Impact of Brexit: UK leaving the European Union

The possibility of UK leaving the European Union without a deal at the end of October seems high as one gets to read reports describing the possible impact of the event; some of these have been published by the UK government itself.

A report published by the Office for Budget Responsibility (OBR), a public body that provides independent analysis of UK’s public finances, outlines the impact of the event. The report says that a no-deal Brexit will shrink the economy, pull down the value of pound, increase unemployment and send house prices tumbling, as Britain will most likely be hit by a recession that could last up to a year. The economy will go into a recession as people and businesses will be reluctant to spend due to the increased uncertainty and falling confidence on investment and trade.

The International Monetary Fund (IMF) had released a report in April 2019, which outlined a couple of no-deal Brexit scenarios; this report by OBR is based on the “less disruptive” of the two no-deal Brexit scenarios. OBR’s scenario is based on the “stress test” devised by the IMF to model the impact of no deal on the British economy. As per the OBR report, the economy would shrink by 2%, unemployment will rise above 5%, house prices will drop by around 10%, and borrowings would increase by £30bn a year due to the downturn.

In the following paragraphs, we take a look at the various assumptions associated with these predictions made by OBR and suggest policy measures that could be undertaken to mitigate against the downsides.

Findings & Discussion

It looks as if the UK is all set to leave the European Union (EU) on 31 October as they have the option to exit EU under a no-deal clause where UK could overnight leave the EU without any agreement in place (BBC, 2019). Once UK leaves the EU, it will cease to be a member of several EU bodies, will no longer contribute to the EU budget, and will not be able to access the EU market as it does now.

When an event of such magnitude takes place, there is bound to be disruption of some magnitude as the businesses will need time to adjust to a new world. However, there doesn’t seem to be a consensus regarding the scale of the impact.

Supporters of Brexit feel any disruption to the business could be quickly overcome, and that some of the suggested risks have been grossly exaggerated. Opponents of no-deal however are of the opinion that the move will cause considerable damage to the economy.

OBR, UK’s spending watchdog and a body that provide independent economic forecasts and independent analysis of the public finances, released a report in July 2019 where it provided an analysis of one of the Brexit scenarios mentioned in an April 2019 IMF report (OBR, 2019).

The report lists how UK could be impacted, and makes a few assumptions.

The main assumption is that a no-deal Brexit would cause a year-long UK recession. This is because most businesses are likely to get impacted in the near term, there is going to be increased uncertainty, reduced confidence would deter investment, higher trade barriers with EU would impact exports. All these would most likely push the economy into recession, which will cause asset prices and the pound to fall sharply (Graeme Wearden, 2019). So, the OBR report makes an assumption that UK will face a year-long downturn.

Other assumptions made in the report include:

• The UK economy would contract by as much as 2% in 2020 before recovering in 2021.
• A year-long downturn would increase borrowings by as much as £30bn a year (a slump in the economy would hit tax collection as well, which explains the deterioration)
• Value of pound will deprecate by 10 percent almost immediately, which could increase prices of UK manufactured products and affect several UK based businesses. Its assumed that UK’s competitiveness with EU will reduce in the near terms, and to compensate for that a fall in the value of pound will take place.
• Trade will follow WTO rules and tariffs. Imports into UK will attract the temporary tariff regime for certain products and services
• Migration into the UK will likely reduce which could weaken the labour force. This along with high trade barriers could also affect the potential output growth.
• Equity prices is expected to fall up to 5 per cent in the immediate quarter
• Unemployment could increase to over 5%.
• House prices will most likely reduce by as much as 10%. Commercial property prices will be more impacted compared to the residential market.

These numbers, mentioned in the OBR report, have also been analyzed by several leading newspapers, including Bloomberg (Andrew Atkinson, 2019).

The OBR report also mentions that its analysis is based on the April projections of the International Monetary Fund (IMF). So, the report assumes that the data provided by the IMF report is accurate. The OBR report says that it’s analysis is actually a scenario and not really a forecast; the report also does not specify what UK’s fiscal policy should be in such a scenario.

OBR’s analysis also presents a “less benign” version as it is based on the less gloomy of the two scenarios which were produced by IMF earlier. A worst-case scenario sketched out by the Bank of England last November estimated a much bigger impact to the economy (Graeme Wearden, 2019).

