Brexit Bungle: boom or bust?

Is it Doom or Boom as the UK attempts to navigate Brexit?

Has Britain got its mojo back, or is it flip-flopping in slow motion towards a second great decline and fall? Has it finally shaken off the huge emotional baggage of the loss of its position as the world’s great 19th century superpower, when it was far richer and far more powerful in relative terms than the US is today? Could the country now be one of the most attractive destinations globally for commercialisation of new technologies and associated investment? Or are the warning bells ringing?

Hot on the heels of visits to China (The Day the War Began) and Australian/Canada (The Age of Rage: Trump’s War on Everyone) to get a first-hand sense of how people are thinking and acting, I spent the last ten days soaking up the economic, commercial and political atmosphere in the UK. There’s no doubt that Britain is at a crossroads. Currently the fifth largest economy in the world, the 2016 vote to leave the European Union has triggered intriguing opportunities and substantial downside risk.

England’s recent World Cup run has lifted the nation’s spirits, the neat blend of fresh talent, new-found skills, confident leadership and a little good fortune being a perfect analogy for the wider economy. Since the turn of the century, world-class new businesses have been built, particularly in high value sectors such as technology, life sciences, advanced manufacturing and creative industries, and there is a palpable sense that the country has got its mojo back, enriched by growing self-confidence and emotional warmth.

There is a palpable sense that the country has got its mojo back, enriched by growing self-confidence and emotional warmth 

Meanwhile, there are more cranes towering over London than ever before. Commercial and residential buildings are sprouting almost everywhere you look, the streets are busy, and there’s a real sense of commercial purpose and optimism. London is, however, no bellwether for the rest of the country. Though national unemployment has fallen to just 4.5% (the lowest level seen since 1975) and employment is at 74.9% (the highest level since records began in 1971), the outlook is much darker as you venture out from the capital. Reflecting this, as Londoners believed a vote in favour of leaving Europe was unthinkable two years ago, the large majority of people in regional and rural Britain thought precisely the opposite, and ultimately carried the day. 

With the benefit of hindsight, this should have come as no shock to anyone attuned to how the distribution of wealth and opportunity has changed over time. Though GDP per head and average incomes may have increased over the years, median wages have stagnated. House prices have raced skywards, inflation has driven the cost of living slowly but inexorably up, and many in society have been left behind. For example, since 2000, the median income of the bottom quintile in the UK grew by 29% from ￡10,834 to ￡13,992. In contrast, prices increased by nearly 45%. In other words, real wages are declining for those who already in the weakest financial position.

Adding to these problems, the country’s once-great physical infrastructure is creaking at the seams, and social infrastructure, including the National Health Service is under ever-growing pressure.

Given the strength in key parts of the economy, these challenges might not be so severe if the country had strong political leaders. Sadly, the response to Brexit on both sides of politics has been a woeful blend of extraordinary incompetence and willful ignorance. Those in charge have blundered from one failed compromise to another, with no obvious sense of purpose beyond clinging on to power. Meanwhile those in opposition – both the within the ruling Conservative party, as well as in the Labour Opposition – have delighted in tossing incendiary criticisms into the mix, without offering any solution themselves. 

Sadly, the response to Brexit on both sides of politics has been a woeful blend of extraordinary incompetence and willful ignorance

Two years ago, ex-Prime Minister David Cameron simply threw in the towel and quit when he lost the Brexit vote, in what should go down as the most abject failure of British leadership in a century. Since then, it has become abundantly clear that there is no-one in any position of influence who can even enunciate clearly what “Brexit” is, beyond what are at best ill-considered sound-bites that typically bear little relation to real issues. More damaging than opposition-leader Jeremy Corbyn, the ruling party’s internal agitators continue to toss political grenades into the party room, seemingly delighting in the havoc they are causing, and perhaps safe in the knowledge that they stashed a good part of their own net worth offshore. And the Chief Hypocrites, led by Nigel Farage, waffle away on the side-lines, simultaneously drawing European salaries and knowing their retirement is underwritten by generous European pensions. 

This last week, with Theresa May’s latest plans in tatters thanks to her Cabinet’s ongoing internal guerrilla war, both main parties voted to take an early and extended summer holiday. Over the weekend, politicians continued their wax-eared bigotry, one half-baked tweet at a time.

Over the weekend, politicians continued their wax-eared bigotry, one half-baked tweet at a time.

With an extraordinary amount of work required by government and businesses to be ready for Brexit, this is nothing short of a disaster. As ex-Prime Minister John Major reminded the few who might still be listening, the UK has some 50 trade deals to renegotiate, exactly one every five days from now until the 29th March 2019 deadline for implementation. This is in addition to attempting to negotiate a resolution with the EU on how a new regime might operate, something that is looking less and less likely by the week. As Major commented, “If we have no deal, the people who have the least will be hurt the most”.

