26 August 2016 Business Voice article
The upcoming US presidential elections and the UK’s decision to leave the European Union have created a political atmosphere on both sides of the Atlantic that presents challenges and opportunities for business
21 March 2016
Read the lecture delivered at London Business School by Carolyn Fairbairn, CBI Director-General and Rain Newton-Smith, CBI Director of Economics
Good morning. It’s a real pleasure to be here – and I’d like to thank London Business School for hosting today’s lecture. So today, I’m here with CBI Director of Economics Rain Newton-Smith to help separate ‘fact’ from ‘fiction’ on Brexit.
There are now just three months until this historic referendum whose effects will be felt for generations. As the CBI, it’s not our role to tell people how to vote. This poll is about a complex range of factors including sovereignty, security and identity. Yet as 45 million British people consider their choice – the implications for the UK’s prosperity and our economy will play a vital part. And it is in answering this question that business is uniquely placed to inform the debate.
The UK’s relationship with the EU deeply affects British firms. It affects UK firms that trade and who are part of European supply chains. Whether a UK manufacturer making components for a car sold abroad or a small retailer ordering from a big supplier. The EU matters to the UK’s universities, its farms and its public finances. And European regulation affects firms of all sizes.
In the months ahead, the debate will be a choice between two competing futures - ‘In’ or ‘out’ - and which will give Britain the best prospects for prosperity. Our role at the CBI is to help inform this crucial choice. To bring the voices of our members and balanced economic analysis to life. This is the purpose of today. So today, we want to do three things in particular.
First, we will examine what leaving might look like. Then we will look at the impact leaving would have on business – on trade, regulation, investment, different sectors of the economy and on uncertainty. And finally we will look at the impact of these factors on the UK economy as a whole. To put some numbers around this, we have asked PwC to conduct an independent evaluation of the overall implications of Brexit for the UK economy. We will set these out in the final part of our lecture.
So now I’ll pass over to Rain to look at the first of these points.intro
An important question, not asked often enough is – what does leaving look like? A process for leaving is set out in Article 50 of the Lisbon Treaty. It’s worth saying that Article 50 has never been triggered. So by choosing this path – the UK would be taking unprecedented action. Yet there are things we can say about the exit process. We know that the European Commission would draw up an exit agreement. This would then be agreed by qualified majority in the European Parliament and Council, before being offered to the UK. The UK can’t participate in the discussions about its withdrawal at the Council and it can’t vote on it in the Parliament.
In trading terms as well, the EU would hold the balance of power. Some see the fact that we import more from the EU than we export to it as proof that they need us more than we need them. But this ignores the fact that 45% of the UK’s exports go to the EU - it’s our biggest export market by far - compared to just 7% of total EU exports which come here. As we’ve seen in our recent economic recovery, where export and productivity growth have been the missing links, finding final buyers for your exports can be hard. If we left the EU and our goods became more expensive for EU companies, they, on the other hand, would have plenty of alternative suppliers to import from within the single market. They could look to Germany or France to buy goods from without tariffs or customs. We would have fewer neighbours to choose from. So while it may be in both sides’ interest to complete a trade deal, the balance of power would be far from equal.
Article 50 allows two years to reach this agreement. If no agreement were reached or other EU states refused to extend negotiations, we would drop out of the EU. This would mean trading under World Trade Organisation Rules, which would leave the UK with significantly reduced access to the Single Market.
Of course, the withdrawal process could include the negotiation of a new formal relationship between the EU and the UK. Over 50 countries – including Norway, Switzerland and Canada - have alternative arrangements with the EU. So some comparisons can be made.leaving
Norway, for example, is part of the European Economic Area – the EEA – with full access to the single market for goods and services. Per capita, Norway’s contribution to the EU budget is more than 80% of what Britain pays. It adopts the majority of EU regulations - yet has no say over their creation. Free movement also operates between Norway and the EU. In terms of influence, it has no Members of the European Parliament, no commissioners and no representatives in the European Council.
