk before the referendum of the NHS benefitting from this saving to the tune of £350m a week – talk from which all the leading Brexiteers busily distanced themselves in the days following the referendum result.

The 4% rise in both GDP and disposable income was predicted by Economists For Brexit.  This body, which included former government adviser, HSBC and Deloitte economist and Daily Telegraph columnist Roger Bootle, seemed to draw most of its projections from a fairly narrow range of sources – most notably from Patrick Minford, Professor of Applied Economics at Cardiff Business School, Cardiff University.

Economists For Brexit were the main economists’ voice trumpeting the benefits of Brexit.  Their views, and those of Professor Minford, were challenged and attacked by pro-Remain economists, of whom there seemed to be rather more.

Lined up against Economists For Brexit, in ascending order of doom-mongering for the UK economy if we left the EU were Oxford Economics, the NIESR, forecasts from the CBI/ PwC, the OECD, HM Treasury and the LSE.  In contrast with the Brexiteers’ forecast of 4% growth, both HM Treasury and the LSE forecast GDP contraction of over 7% following Brexit.  Even Barack Obama came over here to tell the Brits what a bad idea it would be to leave the EU, and Christine Lagarde, head of the International Monetary Fund, made dire predictions of the impact Brexit would have on the world economy.

All these contributions from economists and politicians inevitably themselves became part of the debate, with Michael Gove famously saying at one point that the voters had had enough of experts.  Based on the weight of expert economic opinion ranged against Brexit and the way the vote ultimately went, it looks as if he was right!

So what actually happened following the result, and what’s been happening since?

The result was a shock to the Leavers as much as to the Remainers.  And it had an immediate impact – not only the political bloodbath that immediately followed, but on the economy as well.

On the morning of the referendum result Mark Carney, governor of the Bank of England, made a statement aimed at reassuring the markets and the nation.  This included a pledge of £250bn liquid assets to be made available immediately to the banking sector.

And in short order the bank subsequently announced:

  • A cut in official interest rates to 0.25%, the first such move since March 2009
  • Plans to pump an additional £60bn in electronic cash into the economy to buy government bonds, extending the existing quantitative easing (QE) programme to £435bn in total
  • Another £10bn in electronic cash to buy corporate bonds from firms 'making a material contribution to the UK economy'
  • Up to £100bn of new funding to banks as a carrot to help them pass on the base rate cut, together with a stick in the form of the threat of penalties if they failed to do so

In addition the growth forecast for the UK for the following year was slashed by an unprecedented amount.  Growth was now predicted come to a near-standstill over coming months, and to be much weaker in 2017 and 2018 than had been predicted before the Brexit vote.

Against the dollar, the pound fell below $1.30, initially to as low as $1.28.  A year before it had been worth $1.57 – a fall of 17%.  To put this in context this is only the second time the pound had fallen this low against the dollar since the dollar first came into existence in 1792.  The decline against the Euro was slightly less steep at nearer 14%, and did not seem to make such waves in the media.

One of the most immediate consequences of this was that it made foreign holidays more expensive for British tourists, and it also increased materials import costs for manufacturers as well as those of finished products for the rest of us.

However, it immediately benefitted the UK's tourism sector, as a weaker pound made Britain a cheaper destination for overseas tourists. The travel analytics firm ForwardKeys said that flight bookings to the UK rose 7.1% in the immediate aftermath of the vote.

Caissa Touristic, a tour operator specialising in Chinese travel to Europe, saw a 20% increase in enquiries and bookings for the UK that summer compared with the same period the previous year.

Even before Sterling’s devaluation, in the month of the referendum, Britain's trade deficit widened to £5.1bn after imports hit a new high.

The population’s immediate response to the referendum result was to go shopping.

The UK's services sector saw a record rise in August. The sector, which includes everything from financial services through to cafes and shops, accounts for about 78% of the UK economy.

Confidence among UK consumers fell immediately after the referendum, and further the following month, but it then improved, though at the time of writing it still remains below pre-referendum levels.  And this confidence is reflected in our spending patterns: UK consumers made 168 million purchases on credit cards in July: this was higher than both June and the average of the previous six months.

This continued consumer spending is also reflected in UK retail sales figures. Sales have generally been rising for the past three years, and in July they were up 5.9% on the same month last year, helped by warmer weather.  This may have been a form of retail therapy, or it may be that with the weaker Pound people wanted to make their planned purchases quickly before the full impact of Sterling’s slide made itself felt on the high street.