But rage and rhetoric don’t make for effective corporate strategy, any more than schoolyard insults are helping in politics. 

But rage and rhetoric don’t make for effective corporate strategy, any more than schoolyard insults are helping in politics. So, what should Britain do? Where are the political and corporate opportunities? And are there still attractive opportunities for inward investment to the UK?

Politics

Firstly, to the politics. The UK desperately needs to establish a credible platform to negotiate with the EU. The Prime Minister of the day needs to drop attempts to negotiate internally, let alone with EU leadership, and focus on preparing for a “hard” Brexit. This implies a complete exit from the EU with no trade deal in place. This will, clearly, be extremely tough on a variety of domestic industries, as it will be for offshore European companies that are large importers into the UK, such as German car manufacturers. 

Leaders need to be clear with the British people what this will mean, and that there will be significant winners and losers. The cost of some imported European products will rise, including no doubt cars and white goods. Demand will increase for some domestically-produced goods where there is capacity to increase local production at short notice. Meanwhile, the cost of some agricultural produce may fall significantly, as Britain escapes the effects of European farm subsidies and pricing regimes, though this will negatively impact at least some British farmers.  Worse, any regions that are home to large factories that manufacture products primarily for export to the EU may suffer a significant decline in economic activity and investment. Examples include Nissan in Sunderland, as well as Tata’s Jaguar Land Rover business

Meanwhile, exporters from other parts of the world will rise to meet demand in other sectors. In opening Britain up to new trading partners, consumers must be on their guard to ensure that lower prices do not simply reflect lower quality, unsustainable environmental practices, or human rights abuses. 

In considering policy responses, remember that the UK sits at one end of China’s Belt and Road initiative (see A Tale of Two Centuries), and further enhancement of Britain’s trade relationships with that country might offset much of the pain caused by exiting Europe. Given America’s nascent trade war with both countries, the time for these negotiations could not be better.

The UK can look West and South too – both Australia and Canada are natural partners for trade and investment. Grouped together these three countries have a GDP that roughly matches Japan, and which has grown significantly over the last twenty years. Put another way, in 1980, Australia’s economy was roughly a quarter the size of the UK. By 2017, Australia’s economy had doubled in relative terms to be more than half the size of the UK.

Source: Pottinger analysis, IMF data

One obvious area for collaboration is education, where the game is collaboration rather than competition. Rather than reading headlines like today’s “Australia gains as Britain loses its appeal for foreign students”, the countries would focus on building the reputation of Anglo-Saxon education over and above the rapacious money-machine of US colleges. Taken together, these nations already lead in the further education of international students. Why not build on that, and indeed increase the volume of third country exchange students between these programmes, to create a truly cosmopolitan educational experience.

Ideally, another area of focus would be start-ups, especially the development of IP-rich companies in technology and life sciences. To date, virtually all the world’s most successful start-ups – ie those that have reached unicorn status, with valuations of US$1 billion and above – have been based in the USA and China. This creates significant long-term risks for smaller countries, including the UK, Canada and Australia. Creation of a third ‘home market’ for commercialisation would address this challenge. 

The above would require co-ordination between government and large businesses, investors and the start-up community, within the following simple framework:

• Governments and companies need to become aggressive early-adopters of new technologies, thus making the countries attractive environments for launching new companies;
• Investment needs to be incentivised, for example extending schemes such as the UK’s enterprise investment schemes so that they also provide strong incentives for the companies concerned to retain their head offices and the bulk of their employees in one or more of the three home markets over the long term;
• Start-ups need to shift their belief that winning requires significant success in either the USA or China – we know many companies are already open to this idea, if customers are willing and investment capital is accessible.

Policy action and transitional support will be needed to help drive these changes. Emphasising the exceptional urgency of these matters, the requisite tax and duty measures should already have been introduced in the last budget in May, the last before the Brexit deadline. This places extraordinary pressure on a presumed November interim budget, so work should start today.

Companies

As the old adage goes, “If you want something done in a hurry, ask a busy person.”. With Britain’s politicians packing their bags for their summer holidays, in practice this means that companies and investors need to take the above matters into their own hands as far as possible. 

First, this means preparing for a hard Brexit, both individually, and through relevant industry bodies. Many large financial institutions are already well-progressed in this regard, having shifted relevant areas of business offshore into EU locations. These initiatives should continue, to ensure your wider business remains as healthy as possible. This will create dislocation for some and job losses for others – a product of the nation’s vote for Brexit and political introspection and incompetence in Westminster. The corporate sector can and should be blunt in attributing blame to the politicians and indeed to voters, whilst working hard to ameliorate the impact on their own employees as best they can. 

