May 10, 2017    4 minute read

Brexit: The Cost of Uncertainty

Part II    May 10, 2017    4 minute read

Brexit: The Cost of Uncertainty

This is the second chapter of a five-part series covering Brexit’s impact on UK financial services. Click here for Part I. 

When it comes to living standards, most research suggests that remaining in the EU would be better than leaving. For example, since joining the EU in 1973, UK GDP per capita has increased more than other comparable countries outside the EU over the same period, as can be seen in figure 1: Additionally, evidence suggests that the UK and the EU are both economically stronger (assuming ‘strength’ can be identified loosely with GDP size) with the UK as a member: 

Brexit will negatively impact the EU’s leading GDP position, placing the EU behind the US and China, when the UK leaves the EU.

On the other hand, there is some evidence suggesting that changes in domestic policies partly explains the UK’s strong performance, according to economist Nick Crafts. One example could be the ‘big bang’ which occurred in the 1980s, whereby policies restricting banks’ activities in the United States encouraged businesses to look outside of the US for opportunities.

The impending Brexit may present further opportunities for the UK as a global leading financial hub, along with the expected challenges. Hence it is important for the UK to agree a deal that retains as much access to the single market, but with improved control of the borders in order to assuage the electorate. This is explored further in a subsequent chapter of this article discussing the impact of Brexit on the UK financial services and the UK economy broadly. See Insert B for the perceived winners and losers of the Brexit outcome.

The Cost of Uncertainty

The precise effect of Brexit is uncertain, as are the potential agreements to be reached on trade and immigration policy, all of which contribute to uncertainties about the UK’s growth prospects. Research by economist Jacob Nell suggests that the increase in uncertainty will lead to a reduction in consumption and investment, including FDI, and the resulting effect be a longer-term negative effect on productivity.

“All this uncertainty has contributed to a form of economic post-traumatic stress disorder among households and businesses, as well as in financial markets, leading to some deterioration in the economic outlook” Mark Carney, Governor of the Bank of England

“The UK could possibly move from being the 5th to the 7th biggest economy in the world, therefore setting the UK economy backwards.” Nicola Horlick, CEO, Money & Co

Some of the short and long run drivers of uncertainty identified through the interviews are illustrated below

See Insert C for a table of Brexit’s specific impacts.

Summary

Based on discussions with industry experts, many institutions’ priorities are to ensure minimal disruption to their business and their ability to service clients. As a result, most firms are working towards being well positioned to take advantage of any opportunities that this challenge may provide.

However, a key issue for financial institutions appears to be the outcome on ‘passporting’ and maintaining access to the single market. The financial services ecosystem dynamic suggests that additional activities may leave the UK if economies of scale are lost, thereby extending beyond EU-related activities, and negatively impacting UK GDP.

The impact of Brexit on the various financial services sectors is analysed in the next article.  The best estimate for quantifying the cost of uncertainty appears to be a 3% decrease in GDP by 2020 according to the research by the OECD. To put this in context, according to economist David Miles, the average annual rate of growth has been 2% in the last 100 years. That equates to being about 18 months behind in growth terms by 2020. The global financial crisis of 2008 led to GDP being over 10% lower as illustrated below.

Therefore, in relative terms, although not insignificant, 3% is not a disaster, argues Miles.

 

Stay tuned for the third chapter of Peace Ani’s overview of Brexit’s impact on UK financial services, published tomorrow.

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