Brexit Special - Bloomberg Professional Services
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
September 2016
Brexit Special
Britain is leaving the European Union, one of the world’s most
powerful trading blocs. What’s negotiated between the U.K.
government and its EU partners will have consequences for
decades.
This Bloomberg Intelligence report sets out the short-term
impact on the U.K. and traces the shock across the globe. It also
shows how new trade and migration policies might affect the
economy, and what Brexit could mean for the City of London.
— Jamie Murray, Bloomberg Intelligence Chief EMEA Economist
INSIDE
Britain’s Post-Vote Outlook p.2
International Spillovers p.4
Alternatives to EU Membership p.6
Migration p.8
Trade p.11
The City of London p.13
Asia p.16
Economic Analysis on Bloomberg
BI ECON
Britain’s Post-Vote Outlook
BY DAN HANSON AND JAMIE MURRAY,
BLOOMBERG INTELLIGENCE ECONOMISTS
Britain’s decision to leave the European Union is a shock, but it’s no Northern Rock moment
– predictions of a deep recession now look well wide of the mark. Still, the sudden lack
of clarity over future trading relationships, market access and even the domestic political
situation meant growth was always likely to slow. Elevated uncertainty will have curtailed
investment, delayed hiring decisions and crimped spending to some extent. The impact
on purchasing power from the weaker pound is also now beginning to be felt and will act
as a drag on spending.
Key points: Uncertainty. It’s a word often bandied to shed. BI Economics’ empirical model
around, but for it to have a useful mean- suggests that output might have been
The referendum outcome has deliv- ing it must be quantified. Bloomberg 1% or so higher if Britain had voted to
ered two shocks to the U.K. economy. Intelligence Economics has created a stay in the EU, through this channel
gauge of uncertainty using principal alone.
Uncertainty over Britain’s future rela- components analysis to distil information The vote to leave has also affected
tionship with the EU is likely to prompt from financial markets and surveys into asset prices. The most notable impact
delays to investment and hiring decisions. a single index. A positive reading means has been on sterling, which fell about
uncertainty is higher than usual, while a 10% after the referendum. The drop
The depreciation of sterling will negative reading means it is lower — the is likely to offer a modest boost to net
squeeze incomes as import costs rise. index is plotted in the chart below. trade in the medium term, while house-
The theoretical link between uncer- holds are likely to feel a squeeze on real
Taken together, these shocks are likely tainty and the economy is that a lack of incomes in the near term thanks to the
to prompt growth to slow but a recession clarity causes companies and house- sharp rise in consumer price inflation.
should be avoided. holds to delay investment decisions, Bringing together the effects of the
which are often hard to reverse. At the exchange rate and uncertainty, the first
The Bank of England can take credit same time, it makes more sense to hold chart on the next page shows how BI
for preventing a worse outcome by main- off on hiring someone until you are sure Economics sees the shocks evolving
taining financial stability and providing they will be needed, since it costs money over the coming years. Inflation is set
timely stimulus. to find them and they can be difficult to be materially faster, peaking more
Uncertainty Spiked Following the Referendum
4
BI Economics Gauge
3
2
Standard Deviations
1
0
-1
-2
Jan-00 Dec-00 Nov-01 Oct-02 Sep-03 Aug-04 Jul-05 Jun-06 May-07 Apr-08 Mar-09 Feb-10 Jan-11 Dec-11 Nov-12 Oct-13 Sep-14 Aug-15 Jul-16
Source: Bloomberg Intelligence BloombergBriefs.com
2 September 2016 BI ECON Bloomberg Intelligence: Brexit Special
than one percentage point above what BI Economics’ Base Scenario vs. a Bremain Counterfactual
would otherwise have been the case.
On a quarterly basis, year-over-year CPI CPI Inflation Output Gap Interest Rate (of equivalent policy measure) (right)
inflation is likely to breach the Bank of
1.0 200
Deviations from baseline (Bps)
England’s target across 2017.