Switzerland is part of the European Free Trade Association – EFTA – but not the EEA. It has partial access to the single market for goods and implements EU regulations in these areas. It makes payments to the EU for programmes it takes part in and freedom of movement operates between Switzerland and the EU. As a non-EU member state, like Norway, it has no formal influence over decision-making. Switzerland manages its relationship with the EU through 17 treaties and over 120 bilateral arrangements. The first tranche of these took nine years to implement and the current arrangements took 16 years.
Countries like South Africa and Canada have free trade agreements with the EU – although their quality and access to the single market for goods and services varies. To sign these deals, these countries have had to adopt EU standards in a number of areas. They don’t participate in EU free movement or contribute to the EU budget.
And as you can see, South Africa’s agreement took 10 years to negotiate, while Canada’s has so far taken seven years. But, as yet, no EU country has ratified it. For the UK, a comprehensive EU Free Trade deal could take at least as long to negotiate as this.
Securing a new, formal arrangement would require the agreement of 27 EU member states, followed by ratification by each of them. Given all this – the Cabinet Office estimates we may not have a new relationship for 10-15 years. And – beyond the process of leaving – what would Brexit mean for business? Well, Carolyn’s going to start us off by looking at trade and regulation.alternatives
Let’s start with trade – a major issue for business. If the UK left the EU – would the UK’s trade be helped or harmed? Well, let’s see what firms from around the UK had to say.
[Richard Clothier, Managing Director, Wyke Farms] “We trade all around the world, but probably the easiest business we do is within the EU. We have no tariffs on borders, we have all the same legislation. We put all the same labels on the cheese that we sell throughout all the EU countries. And then when we trade into other countries that might speak the same language as us for example, like Australia or the US, the labelling is quite different. If you look at the US for example everything has to labelled separately in pounds and ounces. We go into the Australasian regions and quite a lot of the weight legislation is different. So just little subtle changes that can add quite a lot of complication and cost.”
[Dave Hall, CEO Renolit Cramlington] “Trading with America, we have to pick up the import duty as the supplying factory, and that means that our trading terms means we are less profitable in that market than we would be than if it were a different trade deal. In the EU it’s far more simple. There are no trade restrictions. No trade import duties. And actually with Turkey which has good trading terms with the EU, and our biggest market, we’ve got an advantage against the competition from Korea and China.”
[Debbie Wosskow, CEO, Love Home Swap] “I think for digital businesses, the access to the single digital market of 500m people is one of the things that has made the UK the centre for European digital. And no digital entrepreneur within the UK wants to see that change.”
[Charlie Allen, Managing Director, Shiner] “By us having a Brexit, it’s going to make it more difficult to trade. Trade deals can be done, but we will definitely find it more difficult. We find it much more difficult to deal with other markets that are outside the EU.”
[Judith Totten, Managing Director, Keys Commercial Finance] “At the moment 70% of our clients would export, either to the Republic of Ireland or to the wider EU community so therefore exiting Europe would potentially have a huge impact on their ability to trade in terms of borders.”
In that video, we heard many firms stress the importance of easy access to the Single Market. The EU is the UK’s biggest trading partner. As Rain mentioned earlier, 45% of our exports go to the EU, compared to just 16% which go to the US. The EU gives UK businesses tariff-free access to a European free trade area, the Single Market. It is the most important aspect for many firms. They can sell easily to more than 500 million customers, effectively creating a home market eight times the size of the UK. And EU trade deals help the UK trade more easily with the rest of the world. Today, EU membership and these deals cover about 60% of the UK’s global trade by value. If the EU concludes negotiations currently underway that figure will increase to 88% of global trade.
So – assuming we stay in – let’s look at how the value of UK exports will change over the next 10 years, according to Oxford Economics. For exports, growth rates are often quoted, rather than absolute values. This can be deceptive as it masks the absolute size of export markets. As you can see from the red bar, today – in absolute values – our exports to the EU far outweigh those to any other market.
And if we look ahead to 2025 – this will continue to be the case. As you can see from the blue bar at the top, UK exports to the EU are expected to increase by more than 140 billion dollars in the next decade – by far the largest source of future growth. While the UK should clearly seize opportunities in growing markets around the world, it is one of the basic economic rules of trade that countries trade most with their closest neighbours.
