Andrew Sentance, PwC

5 April 2016

Easy growth is a thing of the past, says the senior economic adviser to PwC. But Brexit poses a serious threat to the current recovery

“The UK economy is doing well in the ‘new normal’ world that we inhabit,” says Andrew Sentance, senior economic adviser to PwC. Although growth is expected to stay at around 2 per cent, not the 3 per cent people have been accustomed to, and wage inflation has been a “disappointment”, he emphasises the positive: an unemployment rate of 5 per cent is “good for the UK”.

“Some of the gloom and doom about the world economy tends to be overdone,” he adds, reasoning that people continue to have unrealistic expectations. “People’s benchmarks are still focused on that unsustainable world that we had before the financial crisis. What we’re getting now is closer to a sustainable rate of growth.”

While successful businesses will be adjusting to this new reality, Sentance also warns of increased financial volatility, and divergence in the performance of different sectors and countries – driven by technology and demographic change, as much as the macro environment.

“The countries that seem to be doing the best in the current environment are the ones that have flexible economies and business friendly policies to attract trade and investment,” he says. “I’d put the UK in that camp.”

Rocking the boat

But in this era where “easy growth” is hard to come by, what happens when Brexit is thrown into the mix, with its inevitable effect on trade and investment?

The EU has been interwoven into the business relationships of our economy in quite a deep way

“In my view, the European Union has underpinned the trading and investment relationships of the UK economy for over 40 years now,” says Sentance. “Nobody under the age of 58, born and brought up in the UK, has spent any part of their working life when we haven’t been a member. It’s been part of our business environment for quite a long time; it’s interwoven into the business relationships of our economy in quite a deep way.”

Although mainly “home-grown, domestic problems” hindered UK growth after it first joined the EU in the late 1970s, Sentance points out that the UK has been the most successful G7 economy in terms of GDP per head since the early 1980s. “I think some of that improvement has come from making our economy more flexible, but some of that has come from being part of this important trading bloc.

“If we sever our relationships with that trading bloc, we can expect a big shock to the UK economy.”

And as author of research commissioned by the CBI, Sentance has quantified what the potential scale of that shock might be.

If we sever our relationships... we can expect a big shock to the UK economy

His analysis modelled two different scenarios – one in which the UK signs a quick trade deal with the EU, keeps all existing trade deals with third party countries and rapidly secures a deal with the United States; the other, a mid-range “World Trade Organisation scenario”, where the UK trades under WTO rules but is able to renegotiate trade deals with third party countries over the coming years.

Under both scenarios, the hit to the UK economy would be significant and fifteen years later GDP would still be lower than if we stayed in the EU. In the short-term "Brexit" could reduce GDP by as much as £100bn, or over 5 per cent, by 2020. That is £3,700 per household and could mean the loss of 950,000 jobs.

The business view

Talking to Business Voice, Sentance focuses on trade and investment, which he believes are at the heart of the EU. He argues that the business community is closer to the issues at stake and better able to understand them than many members of the public. “There is a responsibility for the business organisations like the CBI to try and make that clear as part of the public debate,” he says. 

“The uncertainty effect will have the biggest impact in the short term,” he continues.

A vote to leave would trigger Article 50 of the Lisbon Treaty, which sets out the process for this to happen. The research highlights that it would take at least two years before the post-exit relationship between the UK and the EU would be clarified, with such uncertainty likely to lead to increased financial market and exchange rate volatility, higher risk premiums in credit and equity markets, as well as potential impacts on business confidence and investment.

The uncertainty effect will have the biggest impact in the short term

“But over a period of time, the effect on trade and investment will be felt more strongly,” Sentance adds. “Investment responds quite sensitively to what happens in the rest of the economy, so you could get potentially big swings in investment on the back of something like the UK leaving the EU.”

That’s particularly significant when the EU currently accounts for the largest share of inward investment into the UK, amounting to £1trn in 2014.

With a 45 per cent share, the EU is the largest export market for UK goods and services – and Sentance emphasises the vulnerability of the latter, as services account for more than half of UK exports.

“In the services sector, the single market is not so well developed as it is for many groups of manufacturers,” he explains.

The UK stands to benefit from the predicted expansion in services trade – services account for 80 per cent of our economy, but less than half of world trade, Sentance points out. “But if we’re not part of the EU, we’re going to lose our influence over how the rules are set and how those markets in services will develop.”

A brighter outlook

Earlier this year Sentance predicted relatively good growth in the EU for 2016. So will that have a bearing on the upcoming referendum?

“Europe has been portrayed as a negative factor economically because of the euro crisis and because we look at some of the poorly performing economies like Greece and Italy, and indeed France. But look at the broader EU, and a lot of the economy is performing relatively well. We perhaps don’t hear enough about that.”

We can't isolate ourselves from the rest of the world

He highlights Germany’s success, Swedish growth that has been outpacing our own, and even Spain – now one of the fastest growing European countries.

“It’s fair to say that the performance of European economies has diverged, but that’s not so much to do with the euro or the EU, it’s to do with the national policies of the governments in those countries,” he adds.

Nevertheless, Sentance believes that the debate is shaped by the hangover from the global financial crisis. “It has coloured people’s opinions and made them worry about negative influences that could flow from our relationships with other countries,” he says. “But I think we have to be realistic about that – we can’t isolate ourselves from the rest of the world.

“We’re in a very integrated global economy, and we’re probably going to be subject to more buffeting from what’s going on in the rest of the world. But we have to be prepared to live with that and the long-term benefits outweigh the negatives.

“We have to choose the relationship that we want to have and work out what’s going to be the most beneficial for the UK.”