Beyond Brexit: Outlook and Risks for the U.K. Economy

Four years after the June 2016 referendum, the U.K. finally struck a deal to exit the European Union (EU). Despite all the attention, controversy, and volatility that Brexit has brought, we don’t expect any meaningful effects on near-term economic activity. Firms are generally well prepared and the government has already rolled over most non-EU trade deals. And while there may be some temporary frictions at the border, they pale in comparison to the near-term uncertainty around the economic effects of COVID-19 and the speed of the vaccination distribution.

Productivity is key

In the long term, Brexit certainly raises many questions, but most areas of the economy will likely be largely unaffected. Labour supply is one example. While the U.K. will now control its own border, it is far from clear whether Brexit will lower net migration. Since the referendum, net inward migration has been mostly unchanged – lower EU migration has been offset by higher non-EU migration – and we see no strong reason for that to change going forward.

One key uncertainty is productivity. It is possible the new trading relationship lowers productivity growth at the margin, with more barriers to trade diluting the benefits from specialising in areas of comparable advantage. This will in part depend on the precise nature of the future U.K.–EU relationship. Negotiations will continue in coming years, especially on services, which were not part of the 31 December 2020 deal and account for the bulk of the U.K. economy. While these discussions may lead to some divergence between the two regions, in our baseline outlook we expect few differences in regulatory frameworks and frictions to services trade. Significant change in trade in services is a key risk, but frictions aside, we do not expect anything too radical.

Putting Brexit in context, however, there are much bigger questions around future productivity growth, which has been on a secular decline in the U.K. for many decades. While this has been a global phenomenon, the slowdown has been particularly pronounced in Britain since the 2008–2009 financial crisis. There are many possible drivers – measurement error, diminishing returns to innovation, scarring from the financial crisis, and anti-competitive regulation, to name a few. There are reasons to believe productivity will pick up in coming years as new technology improves efficiency. But other factors, including potential scarring effects from COVID-19, could depress productivity further. The impact of Brexit on productivity is likely marginal relative to these bigger questions.