Whatever may follow Wednesday’s crucial ‘indicative’ votes in Parliament, planning for the post Brexit economic environment is long overdue.
It matters not if it is a soft Brexit, no deal, short extension, long extension or an election. It’s now time for sustained and concentrated efforts by the British government to begin shaping policy to mitigate the paralysis that has dampened the economy.
Whether it’s 'Brextra Time' or a new referendum, it’s far past time to lift the uncertainty tax that has hung like a sword of Damocles over the UK economy for the past three years. Anything else would be a dereliction of duty by elected officials that need to start putting in place policies to palliate the post exit pain that is coming.
For the past two years, the primary deadweight holding back the British economy has been the uncertainty over the direction of policy linked to the type of exit from the European Union. That uncertainty has led to a policy paralysis of the highest order. It is important for policymakers to acknowledge the supply shock that is coming as the economy exits the EU.
The delinking from continental supply chains will be painful and the optimal policy that will need to be put in place should not wait for confirmation of the decline. Ex-ante action of the first order is warranted linked to the shape of the economy in a post Brexit world.
These policies should revolve around reductions in tariffs, incentives to bolster outlays on capital expenditures and a reduction in rates by the Bank of England. These should all be put in place as soon as possible following any exit whether it be after April 12 or after an election which points to leaving the EU.
First, the government’s plan to reduce tariffs by 80 per cent is a good start. It is necessary but not sufficient. Where possible these should be cut to 100 percent to boost exports in line with what will likely be a depreciation in sterling against the euro and the dollar. Even then, arguably, it will not be enough.
Many who may choose to support the status quo will argue that free trade agreements will be put in place and there is no reason to support robust and sustained action. That’s an overly optimistic outlook that is not tethered to any empirical reality.
It will not be months, but years before any new UK relationship with the EU or the United States can be negotiated. British policymakers need to act now and again later if necessary once the impact of the supply shock can be ascertained.
Second, in the final quarter of 2018 business investment declined 3.7 percent. If the status quo holds, there is no reason why firms will unlock pent-up demand for outlays on new software, equipment and intellectual property that will be the backbone of the service economy, supplanting the lost domestic manufacturing capacity that will follow Brexit.
Make no mistake about it – write offs and consolidation are coming to domestic manufacturing operations enmeshed in European supply chains. The fracturing of those economic ecosystems requires strong and sustained measures to cushion the blow following the de-linking from the EU.
Third, the Bank of England should alter the balance of risks to the economy and begin to shape expectations for a rate cut in its primary policy variable. It should prepare to bring the nominal policy rate down from 0.75 percent to zero in an effective and orderly manner with the goal of pushing the real rate further into negative terrain from the current -1.15 percent by the end of 2019 at the latest.
Inflationistas will certainly cry out, but I doth think they protest too much. The hit to the economy will almost certainly result in a weaker inflation trend over the medium term. Despite the fog of Brexit uncertainty surrounding the dysfunction in the British government the BoE needs to act. The monetary and fiscal authorities can worry about inflation once the need for stabilisation policies has passed.
The political dysfunction in Whitehall implies that the long period of uncertainty is not likely to an end anytime soon. However, that does not mean the domestic economy need be left rudderless. With only 75 basis points of firepower on reserve at the Bank of England, the fiscal authority will need to move deliberately and in advance of the hit the economy will take over the next year. Failure is not an option.
See our Brexit checklist for guidance on how to mitigate risk, maximise opportunity and maintain continuity.