Let us know take a look at some of the measures that could help to mitigate these effects so that there is no chaos and/or significant economic damage.

• The UK service industry will most likely lose its guaranteed access to the EU single market which is likely to affect people in most professions, as well as businesses.

In such a scenario, the government could focus more on growing trade with these countries and also look for opportunities to do trade with other non-EU countries. Identifying and targeting new markets will take time because of the various factors involved, but this is something that businesses should seriously start exploring.

The advantage to this approach is that any loss from business to EU could be offset by exporting to non-EU countries.

The good thing is that UK already exports to several countries outside Europe, and the economies of many such countries (including India) are showing impressive growth, so it should try to capitalize on it and try to expand trade with such countries.

• Currently, the financial services sector in UK, which also happens to be Europe’s leading financial centre, has “passporting” rights that allow them to offer products to EU and European Economic Area (EEA) while adhering to only one set of regulations (Ben Waterton, 2019). Thousands of UK firms rely on corporate passports to conduct business with EU.

However, not many are sure whether passporting will be retained post-Brexit, which would mean additional costs for UK financial companies in order to adhere to the new set of regulations.

So, it is important for risk managers to analyze various scenarios and come up with mitigation plans to counter any impact this might have on their business.

• Post-Brexit Trade will be carried out as per the rules and regulations of World Trade Organisation (WTO), which means tariffs may be applied and border checks for goods could happen at ports. However, lot of countries are already trading as per WTO’s tried and tested rules, so it is a matter of getting used to and adapting to the new rules.

Another area that businesses should study is that if it makes business sense to start operations within the UK. If a business has most of its customer base in the UK, it might make sense to set up operations in the UK, in order to avoid trade tariffs which could help the business price their products competitively. While this may not always be viable business decision, it is something that companies should investigate.

• Manufacturing companies must try to put a system in place that will identify supplier risks. It’s important to map out the full supply chain to see if the suppliers can get impacted due to Brexit. Where all the suppliers based – UK, EU? If the suppliers of a business have significant exposure to Brexit, it needs to be investigated how they will get impacted. Businesses will need to liaise closely with their suppliers and get a proper understanding of their challenges and action plans (Alex Saric, 2018). If a company’s supply chain faces enhanced risk due to Brexit, they will need to start looking for alternatives right away, because it takes time to identify reliable suppliers, especially when the new suppliers are located in countries where you do not have any business relationship.

Manufacturers will also need to work closely with their suppliers and ensure they are prepared as well for the event. It’s important to build trust and relationship with partners so that all the parties involved can quickly adapt to the new environment, when the need arises. It’s often seen that Agile supply chains are generally the ones that are also the most collaborative.

So, for manufacturing companies, this is the time to take a closer look at their supply chain, see where slowdowns of components could occur, and understand how easy it would be to tweak the supply chain to incorporate changes in the near future.

• Businesses will need to keep an eye on logistics. It makes sense for businesses to monitor logistics related developments.

Because of tariffs and border checks, goods shipped to/from or via the UK will most likely be impacted. It means, businesses may have to deploy additional administration staff to track the shipments, and also hold higher levels of inventory to overcome longer lead-times and possible customs delays.

All these can increase the working capital requirements. So, businesses will need to monitor developments related to logistics and also plan for additional working capital that may be required, before it turns into a crisis.

For the immediate short term, companies can prepare for the downturn by stockpiling on products, raw materials, in case supplies are disrupted after Brexit.

• No-deal Brexit will cause the pound to fall by as much as 10% as per the report. Prices of some utilities, food, medicines may increase.

Because the pound is likely to become weaker, businesses in UK may have to increase the prices of products.

It makes sense for businesses to find out how their customers are likely to react and how much price sensitive the customers are, and perhaps condition them to brace for price increase.

While it seems unlikely that businesses will price the products a lot higher (to compensate for the full Brexit cost impact) so as not to drive their customers away, small price increases can help businesses cope with the challenge.

• Businesses may also have to factor in visa related costs, assuming rules related to travel gets impacted.

Post Brexit, UK nationals will be able to enter the EU without any visa for short periods. However, this facility will be extended to UK nationals only if its reciprocated, meaning that even EU nationals should be also to enjoy the same conditions when travelling to the UK (Estefania Narrillos, 2019).