Yet if the UK leaves the EU without a Free Trade deal, 90% of British exports to the EU, by value, could face tariffs. As you can see from this chart, some sectors could be hit particularly hard. Under WTO rules, UK textile exports to the EU, shown by the top bar, could face tariffs of nearly 10%. Transport equipment could face tariffs of about 7%.
Products imported from the EU into the UK could also face tariffs – passing the costs onto customers through higher prices.
The WTO regulates against discriminatory tariffs, so the only way to avoid tariffs on EU imports would be to lower tariff barriers for all countries. But this would risk flooding UK markets with cheap imports – doing more harm than good.
Of course, the UK could seek to avoid EU tariffs through a free trade deal. But it is much harder to avoid non-tariff barriers, like small differences in regulation. For example, Norway, the non-EU country with the most comprehensive access to the EU single market, faces additional non-tariff barriers to trade. Even as part of the EEA or EFTA, rules of origin reporting and VAT payments at borders make it harder for small firms to trade with the EU. Firms feel the difference between trading with countries outside and inside the EU every day.
Just take Palletways. A British distribution company which employs 400 people in the UK and transports bulk goods across Europe. They say that exporting and importing to Switzerland takes 24 hours longer and costs a third more than to the EU. So, in short, leaving the EU could mean the return of significant barriers to trade.
It is hard and increasingly uncommon for countries to go it alone. As you can see from the coloured areas on this map – most countries are part of some sort of regional trade bloc – from economic unions through customs unions to multilateral free trade areas. In the last quarter of a century, the total number of Regional Trade Agreements in force has grown more than tenfold, from 25 in 1990 to more than 260 today.
For the UK, being part of the EU lets us go ‘toe-to-toe’ with other economic giants around the world in negotiations. Some argue that outside the EU, the UK could get deals signed faster. We wouldn’t have to consider the complex positions of 27 other countries in our negotiations. However, by leaving, the UK would drop out of the EU trade deals it has at the moment – and have to renegotiate them from scratch. This is – in part – a capability point. We haven’t had the trade negotiators to do this for about 40 years. It is also a capacity point. We’d need to negotiate many new deals at the same time.
The UK would also risk being at the back of the queue, with many countries preferring to negotiate comprehensive deals with regional blocs. And as a country of 64 million people – the UK would inevitably have less influence than a bloc of over 500 million. As a consequence, it’s hard to imagine the outcome would be better deals than the UK has today, unless we somehow managed to negotiate better free trade deals than currently exist anywhere in the world with the EU, the 50 countries covered by EU trade deals and countries like America with which the EU is still negotiating. Over the next five years, the UK’s trade position would not be improved by leaving, and would almost certainly be worsened.trade
But EU membership isn’t just about trade. Some claim that leaving would benefit British firms, letting them break free of EU red-tape. Hence our next question – would regulation be lighter and what difference would this make?
While estimates vary dramatically, about 7% of UK primary legislation involves some element of implementing EU obligations. Does EU regulation harm or help UK business? The answer is a bit of both. It is a ‘double-edged sword’, with both advantages and disadvantages.
On the plus side, equivalent regulation across 28 member states creates a level playing-field for EU firms. The Single European Sky – for example – is a great example of EU regulation making Europe more competitive. As well as reducing delays and the impact of flights on the environment. And regulations allowing the free flow of data around the EU benefit communications technology firms – like Bracknell-based Redwood Tech. Letting them operate as easily at their sites in Germany and the Netherlands as they do in the UK.
Yet poorly-designed EU regulation can also be a headache for business.
And this can be worsened by inconsistent implementation – both through adding more red-tape at national level and a lack of enforcement in other member states. So let’s see what Britain’s businesses think about EU regulation.
[Miranda Barker, MD, Allan Environmental] “We’re an environmental consultancy so the EU regulation structure helps our business. Because all our work is dictated by the environmental regulations which are formulated in the European Union. So it would be a huge disruption to us if we came out of Europe. We would then be looking at a period where the UK wasn’t sure about which regulations it would have to adhere to and there’d be a lot of turmoil as the new regulations were written. So it would be a big upheaval to our business, a big disturbance.”
