The underperformance gathers pace

One of the exercises I have been conducting over the past three years is to assess how the UK economy has performed relative to pre-Brexit referendum expectations. At the end of 2017 I looked at the economy’s performance and motivated by this set of tweets by FT journalist Chris Giles, I thought it worthwhile providing an update. The analysis is complicated by historical revisions to data which make it extremely difficult to compare GDP levels. But based on data for growth rates we can make some observations.

Rather than use one single forecaster as a reference, I have compared outturns against a panel of long-term GDP growth forecasts made in May 2016  which are reported in the Treasury’s monthly publication ‘Forecasts for the UK economy’. No less than 14 institutions made projections covering the period 2016 to 2020 (with a higher number providing near-term projections) providing a decent sample size. Using the current 2019 consensus forecast as a basis for this year’s outturn (we already have half of this year’s GDP figures so it is a reasonable assumption), real GDP in 2019 is likely to end up around 2 percentage points lower than predicted prior to the referendum (chart 1). That is equivalent to a year’s worth of pre-referendum expected GDP growth.

Measured in terms of constant 2016 prices this amounts to £41.5 bn. With the GDP deflator estimated to have increased by a cumulated 5.7% since 2016, this amounts to a loss of GDP in nominal terms of around £43.9 bn. For the record, that averages out at around £281 million per week. Recall Boris Johnson claimed that the UK would be better off by £350 million per week. Even on the basis of his vastly inflated figures, 80% of the gains have been wiped out by weaker growth. But since the UK’s net contribution to the EU is actually between £150 million and £212 million per week, depending on how we measure it, (here for a useful ONS calculator) the hit to growth now far exceeds any savings from ending contributions to the EU budget. The further ahead we roll the figures, the worse it looks. Comparing the current 2020 consensus forecasts with the May 2016 projections, the loss of output translates into a figure of £328 million per week.

To understand why GDP has underperformed so dramatically it is worthwhile taking a dig into some of the components. We do not have long-term consensus projections for all the components so I have resorted to using the OBR’s pre-referendum forecasts to give a feel for the underlying detail (which can be found here). This dataset does, however, allow us to look at the data on a quarterly basis so we can compare the figures from the aftermath of the referendum right up until the latest data available (Q2 2019). 

After adjusting for the change in the national accounts base year, we discover that by mid-2019 household consumption was around 1% below the OBR’s 2016 projection. Government consumption is around 3% above the OBR’s estimate, largely thanks to a huge increase in outlays over the last nine months as the government has opened the taps. But the biggest single shortfall comes from fixed investment which is 10% below the 2016 projection, with business investment falling 15% below the forecast (chart 2). Indeed, all the non-investment components broadly net out against one another leaving the collapse in fixed investment to account for pretty much all the slowdown in GDP. And why has investment proved so weak? Because companies have lined up to tell us that Brexit-related uncertainty has forced them to put their capital spending plans on hold.

We cannot say with any certainty that the outturn in 2019 would have come anywhere close to the predictions made in 2016. But the comparison does show that there was a structural break in the way the economy was expected to behave and it is too much of a coincidence to say that it was not associated with the Brexit referendum. Brexit supporters will point to the continued strong performance of the job market and argue that the UK has continued to create jobs. It is certainly true that the unemployment rate will turn out around 1 percentage point lower than the 4.9% rate predicted by the consensus in May 2016.

But in 2016, the OBR expected a cumulative increase in productivity of 5.2% between 2016 and 2019. Data released this morning suggest that output per hour worked has risen by a measly 0.9% in the last three years. Productivity is the key driving force of our living standards, and it is simply not rising fast enough. This may not all be due to Brexit – after all, productivity growth has underperformed for the last decade. However, the increase in output continues to be driven by labour input in a way which is reminiscent of less well developed economies and without any capital input to supplement it (i.e. investment), it is likely that GDP per head will continue to stagnate.

Finally, just to illustrate the UK’s economic underperformance in an international context, the ONS has compiled quarterly data on GDP across a range of countries. Using a base period of Q4 2016, the UK has underperformed against all major industrialised economies bar Italy and Japan, up to and including Q2 2019 (chart 3). You can argue as much as you like about the poor performance of Germany in recent months, but the data still show that it has outperformed the UK in growth terms since the start of 2017.

Politicians (and their advisers) focused on “getting Brexit done” are oblivious to the risks which Brexit poses to the economy. To be frank, most of them are spectacularly ignorant of even basic economic concepts so those ordinary voters who still support Brexit can be excused for their lack of understanding. But what the overall picture shows is that there was a structural break in the performance of the UK economy in the second half of 2016. It cannot be denied; it cannot be dismissed as Project Fear. It is there in the economic numbers in black and white. And the growth shortfall is broadly in line with estimates made prior to the referendum. Moreover, the UK has not yet left the EU. Things could get even worse, depending on the nature of the departure.

As I noted in a post last week, economics will ultimately determine whether Brexit is a success. The evidence so far suggests it is not going particularly well and those who continue to push this ruinously stupid economic policy will ultimately be forced by the evidence to account for their actions. Nobody has yet come up with any good economic arguments in favour of Brexit, and there is a good reason for that – there aren’t any.