The UK’s decision to leave the European Union will affect the UK economy for decades to come. In the short term, it led to the pound falling sharply, but didn’t affect the immediate growth performance of the economy. In the longer term, the country’s new trade arrangements with the EU and the rest of the world will be crucial in determining Brexit’s economic impact.
Short-term effects of Leave vote
If a Martian economist compared the performance of the UK economy before and after 23 June 2016, they would not really notice any difference. Contrary to most economists’ expectations growth continued in line with the trend of previous years, supported by strong growth in consumer spending. But that is not to say the vote had no effect. The pound and remains around 10% below its pre-vote value.
A weaker pound may boost UK exports (at least in the short-term) but it has also pushed up inflation via higher import prices, squeezing household incomes. In addition, the pound’s decline means UK assets – its wealth – are worth now than they used to be, compared with other countries. This matters because we buy a lot of things from abroad: imports are equivalent to 30% of UK GDP. If our incomes don’t rise to compensate for the lower value of the pound, we become poorer.
Exchange rates can and do fluctuate for all sorts of reasons. In this case the fall in the pound is clearly a result of the referendum outcome, presumably due to the belief that Brexit will harm the UK economy. If this view changes, say if the UK agrees many advantageous trade deals, the pound may lost ground.
Long-term effects of Brexit
Brexit won’t be the only factor to affect the economy by any means. There is, for instance, the critical question of whether the economy breaks out of its decade-long productivity stagnation. Nevertheless, when all is said and done, how will Brexit have affected the UK economy?
Both sides of the referendum debate broadly agree that it’s in the UK’s best interests to have an economy open to trade and investment. Economists agree. Theory and literature show a link between the degree of openness to foreign trade and investment and long-term growth rates (see margin). In other words, more barriers to trade and investment lead to lower growth.
New trade arrangements
We obviously don’t know the scale and scope of the UK’s new trade and investment relationships in a post-Brexit world but we can make some
It is likely that following Brexit it will be more difficult for UK companies to trade with the EU and for EU companies to trade with the UK. The degree to which this is the case will depend on the type of trade relationship that is negotiated.
The UK’s future trading arrangements with non-EU countries will also be important in determining Brexit’s long-term economic impact. After leaving the EU, the UK will be able to negotiate its own trade agreements with non-EU countries (if it leaves the EU Customs Union, which seems very likely). The UK will also likely have to renegotiate the trade deals the EU currently has in place with other countries (11% of UK exports go to these countries).
What does it all mean?
As a result, they believe the final post-Brexit settlement will leave the UK economy less open, lowering the UK’s long-term growth rates compared
to a scenario in which the UK had stayed in the EU.
Other factors will also play a role in determining Brexit’s impact. The UK, if outside the Single Market, will have more control of its regulations (potentially making them more business-friendly) and immigration policy
Much is still uncertain about the UK’s post-Brexit trading arrangements. How these new relationships shape and change the future of UK trade and investment will be crucial in determining its long-term economic impact.
This article is part of Key Issues 2017 – a series of briefings on the topics that will take centre stage in UK and international politics in the new Parliament.
How greater openness to trade and investment can benefit an economy
- More investment – increases amount of capital in the economy (machinery, computers, etc.) leading to higher labour productivity growth
- New technologies – foreign investment is often associated with technological innovation and better work practices, which may then be adopted by domestic firms
- Competition – more foreign companies in domestic market can lead to increased innovation and efficiency
- Specialisation – easier access to large trading markets allows domestic firms to specialise and expand, improving productivity