(Percent/Percentage Point)
Deviations from Baseline
Taken together, the shock to the 0.5 100
economy from the uncertainty spike
and the shift in the pound is likely to 0.0 0
see growth slow sharply, but recession
should be avoided. The second chart -0.5 -100
at right illustrates the expected impact
-1.0 -200
of the vote to leave on calendar-year
growth over the next couple of years. -1.5 -300
The impact will be noticeable – unem-
ployment may tick up somewhat and -2.0 -400
wage growth is likely to remain weaker 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q
than it would have been – but the shock 2016 2017 2018 2019 2020 2021
is nothing like that which was experi- Source: Bloomberg Intelligence BloombergBriefs.com
enced during the global financial crisis,
when the level of output fell by over 6%
peak to trough.
One of the main reasons for the rela-
tively benign impact of the referendum
is that financial stability has been pre-
served. Here, the BOE deserves some U.K. Calendar-Year Growth Set to Slow but Avoid Recession
credit. Its pledge to provide short-term GDP Growth, No Brexit GDP Growth, Brexit
liquidity in advance of the referendum
and its decision to offer longer-term 2.0
finance, announced on June 24, has
meant that the liquidity of Britain’s bank-
ing sector has been beyond doubt. And 1.5
the Financial Policy Committee’s deci-
Percent
sion to lower the countercyclical capital
buffer has helped ensure credit supply 1.0
is not a problem.
The BOE has also acted swiftly to
stimulate the economy with looser mon- 0.5
etary policy – that’s taken into account
in the BI Economics outlook for the U.K
economy. The third chart at right shows 0.0
2016 2017 2018
how the stimulus is delivered across
the different policy tools that the BOE Source: Bloomberg Intelligence BloombergBriefs.com
has utilized. The purchase of 60 billion
pounds more in gilts is assumed to de-
liver the equivalent of a 40-bp cut to
the policy rate, while corporate bond
buying is assumed to be slightly more
effective, with the full 10 billion pounds Decomposition of Monetary Stimulus
of purchases delivering 10 bps of easing.
Rates Corporate Bonds Gilts
Combined with the 25-bp cut to the pol- 0
icy rate, that suggests the August policy
package will be equivalent to 75 bps of -20
easing, once fully implemented. -40
The shift down in rates delivers the
Basis Points
bulk of the stimulus, compared with the -60
scenario in which Britain remained in the -80
EU. It’s not just that interest rates are
-100
being cut but also that they aren’t be-
ing raised, as they would otherwise have -120
been. Should the U.K. outlook evolve -140
broadly as BI Economics expects, the
Bank of England is unlikely to do much -160
more to stimulate the economy. 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q
2016 2016 2017 2017 2017 2017 2018 2018 2018 2018
Source: Bloomberg Intelligence BloombergBriefs.com
September 2016 BI ECON Bloomberg Intelligence: Brexit Special 3
Measuring Brexit’s International
Spillovers
BY JAMIE MURRAY, BLOOMBERG INTELLIGENCE ECONOMIST
Weaker spending in the U.K. as a result of the vote for Brexit is likely to have spillover
effects on the euro-area economy. BI Economics has assessed the likely impact using
NiGEM, a global macroeconomic model, and found that trimmed export growth and the
impact of uncertainty might leave output in the euro area 0.5% lower in 2018 than it would
have been if Britain had voted to remain in the EU. That’s worse than the European Cen-
tral Bank expected in September and could mean further easing is required.
Key points: A Momentary Loss of Clarity?
Uncertainty in the euro area moved up- 4
wards in the aftermath of Britain’s decision EA Uncertainty Gauge U.K. Uncertainty Gauge
to leave the EU but by far less than in the
3
U.K. itself – it will exert a modest drag on
growth.
2
Standard Deviations
The weakness of demand growth in the
U.K. and the depreciation of sterling will 1
act as a drag on euro-area export growth.
The trade impact of the Brexit vote 0
could leave output 0.4% lower in 2018
than if Britain had stayed in the EU, and -1
the uncertainty impact may lift that to 0.5%.
