An extension to Article 50 deadline until 31 October 2019 resulted in the UK government halting the contingency no-deal planning. On the one hand, this gives the UK time to secure a deal with the European Union (EU) but on the other, adds to the business uncertainty with damaging effect on business confidence and investment plans.
The uncertainty is made worse by unanswered questions on how the UK will transition to a new UK-EU trade relationship, what this means for market access for UK businesses, clarity on regulations to employ migrant labour and future regulatory framework.
Ongoing business uncertainty and lack of clarity surrounding UK’s exit from the EU has affected the economy. The UK economy grew by just 1.4% – the lowest growth rate since 2012 (IMF, 2019).
Figures released by the Office of National Statistics (ONS) report that UK’s gross domestic product (GDP) increased by 0.2 percent in the fourth quarter, and business investment declined by 0.4 percent between 2017 and 2018. In volume terms, the estimates by ONS (2019) show that business investment has fallen by 0.9% to £46.7 billion between Quarter 3 (July to Sept) 2018 and Quarter 4 (Oct to Dec) 2018 (see Figure 1).
The data also shows that the period October to December 2018 was the fourth consecutive quarter-on-quarter fall in business investment and this decline was for the first time since the economic downturn of 2008-2009 (ONS, 2019).
The International Monetary Fund (IMF) issued a warning on the potential detrimental impact of Brexit on the UK and EU economies (IMF, 2019). The estimates show that the EU will lose the world’s fifth largest economy, which represents more than 15% of the EU’s combined GDP.
The UK will not be able to benefit from the network of more than 40 free trade agreements (FTAs) that the EU has in place. This implies that UK content will no longer count towards rules of origin requirements for EU goods exported to FTA partners with damaging effect on trade and business.
The Bank of England (BoE), in the summary of business conditions released in December 2018, stated that “investment intentions eased further, with a growing proportion of contacts putting new capital investment on hold until there is greater clarity around Brexit” (ONS, 2019).
To retain contracts or win new business, firms have had to build up months of stock, tying up all their working capital and exhausting their lines of credit. In addition, the stocks of inventories and finished goods have been rising at the highest pace in March 2019 and this is likely to destabilise future production and just-in-time supply chain, lock up working capital with a devastating impact on business credit lines.
Business groups and trade associations, such as Confederation of Business and Industry (CBI), Federation of Small Businesses (FSB), British Retail Consortium (BRC) and MakeUK, have articulated business concerns. They have reported a tangible negative impact in the confidence of businesses to invest in UK operations, and expressed the view that businesses will be unable to agree new contracts with European customers until the terms of trade with the EU become clearer.
Data shows that the UK ranks tenth and fourth as an exporter and importer in global trade, respectively. The Department for International Trade (DIT) (2018) released estimates that UK exports and imports were £ 661.7 and £629.4 billion, respectively.
Among the main partners, seven countries are from the EU. Germany is the largest trading partner by value (£78.6 billion in 2017) while Ireland is dependent on UK trade in terms of its share of total trade. In 2016, UK exports to the EU were 47% of total trade. The other major trading partners were USA (15%), Switzerland (5%) and China (4%).
The pattern of trade interdependence is evident from UK’s trade from the EU – 52% imports were from the EU compared to 22% from three countries combined – China (9%), USA (9%) and Switzerland (4%). In 2015, about 44% of UK exports were to the EU, and approximately 53% of total UK imports originated in EU countries (WTO, 2017).
The UK is an important production and consumption player in the European value chain following its membership of the EU that has allowed UK’s manufacturing sector to embed intermediate EU inputs into exports.
UK firms are highly integrated in pan-EU supply chains that enabled the manufacturing sector to integrate production and specialise in activities in which firms have a comparative advantage.
Brexit could lead to dislocation of trading links between the UK and EU, given that intermediate goods and services from the EU account for 44% of British exports and 53% of imports (Khorana and Escaith, 2019).
The authors estimate that transport equipment, chemicals and electronics sectors will be primarily affected due to disruption of the existing supply chain linkages, so much so that after the UK leaves the EU supply chains will need rebalancing.
This is in line with report (2019) issued by The Society of Motor Manufacturers and Traders (SMMT) which highlights a drop in new investments in the auto industry by half in 2018.
Against the backdrop of uncertainty and lack of trading relations clarity, it is likely that manufacturers would move some of their UK operations to the EU to avoid supply chain delays and to address the increase in costs of moving dutiable inputs multiple times across the border.
Uncertainty about future trade policies is impacting on business confidence and investment and firms are likely to postpone making strategic capital investment decisions about warehouses, factories or logistic capabilities.
Decisions that cannot be postponed may be biased in favour of non-UK locations. Given businesses calibrate cost levels versus service levels of nodes in the supply chain if transaction costs are high, firms may reconsider and review the current or planned locations in the UK, as is the case with automobile manufacturing firms such as Honda, Nissan and BMW among others.
To mitigate uncertainty from Brexit any deal between the UK and EU must provide frictionless trade, regulatory alignment, access to labour, and a lengthy transition period that allows time to businesses to adapt to change.
The UK will have to have a close partnership with the EU through a customs union and regulatory alignment for frictionless trade and this may be the only answer. If the UK is out of the customs union this may mean that it is able to renegotiate trade deals with the rest of the world.
But while the trade deals are being sorted out and with limited access to the EU markets, multinationals and major supply chain anchors may re-assess the attractiveness of the UK as a gateway to the EU market and switch base to the Continent with devastating effect on UK businesses.