Earlier this month, the UK’s opposition Labour Party broke its three-month silence over Brexit to accuse the government of hiding evidence by not publishing an economic impact assessment. Shadow Cabinet Office minister Rachel Reeves cited Office for Budget Responsibility estimates that leaving the European Union has reduced Britain’s gross domestic product by 0.5% in the first quarter of 2021 and will lead to a 4% hit to UK productivity over the longer term.
It’s the latter estimate that’s worrying. Without improved productivity, the economy will struggle to expand quickly enough. Britain’s lagging productivity growth — described by the Office for National Statistics as “unprecedented in the postwar era” — has blighted the country since the financial crisis. There has been much discussion about its causes, and some debate about how productivity is measured, but inadequate investment, skills and infrastructure share much of the blame.
For Prime Minister Boris Johnson, it’s hard to imagine a higher economic priority. A further worsening of productivity would undermine his twin challenges after the pandemic: fixing regional economic disparities and reaching a “net zero” target for cutting carbon emissions. And yet, things may not be quite as bad as they appear.
On the face of it, Brexit makes solving the problem harder. Trade improves productivity through several channels: Imports expose domestic companies to increased competition and force improvements to products and services; importing companies get better supplies for their own goods; exporters learn from their overseas customers; and more competition forces inefficient firms to exit the market.
Brexit created a load of new non-tariff barriers — things like customs controls, sanitary and phytosanitary checks (ensuring the safety of plant and animal trade) and rules of origin. If trade barriers mean some industries are less viable, such as the beleaguered shellfish industry, then labor will have to be deployed elsewhere, perhaps less efficiently. Some have noted that even the loss of au pairs and nannies from EU countries will impact the productivity of British families that relied on them.
It’s possible some trade barriers could be lowered by mutual agreement, although Britain hasn’t yet started enforcing customs checks on imports, which will add frictions. The OBR estimates trade will be up to 15% lower because of Brexit, and its worrying productivity forecasts are in line with analysis produced under Theresa May’s government in 2018.
Despite that grim assessment, there are a couple reasons for optimism. The OBR estimated that two-fifths of the total productivity hit of Brexit was incurred in the period after the 2016 referendum, when consumers cut back on spending and investment levels fell. There was also presumably the impact of productive resources being diverted for Brexit preparations. If so, then Britain has absorbed a good share of the hit already.
More important, the actual picture might not be as bad as the OBR suggests. David Frost, who negotiated the Brexit deal on the UK’s behalf and who’s now a cabinet minister overseeing the EU relationship, argued in a lecture last year that the impact of non-tariff barriers has been exaggerated. He questioned some of the orthodoxy that trade drives productivity, which is based largely on the impact of trade-opening measures on less developed economies.
You’d expect Frost to downplay any negative impacts of Brexit. But does he have a point? “The trade-productivity relationship is very complicated,” says Geoffrey Wood, an economist at City University’s Business School. “There will probably be short-term harmful effects, but these may come from innovating faster than usual. And also, we’re not moving toward or away from free trade, but to more free trade with some and less with others — notably the EU.”
Trade substitution may be slower going in practice. So far, most of Britain’s new trade deals merely roll over existing EU agreements. Even a deal with Japan only gives a boost of 0.07% to GDP over the long term. An agreement with the US., which would add about 0.16% of GDP over the long term at the high end of estimates, doesn’t look likely soon. And relations with China are, at best, rocky.
Still, Wood’s broader point is that the openness of the economy and the strength of its institutions matter. “Open economies tend to have better governance and that in itself helps innovation and investment,” he notes.
As a rich EU member, the UK wasn’t highly incentivized to solve its productivity puzzle. But a decade of low wage growth generated resentments that fed into the Brexit vote and changed the electoral map in the 2019 elections, as the country’s former industrial heartlands abandoned the Labour Party. Productivity got political.
Indeed, productivity is the key to the success of Johnson’s “levelling up” agenda and he seems to know it. It was a core part of his 2019 Conservative Party conference speech. That explains this government’s attitude toward public spending. New strategies, with heavy financial commitments for national infrastructure, skills and training and boosting investment and innovation, are all aimed at the problem.
The devil is in the implementation. Government resources and attention are finite and there are so many demands on a ballooning post-pandemic budget that the challenge is prioritization. Building roads, homes — on which there is no compelling strategy — and rail services, and improving education and skills for a modern workforce, takes time to feed through into growth and living standards. Brexit complicates the productivity picture, but it at least brings an intensity of focus to the problem.
Bloomberg
