Brexit Economics: Die is cast for British and Irish economies

The Guardian newspaper today leads with the headline 'Irish leaders fear Brexit will bring economic disaster' while following a period of calm, the British economy appears to be moving towards big headwinds as Theresa May, the prime minister, risks being tarred with a new name: Mayhem.

While dire economic warnings may not materialise, both Ireland and the UK are unprepared for the economic blowback from Britain's exit from the European Union.

Ireland has a very low number of exporting firms while the Department of Finance's chief economist recently said that just 5 companies account for 30% of Irish headline exports — in 2014 Finfacts estimated that 40 American companies were responsible for about 66% of Irish headline exports in 2013.  Ireland also has a low rate of new startup firms  (see below).

As for the UK, it like Ireland also relies on the self-interest of foreigners for its standard of living.

Last January Mark Carney, governor of the Bank of England, warned of financial instability, higher interest rates and capital flight if Britain voted to leave the EU, saying the country could not depend on “the kindness of strangers” to fund the country’s deficits — "I have always depended on the kindness of strangers," is a line from Tennessee Williams' 'A Streetcar Named Desire (1947).  

The expressions "the die is cast!" or "let the die be cast!" are historically attributed to Julius Caesar who is said to have spoken the words in Greek in 49 BC, by the small Rubicon River in Northern Italy, before crossing in defiance of an old Roman law that forbade the general of a standing army to do so. The decision inevitably sparked a civil war with the Roman Republic.

Conciliatory statements by both British and European leaders in the aftermath of the June British vote for exit from the EU gave rise to hopes of compromises on the main issues but in recent weeks, the British government has stressed the importance of having control of emigration while the leaders of Germany and France along with Donald Tusk, president of the European Council, have ruled out any special concessions for the UK — every one of the remaining 27 EU countries have to agree to whatever deal is negotiated.

Banks in the City of London could begin making decisions to move assets out of the UK as early as the end of 2017 if there is no agreement to ensure their rights to sell services freely across the European Union, Open Europe, a think-tank, has warned. These rights are called passporting.

The warning came as the Financial Times reported Monday that the UK government is considering proposals [via Irish Times] that would see billions of pounds paid into the EU budget in exchange for giving the financial sector continued access to the single market.

The prime minister’s demand that Britain controls its borders and throws off the jurisdiction of EU judges has led many in London and Brussels to conclude that UK-based banks and insurers would inevitably lose the “passporting” rights that allow them to trade freely in Europe. But in a move likely to upset Eurosceptics in her governing Conservative party, Ms May has not ruled out making future payments to the EU to secure privileged access to the single market. Finance is among the sectors most likely to benefit in any deal that recognised the “equivalence” of regulatory regimes.

She assured Japanese carmaker Nissan on Friday that trading conditions for its car plant in northeast England would not change after Brexit, in the first suggestion the government could pick favoured sectors to shield from the impact of leaving the EU.

In the Open Europe report Monday, the think-tank recommends May push for a bespoke deal with the EU that ensures banks in the UK retain access to the bloc’s single market and offer reciprocal access for banks on the continent. It also says she should agree an interim agreement with the European Union that would preserve banks’ ability to provide services on broadly similar terms to now beyond the two-year negotiation period.

"The clear priority for the government is to maintain passporting or something close to it in wholesale banking," said Stephen Booth, acting director and director of policy and research at Open Europe. "The risk is there is contingency planning by banks who don’t want to be in a cliff-edge situation."  

However, speaking to an audience of policymakers in Brussels on Thursday, Donald Tusk said it was useless to speculate about a soft Brexit, in which the UK remained a member of the single market. “The only real alternative to a hard Brexit is no Brexit, even if today hardly anyone believes in such a possibility.”

Zanny Minton-Beddoes, Editor-in-Chief of The Economist

UK trade and investment

Opening up new export markets typically seems easier to politicians and others than it is for the people directly involved while the benefits of devaluation for exporters of commodities selling at a world price differ from producers of goods and services.

Some of the biggest exporters in the UK and Ireland are foreign-owned firms. This is important when looking at the potential for the UK increasing exports.

Ireland, Germany, Luxembourg, Belgium, the Netherlands, Denmark, and Sweden are some of the biggest consumers of UK goods.

Credit Suisse said in a note last August: “The past 20 or 30 years have seen a proliferation in global supply and value chains, changing the nature of trade.”

“Instead of a good or service being produced in one country and exported to and consumed in another, a growing share of a country’s exports are actually comprised of inputs from several countries,” the note says.

The investment bank added: “Improvements to a country’s competitiveness from exchange rate depreciation may be more limited than was the case in the past, as a weaker exchange rate means input costs will rise.”

The $49bn (£37.8bn) of foreign goods the UK imports then re-exports to the EU will only get more expensive as the pound falls. And many of the raw materials that go into the $158bn (£121.9bn) worth of UK-made goods exported to the EU are likely sourced overseas too. That means higher prices again.