The Royal Institute of Chartered Surveyors expected house prices to fall over the first three months following Brexit, then rise again over a 12-month period.  In the event prices did not initially fall as expected, but continued to rise, though expectations for the top end of the market are of substantial declines in value – as much as 10%.

It is a clearer story when it comes to commercial property. Demand for London office space bounced back from a pre-referendum dip, according to the commercial property firm CBRE.  The amount of space being taken by firms in the capital rose to almost a million square feet in July, up 24% on June.

What became of the economic forecasters who made such dramatically positive and negative pronouncements?

Let’s start with the Brexiteers.

Boris Johnson is the new Foreign Secretary, and probably the first ever to be photographed with a muppet.  This neatly illustrates how the role of Foreign Secretary has been devalued since the heady days of David Owen and Lord Carrington, as prime ministers like Tony Blair and David Cameron have taken much of it upon themselves.  This has been reflected in the appointment of a string of ineffectual lightweights like William Hague, Jack Straw and David Milliband to the job.  Boris would seem to follow in this tradition.

Andrea Leadsom, having failed in her bid to become Prime Minister following David Cameron’s resignation, now has the job as agriculture minister of explaining to farmers why they will be better off without the 78% of their profits which currently come from EU subsidies.

Nigel Farage went campaigning for Donald Trump in the US, where he made even less impact than Barack Obama campaigning for Remain when he came over here.  But at least most British voters knew who Barack Obama was.

And Michael Gove has been keeping a relatively low profile, tentatively returning to his former job as a Times journalist in September 2016.

What of the economic forecasters in the Remain camp?

George Osborne obviously won’t be bringing in that emergency budget he promised if the nation had the temerity to vote for Brexit.  And as things stand his parliamentary constituency will cease to exist in 2018.

Other coalition government and shadow economics ministers from the Remain campaign have taken up second careers in light entertainment: both Vince Cable and then Ed Balls competed on Strictly Come Dancing.  And if dancing offers them relief from the cut and thrust of politics, it also guarantees them more viewers than their more important day jobs ever did.

Meanwhile Christine Lagarde, head of the IMF, has got herself mixed up in a complicated and still unfolding scandal in French politics, involving alleged 'negligence' (in this case a euphemism for corruption) over a controversial €400m compensation payment from the (now conveniently defunct) bank Crédit Lyonnais to one Bernard Tapie, an ally of Nicolas Sarkozy.  At the risk of over-simplifying a complex case, Lagarde is basically accused of wrongly nodding this payment through when she was Sarkozy’s finance minister.  She will now have to stand trial for her part in these murky goings on, while Sarkozy is taking another tilt at the French presidency.

What is not an over-simplification is to say that the heads of the IMF have not covered themselves in glory over the past few years: Lagarde is the third successive MD of the IMF to face criminal charges.  Her immediate predecessor, Dominic Strauss-Kahn was charged with attempted rape in the US.  These charges were subsequently dropped and he made a private settlement with his accuser, but he was then put on trial in France on a separate charge of 'aggravated pimping'.   His wide-eyed claim in his defence that he had no idea that all the women at the orgies he was attending were prostitutes was somehow believed.  Strauss-Kahn had taken over as head of the IMF from Rodrigo Rato, a former Minister of Finance in Spain.  Rato was arrested in 2015 and charged with fraud, embezzlement and money laundering in a €12m credit card corruption scheme involving 'secret' corporate credit cards at the troubled bank (Bankia), of which he had been president.  His case went to trial in Spain in September 2016.

It is becoming increasingly difficult not to see parallels between the IMF and that other tax-exempt bastion of the benefits to all of internationalism, FIFA.

What else is in store for the economy?

When Mark Carney was grilled on September 7th by the Treasury Select Committee, he noted that UK GDP growth of 0.6% in the 3 months prior to the referendum result had halved in the period following it.  The British Chambers of Commerce recently cut their estimate of GDP growth for 2017 from 2.3% to 1% – which would be the country’s worst since the GFC of 2009.  In their words:

"Though individual businesses continue to report strong trading conditions, the overall picture suggests a sharp slowdown in UK growth lies ahead"  Adam Marshall, BCC

Similarly, the bank of England reduced their 2017 forecast to 0.8%.

