Brexit has disrupted the UK economy on top of the Covid-19 pandemic ?

Introduction

It has been two years since the world has been facing unprecedented and multiverse COVID-19 pandemic related challenges. With the world trying to learn how to live with the Covid-19 virus, the global economy is opening up again and slowly moving towards the pre-pandemic levels.

In our previous research, we have explored the impact of Covid-19 on global disruption of supply chains, raw materials price increase and container shipping crisis. We concluded that current market conditions are driving up the cost of many raw materials. The sharp and uneven rebound in global manufacturing activity during the 2021 year caused a substantial rise in international orders and some supply bottlenecks.

However, there were some reassurances from the global analyst community that while the aftershocks of the 2020 year will likely linger throughout 2021, and possibly the years to come, the situation of a global surge in shipping costs was likely to be temporary, given its unsustainable nature1.

Most recently, the impact of Covid 19 is associated with labour shortages, energy price hiking and rising inflation. The above negative economic consequences are valid for every country in the world, but globally they are felt uneven.

Covid-19 was a massive shock to the global economy, but it hit harder in some countries, including the UK. In this research, we will explore some of the new realities in the UK economy and how they might impact the way of doing business in/with the UK.

Labour shortages

According to the latest ONS report, as the UK economy reopened after the removal of Covid-19 restrictions, the number of job vacancies from August to October 2021 continued to rise to a new record of 1,172,000, an increase of 388,000 from the pre-coronavirus (COVID-19) pandemic January to March 2020 level, with 15 of the 18 industry sectors showing record highs. That is equivalent to 3.7 vacancies for every 100 employee jobs — which is also a record2.

As the graph below prepared by the UK in a Changing Europe shows, fewer people are working in manufacturing, accommodation and food services.

Rising vacancies reflect falls in the number of older workers in the labour market and a significant reduction in the number of EU-origin workers. The number of EU-origin workers on company payrolls (which omits the self-employed) fell by about 200,000 in 2020. While the pandemic primarily drove the exodus of EU workers in 2020, their failure to return (or to be replaced by new migrants) is likely to be driven by Brexit.

HGV drivers’ shortage

The shortage of HGV drivers is due to Covid, Brexit and other factors. As travel became increasingly restricted last year and large parts of the economy shut down, many European drivers went home. Moreover, haulage companies say very few have returned. The pandemic also created a significant backlog in HGV driver tests, so getting enough new drivers up and running has been impossible.

A Road Haulage Association (RHA) survey of its members estimates there is now a shortage of more than 100,000 qualified drivers in the UK. That number includes thousands of drivers from European Union (EU) member states who previously lived and worked in the UK.

The Annual Population Survey produced by the Office for National Statistics (ONS) estimates that 16,000 fewer EU nationals were working as HGV drivers in the year ending March 2021 than in the previous year. Even before Covid, the overall estimated shortage was about 60,000 drivers4.

The government introduced several steps to address the shortage of HGV drivers amid concerns about deliveries of food, fuel, and other items in the run-up to Christmas. The UK government introduced temporary visas for 5,000 lorry drivers to work in the UK. However, only just over 20 of the 300 applications have been approved so far, according to Conservative Party chairman Oliver Dowden5.

There are HGV driver shortages across Europe, but Brexit has made things worse in the UK. Many European drivers who went back to their home countries or decided to work elsewhere cannot return. When the UK was part of the EU single market, they used to be able to come and go as they pleased. However, things have changed dramatically now with new immigration rules that mean HGV drivers cannot come to work in the UK as before Brexit.

There is also new bureaucracy, and the decline in the pound's value against the euro since the Brexit vote has made working in the UK less attractive for EU nationals. According to the Hauliers’ poll, the top reasons for driver shortage are drivers retiring, Brexit and reforming the tax system in the UK.

While the supply chain disruption is a global phenomenon attributed primarily to the impact of Covid-19 and bottleneck problems, the lack of HGV drivers is something that the UK authorities should blame themselves. Brexit has diminished the attraction of HGV work in the UK because of the heavily regulated immigration policy and new border controls and red tape involved. Border checks have introduced further administrative burdens on supply chains and may exacerbate issues related to the HGV driver shortage. On top of that, the Covid-19 pandemic has delayed HGV training schedules and HGV certification.

Fuel supply crisis

In September/October, petrol stations in some parts of the UK ran out of fuel for a few weeks. Although the UK did not have a shortage of fuel, some argued that this had happened mainly due to panic buying of fuel caused by media reports of a leaked government briefing discussing the shortage of HGV drivers. Some analysts and politicians linked the driver shortage to Brexit, whilst others blamed the COVID-19 pandemic or their combined impact.