-2
The ECB expected a small growth im-
pact and may have to revise its forecasts
downward. -3
Jan-01 Aug-02 Mar-04 Oct-05 May-07 Dec-08 Jul-10 Feb-12 Sep-13 Apr-15
The impact on the U.S. and China is Source: Bloomberg Intelligence BloombergBriefs.com
likely to be small.
Bloomberg Intelligence Economics es- slow, and inflation will probably burst That indicator shows uncertainty picked
timated the impact of Brexit on the U.K. through the central bank’s target rate, up a bit in the euro area but only mod-
economy using a combination of meth- thanks to higher import costs, and re- estly and, in any case, by far less than it
ods. First, an uncertainty gauge was main above it for much of 2017. Sensibly, did in the U.K, as illustrated in the chart
constructed that combines information the BOE is looking through the tempo- above. Running this measure through a
from business surveys and financial mar- rary rise in inflation and eased policy to structural VAR model of the euro-area
kets, in much the same way as the Bank support the economy and help keep un- economy suggests the modest increase
of England’s measure. Second, this has employment low. ECB President Mario could drag slightly on growth, having a
been used with a structural VAR model Draghi was much more cautious. The peak impact on the level of output of
to estimate the impact of elevated un- central bank made no adjustment to the between -0.1% and -0.2%.
certainty on demand. Third, how that policy stance in September. Whether The other channel through which the
affects GDP and inflation is assessed more stimulus comes to be needed will Brexit vote can affect the euro area is
using a DSGE model, which takes into partly depend on how the euro-area trade. To estimate the impact of a slow-
account the impact of looser monetary economy is affected by the shock from down in the U.K. on the rest of the world,
policy as well as the depreciation of ster- Britain’s referendum. BI Economics has used NiGEM, a global
ling. This is similar to the BOE’s main BI Economics has estimated the im- macroeconomic model used by many
forecasting and scenario model. pact on euro-area growth in two stages. central banks and forecasting institu-
Overall, Britain is likely to see growth First, a gauge of uncertainty was created. tions worldwide. The uncertainty shock
4 September 2016 BI ECON Bloomberg Intelligence: Brexit SpecialTracing Impact of U.K. Slowdown on Other Big Economies
0.0
0.2
0.4
-0.6
Percent
0.8
-1.0
-1.2
Euro Area United States United Kingdom China
-1.4
2016Q2 2016Q3 2016Q4 2017Q1 2017Q2 2017Q3 2017Q4 2018Q1 2018Q2 2018Q3 2018Q4
Source: Bloomberg Intelligence, NiGEM BloombergBriefs.com
in the U.K. is applied to the model, to- How the ECB’s Forecasts Have Changed
gether with the depreciation of sterling,
and its impact can be traced across the 2.0
ECB June ECB September BI Economics Counterfactual
globe. As the chart above illustrates, 1.8
weaker demand from the U.K. has a neg-
ative impact on the level of GDP in the 1.6
euro area, depressing it by about 0.4%
compared with what it would otherwise 1.4
Percent
have been. It also has an effect on output 1.2
in the U.S. and China but it is negligible,
reflecting the small role played by U.K. 1.0
importers in external demand.
BI Economics estimates that the pri-
0.8
mary channel through which the euro- 0.6
area economy is affected is through
trade flows, with domestic uncertainty 0.4
having a smaller impact. The deprecia-
0.2
tion of sterling makes euro-area busi-
nesses less competitive compared with 0.0
those in the U.K. and that, together with 2016 2017 2018
the weakness of U.K. demand, pushes
exports down by a bit more than 1% Source: Bloomberg Intelligence, NiGEM BloombergBriefs.com
when compared with what might have
been expected if Britain had voted to
remain. Imports are a little lower, too,
largely because imported goods are
used to make products that are exported
and domestic demand in the euro area more than that in the aftermath of the weekly as fresh data on the near-term
is little changed. Brexit vote. impact become available. If it plays out
So what does all this mean for the If the ECB had revised its forecasts as BI Economics expects, downward re-
ECB? Well, its September forecasts re- in-line with BI Economics’ estimated im- visions to the ECB’s growth forecasts
corded only a minor revision to growth in pact of the vote, it would have projected will be likely at some point, and then
2017 and 2018 of -0.1 percentage point, growth of about 1.2% in 2017. The aver- pressure for additional stimulus will in-
down to 1.6% in both years. That may age forecast of economists surveyed crease.
