UK economy likely to defy gloomy forecasts in 2018, again
Many forecasters fall at the first hurdle because they do not even understand the present. The conventional wisdom is that the UK economy has slowed sharply in the wake of the EU referendum in June 2016. In fact, the latest data show that quarterly growth in GDP was exactly the same (just over 0.4%) in the five quarters since the referendum as it was in the five quarters before.
Annual growth probably did slow in 2017, to around 1.7%, from 1.9% in 2016. But to put this in context, the new forecasts in the Treasury’s poll of independent analysts for July 2016 predicted a collapse to just 0.5% in 2017, from 1.5% in 2016. Even in January 2017 the average of new forecasts was only 1.4%. In other words, the UK economy has continued to grow more quickly than most had expected, despite the Treasury’s own warnings of a severe recession.
To be clear, it is reasonable to argue that the UK economy has grown more slowly than it would otherwise have done. The fall in the pound after the Brexit vote has added to inflation pressures and contributed to the squeeze on real household incomes. Business surveys show that uncertainty over the UK’s future relationship with the EU has held back investment. Net migration from the EU has also slowed.
Nonetheless, claims that Brexit has already reduced UK GDP by up to 1% are surely over the top. The Financial Times published a piece at the end of last year estimating the cost at around £350 million per week. (This happens, of course, to be the opposite of the infamous claim on the side of the Leave bus.) The difficulty is that we cannot be sure what would have happened if the UK had voted to Remain. This, as the Financial Times acknowledged, is the problem of the ‘counterfactual’.
For example, several studies have attempted to quantify the impact of the fall in the pound on inflation, and hence on real incomes. But they have assumed that, had it not been for the Brexit vote, sterling would not have depreciated at all. On this basis, research published by the LSE has estimated that the average household was more than £400 worse off by July 2017, while later work by the National Institute of Economic Research (NIESR) has put the cost to households at more than £600 per annum.
However, while the sharp fall in the pound in the days after the referendum result was clearly due to concerns about Brexit, the currency had already been weakening for a year. It might reasonably have been expected to fall further at some point, regardless of the outcome of the referendum, given fundamentals such as the large deficit on the UK current account (which had exceeded 7% of GDP at the end of 2015). Focusing solely on the inflationary impact of a weaker pound also ignores any potential benefits from a more competitive currency.
Similarly, studies which assume that UK GDP would have accelerated in line with its peers ignores the fact that the UK had already experienced several relatively strong years and household finances were already looking stretched. Much as we might like to think that the UK’s natural place is near the top of the league tables for growth, the economy was probably overdue a period of underperformance.
These caveats do not necessarily refute the argument that the initial economic impact of the vote to leave the EU has been negative. But for what it is worth, I would suggest that the hit to GDP has been at the low end of the range of estimates published so far – perhaps 0.5%.
Whatever the precise number, the more important question now is what happens next. Many sensible Brexiteers recognised the likelihood of a temporary slowdown in the wake of a surprise vote to Leave. However, the tone of almost all the subsequent analysis has been that any damage to date is just ‘the beginning’ and that the net costs will only grow. For example, more than half of economists surveyed in a new year poll for the Financial Times forecast that GDP growth would be no more than 1.5% in 2018. This is broadly in line with the Treasury’s poll in December 2017.
In contrast, I expect growth to pick up to at least 2% this year, with a similar outturn in 2019. The squeeze on real incomes should end as inflation falls back and the tightening labour market finally feeds through to higher pay settlements. This in turn should support consumer spending. Productivity also appears to be picking up again, just as the independent OBR has chucked in the towel and revised its forecasts sharply lower.
What’s more, any easing of uncertainty about Brexit should allow investment to accelerate once more. Pessimists assume that the drag on business spending will only worsen as contingency plans are put into effect, but the survey evidence suggests otherwise. Plans to relocate City jobs are a useful bellwether and are already being scaled back. Indeed, there may well be plenty of pent-up investment in UK projects that had been put on hold in the wake of the referendum.
Finally, net trade should make a bigger contribution. Some Brexiteers have made too much of the current strength of manufacturing in the UK, which so far has owed more to the buoyancy of the global economy. (The manufacturing PMIs for the eurozone, for example, have been even stronger.) However, the benefits from a more competitive pound should build over time.
Of course, a good 2018 or 2019 would not prove anything about the long-term implications of Brexit itself – especially if a lengthy transition period replicates the existing economic arrangements. But at least the doomsayers are likely to be proved wrong for a while longer.