Soft Brexit but a hard landing could create an economy that works for no-one.

A huge focus on Brexit…

I recently wrote that businesses must devote as much attention to responding to the immediate changes in the UK economy, clearly described in the EY ITEM Club Winter 2017 Forecast, as they devote to preparing for Brexit. The same is true for the UK Government. If all the of the Government’s focus is on Brexit, the risk is that other challenges will be left unaddressed and a successful Brexit might be followed by a hard landing and disappointment.

..which might succeed…

The mood music from the EU Summit in Malta suggested that as the start of negotiations around the UK’s exit from the EU edges nearer, a desire to minimise disruption might be starting to influence thinking in Europe. There are reasons to believe that a smooth Brexit is possible:

• As we learn more about the structure of goods trade between the UK and Europe, it does appear the interconnected nature of supply chains could encourage policy-makers to seek to preserve most of the current arrangements;
• The important role played by the UK financial services sector in providing liquidity to European corporates, highlighted by Mark Carney recently, might support a deal in this sector less punitive than some commentators have predicted; and
• The UK’s role and contribution to NATO provides another reason for believing a favourable deal may be possible.

…but at some cost…

Brexit might therefore be less painful than some of the pessimistic scenarios being painted today. Nevertheless, the run up to March 2019 is likely to see some slowing in the growth of the UK economy, as imported inflation and uncertainty weigh on business and consumer spending.

The expected exit could also create some further friction and discontinuity. It seems reasonable to expect migration will be lower and hence potential gaps in the supply of skilled and unskilled workers are possible, at least in the short-term. Trade may also be disrupted, at least until the UK signs new trade agreements, risking higher costs of goods in the shops and lower demand.

..while other challenges grow…

Public statements of intent suggest that, unsurprisingly, the UK Government is very focused on a successful Brexit. However, this also means that there may be limited bandwidth to focus on other issues. This is a major risk as Brexit is not the only challenge that the UK faces.

Most obvious of the other issues out there is the state of the NHS. Quality of service targets are being missed, but this is a symptom of a wider problem, especially around the finances of the health service and social care. Local authorities have the option of an increase in council tax of 3% annually from 2017/18 to support higher care spending, but this is at best a patch. Indeed it is generally the case that the local authorities with the highest care spend are often those with the lowest Council tax bases. Gross expenditure on elderly care is approximately 20% of the tax base in Richmond but 77% in Stoke-on-Trent, 3% would only scratch the surface in the latter case. The NHS needs radical action and needs it soon.

With demographic pressures mounting, efficiency improvement is not the solution, there is no time to wait, more funding is required.

But the NHS is not the only non-Brexit challenge the UK faces. The Government has set itself the target of building an economy that works for everyone, and has published an Industrial Strategy to support this. However, current plans for spending and action are very modest, with the infrastructure plans in the Autumn Statement very much skewed towards spend in the long-term, well after the expected date of Brexit. It is inconceivable that the current plans will go any way to making a significant difference to the lives of people in the North and Midlands in the cities and towns that voted heavily pro-Brexit. Thirty years of policy favouring the south of the country, and especially London, will not be reversed by words. Bold, transformative action is required. For example, the Palace of Westminster needs repairing with a bill of ￡4 Billion or more. Why not take the opportunity to move Parliament to the North or Midlands to relocate the centre of power in the UK. Similarly, why not move now to build better road and rail connectivity across the northern half of the country? Something I have yet to hear anyone dispute the value of.

…a worst of all worlds is a possible outcome.

The prominence of Brexit in the political sphere currently makes it hard to imagine that Brexit may not be the UK Government’s biggest challenge. The reality is that Brexit could exacerbate other problems in the UK economy – a smooth Brexit could still mean lower economic growth for some time, reducing the Government’s ability to implement change in other policy areas.

Low growth would reduce the resources available to invest in changing the economy, but this is only one potential impact of Brexit. The UK’s new trading arrangements might lead to higher imports with associated shocks to existing UK industry, especially manufacturing and agriculture – both of which are concentrated in those regions the Government has expressed a desire to help. While the risk of higher inflation would most likely have the greatest impact on the budgets of people with the lowest disposable incomes.

Choosing to focus on delivering a successful Brexit is a logical approach from the Government given the nature of the issue. The paradox is that this approach might divert focus from other critical issues, and, at the same time, create other challenges among the groups the Government has committed to improve the lives of. A lack of balance in policy may mean that even a smooth Brexit is not enough.

@MarkGregoryEY

markgregoryeconomics.ey.com

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