In case this doesn’t happen and if travelers will require visas to travel between UK and the EU, businesses will have to incur additional visa costs and also factor in visa processing times as key people are always required to travel for smooth functioning of their businesses.

Travelers will also be expected to take insurance covers to cover for their medical treatments when travelling to other countries in the EU. Until now, UK nationals were able to access healthcare benefits during a temporary stay to other member states in EU via the European Health Insurance Card (EHIC). However, that will no longer be applicable once UK leaves the EU. EU nationals travelling to the UK and UK nationals travelling to EU countries will require private insurance that covers the costs of medical treatment abroad (Newsroom, 2019).

Currently, the U.K. is scheduled to exit the EU at the end of October in 2019, and the current Prime Minister Boris Johnson has promised to stick to the deadline with or without a divorce agreement.

Countries like Ireland are expected to bear the brunt of the event; countries that export a lot to the U.K. are also expected to be severely impacted.  Many are worried that a no-deal exit move not only impact the UK economy, it could have repercussions on the global market as well. The US-China trade war has already created an increased level of uncertainty in the global markets.

Any shock to the U.K. economy usually impacts the European economy hard and the impact can then reverberate round the globe. So many are worried that the no-deal Brexit could impact global sentiments and result in a cascading effect, and could kickstart a downward spiral in markets (David Goodman, 2019).

The OBR April 2019 report, based on the IMF scenario, says that if Britain crashes out of the European Union without having any transition pact in place, the effects would be detrimental to the British economy and plunge it into recession.

Not just the OBR report, but a lot of analysts are predicting that the move would tip the already fragile economy into a recession. More than the impact of the no-deal Brexit it’s the uncertainty associated with the event seems to be a problem for everybody right now. In this uncertain scenario, lot of companies will stop or delay spending on capex as many would want to wait and see what happens with Brexit, and that itself is enough to slowdown the economy.

Currently, passions are running high due to the uncertainty surrounding the no-deal Brexit, and one gets to read sensational headlines in media. So, it’s important for the government to seek opinions of experts on the matter, rather than get swayed by the noise. Most economic forecasts are based on certain assumptions, and forecasters usually assume worst-case scenarios which may not necessarily come out to be true; the analysis are also usually vulnerable to forecasting errors, considering the nature and limitation of most forecasting models.

So, the government should take opinions about the repercussions from more experts as its quite possible that most of the claims about the risks could be exaggerated. Lot of experts also feel that a plunge into recession, given the resilience of the UK economy does not seem credible. Besides, the OBR report is based on scenarios suggested by IMF so it would be worth investigating if the IMF analysis took into account the relevant factors, and if in the past, projections made by IMF in this matter have come out to be true or not.

The government and businesses need to be well-prepared to face the consequences, and should consider taking necessary steps to mitigate the impact of this event. The government should also pledge additional budget to prepare for the various eventualities considering a range of Brexit scenarios.

Q. Assess critically what the potential impact on businesses could be as a result of the UK’s withdrawal from the EU. Reference should also be made to the current stage of negotiations between the UK and the EU.

Answer:

The United Kingdom exited the EU on 31 January 2020 and has since entered a transition period that will last 11-months. During this period, the UK will remain part of the single market and will effectively follow all the EU rules, but it will not be a part of the political institutions. A no-deal Brexit refers to the scenario where UK would immediately leave the European Union (EU) without any withdrawal agreements. While, the deadline for extending the transition period has passed, one of the top priorities for the two sides is to negotiate a trade deal. If the end result is no trade deal, then the UK faces the prospect of tariffs on exports to the EU.

While the UK may try to get as much access as possible to the EU market for its goods and services, it may also want the freedom to diverge from EU rules so that it can easily do business with other countries as well. Besides, the trade deal, UK will have to agree on several other areas (such as security) where co-operation would be needed.