underplay the impact of a slowdown in by Bloomberg News was 1.3% at the
Britain’s economic growth on the euro time the analysis was published. A lot
area. Most other forecasters lowered depends on what happens to the U.K.
their projections for growth in 2017 by economy, and the outlook is evolving
September 2016 BI ECON Bloomberg Intelligence: Brexit Special 5Alternatives to EU Membership
BY NIRAJ SHAH, BLOOMBERG INTELLIGENCE ECONOMIST
The U.K. faces years of uncertainty over
Key points:
its future trade relationship with the Euro-
pean Union as well as the rest of the world. The U.K. has three major options for its future trade rela-
tionship with the EU.
Trade deals tend to move slowly, and Britain
is likely to have to do the groundwork for The Norway model would keep it in the European Economic
Area, but with strings attached.
several at the same time. The prime minister
has talked of a bespoke model for the U.K. British negotiators would prefer a bespoke agreement with
single market access — a hard deal to strike.
rather than an off-the shelf solution. Yet the
ability to restrict immigration may be a red World Trade Organization rules offer a fallback, but with
high tariffs likely.
line for both sides in negotiations with the
EU -- that will make reaching a trade agree- The two-year clock for EU negotiations is likely to start
in 2017. That may not be enough time.
ment all the more difficult and protracted.
The U.K. can continue to trade with the Trade Options
EU without a free trade agreement (FTA)
once it leaves the customs union. Indeed, Option 1 Option 2 Option 3
the U.S. trades with the EU without one.
Yet without a comprehensive deal, the
U.K. faces tariffs and in particularly non- Bespoke
EEA WTO
tariff barriers, where there currently are Deal
none. That could prove costly in the long-
term. Getting a deal that covers the ser-
vice sector will be important given the Example:
Norway
U.K. is the world’s second-largest ex- Switzerland Example:
porter of services and the EU its largest Iceland
Turkey Russia
market. There are several alternatives the Liechtenstein
Canada Brazil
U.K. can pursue, including becoming a
member of the European Economic Area
(EEA), like Norway, negotiating a bilateral Verdict: Unlikely Preferred Option Default Position
agreement, like Canada, or falling back on
World Trade Organization (WTO) rules. Source: Bloomberg Intelligence BloombergBriefs.com
Each has its downsides and none give
the full, unrestricted access to the single Liechtenstein also has to accept the EU’s There are several examples of trade
market that the U.K. currently enjoys. single-market rules without having a say agreements with the EU. It has taken
on when they are made. This option is Switzerland decades to negotiate more
Norwegian Model likely to prove unacceptable in the U.K., than 100 bilateral agreements with the
This would involve staying in the looser since it addresses none of the concerns bloc. It still only has partial access to the
European Economic Area, whereby the of those who voted to leave the EU. single market and has been bound by the
U.K. would still have access to the EU’s principle of free movement of people.
single market. Iceland and Liechtenstein Bespoke Trade Agreement Turkey is part of the EU’s custom union,
are other members. Banks prefer this A bespoke U.K.-EU trade agreement is though arrangements do not cover ser-
model because it would preserve their likely to prove complicated to negotiate vices. Moreover, its external tariffs must
access to EU customers, though the but appears to be the British govern- align with EU tariffs, and this limits the
trade in goods would be subject to cus- ment’s favored option. While the other trade deals that Turkey can forge out-
toms checks. Countries in this arrange- 27 EU leaders insist that open borders side the EU.