[Chris Ormrod, Managing Director, Ministry of Cake] “We’re in the food industry, and this doesn’t get talked about a lot, people tend to refer to ‘manufacturing’ generically. The food industry is very, very different. If you look around the kitchen you’ll see we’re making a load of cakes. There’s something like 700 ingredients that we use across all of our cakes. All of those will have been approved by and are agreed to EU standards. If we step outside the EU, and this would be a real fear, we will suddenly find ourselves making products which perhaps aren’t quite to the latest EU standards or even worse we don’t have a say in how those standards are made.”
[Gerald Mason, Vice-President, EU Affairs & Strategy, Tate & Lyle Sugars] “European regulations are the biggest thing that holds back our business and threaten our competitiveness. We make sugar from cane sugar here. Europe restricts who we can buy that from and often charges us import tariffs. And in sharp contrast the sugar beet production in Europe isn’t regulated and actually is subsidised quite heavily by the European Union.”
[Debbie Wosskow, CEO, Love Home Swap] “All of the EU directives around transparency and trust have a very positive impact upon consumers of the sharing economy and that has been one of the reasons why the sharing economy has scaled up so quickly across Europe.
[Anthony Shepherd, Chairman, Alderley Systems] “Some of the EU regulation is actually good, although it’s not liked by this country. I think the 48 hour week thing, for example, is good news, I don’t think that’s bad news at all. But otherwise, we really aren’t very conscious of what this EU regulation is. We don’t find it any different dealing with a firm in France or in Germany or somewhere like that. And when people say ‘look at all this EU regulation’ I don’t recognise it. I don’t know what it is.”
So there is a broad range of views on regulation – and its impact. And there’s little doubt that regulation can cause real problems for business. Yet the overall impact of EU regulation can be overstated.
According to OECD figures, the UK ranks 4th in the developed world for labour market regulation and 2nd for product market regulation. It’s clear that EU membership has not stopped us from having one of the most competitive regulatory environments in the developed world.
Of course – if we left the EU, the UK could repeal some regulations currently in place. But what regulations might the UK repeal? And how likely would we be to do so?
Here are the five EU regulations which - according to the think tank Open Europe – cost the UK economy the most money. Let’s go through each of them.
Two are environmental – covering renewables, climate and energy. Yet given the UK’s history of leadership on environmental protection, it’s unlikely these would be repealed – or at least there would be equivalent UK legislation. Next, the Capital Requirements Directive transposes requirements previously agreed by the Basel Committee into EU law – the vast majority of which the UK would sign up to voluntarily.
Then there’s the Working Time Directive. Most of the cost of this comes from annual holiday and rest break entitlements – which are likely to remain whether the UK is in the EU or not. No CBI member is suggesting to me that the way to make the UK more competitive is to end paid holiday time for working people. And there are things that could be done right now from within the EU to reduce the regulatory burden of these labour market interventions. These few examples just show that some of the regulatory savings often cited would be illusory.
And we would need to bear in mind the constraints that may come with a new trade deal with the EU post-exit. For example, if the UK followed the Norway model and joined the EEA, it would keep nearly 95% of the most costly regulations already in place. And – like Norway – which adopts 75% of EU law, the UK would be required to adopt new EU law.
Even the Canadian Free Trade Agreement stipulates that Canada – more than 2,000 miles away from continental Europe – has to implement a range of EU standards. Whatever the circumstances, firms trading with the EU would have to follow EU regulations as well as UK ones. Some companies may benefit – for example, those who do not export or are willing to apply two different sets of product standards. But others, particularly small firms, may struggle to cope with different sets of rules. So – overall – while some firms may benefit from deregulation, many would lose out.
And let me just say a word about the costs of contributing to the EU budget. As one of the largest EU economies – we have historically been one of the largest contributors to the EU budget, with a gross contribution of £18.8 billion in 2014. We get much of that money back through the ‘rebate’ and the EU’s major funding programmes – research funding, agriculture and regional aid – leaving a net cost of £9.8 billion or 0.5% of GDP.