On October 24, petrol prices hit 142.94p per litre, beating the record set in 2012. The price of unleaded has rocketed from 114.5p a year ago, adding ￡15 to the cost of filling up a 55-litre family car6.

In September/October, the average fuel levels at forecourts remained at 20% for the fourth day running, compared with a usual 43%.

Due to the central government interventions, including relaxing the law on competition and mobilising the army forces as a substitute for HGV drivers, the fuel supply crisis was short-lived, regardless of the prediction from the industry sources that have voiced the concern there could be a disruption for up to a month.

According to the Economist, the UK was not the only country with a shortage of lorry drivers, but it is unique in failing to supply its forecourts10.

Worth mentioning here, there was no EU or global fuel shortage, while this happened only in Great Britain in the UK. In Northern Ireland, also affected by the driver’s shortage, due to their access to the EU single market and close cooperation with the Republic of Ireland, it was possible to get fuel redistributed from the Republic of Ireland and avoid the fuel crisis.11

Prices of petrol and diesel reached new (cash) record levels on November 15 2021, of 145.9 and 149.8 pence per litre, respectively. They had fallen rapidly after the coronavirus outbreak, mainly due to sharp drops in oil prices. Since the first lockdown, prices increased and passed their pre-pandemic levels in June 2021. In early October 2021, the UK had the 10th highest petrol and second-highest diesel prices in the EU+UK12.

The current trend shows a steady price increase as the graph below illustrates13:

The fuel crisis came after the UK economy showed 4,8% growth during April/June 202114. It predicted some rough few months ahead, characterised by the global disruption of supply chains, a persistent lack of HGV drivers and hiking of prices.

Consumers across the UK were shocked by pictures of empty supermarket shelves and the essential products’ price hiking. According to a survey conducted by the ONS on October 15, 17% of respondents reported they could not buy an essential food item, while only 57% stated everything they needed was available.

The surge of energy prices

As the economy bounces back to some semblance of normality as we live with Covid-19, the energy market isn't keeping up with the sharp rise in energy demand.

Energy prices have risen strongly across Europe, but the UK has come under more intense pressure due to its high dependence on gas and renewables to generate electricity. The UK's accelerated coal phase-out and reduced nuclear availability, and low wind generation have exposed the market to rising gas prices. Since the closure of the Rough gas storage facility, the UK has no large-scale storage sites and only a limited number of smaller storage facilities, leaving the UK potentially exposed to increased supply security risk than its European neighbours.

The UK's domestic gas production has been a significantly lower year on year due to a heavy schedule of planned maintenance and delays to new projects. According to S&P Global Platts Analytics data, UK gas production in the year to September 10 was 20.2 Bcm -- down by 5.7 Bcm

from the 25.9 Bcm produced in the same period of 2020. New fields such as Tolmount have been delayed.

In mid-September 2021, UK electricity prices were the most expensive in Europe. Market prices for gas have quadrupled in a year, and electricity prices are up by a similar amount.

The expectations are that prices could continue to increase through the autumn at least17.

The hiking of energy prices has made businesses rethink their operational models. For example, the Rail Freight Group, the trade association representing operators in the UK's rail freight sector, said that some of its members are switching to diesel locomotives, leaving their electric freight trains because of the soaring energy costs18.

Several factors are driving the energy price up. At a macro level, the pandemic led to a global slowdown in demand and a surge as economies opened up again. In addition, Europe and Asia usually at this time of year experience frigid winters associated with a very high energy demand to keep the homes warm.

At the domestic level, the most crucial factor is the UK has limited reserve gas storage, making it vulnerable to shortages if continued high demand leads to reduced availability. Apart from issues in the gas sector, a fire at an electricity interconnector between Britain and France disrupted the import of 2GW energy from the European continent to the UK. This disruption is expected to last for about two years19.

The supply of LNG has proved highly variable. However, in recent years the dominance of Qatari supply (over 98% in 2011) has been diluted by the development of LNG capacity in the US and Russia. In 2020, 48% of UK LNG imports came from Qatar, 27% from the US and 12% from Russia. The UK has three LNG terminals at the Isle of Grain in Kent and two at Milford Haven in Wales. This LNG supply chain connects the UK to global gas markets, while imports from Norway and via the interconnectors link us to the NW European gas market20.