ment still have to allow the free move- are critical, the U.K. is likely to push for The U.K. is likely to look to the Com-
ment of workers and contribute to the a unique free-trade agreement where it prehensive Economic and Trade Agree-
EU budget. In the U.K.’s case, that bud- has at least partial access to the single ment (CETA) between Canada and the
get contribution would only fall by about market. Negotiating its own agreement EU. This gives preferential access to the
17% if it were to join the EEA, according would limit most tariffs on both sides. Still, EU single market, without the free move-
to a House of Commons Library paper banks are unlikely to maintain the same ment of people and the need to pay into
— meager savings. Norway, Iceland and kind of access they currently have. the EU budget. However, it took seven
6 September 2016 BI ECON Bloomberg Intelligence: Brexit Special years to negotiate and still isn’t rati- it would have to do the same for the which the U.K. would need to negoti-
fied. Moreover, it only included limited more than 160 other countries in the ate its terms of exit from the world’s
provision for services and maintained organization. That would then pose a largest trading bloc, taking the discus-
financial restrictions. Canadian finan- stiff choice: lower tariffs for all countries sions to 2019. This could be extended
cial services providers will have to set and undermine Britain’s position in fu- further only if all EU members agree
up subsidiaries inside EU countries, dis- ture trade negotiations, or raise tariffs unanimously that more time is needed.
placing some Canadian jobs. with EU countries and increase costs for That may indeed prove too short, given
businesses and consumers. In short, the that a free-trade agreement may have
WTO Option U.K. would have no favorable relationship to be ratified by each of the 27 coun-
Failing another arrangement, Britain’s with the EU or any other country. This tries. An extended period of uncertainty
fall back would be existing World Trade option would likely give the U.K. most now beckons, with a risk that the U.K.
Organization rules. This would avoid sovereignty but come at the cost of less reverts to WTO rules by default. These
the hassle of setting up a complex new trade and incomes that will be lower than complex negotiations will shape Britain’s
deal and allow the country to set its own they could have been otherwise. economy and its place in the world for
trade tariffs with the EU, just like Rus- Any formal trade deals are likely to be decades to come.
sia and Brazil. The U.K. would, however, years away, given that the U.K. can only
face significant tariffs on certain goods. legally sign deals with other countries
British exporters to the EU would face once it has officially left the EU. Britain
average levies of about 10% on cars to currently benefits from EU trade deals
more than 35% on dairy produce. Criti- with over 50 different countries. Renego-
cally, the WTO has also done little to tiating them after Brexit is also likely to
open up trade in services. take a long while. The government looks
Under WTO rules, the U.K. cannot set to take the time needed to prepare
differentiate between countries. That before triggering Article 50 in 2017.
means if Britain wanted to allow Ger- Invoking Article 50 in the new year
man goods to enter the U.K. tariff-free, would lead to a two-year window in
Follow Industries?
>>>>>>>
Data Downloads Now Available
INDUSTRY
RESEARCH
BI
September 2016 BI ECON Bloomberg Intelligence: Brexit Special 7Curbing Migration Would Leave
Economy Smaller
BY JAMIE MURRAY AND DAN HANSON,
BLOOMBERG INTELLIGENCE ECONOMISTS
Migrants “swarm to Britain,” “steal ALL our jobs” and must be “banned” – so say
the British tabloids. Accurate or not, those assertions seem to be reflected to some
extent in public opinion, and migration featured prominently in the campaigns ahead
of Britain’s referendum on membership in the European Union. If EU migration flows
shrink, the U.K. economy will be smaller for it.
Migrants: How Many and U.K. before 1990, as well, those born in
Key points: Where From? the EU account for only about a third of
People are more concerned about mi- people living in the U.K. who were born
The net flow of migrants to the U.K. gration than they were in the 1990s. abroad. The U.K. has also been a net
has been large, and EU migration has ac- Almost 4 million more newcomers had exporter of Britons in recent decades.
