Last weekend’s news that Nissan will not after all build its X-Trail model in Sunderland, having indicated in 2016 that it would do so, highlighted once again that there are costs associated with Brexit: Trade-offs about which politicians have not been clear. To be fair, Nissan’s decision was not all Brexit-related and is partly due to the fact that demand for diesel cars in Europe is falling. But Brexit undoubtedly weighed at the margin. After all, Nissan set up shop in the UK in the 1980s to export to the European market but now that economic ties to the rest of the continent are threatened with disruption, the case for being here is weaker.
Nissan continued to make all the right noises about its commitment to its existing UK workforce but let’s not be fooled. It has R&D facilities in Belgium and Spain, and production facilities in Spain – as well as a joint venture with Renault which gives it access to production capacity in France. Nissan has options which may not necessarily include the UK, and given excess global auto production capacity, companies are always looking for reasons to slim down. But for the moment it will continue producing in Sunderland so long as border disruptions do not become too excessive. However, this hides a wider truth about Brexit which is often lost in the hysteria – as Tom Kibasi, director of the Institute for Public Policy Research, reminded us in an excellent article in The Guardian.
Although we cannot rule out Armageddon scenarios in the event of a no-deal Brexit on 29 March, the likelihood is that both sides will take pragmatic decisions to ensure business continuity. As Kibasi points out, “in a no-deal Brexit, the EU will not place the UK under some medieval siege; there won’t be trucks filled with rotting food in Calais or shortages of medicines in pharmacies.” But the longer-term effects will hurt. Just as happened in 2016, the economy is unlikely to immediately fall off a cliff but a sharp fall in sterling – generally expected in a no-deal scenario – will produce a spike in inflation and squeeze real incomes. To put it into context, real wages – which were rising at a decent pace of 2%-plus in 2015 – have flatlined since Q2 2016. As Kibasi put it, “living standards that have barely improved for more than a decade would get noticeably worse.”
Companies will also rethink their location decisions, as Sony and Panasonic have already done by shifting their European headquarters out of the UK. This may not matter so much if equivalent jobs can be created in other sectors, but the evidence suggests that such actions risk sending cluster effects into reverse which will have a bigger knock-on effect on employment. In effect, we will suffer a “boiled frog Brexit.” Drop a frog into a pan of boiling water and it will realise it is being boiled alive and hop out of the pan. But put it in a pan of cold water and turn the heat up slowly, and you can boil the frog without it being aware of its fate.
To assess this in economic terms, consider trends in potential GDP - the economy's underlying speed limit - and how Brexit could impact on it. The evidence suggests that growth potential has slowed anyway – the BoE estimated in this week’s Inflation Report that growth has fallen to around 1.5%, which is a full percentage point slower than twenty years ago (chart 1). In order to understand the underlying forces we can think of growth potential as being driven by three main factors: capital, labour and technical progress (or total factor productivity, TFP).
The good news is that the contributions from labour and capital have held up reasonably well. On my calculations based on European Commission data, they together contribute around one percentage point to growth potential which is not significantly different to twenty years ago (see chart 2). The real problem is the slowdown in TFP which has recorded its worst performance in a century (chart 3). Numerous possible explanations have been advanced for this slowdown. One view, promoted by Robert Gordon [1], is that the number and scope of technical innovations in the period 1870 to 1970 was exceptional in its applicability to a wide range of areas and there is no reason why this pace should be expected to continue. Another is that there has been a slowdown in the rate at which technology is diffused through the economy. Analysis conducted by the ECB [2] in 2017 suggests that there has been a widening gap across the OECD between productivity growth in so-called global frontier firms on the cutting edge of the technological revolution, and non-frontier firms which make up the bulk of the corporate sector.
What does any of this have to do with Brexit? On the one hand an ageing population, in which baby-boomers are retiring in droves, relies on immigration to expand the labour force. During the 1990s the working age population expanded at a rate of 0.3% per year. In the eight years prior to the financial crisis, this accelerated to 0.8% per annum, but over the last five years has slowed back to 0.3%. If we do not get any offsetting pickup in productivity growth, migration curbs will likely act as a drag on growth potential. Moreover, by reducing the attractiveness of the UK as a business location, the UK may not attract the technological leaders required to disseminate cutting edge technology and working practices into the UK capital stock, which will hold back any recovery in TFP.
Not all of the slowdown in potential growth is attributable to Brexit. Indeed, it is largely the result of pre-existing secular trends, but it threatens to make a bad situation worse. We may not notice this immediately but as we have learned over the last 10 years, a slower speed limit makes us all feel as though we are not doing as well as we once were.
[1] Gordon, R., ‘The Rise and Fall of American Growth: The
U.S. Standard of Living since the Civil War,’ Princeton University Press,
2016
[2] ‘The slowdown in euro area productivity in a global context’, ECB
Economic Bulletin, Issue 3/2017