Service and construction output are now beginning to show signs of sharp decline, but some of the figures are contradictory.  Meanwhile Sterling has continued to take a pounding in money markets, and this was exacerbated by a widely reported ‘flash crash’, supposedly triggered by mistake

While the current thinking is that the UK will avoid outright recession, the economy is expected – at least in some quarters – to continue to slow, which will also have a knock-on effect on tax revenues.  However, at the beginning of November the Bank revised its 2017 forecast back upwards to 1.4%, suggesting a belief that the Brexit impact will be less than originally feared.  Further changes of mind should not be ruled out.

Inflation is expected by some economists to rise as a result of all this QE (they have been forecasting this since its introduction in 2008, but this time they seem to really mean it), and by the falling value of the Pound.  This would finally be good news for savers, but less good for household incomes, pensioners on fixed annuities, and for retail sales generally.

The form and the terms of Brexit are still completely unknown, and the safest prediction is that as they become clear they will have a huge impact on the UK economy … either positive or negative.

But services now account for 78% of GDP, and the UK is the second biggest exporter of services in the world after the US.  Of this about 8% is from financial services, and London is currently the world’s capital city for financial services.  Brexit now makes the UK financial services sector much more vulnerable.  Some forecasters expect a decline of up to 10% in this sector – and several US banks were recently reported to be threatening to move their European HQs out of London.

So no balance it looks likely to be bad news for the economy in the short to medium term – but how bad is not yet clear…

What else could affect the UK economy?

Events elsewhere send ripples through the global economy, and hence the UK economy too.

Larry Summers, the US economist and former Secretary of the Treasury, has stated that the election of Donald Trump to the US presidency could trigger a global recession.  His actual words were:

"If he were elected, I would expect a protracted recession to begin within 18 months. The damage would in all likelihood be felt far beyond the United States"  Larry Summers, June 2016

And The Economist Intelligence Unit went on record with its agreement.  On the other hand, Trump might put the UK at the front of the queue on trade talks if he wins.

Meanwhile concerns are growing that the currently highly inflated corporate credit bubble in China will burst, and may do so soon.  There is particular concern about the banking sector, where much of the debt resides.  As the Bank for International Settlements put it in September 2016:

"The [Chinese] banking sector may become an amplifier of shocks rather than an absorber of shocks"

The Bank for International Settlements warned in its quarterly report that month that China’s credit to GDP gap is both the highest to date, and in a completely different league from any other major country tracked by the institution.  Perhaps more significantly, it is also substantially higher than that in the US just before the subprime bubble there burst as the Lehman crisis unfolded.  Adding fuel to these concerns, 2015 was China’s worst year for economic growth in 25 years, both in production and in demand.  If the credit bubble there bursts it could be like 2009 all over again – but with the QE card already having been played.  And it is not clear what other cards governments hold.  As the Annual report of the UN Conference on Trade and Development in September 2016 put it, with admirable understatement:

"Alarm bells have been ringing over the explosion of corporate debt levels in emerging economies, which now exceed $25 trillion.  Damaging deflationary spirals cannot be ruled out"

The papers have also recently been full of alarm about the health of Deutsche Bank, whose share value has halved since January, and the bank’s $14bn fine by the US Department of Justice in September won’t have helped.  There are similarly growing concerns about the health of the whole banking sector in Italy.  Meanwhile the UN is getting increasingly worried about spiralling corporate debt throughout the world’s emerging economies…

Any one, or combination, of these alarmist scenarios could have a significant negative impact on the UK economy.

Finally, if the Transatlantic Trade & Investment Partnership (TTIP) between the US and EU goes through, the UK will be left out of the world’s largest trade agreement, which will account for 45% of global GDP.  However, this looks increasingly unlikely, at least in the near future, as resistance in the EU is increasing among both populations and politicians.

As a footnote to TIPP, the equivalent trade deal with Canada, the Comprehensive Economic and Trade Agreement (CETA), has many of the same controversial elements and is much closer to ratification, so the UK may yet benefit or suffer from this agreement (depending on your point of view), and do so for the next 20 years, if it is ratified before we leave the EU.  While Canada does not sound like much of a big deal compared with the US, CETA will cover US subsidiaries in Canada, so it may in effect produce a form of ‘cut down’ TTIP through the back door.

In a nutshell

The UK economy remains in reasonable comparative shape, but the declining Pound is a mixed blessing, and the real impact of Brexit will only emerge when the terms become clear.  Meanwhile strong winds are gathering in the world economy, especially in the Far East, and perhaps too in the event of a Trump win in the US.

Interesting times indeed.