There have been many articles, commentaries and academic papers discussing and highlighting the wide-ranging impact Brexit will have on the UK economy. From Mr Osborne claiming that “leaving the EU would leave every family £4300 worse off,” to Mr Farage stating that Brexit means the UK will save money as a consequence of not having to pay a membership fee. However, one thing that has gone under the radar is that there has been a subtle rebalancing of the UK economy with Brexit perhaps being the reason why this is happening.
A Weakening Sterling
As the graph above demonstrates, Brexit clearly had a negative effect on the pound, sending it from €1.35 down to €1.11. This is because investors speculate that the UK economy will worsen due to Brexit. Thus, they sell their pounds, which leads to a run on the currency. Historically, Britain has always been a nation that relies more on its imports than exports for economic growth. Exports have been weak for a number of reasons. Britain has seen a decline in manufacturing ever since Margaret Thatcher’s premiership, a point which will be developed upon later.
However, more recently it has been due to an overvalued pound sterling. This is supported by the IMF stating that in 2015 the pound was overvalued by between 10% to 20%. World Bank figures from 2016 show that British exports only made up 28% of national GDP compared with 45% in the case of German exports – a stark contrast.
However, post-Brexit, there have been signs that a subtle rebalancing regarding UK exports has begun. According to the Office for National Statistics (ONS), the UK export index has risen from 91.2 in Q2 2016 to 98.7 in Q2 2017, one year on from the referendum.
There is a strong correlation between this and the pound sterling falling 8.7% over the same time period. It is an increase in foreign demand which is driving the increase in the UK export index. Businesses and individuals in foreign countries now use less of their domestic currency in order to purchase goods from Britain. British goods now appear cheaper which in turn means British manufacturers have become more competitive. This is highly beneficial for the UK economy. Unfortunately, the UK still has a large trade deficit, however, this may subside in the long-term providing the pound remains at its true value and British manufacturers remain competitive with their rivals in Europe and further afield.
From Services to Manufacturing
The UK has always been highly reliant on the services sector. As previously mentioned, this was the sector Thatcher wanted to invest in during her premiership and this has had a lasting legacy. The UK service sector contributed 58% to national GDP in 1978, one year prior to Thatcher becoming Prime Minister. In 2012, that figure reached 80% (ONS, 2013). The service sector in the UK is the backbone of the economy.
There are two reasons for this. Firstly, it is due to government policy. The current Conservative government, led by Theresa May, has very little interest in promoting manufacturing relative to services. This is supported by a leaked document regarding industries needing to be prioritised during Brexit negotiations. Steel construction is a low priority whereas insurance and banking are high priorities, according to the Business Insider (2017). Financial services are the UK’s biggest asset. According to the TUC (2012), in 2012 financial services were growing at 0.8% per year while manufacturing contracted 3.1% over the same time period. Clearly, there is an imbalance when it comes to economic growth in the UK.
Perhaps this is changing. Looking at the Purchasing Managers’ Index (PMI) by IHS Markit for August 2017, just over a year post-Brexit, manufacturing is growing, yet services are declining. PMI is based on monthly surveys of carefully selected companies covering variables such as inflation, employment and business activity. The higher the PMI, the healthier businesses believe their sector to be in.
The UK services PMI scored 53.2, slipping to an 11 month low. This was down to subdued client demand and stronger cost pressures across the service sector. In contrast, the UK manufacturing PMI scored a strong 56.9 – a four-month high. Production rose at the steepest pace in 7 months with foreign and domestic demand increasing, primarily because of a weakening sterling and a faster intake of new work received respectively. In fact, around 50% of companies expect output to be higher in one year’s time, compared to 7% who forecast a decline.
Hopefully, this will mean UK GDP growth is slightly more balanced for 2017, as in 2016 the service sector accounted for the near entirety of UK GDP growth. Perhaps, in the long term manufacturing will become the dominant sector in the UK economy, only time will tell.
Whilst Britain is only at the start of the Brexit process and there are many economic and political unknowns, it can be argued there has been a subtle rebalance of the UK economy. Imports are falling and exports are increasing. Whether this increase in net exports is contributing positively to the UK economy is an entirely different question. One thing that is for sure is the ONS statistics showing a rise in the UK export index is down to a fall in the pound sterling.
The government must now harness this opportunity by investing more in the domestic economy and providing subsidies to UK SMEs, who constitute 99.9% of UK businesses, to make sure Britain takes advantage of the weak sterling. Regarding, manufacturing perhaps in the long run cost pressures of importing raw materials may hinder this sector’s growth. Although currently, this is certainly not the case. The growth in manufacturing has also led to a slight spatial rebalance as the majority of UK services are based in London and the South East whereas manufacturing plants and factories tend to be located in the Midlands and North of England.
Overall, the last 12-18 months have seen a slight rebalancing of the UK economy. Whether this will continue into the future is unknown, as no country has ever invoked Article 50 to leave the EU. However, at this present moment, the picture is certainly looking rather mixed.