What is a realistic UK economic forecast for 2019? That was the test the Financial Times set 81 economists and their answers, typical of the profession, were to say “it depends”. This year it depends crucially on Brexit. We all need to think clearly about potential Brexit effects in 2019, however, having got many of them wrong in 2016.
Britain’s economy is one of the most resilient in the world. Strong competitive forces mix with a flexible labour market in a much more regionally and industrially diverse economy than lazy caricatures suggest. It is difficult to break such complex systems.
Corporate uncertainty over the way Britain might leave the EU is insufficient to cause a significant downturn. Business investment fell in 2018, but it accounts for less than one-tenth of gross domestic product and building offices, kitting out a supermarket, updating software or buying vans does not end with Brexit. The postponement of big investment decisions is highly unlikely to do much more than damp economic growth figures.
A no-deal Brexit would raise big questions about the UK’s infrastructure and its system of distribution. Some supply chains would break and disruption is likely to be extensive because the normal functions of tax administration and product checks at the new UK-EU border would be far from instant. But, again, we should not exaggerate these supply effects for the whole economy.
In its “disorderly” Brexit scenario in November, the Bank of England had to throw everything at the economy to produce its large 8 per cent drop in output. Brexit would wipe out 5 per cent of the productive capacity of the UK economy, it assumed, even though goods and services exports to the EU account for only 14 per cent of the economy. Capital flight, a plunge in sterling and the associated inflation pressure would force the BoE to raise interest rates from 0.75 per cent to 5.5 per cent, it also assumed. I have yet to find even a member of the bank’s Monetary Policy Committee who thinks this is plausible. Embracing complacency is just as great a sin, however. Brexit could easily cause a deep UK downturn, but it would stem from the indirect effects of a drop in household spending rather than the direct effect of border disruptions or caution among business leaders.
With the benefit of hindsight, the error economists made in 2016 when expecting a worse reaction to the Leave vote was to predict people would modestly tighten their belts on account of the uncertainty Brexit would cause. Saving a little more of their incomes would slow growth, they thought. But the opposite happened; the savings ratio more than halved in 2016 from 7.8 per cent to 3 per cent. It has barely recovered, languishing close to a 55-year low of 3.8 per cent in the latest data, ripe for a rebound if confidence in the economy takes a knock in the next few months.
This is the story of every other UK downturn of the past 40 years. An external trigger generates job losses and a recession only when households lose confidence and curtail their spending. In the financial crisis a decade ago, the savings ratio jumped from 6.5 per cent to 11.9 per cent, causing the recession. Efforts to eliminate inflationary pressure in the early 1980s and 1990s generated similar increases in the savings ratio. It is telling that the BoE did not assume any rise in savings in its disorderly Brexit scenarios. That is why it had to assume such enormous disruption to generate the nasty effects.
Economists are therefore right to say the economic outlook depends on Brexit, but the crucial unknown for 2019 is not whether Brexit happens or whether it is hard or soft, but the response we collectively make. If politicians continue to test our confidence to destruction in their ability to govern, it would not take much to tip the UK economy over the edge this year.