That sounds like a huge amount of money. But it has to be seen in the context of government spending of over 700 billion pounds. In fact, for each person in the UK that’s about £150 a year. And now Rain’s going to look at what Brexit might mean for investment.regulation
International investment supports thousands of jobs in the UK. Foreign-owned companies created 85,000 new jobs in 2014 alone – with benefits for growth and productivity. So here’s our next question – if we left the EU, would this foreign investment go up or down?
Well, currently the UK is doing a great job of attracting investment – both from the EU and the rest of the world. As you can see from the red bar – the UK attracts the most foreign investment of all EU countries – about 1.7 trillion dollars. That’s more than double the investment Germany gets – seen here in yellow.
And – as shown by the blue area on this chart – almost 50% of the UK’s foreign investment in 2014 came from EU companies. This makes them the biggest investors in the UK. And it is clear that the UK’s EU membership is a large part of the UK’s appeal.
According to EY, 72% - almost three quarters of investors - say single market access is important to the UK’s attractiveness. Of course, it’s not the only reason people invest here. Our time zone, our rule of law and our language are all important. But the evidence shows that EU membership really counts.investment
And another important consideration is how would Brexit affect different sectors in the UK economy? Well, let me illustrate with three of our most important - automotive, financial services and food & drink.
While our home market is important, more than 40% of UK-made cars go to the EU. So trade is vital to the automotive industry. Leading car companies have already spoken out publicly about what the EU means for their business. BMW highlighted Britain’s influence in the EU. While Toyota talked about long-term competitiveness. The return of tariff barriers would have a particularly negative effect for this important sector. It would push up UK car prices and disrupt European supply chains which cross national borders.
For example, a small component can be made of metal forged in Spain, with a joint made in Germany, assembled in France and finally be included in an engine in Sunderland. What businesses tell us is that these supply chains are supported and made possible by EU membership.
But automotive isn’t the only sector which could be affected. As you can see from the red bar, the UK is a world leader in financial services - responsible for almost a quarter of Europe’s financial sector GVA. The City of London is home to over 250 foreign banks, many of whom use the UK as a ‘gateway to Europe’. They are all able to use EU ‘passporting’ rights to do business across the 27 other member states.
This valuable source of foreign investment in the UK supports thousands of jobs. In the event of Brexit – and the UK not joining the EEA but signing a Free Trade Agreement – it would be the loss of EU market access which would hit banks hardest. It’s likely they would lose these ‘passporting’ rights – meaning they would have to comply with an additional regime to be able to provide services in other EU countries. Of course – they could relocate their HQ to a country with EU membership, with all that means for UK jobs.
In terms of international financial centres, the next highest ranked EU city – after London – is Frankfurt at number 14. This headroom would give our financial services ‘breathing space’. And the City has shown itself to be innovative and adaptable over the course of history. But the harsh effects of regulatory divergence could add up over time – providing other financial hubs with an opportunity to challenge London’s pre-eminence.
And leaving the EU would also affect the UK’s largest manufacturing sector – food and drink. Almost three quarters of the UK’s food and non-alcoholic drink exports go to the EU. Eight of the sector’s top 10 markets are EU countries – with Ireland making up nearly a quarter of exports. In the event of a vote to leave, these markets would continue to be important – as businesses tend to sell perishable goods to nearby countries as they reach them more quickly. So while we might hope to boost sales of some products to China – it’s less likely to be fresh salmon, strawberries or sausages!
In addition, regulation of food and drink is harmonised across the EU to make trade easier. From production to processing, storage to distribution – every stage of producing food and beverages in the UK is regulated. Earlier we heard Richard Clothier from Wyke Farms talking about EU labelling requirements. These require firms to display detailed information on allergens and ingredients for goods sold in the EU.