Wholesale gas prices have risen sharply, meaning that some companies could not afford to supply gas to their consumers. Energy customers in the UK can choose between a 'fixed' and 'variable' tariff. The fixed tariff sets a defined price on energy consumption for a set period (e.g. 12 or 24 months). In contrast, the cost of energy on a variable tariff fluctuates according to market prices.

The recent surge in gas prices has meant that energy companies are supplying energy to their customers on fixed or capped tariffs at a price that, in many cases, is significantly below the market rate. In some cases, this has pushed them to collapse.

The government also limits what energy companies can charge their customers on most of the available variable tariffs through the energy price cap – which increased to ￡1,277 for typical usage at the start of October 21.

Fixed tariffs usually are cheaper than variable ones. However, the current crisis has meant that companies' fixed tariffs are significantly more expensive than what is permissible under the energy price cap.

In two weeks in September, suppliers to 1.5 million energy customers collapsed, and more companies have collapsed since22.

Some have argued that the UK is experiencing such high gas prices right now because of Brexit, and the UK is leaving the Internal Energy Market. As even the EU states are experiencing similar energy price increases23, there is no evidence that this is a significant factor in higher wholesale gas prices in the UK.24

However, even if the present energy crisis is not a Brexit issue, the place of Great Britain outside the single energy market might still cause problems in the future (Northern Ireland remains connected to the Internal Energy Market as it is part of a separate Single Electricity Market with the Republic of Ireland).

Due to Brexit, Britain is no longer covered by the SDAC and its 'implicit allocation' scheme, which redistributes energy supply to the parts of the Internal Energy Market where the need is greatest.

Instead, traders must now buy interconnector capacity and power each day in two separate transactions via something called 'explicit auctions' – before daily prices are set – and businesses must re-register with the EU, making the whole process less attractive due to increased bureaucracy25.

The result is that the flow of electricity through interconnectors is much less efficient than when governed by the SDAC, meaning a loss of cost efficiencies26.

An external factor contributing to the gas price surge in the UK and European markets is the heavy dependence on Russian gas exports, which remain well below their pre-pandemic level.

The UK imports little Russian gas, but that is less reassuring than it sounds. It is part of Europe's integrated nexus, and cross-Channel prices move in near lockstep.

The UK sits 'both physically and politically' at the end of the pipeline from Russia: 'Europe will take what they need, and we are right at the end of it.' This makes the UK especially susceptible to fluctuating market prices. However, the more likely consequence of this is volatile prices rather than energy blackouts27.

Clive Moffatt, an expert on energy security, said it is already too late. "There is no short-term fix to this, and the grid will have to shut down industrial gas users. That is the only way to keep hospitals open and homes heated," he said. However, if I had to choose, I would rather be in Boris's Britain this winter than Ursula's Europe28.

UK inflation

The Bank of England predicted rising prices would eat into consumer demand at the beginning of November. It is forecast that inflation will hit almost 5% in April next year, mainly due to post-lockdown supply chain bottlenecks and surging energy prices.

Economists said the higher inflation rate and robust employment figures published in November would give the green light for a rise in interest rates in December from the current level of 0.1%, most likely to 0.25%29.

A separate survey of broader household spending by card payments firm Barclaycard showed consumers increased their spending by 14.2% compared with October 2019.30

According to the Office for National Statistics, a sharp increase in gas and electricity prices pushed inflation as measured by the consumer prices index to 4.2% in October, up from 3.1% in September, according to the Office for National Statistics – the highest rate since November 201131. The news pushed sterling to its highest rate against the euro since February 202032.

Ofgem lifted its consumer price cap after wholesale gas prices soared to record levels as economies worldwide emerged from lockdown and supplies of Russian gas to Europe failed to meet demand.

Higher prices also drove the jump in the annual inflation rate in restaurants and hotels after partial removal of a VAT cut for the hospitality sector and soaring prices for second-hand cars.

Much of the increase reflected depressed price levels a year ago as the coronavirus pandemic dragged down economic activity worldwide, including the worst recession in Britain for 300 years.

As measured by the Office for National Statistics' Consumer Price Index, the cost of living rose at its quickest rate since November 2011 last month. In October alone, it surged by 1.1 per cent, mainly due to higher energy costs for households.

The ONS said soaring inflation was caused by rising energy bills, fuel and higher bills in restaurants and hotels, and the costs of raw materials and goods in factories.

Rising domestic energy bills are influential in the forecast for the inflation rate (measuring the rising cost of living), rising in the coming months before being expected to drop as the situation eases.