Motor vehicles account for more than one-third of UK exports to China but these are from foreign-owned firms and could be sourced from elsewhere while, gold, re-export is the next biggest export at 17% according to a briefing paper by Bruegel, a Brussels think-tank.

The UK’s Brexit minister David Davis has argued that an FTA (free trade agreement) with China will reduce the intermediate cost of car components and increase the UK car sector’s global competitiveness. However, according to our estimates, only eight percent of the UK’s imports from China fall into the intermediate goods category, so the final effect is expected to be small.

Neither are re-exports of Chinese imports a threat as the UK has only two ports that can handle Chinese ships.

The City of London Corporation says: "Overseas owned companies represent 46% of all financial services groups worth in excess of £100m. This is nearly three times larger than any other sector of the market and demonstrates the continued international nature of UK financial services."

The FT says that half of the UK’s trade surplus in financial services — worth some £18.5bn in 2014 — comes from exports to the EU. London dominates across multiple niche areas of finance. It does 78% of the EU’s foreign exchange business and 74% of over-the-counter interest rate derivatives; 59% of international insurance premiums are written in London; and 85% of the EU’s hedge fund assets and 64% of private equity assets are managed in the city.

How important is the EU to UK trade?

Foreign investments in the UK and income from past investments overseas maintain the British standard of living.

The current account/ Balance of Payments — the trade and investment balance with the rest of the world balance — was at 5.2% of annual GDP in 2015, the biggest ratio in 67 years.

Germany has not posted an annual goods trade deficit in any year since 1951 while the UK's last trade surplus was in 1997.

Germany's record trade surplus in 2015; US, UK, France in deficit

The Office for National Statistics (ONS) says UK government expenditure has been larger than government income for most years since 1980, which is why the UK budget deficit has been typically positive since 1980.

Roughly 45% of the UK’s investment abroad is in Europe, with around 35% of holdings in the Americas. UK liabilities show a similar picture with just over half of investment into the UK coming from Europe, while around 33% coming from the Americas.

The UK hasn't reported a current account surplus any year since 1985!

The EY Item Club, a think-tank sponsored by a Big 4 accounting firm, has warned on the consequences of inflation that the UK economy has shown greater resilience than many had anticipated since the EU referendum but this picture is “deceptive.”

The think-tank forecasts inflation will rise by 2.6% in 2017, before falling back to 1.8% in 2018.

This will result in consumer spending slowing from an expected 2.5% this year to 0.5% in 2017 and 0.9% the year after, the report said.

Ireland

We have previously discussed here (first link) how the indigenous dominant food and drinks industry which has as many direct jobs at about 50,000 as the FDI (foreign direct investment) dominant drugs and medical devices sector, is most exposed to Brexit:

The fable of the frog and Ireland's response to Brexit

Irish tax break addiction and failed entrepreneurship

Is Euro Area Ireland's top trading partner?: EU28 is overwhelmingly UK's

The economic linkages of the food and drinks industry are much greater than the impact of drugs and medical devices sector.

Business demography data show that new enterprises in 2014 accounted for 6.7% of all enterprises in Ireland; 13.7% in the UK and 10.7% in Denmark.

The rate of growth of employer enterprises in the UK with at least 1 employee was 14.6% according to the ONS while a third of new enterprises in Denmark were employer firms. There is no comparable Irish data.  

In Ireland in 2014 there were 4,200 exporting firms (indigenous + foreign owned based on Enterprise Ireland and IDA Ireland data) or 1.8% of total enterprises of 238,000.

Despite there being 15 times as many UK-owned businesses exporting goods and/or services than foreign-owned (207,700 compared with 13,600), in 2014 there was a higher proportion of foreign-owned businesses exporting than UK-owned, 59.3% compared with 10.3%.

The population of Denmark at 5.7m, is 21% higher than Ireland's 4.7m population.

OECD's Entrepreneurship at a Glance 2016 report: Incidence of exporters, industry — Share of exporting enterprises in total enterprises, percentage, 2013 and 2011. Ireland provided no data>>>> 

In 2014 the Danish government said that Denmark has 30,000 exporting firms or 10% of enterprises based on demography statistics.  

The OECD says in its Entrepreneurship at a Glance 2016 report published last month (no data for Ireland):

The share of enterprises participating in international trade varies significantly from country to country, ranging from 10% to 40% for exporters and from 10% to 70% for importers. Larger countries tend to have smaller shares, largely reflecting the size of their internal market. But significant differences exist even among large countries. For example, the share of firms that export (import) in Germany is three (four) times as large as in France, reflecting the very low incidence of directly importing and exporting SMEs in France. In most countries, the number of directly importing enterprises was systematically higher than the number of exporters in 2013 and increased in many countries compared to 2011, pointing towards increased participation in global value chains. With the exception of Poland, most exporters are importers, again pointing to the importance of global value chains.

Ireland's indigenous exporting performance has been masked by tax-avoidance inflated FDI firm data. Now with the dependence of the food and drinks sector on the UK for over 40% of exports and with the trade balance with Britain having evaporated in recent years, the Tesco-Unilever fight about the price of marmite, is a signal of what awaits Irish suppliers.