If British firms wanted to continue exporting to the EU, they would need to keep applying EU regulations – such as labelling laws. Yet from outside the EU – we would be unable to influence the rules. And UK food and drink firms might also have to shoulder the cost of applying two sets of regulation – UK and EU.sectors
So we’ve looked at three big themes – trade, regulation and investment. And we’ve considered the high-level impact for three big sectors employing millions of people. But – we also need to consider the impact of uncertainty. Uncertainty over the UK’s EU membership is already having a negative impact on investment plans for some of our members with decisions delayed, though this impact is not yet widespread.
But in the CBI’s latest forecast we have highlighted a risk to business investment owing to uncertainty ahead of the referendum. So it’s something we’re monitoring closely. And a vote to leave would push this down much further – as decisions are not just delayed but diverted elsewhere.
The period of uncertainty is likely to linger for the full duration of the transition period to a new trading relationship with the EU. And – as I said earlier – under the defined EU exit process of Article 50, this could potentially last a decade. But let’s look at what firms have to say.
[Jarl Severn, Managing Director, Owen Mumford] “The uncertainty is going to affect the pound more than anything and that uncertainty will keep sterling weak for quite a long period. That will help our exports outside of Europe but our sales into Europe, coupled with our imports from Europe, is going to be a bit of a seesaw and a rollercoaster ride for all concerned.
[Maria Ferraro, CFO, Siemens] “Being part of a single market is extremely important to us here at Siemens in the UK because we import and export. It allows us to do that quite seamlessly. However, should we exit, that creates, again, the necessity to negotiate. And being Canadian, I can certainly say it took over seven years for us to negotiate our trade agreement with the EU. It’s a lengthy process, which again contributes to the uncertainty which we will have during that time. Will investment cease? No, of course not. But it will take a period of time for that stability to regain and for us to look to the UK as an attractive place to invest.”
[Sir Roger Carr, Chairman, BAE Systems] “I think being in the EU and remaining in the EU provides a certainty on which business can make investment. All businesses find uncertainty the most difficult thing to deal with. It offers risk. It undermines the certainty of reward. If we were to leave Europe we would have, undoubtedly, a long period where there was not the bedrock of certainty on trading relationship, on exchange rate or indeed on industrial activity.”
[Charlie Allen, Managing Director, Shiner] “A Brexit would be devastating for us. Because of all of our business we do in Europe, it would make things more difficult to trade. The uncertainty that’s being created by even the question of a Brexit has been really bad for us as far as the exchange rates.”
[Douglas Flint, Group Chairman, HSBC] “Every business, in event of a Brexit vote would have to stand back and look at its business from the point of view of contingency. What happens next? What happens to our supply chains? What happens to our customers? What happens to the employees we have? So people have to think very carefully about what the implications would be in a period where there would be two years of negotiation before there would be clarity on what the terms of exit were actually going to be.”
We heard the pound mentioned in that video and there’s an important question as to how financial markets would react to Brexit. What would it mean for confidence in the pound, our share prices and the price we pay on corporate and government bonds?
Well, as you can see from the area circled in red – when compared against a basket of currencies the pound has been weakening recently. This has been for a variety of reasons, including the announcement of the referendum. Indeed, the day after the referendum was announced, the pound fell to a seven-year low against the dollar.
Sterling could well be the first to feel the effects of a vote to leave. HSBC and JP Morgan both expect a significant fall in the pound – with JP Morgan citing a fall of 10% in the event of Brexit. Of course – a one-off depreciation is not necessarily a bad thing. If we left the EU, a weaker pound could benefit exports and manufacturers – aiding the economy in the short term.
The ultimate impact would depend – in part – on how the Bank of England reacted. But our members tell us one of the hardest things to deal with is volatility. It is very hard to plan and invest when exchange rates and asset prices are moving up and down.
On top of this, both Moody’s and Standard & Poor’s expect to downgrade the UK’s credit rating if we leave the EU, as a result of concerns around our current account deficit, our fiscal position and confidence. And – let’s remember that the uncertainty generated by a vote to leave would come on top of a lot of doom and gloom around a range of global risks.
