What impact is Brexit uncertainty having on the UK economy?

This article is part of
Guide to the UK market post-Brexit

What impact is Brexit uncertainty having on the UK economy?

The vote to leave the European Union (EU) made by the UK electorate in June 2016, plunged the UK into economic uncertainty.

The debate facing policy makers up to that point in 2016 was how to square the circle of improved economic growth and falling unemployment with a lack of real wage growth, and sluggish productivity.

Those problems haven’t gone away, but have been swept from the consciousness of policy makers, the public, and their financial advisers faced with the challenge of understanding what the economic climate will look like when the UK exits the EU. 

Jeremy Lawson, an economist at Aberdeen Standard Investments, says the reason many policy makers, economists and advisers, including himself, are perceived to have been wrong about the economic situation in the aftermath of the Brexit vote, is because the change that happened in the economy was a “supply shock”, and not a “demand shock”.

Mr Lawson explains: “Economists - because most economists are in favour of remain - forgot that if a majority voted to leave, well, that majority were not shocked by the outcome, so they didn’t stop spending or change their behaviour.”

Supply and demand

Demand shocks tend to have a more immediate impact on the economy as people stop spending, while supply shocks lead to lower growth over the longer term.

Mr Lawson’s point is that demand shocks happen when the general public think their immediate economic prospects will become worse, and so reduce spending, causing the level of demand for goods and services to fall, and send the economy into recession.

He says that leave voters were happy with the outcome and therefore didn’t think their economic prospects had weakened, so continued to spend, meaning demand didn't fall.

A supply shock happened because the fall in the value of sterling caused input costs for goods and services to rise - for example, oil and metals. This makes it more expensive for those who supply goods and services to do so, limiting supply, while investors pulling capital out restricts the supply of capital in the economy, and workers leaving the country restricts the supply of labour.

All of those things are harmful to the long-term health of the economy, but the effects are felt in small doses over a prolonged period of time, rather than as a sharp shock, as many had anticipated.  

Andy Haldane, chief economist of the Bank of England, speaking before the Treasury Select Committee of the UK parliament in February 2018 quantified the impact of those supply shocks.

He said the long-term trend rate of growth, which is defined as the level of growth an economy can achieve in normal times without exceptional policies being pursued, will be 1.5 per cent a year as a result of Brexit, rather than the 2 per cent a year that would be the case without Brexit.