Scott Byrom, chief executive of price comparison website TheEnergyShop, says: "The bubble has not burst yet.33"

The threat of triggering Article 16

It is common for trade agreements to contain provisions enabling either party to take unilateral action if the agreement's implementation gives rise to negative consequences. In the Protocol on Ireland/Northern Ireland, these measures are set out under Article 1634.

Many Northern Irish businesses have benefited from this post-Brexit landscape. Under the Protocol with the E.U., the region benefits from being both part of the U.K. and E.U. single markets for goods. Many companies saw orders jump as customers in the Republic of Ireland sought to avoid the complications of receiving goods from other parts of the British Isles. Ripping up the Protocol would erase that advantage.

Article 16 provides both the U.K. and the E.U. with a unilateral power to act should the application of the Protocol give rise to 'serious economic, societal or environmental difficulties that are liable to persist, or to diversion of trade.'

It does not provide any detail on what constitutes a 'serious' impact or what is meant by 'diversion of trade', but the intent behind the agreement is that neither side will seek to act unilaterally to alter the Protocol and that resolutions will be found through cooperation in the first instance.

Until mid-November 2021, the expectation in Westminster and Brussels was that by the end of this month, Boris Johnson would reach for the nuclear option in relations with the E.U., and suspend parts of the Northern Ireland Protocol by triggering Article 16.

While it would take the E.U. months to introduce tariffs on British imports, ministers have been warned that more stringent border checks could be unleashed "in a matter of hours" by member states if Johnson went ahead with suspending parts of the treaty agreed as part of Brexit talks.

An industry figure with knowledge of negotiations said officials were "shit scared" of the potential impact this would have on the flow of goods into the U.K. in the run-up to Christmas, with supply chain disruption caused by labour shortages already resulting in empty shelves36.

According to Bloomberg, economists warn that suspending parts of the Brexit deal could induce faster monetary tightening from the U.K. central bank, and London's new stocks are not as hot as continental rivals.

Triggering Article 16 would hit British exporters and stall businesses' investment plans as the uncertainty plagues the country after the 2016 referendum returns, adding another headwind to the already struggling economic recovery. Sterling may fall. With inflation already on track to hit 5%, a devaluation of the currency would force up the cost of goods. That would leave the Bank of England with far less latitude to provide financial support and, in some scenarios, force it into the role of defending the currency.

Still, it would be "legitimate" for the U.K. to activate Article 16, if the bloc does not agree to rewrite the Protocol, according to Prime Minister Boris Johnson. The U.K. Brexit Minister David Frost tried to lower the tone and warned the E.U. not to start a trade war37.

France's Europe Minister, Clément Beaune, has threatened to cut off exports of French electricity to Britain and the Channel Islands in response to U.K. threats to jettison the Northern Ireland Protocol and refusal to grant the majority of applications for fishing licenses from smaller French vessels.

Imports via interconnectors account for about 10% of U.K. electricity supply, of which almost half is from Franceand, as mentioned above, there are also plans for a further interconnector with France – so that imports from Europe may provide a quarter of U.K. electricity supply by 2024. France provides 95% of Jersey's electricity supply. a document released by the Department for Business, Energy and Industrial Strategy (BEIS) in July this year said that, as of 2020, just under half of the U.K.'s electricity imports (47%) were from France.38

The UK-EU Trade and Cooperation Agreement says if either side fails to comply with the fisheries element of the agreement, the other party may in some cases respond by wholly or partially suspending its obligations in other parts of the agreement, including the section on energy.

This means the E.U. could cut off the energy supply from France to the U.K. in response to perceived failures of responsibility for fish, but it would require collective E.U. approval and could not be a result of unilateral action by France.

Conclusion

Like the rest of the world economy, the UK economy has been hit by an unprecedented and massive economic shock caused by many factors, such as the Covid-19 pandemic, lockdowns, and other health-related restrictions. As the world is trying to learn to live with the Covid-19, it is set to reopen almost all the affected economic sectors by the pandemic.

On the other hand, Brexit has radically changed the UK's economic landscape with its largest trading partner, the EU. The UK government, arguing that Brexit is driving a necessary albeit painful transformation of the British economy, is pushing hard to make viable the Withdrawal Agreement, which represents only the tools of a minimal free trade deal. It is desperately looking to find workable solutions to mitigate the post-pandemic disruptions in its economy in many areas and exacerbated by Brexit.