When taken together, slowing growth in emerging markets, rebalancing in China and high volatility in financial markets, make this a tougher time for the UK to choose to leave the EU. So – finally beyond the business impact – what would Brexit mean for our economy as a whole? What would be the headline figures for growth?uncertainty
As we’ve already mentioned – for today’s lecture the CBI commissioned an independent study from PwC looking at the implications of an EU exit for the UK economy. The study uses a rigorous economic model to estimate how two different exit scenarios would impact the UK economy compared to a counterfactual where the UK votes to remain part of the EU.
This modelling technique is widely used by government, institutions and academics, allowing the effects of different impacts to be compared ‘like for like’ in a transparent way. The study is more comprehensive, in our view, than other similar studies that have been done. As you can see from the chart, it covers the channels of uncertainty, trade barriers, migration, regulation, fiscal costs and provides the impact on GDP and other variables. We have deliberately chosen what we think are relatively optimistic assumptions. So let’s quickly look at the assumptions behind the two scenarios.
First – there’s the ‘Free Trade Agreement’ scenario. Which we can think of as a ‘best case’ scenario of a vote to leave. Here the UK is able to quickly negotiate a free trade agreement with no tariffs on goods between the UK and Europe. The UK experiences a modest rise in non-trade barriers with the EU, but is able to keep the third country free trade agreements it currently has.
We also sign a new trade deal with the US by 2021. Additionally, changes to immigration policy lead to significant reduction in low skilled workers from the EU but a higher proportion of high skilled workers from around the world. Of course, we understand this is a sensitive issue and here we’re only looking here at the economic impact. But we should not underestimate the positive effect which migration is having on the economy. If we left and really closed all our borders, it’s likely we’d see more skills shortages and a greater drag on growth than set out in this scenario. And finding people with the right skills remains one of the most pressing business concerns for our members.
PwC have also modelled a second scenario, a ‘World Trade Organisation’ case, under which the UK fails to secure a Free Trade deal and trades under WTO rules with the EU from 2020. Trading through the WTO involves a significant rise in tariff and non-tariff barriers with the EU. PwC assumes that the UK loses its existing free trade agreements with non-EU countries but manages to recover them all and sign a deal with the US by 2026. In this scenario - the uncertainty shock continues for longer than in the ‘Free Trade Agreement’ scenario.
And in both scenarios, the UK no longer makes budgetary contributions to the EU. In both, it is assumed that over 12 billion pounds of regulatory savings could be made per year, but this includes repealing some of the regulations on climate change that we think are here to stay.
So this is an upper bound on the saving. In addition, the scenarios do not consider the feedback from the impact of Brexit on the rest of the world for the UK. Nor any additional impact from lower Foreign Direct Investment on our productivity growth in the long run. So there are undoubtedly worse states of the world out there than in these scenarios. So there’s the ‘small print’ but what happens when we run the numbers?methodology
In both scenarios, the largest effect comes through the investment component of GDP. PwC have calculated that, even in the ‘FTA’ scenario – shown by the yellow line - whole economy investment could fall by 16% below baseline. And in the ‘WTO’ scenario – shown by the red line – investment could fall by up to 26% below counterfactual in 2020. Outside the EU and trading under WTO rules, investment would gradually start recovering, but by 2030 it would still be around 10% lower than if we had remained in the EU. And now I’ll pass over to Carolyn to set out what the research says about growth – and close today’s lecture.reducedinvestment
[CBI Director-General Carolyn Fairbairn]
This graph shows the overall impact on the UK economy in the ‘Free Trade Agreement’ scenario. Greater control over regulatory policy means some regulatory cost savings from 2019 – shown by the small yellow area above the 0% line. But the small benefit of reduced regulation and a very small benefit of fiscal savings for the Treasury are greatly outweighed by the negative effects of trade barriers, uncertainty and reduced migration. As you can see from the large dark red section at the very bottom, the impact of uncertainty would only fade away around 2025.
