Can Brexit be the catalyst for UK economic reform?

An uncertain outlook….

The EY ITEM Club Summer forecast sets out how challenging and uncertain the economic outlook is with a significant downgrade in expected GDP growth compared to April’s forecast. Given the likely shock to the economy from the decision by the people of the UK to leave the European Union, this change in outlook is unsurprising.

However, all the current forecasts are highly uncertain - we arguably know no more, and possibly less, than we did before the referendum. The result is clear but the UK political landscape is being rebuilt after an earthquake and discussions with the other members of the European Union have not yet started.

…unlikely to change soon…

Businesses should organise their planning and analysis in this uncertain environment around 3 time periods:

• The short-term, probably until after the Autumn Statement, when we will have more clarity on UK Government policy and sufficient post-referendum economic and corporate data to enable us to develop a clearer view on the likely future path of the economy;
• The negotiation period: two years seems a sensible working assumption for the process. The hope is that the options will be narrowed down as time progresses and hence uncertainty will be reduced; and
• The longer-term: post exit when the UK will be pursuing its individual economic course. It is of course possible that a new trade deal may take longer than 2 years but the longer-term should nevertheless be significantly clearer in 2 years than it is today.

…so take the time to prepare.

In the short-term, businesses should avoid knee-jerk reactions. Absent good data, decisions made in this period are as likely to be good as they are bad. The focus should be on shoring up the business and initiating the research and analysis to enable strategic and operational decisions as we learn more.

There are obvious challenges moving forward: the EY ITEM Club expects both business investment and consumer spending to slow for the rest of 2016 and companies will need to adjust to this.

However, there will also be opportunities, especially for exporters, as the pound is likely to remain low for some time. Moreover, as the UK develops its new trade strategy, new markets may open up and existing markets could become more attractive under improved trading arrangements.

Monitoring developments will be critical…

The move from the current arrangements to the long-term post-EU position will be driven by four factors:

• Agreement on arrangements for post-Brexit, UK-EU and UK-rest of the world trade which will impact both exports and imports, the latter critical for many supply chains;
• Approach to movement of labour between UK and EU and UK and the rest of the world with clear implications for the recruitment and retention of skilled and unskilled workers and also potentially for investment in labour saving technology
• UK regulation in areas where EU rules no longer apply, offering the scope to “free up” British businesses; and
• UK Government policy across a range of areas, using the potential freedom from EU “State Aid” rules to forge a new role for the public sector in UK economic activity.

Each of these four areas has clear implications for business but their impacts could vary significantly depending on negotiations. Some effects are likely to be felt sooner than others. Beyond the exchange rate effect already mentioned, shifts in trade are likely to take some time to become clear. But just the potential for changes in the current arrangements for the free movement of labour might start to impact current workforces and upcoming recruitment activity very quickly.

Close attention to the developments in each of these areas in the UK’s exit negotiations will be critical in shaping strategy over the next two years and for the longer-term. Signs of clarity are emerging, the new prime Minister has made clear the approach to the free movement of labour needs to change, and more details in other areas will hopefully emerge in the not too distant future.

…and especially not ignoring opportunity.

Some of the likely opportunities arising from the UK leaving the EU are relatively easy to identify: a reduced regulatory burden and greater trade freedom most obviously. But there are others.

With the likely slowdown in both consumer spending and business investment identified by the EY ITEM Club, the public sector may need to take up some of the slack. The referendum campaign identified concerns over immigration, inequality and geographic differences in economic opportunity amongst others, policy is also likely to evolve to address these concerns.

I expect that there will be a greater focus on infrastructure, education and skills going forward and that this will create business opportunities. It also seems likely that these initiatives will have to be delivered locally meaning an acceleration of the devolution of powers and responsibility to bodies such as the Northern Powerhouse and Midlands Engine.

The outlook is challenging and things may well be rocky in the short-term but the die has been cast and now is the time to begin to shape the future.

@MarkGregoryEY

markgregoryeconomics.ey.com

EY ITEM Club is part of our Economics for Business programme which provides knowledge, analysis and insight to help businesses understand the economic environments in which they operate.