If the UK ceases to be a part of the EU free trade area, the following aspects related to businesses are likely to be impacted:

• The Import and export of goods and services from the United Kingdom to and from EU countries will be impacted due to possible addition of tariffs and duties
• Employment of EU citizens in the UK, and UK citizens in the EU is likely to be impacted. Employees may require some kind of visa to access the markets.
• Transport and logistics will be affected; they are likely to be held at border posts for checking and to see if appropriate papers are in place.
• Product safety standards including packaging and labelling may be impacted, as UK and EU may follow different standards.
• Areas like Eco-compliance, Environmental industrial standards, including emissions, could be impacted because EU and UK may have different standards.
• Copyright, trademarks and patents could be impacted.
• State aid, including grants and block exemptions could be impacted.
• Mutual recognition of qualifications and relevant licences for various industries. Again, the two sides may have differences on these.

For UK businesses, Brexit has been a major source of uncertainty for some time now with a majority of businesses anticipating that Brexit will eventually result in reduced domestic as well as overseas sales and will increase costs. UK based businesses that see Brexit as a source of uncertainty have also experienced reduced investment and employment growth. UK Firms also feel that Brexit will impact their productivity. UK based firms sell more to the EU, import more from the EU, and use more labor from the EU expect Brexit to adversely impact their sales. UK firms that are more internationally exposed tend to be more productive (above the average) and Brexit will eventually have a bearing on their productivity.

References

Alex Saric (2018), How to mitigate risk in manufacturing with the Brexit clock ticking  [Online]. Available at https://www.manufacturingglobal.com/people-and-skills/how-mitigate-risk-manufacturing-brexit-clock-ticking  [Accessed: 06 October 2019]

Andrew Atkinson (2019), U.K. Faces Yearlong Recession in No-Deal Brexit, Watchdog Warns [Online]. Available at https://www.bloomberg.com/news/articles/2019-07-18/u-k-faces-recession-in-no-deal-brexit-watchdog-warns [Accessed: 03 October 2019]

BBC (2019), What is a ‘no-deal Brexit’? [Online]. Available at https://www.bbc.com/news/uk-politics-48511379  [Accessed: 06 October 2019]

Ben Waterton (2019), Brexit checklist for risk managers: How will it affect your business?  [Online]. Available at https://www.airmic.com/news/brexit-checklist-risk-managers-how-will-it-affect-your-business [Accessed: 06 October 2019]

David Goodman, Craig Stirling, and Liz McCormick (2019) How a No-Deal Brexit May Become a Problem for the World Economy [Online]. Available at https://www.bloomberg.com/news/articles/2019-10-04/how-a-no-deal-brexit-may-become-a-problem-for-the-world-economy [Accessed: 06 October 2019]

Office for Budget Responsibility (OBR) (2019) Fiscal Risks Report, July 2019 [Online]. Available at https://obr.uk/docs/dlm_uploads/Fiscalrisksreport2019.pdf [Accessed: 03 October 2019]

Estefania Narrillos (2019), Brexit: reciprocal visa-free access for EU and UK nationals [Online]. Available at http://www.europarl.europa.eu/news/en/press-room/20190403IPR34819/brexit-reciprocal-visa-free-access-for-eu-and-uk-nationals [Accessed: 05 October 2019]

Graeme Wearden (2019), Britain at risk of ‘full-blown’ recession as no-deal Brexit looms – as it happened [Online]. Available at https://www.theguardian.com/business/live/2019/jul/18/no-deal-brexit-uk-recession-obr-fiscal-risks-retail-sales-business-live  [Accessed: 04 October 2019]

Newsroom (2019), Brexit: Plans in place to mitigate impact of no deal [Online]. Available at https://moderndiplomacy.eu/2019/07/27/brexit-plans-in-place-to-mitigate-impact-of-no-deal-2/  [Accessed: 05 October 2019]

Ruth Lea (2019), Take these No Deal meltdown warnings with a large pinch of salt [Online]. Available at https://www.conservativewoman.co.uk/take-these-no-deal-meltdown-warnings-with-a-large-pinch-of-salt-2/ [Accessed: 05 October 2019]

(Tim Wallace and Tom Rees, 2019), Deficit to double in ‘no deal’ Brexit recession, Budget watchdog warns [Online]. Available at https://www.telegraph.co.uk/business/2019/07/18/deficit-double-no-deal-brexit-recession-obr-watchdog-warns/  [Accessed: 04 October 2019]

Will Dunn (2019), Would a no-deal Brexit crash the housing market? [Online]. Available at https://www.newstatesman.com/politics/uk/2019/10/would-no-deal-brexit-crash-housing-market [Accessed: 04 October 2019]

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