And as you can see from the two lighter shades of red - increased trade barriers and tighter restrictions on migration are the main effects that are likely to reduce GDP growth in the long run. So even in this scenario – which we think is optimistic – Brexit’s overall impact on the UK economy would be negative.ftascenario
But, as this graph of the ‘World Trade Organisation’ scenario shows, the result is much more pronounced if the UK cannot secure a quick deal with the EU. Here, we see the same net benefit due to looser regulation – shown in yellow. Yet as you can see – the overall negative impact is greater. The initial uncertainty has a greater impact on GDP – shown in the darkest shade of red - causing a substantial decline whose effects are felt until 2030. The short term impact is particularly harsh. The UK’s ability to pursue its own external trade policy would not make up for the negative effects of the return of trade barriers and a rise in non-tariff barriers - shown in the middle shade of red. This could permanently reduce GDP by as much as 2% in 2030. Additionally, the effect of lower migration – shown by the lightest shade of red – would be more negative in this scenario – playing its part in reducing GDP in the long run.wtoscenario
This graph shows both the ‘Free Trade Agreement’ and ‘World Trade Organisation’ scenarios. As you can see – in both scenarios – the reduction in GDP compared to the baseline scenario is significant, causing a serious shock to the UK economy. In the ‘Free Trade Agreement’ scenario – shown here by the yellow line – by 2020, GDP would be down 3%, or 55 billion pounds, on where it would otherwise be. That equates to a cost of £2,100 per household. In this scenario, 550,000 jobs are lost by 2020. As the negative effects of uncertainty faded away, the UK would slowly recover – but by 2030 it would still be 1% below the long-term trajectory if we’d remained and be unlikely to ever close the gap.
And there is also the ‘World Trade Organisation’ scenario where the UK is unable to secure a free trade deal – shown by the red line. In 2020, GDP would be down 5%, or 100 billion pounds, on where it would otherwise be. That equates to a cost of £3,700 per household. The impact on jobs is also striking. In this scenario 950,000 jobs are lost by 2020. The UK’s unemployment rate rises from 5% to 8%. As you can see, the recovery back towards trend GDP would be slower, stabilising in 2026 instead of 2022. And 15 years after a vote to leave, GDP would still be permanently 3% below the trend line of remaininggdpimpact
So, we are coming to the end of this lecture. Lots of graphs, lots of facts and lots of figures. But what can we conclude from all this? What would leaving really mean for our prosperity?
On the process of leaving, we’d be putting our fate in the hands of 27 other countries. And none of the alternatives on the table offer the same access to and influence over the EU single market as full EU membership. On the impact for business – it is hard to see circumstances under which the UK could get a better set of deals on trade and investment outside the EU than it has now. Leaving the EU would hit some of the UK’s top sectors hardest. And current global uncertainty means that now could be one of the worst times to leave. And on the wider impact for growth – we’ve seen that, whether or not the UK managed to secure a rapid deal with the EU, the UK would not recover from Brexit’s impact on growth in the next 15 years. In the best case scenario we’d lose 550,000 jobs over the next four years. While trading under WTO rules it could be closer to one million.
So – we’ve analysed the arguments. But – of course – there’s one more thing, promised on the very first slide today. The business view. Throughout our presentation – we’ve heard from a range of firms of different sizes, sectors and from different parts of the country. And at the CBI, we’ve consistently heard from our members that the majority – though not all – want to stay in a reformed European Union. We committed to asking our members once again when the Prime Minister came back with his reform package. And now we’ve done so. Undertaking a representative survey of our members which concluded last week.
The result? A resounding 80% of CBI members think that remaining in the EU would be best for their business. So that’s what our members think. And we’re looking forward to hearing your thoughts and questions in just a few minutes. Thank you.conclusion
26 August 2016 Business Voice article
The upcoming US presidential elections and the UK’s decision to leave the European Union have created a political atmosphere on both sides of the Atlantic that presents challenges and opportunities for business
25 August 2016
The government’s announcement that it will guarantee funding for UK research and innovation projects under the EU’s Horizon 2020 initiative was welcomed by the CBI.
23 August 2016 Business Voice article
Success in British cycling has shown the the value of innovation - and how international competition spurs it on. Now Innovate UK wants to help the country's small businesses think more globally