Make no mistake: I am not advocating a “no deal” outcome, as this is likely to be the most painful option. It is simply that this is an outcome that is inevitable, assuming a better alternative cannot be negotiated. 

Second, major industries should reach out across borders to create avenues for greater co-operation, particularly between the UK, Australia and Canada, as well as potentially with India (I’ll return to this last in another post in due course). Where possible, this can be progressed in conjunction with government initiatives, such as the recently established Australia/UK Fintech Bridge. That being said, New York hustle is essential – no-one should sit back and wait for governments to take the first step. So, pursue individual, bilateral and multilateral initiatives in parallel, just as Pottinger launched its Runway 41 global expansion platform for start-ups earlier this year.

Third, consider making your own small investments in promising start-up companies, using time to leverage these investments. Great care and focus is required in doing this, and we certainly don’t advocate the semi-focused start-up menageries (aka “corporate accelerators”) that have become all the rage over the last few years. How best to approach this goes well beyond the scope of this note, so please do reach out to our team in Sydney, London or New York for a more nuanced perspective. 

Investment

There’s no doubt that the economic outlook and political landscape in the UK is highly uncertain. So it may be tempting to adopt a ‘wait and see’ approach to investment. We caution against this mindset. With such rapid and significant changes under way, there is much to be said for being on the ground and actively involved as the story unfolds, so that you build a first-hand understanding of the dynamics of an admittedly complex situation. 

As we’ve flagged above, seek out small, carefully targeted investments with potential to grow into highly profitable businesses over the long term. Leverage these with the compounding effects of time, rather than weighing them down with debt. Where possible, spread your risk, while still making sure that every investment aligns with clearly-defined long term objectives. In parallel, be ready for much larger, opportunistic acquisitions, if strategically attractive targets stumble due to their own failure to plot a sensible path.

Meanwhile, investment in long term infrastructure continues to offer an attractive combination of low risk and stable long-term returns. Ideally these investments should be structured to offer inflation-protected dividend streams, whilst ensuring that the proposition to underlying customers and other stakeholders who pay for the infrastructure are sustainable over all time horizons. 

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Where to from here? More than anything, roll up your sleeves, get to work, and find opportunities on which you and your organisation can act. Speak out publicly in support of important policy initiatives and beware of favouring short-term expedience and financial gain over longer term sustainability. The risks of radically disruptive political leaders gaining power are growing month by month, and the subsequent revolutionary changes may take many decades to reverse. 

Meanwhile, keep a very close eye on the USA. As America’s 150-year global ascendancy runs out its final decade, huge changes are afoot both socially and politically. Once globally respected as an icon of peace, prosperity and democracy, domestic politics has descended into schoolyard name-calling, open corruption, and increasingly flagrant breaches of the rule of law. Wealth inequality continues to grow, and nearly half the population has zero net worth, and thus nothing to lose in a modern-day peasants’ revolt. Bipartisan values, including freedom of speech, equal rights and Christian morality, appear to be smouldering on a nationwide bonfire of the vanities, and the nation appears more divided than at any time since the 19th century. These are dark days for America: though a dissolution of US democracy was unthinkable two years ago, such an outcome is no longer entirely fanciful. Ignore this risk at your peril.

Your other eye should be trained on China. Though frequently ill-understood in the West, its policy agenda appears to offer many positive implications, particularly the poorest third of the world’s population. Its ambition to lift a second billion people out of poverty – this time outside China, and without the environmental problems it is currently navigating at home – would support significant global economic growth over the long term. And its long-termism and systems-thinking approach offers important lessons for Western countries and companies looking for a better way balance demands for near term profit with the importance of building widespread, long term economic and social prosperity. 

To twist the words of L P Hartley: “The future is a different country; they do things differently there”.

Just as a relentless focus on short-term results drove the decision-making and (short-term) success of many companies in the twentieth century, we see relentless long-termism as the only way to make effective decisions in the face of accelerating change. This is an unfamiliar approach for many, not least as it can be hard to argue the case for strategies that will take time to deliver results when commentators are calling for something that will start to work by Christmas. We founded Pottinger in 2003 precisely to help leaders address these challenges. Over the years, we have developed a complete philosophical and analytical toolkit to smooth the path to long term success which has proved phenomenally effective. If you’d value a fresh perspective on where the most attractive opportunities lie, and how best to unlock them, please let us know.

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Nigel Lake is co-founder and Executive Chair of Pottinger