counted for a significant proportion of arrived in the U.K. by 2014 than had left One might reasonably ask, then, why
those flows lately. since 1990, according to census and there has been so much attention on
survey data available in early 2016. It those moving to the U.K. from within the
Migrants are more likely to be of work- might come as a surprise, but those from EU, whose right to do so is currently en-
ing age and are less likely to claim out-of- the European Union’s recent accession shrined in law. After all, it would surely be
work benefits than those already living in countries – such as Poland and Slova- easier to reduce the typically large num-
the U.K. kia – account for only a minority of that. bers of those arriving from outside the
Data on migration by country of citi- common market, many of whom are let
Clamping down on migration from EU zenship shows that, of the roughly 5 mil- in at the government’s discretion. Partly,
states would leave the economy smaller, lion net inflow of foreigners to the U.K. the answer may be that, although non-
though GDP per capita would be little between 1990 and 2014, those from EU migration accounts for much of the
changed. other EU countries account for about cumulative increase, flows from within
a quarter and those from the eight ac- the EU have become larger, as the chart
A significant decline in net migration cession countries a tenth. The actual on the next page illustrates.
would mean debt relative to GDP would proportion from within the EU may have
be higher in the medium term. Taxes could been a little higher than that because
5,000
be raised or spending lowered to prevent census figures point to faster migration
that. than was reported by the surveys. Still,
considering people who arrived in the 4,000 Net Cumulative Flow (Thousands)
Britain is unlikely to be able to secure
access to the single market without ac-
cepting free movement of people.
3,000
2,000
1,000
0
Cumulative Flows of Net Migration -1,000
Other EU EU8 EU15 Non-EU British Total
-2,000
1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014
Source: ONS, Bloomberg Intelligence BloombergBriefs.com
8 September 2016 BI ECON Bloomberg Intelligence: Brexit Special The Changing Composition of Migrant Flows
How Do Migrants Affect the Other EU EU15 Non-EU
British Economy?
250
Employment
The facts are relatively simple. Those
200
arriving in the U.K. are more likely to
Thousands
be of working age than the indigenous
population, and they generally come to 150
work. Slightly more complicated is that
they are more likely to be high- or low- 100
skilled than are the locals.
There is no convincing evidence that
50
the migration flows to the U.K. have
caused higher unemployment overall
among those already in residence. In 0
other words, they haven’t stolen jobs, as 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013
the newspaper headlines suggest. After -50 ONS, Bloomberg Intelligence
Source: BloombergBriefs.com
6,000
all, there is no fixed number of jobs in the Other EU
EU8
Net Cumulative Flow (Thousands)
economy – people come to the U.K. and
make themselves useful. And despite the
net influx, unemployment was very low
before the referendum vote.
The Workforce Will Grow Mostly Because of Migration
Earnings
Natural Change Net Migration Total
The bifurcated skills distribution of mi-
grants means that the arrival of foreign 3.0
Cumulative Contribution to Growth
workers affects groups of workers dif-
ferently. Some migrants are likely to be 2.5
competitive with less-skilled local work-
(percentage points)
ers, squeezing the earnings of those at
2.0
the bottom end of the pay distribution.
Empirical evidence suggests this has
happened only marginally. Still, that may 1.5
explain why those on low pay are far
more likely to cite jobs as a motive to 1.0
reduce migration than top earners do.
At the high end of the skills distribution, 0.5
migration could help to push up wages if
knowledge and best practices brought 0.0
from abroad lift the productivity of do- 2016 2017 2018 2019 2020
mestic workers. In aggregate, the overall
impact of migration on wages is likely to Source: Bloomberg Intelligence, OBR BloombergBriefs.com
be roughly neutral.
Output
As of early 2016, the Office for National come 2020. ing the world and being educated has
Statistics expected a further 2.3 million been absorbed elsewhere. And fewer
people to be living in the U.K. in 2020 Living Standards migrants than locals collect out-of-work
than in 2015, an expansion of 3.5%. Of Whether migration economically ben- benefits. Over the course of a lifetime,
that projected increase, net migration to efits the locals depends not on whether migrants are likely to contribute more
Britain explained a bit over half. A big- the economy will be bigger or smaller to the public purse than those already
ger migrant population means a bigger but on what will happen to locals’ own living here.