Supply chain disruptions, labour shortages, and sharp rises in energy prices are also present in the EU and many other countries globally, so Brexit alone cannot be blamed. The HGV shortage is more acute in the UK than elsewhere, while its impacts — fuel shortages, problems with supermarket deliveries — seem unique and have been aggravated by Brexit. Brexit has diminished the attraction of HGV work in the UK because of the heavily regulated immigration policy, new border controls, and red tape. Border checks have introduced further administrative burdens on supply chains and may exacerbate issues related to the HGV driver shortage. On top of that, the Covid-19 pandemic has delayed HGV training schedules and HGV certification.

As the economy bounces back, the energy market is not keeping up with the sharp rise in energy demand.

Some have argued that the UK is experiencing such high gas prices right now because of Brexit, and the UK is leaving the Internal Energy Market. As even the EU states are experiencing similar energy price increases, there is no evidence that this is a significant factor in higher wholesale gas prices in the UK.

However, even if the present energy crisis is not a Brexit issue, the place of Great Britain outside the single energy market might still cause problems in the future. As it's no longer covered by the SDAC and its 'implicit allocation' scheme, which redistributes energy supply to prices, have risen strongly across Europe. However, the UK has come under more intense pressure due to its high dependence on gas and renewables to generate electricity. The UK's accelerated coal phase-out and reduced nuclear availability, and low wind generation have exposed the market to rising gas prices. Since the closure of the rough gas storage facility, the UK has no large-scale storage sites and only a limited number of smaller storage facilities, leaving the UK potentially exposed to increased supply security risk than its European neighbours.

Some have argued that the UK is experiencing such high gas prices right now because of Brexit, and the UK is leaving the Internal Energy Market. As even the EU states are experiencing similar energy price increases, there is no evidence that this is a significant factor in higher wholesale gas prices in the UK.

However, even if the present energy crisis is not a Brexit issue, the place of Great Britain outside the single energy market might still cause problems in the future. As it's no longer covered by the SDAC and its 'implicit allocation' scheme, which redistributes energy supply to the parts of the Internal Energy Market where the need is greatest. An external factor contributing to the gas price surge in the UK and European markets is the heavy dependence on Russian gas exports, which remain well below their pre-pandemic level.

The Bank of England is expected in December to increase its interest norm from 0.1% to 2.25%, in response to unprecedented rising prices. It forecast that inflation would hit almost 5% in April next year, primarily due to post-lockdown supply chain bottlenecks and surging energy prices. Higher prices also drove the jump in the annual inflation rate in the UK in restaurants and hotels after partial removal of a VAT cut for the hospitality sector and soaring prices for second-hand cars.

Triggering Article 16 would hit British exporters and stall businesses' investment plans as the uncertainty plagues the country after the 2016 referendum returns, adding another headwind to the already struggling economic recovery. Sterling may fall. With inflation already on track to hit 5%, a devaluation of the currency would force up the cost of goods. That would leave the Bank of England with far less latitude to provide financial support and, in some scenarios, force it into the role of defending the currency.

The UK officials fear the potential impact triggering article 16 would have on the flow of goods into the UK in the run-up to Christmas, with supply chain disruption caused by labour shortages already resulting in empty shelves.

While officials of both sides of the channel are negotiating to avoid a "trade war", France's Europe Minister Clément Beaune has threatened to cut off exports of French electricity to Britain and the Channel Islands, in response to UK threats to trigger article 16 of the Northern Ireland Protocol and refusal to grant the majority of applications for fishing licenses from smaller French vessels.

While Covid-19 pandemic related disruptions to the UK economy will fade in short term, Brexit, which so far has not provided any clear evidence of boosted exports to non-EU countries, can exacerbate trade volumes over the medium to long term and the UK economy has to wait a little longer to become a "high-productivity" economy.

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Graphic illustrations

Figure 1. Change in number of payrolled UK Employees- October 2021. Source ONS & UK in a Changing Europe

Figure 2. Time taken to fill last HGV driver vacancy. Source Road haulage Association & BBC Figure 3. Reasons for the driver shortage. Source Road haulage Association & BBC

Figure 4. United Kingdom Gasoline prices (per litre in GBP) - Source: Global Petrol Prices Figure 5. Gas price in the UK, Source Bloomberg & BBC

Figure 6. Gas storage capacities among selected European countries. Source UK in a changing Europe.

Figure 7. The number of UK households affected by the collapse of energy firms. Source Ofgem & BBC

Figure 8. Europe is dependent on Russian gas. Source: Telegraph

Figure 9. CPI index in the UK. Source: BoE & ONS & BBC

Figure 10. Northern Ireland Protocol explained. Source: Bloomberg