economy. How much bigger depends spending power. As mentioned above, The chart on the next page illustrates
on how many migrants will choose or the average pay of those already in the the importance of migration to debt dy-
be able to work. Taking age and sex country is unlikely to have been sub- namics. The population is likely to ex-
into account, the U.K. economy may be stantially affected by migration flows. pand, reflecting net migration over the
about 2.2% bigger in 2020 than at the Still, there could be advantages. If mi- next few decades. Should migration be
end of 2015 because of migration, and gration improves the public finances, for lowered immediately by about 120,000
perhaps about one percentage point of example, that would lower the burden on people per year (roughly what might be
that will be thanks to EU migration, if domestic taxpayers. expected if EU migration were to be sig-
relative flows are maintained. That’s a The new arrivals tend to consume less nificantly stemmed), the public debt-to-
bigger source of growth than the natu- by way of public services over the course GDP ratio would gradually rise compared
ral change in the working age popula- of their time in the U.K. than those born with the baseline and might be about 1%
tion, which may provide a boost of 0.7% there. In many cases, the cost of enter- higher by 2020. By 2040, debt could be
September 2016 BI ECON Bloomberg Intelligence: Brexit Special 9 13% of GDP higher. Without those mi- Debt Effects of Different Migration Paths
grant flows, spending may have to be
cut or taxes increased to keep debt on Difference in Debt to GDP Ratio Population Change Due to Net Migration
the same path relative to national in- Low Migration Scenario
come. Of course, the longer EU migra- 350,000 14
tion continues, while negotiations over
Britain’s withdrawal take place, the later 300,000 12
will be the influence of lower net inflows
Percentage Points
on GDP and debt. 250,000 10
People
Still, it’s not just debt and incomes
200,000 8
that matter – prices do, too. There’s little
reason to think that migration affects 150,000 6
the price of many goods and services
in the U.K., but the cost of housing is 100,000 4
the exception. By 2040, there could be
more than 9 million extra people living 50,000 2
in Britain than there were in 2015. They
will need somewhere to live and, unfor- 0 0
tunately, the U.K. has a poor track re- 2015-16 2021-22 2027-28 2033-34 2039-40
cord in building houses. The combination Source: Bloomberg Intelligence Calculations, OBR BloombergBriefs.com
of increased demand and constrained
supply has helped push house prices up
significantly and there seems to be little The outcome of the negotiations is any- The rules around this are largely at the
prospect of a meaningful housebuild- one’s guess, but meaningful controls government’s discretion, but it seems
ing revolution in the near term. Migration on migration of EU citizens to the U.K. the flows would be higher in this sce-
is likely to keep putting upward pres- would clash head on with EU freedom- nario absent a significant policy change.
sure on home and land prices in years of-movement rules. It seems very un- The effect on the level of GDP via the mi-
to come. likely that access to the single market gration channel over the next few years
for goods and services can be retained might therefore be smaller than if EU
Migration After Article 50 if migration flows are to be stemmed. migration ceased entirely.
Once Britain triggers Article 50 of the If the negotiations conclude with Brit-
Lisbon Treaty, it will have two years to ain turning its back on free movement
reach an agreement on its withdrawal. and the single market, some migrants
Until that is achieved, the current free- would likely apply for access to the U.K.
doms of the EU will be respected and via the existing system for non-EU mi-
those in other EU countries will retain grants. That channel is associated with
their right to live and work in the U.K. about half of current net migrant flows.
ECONOMICS
ECONOMICS ASIA
ECONOMICS EUROPE
NEWS, ANALYSIS & COMMENTARY
10 September 2016 BI ECON Bloomberg Intelligence: Brexit SpecialBrexit’s Cost to Trade Raises
Stakes for Deals
BY DAN HANSON AND JAMIE MURRAY,
BLOOMBERG INTELLIGENCE ECONOMISTS
Key points:
Advocates of Brexit argue that leaving the European Union Britain is an open economy and a big
share of its trade is with other EU members.
poses little risk to U.K. trade. A Bloomberg Intelligence
economic model suggests that the stakes are high: being A Bloomberg Intelligence model of Brit-
ish goods trade shows that EU membership
a member of the biggest single market in the world has boosts flows – possibly by about 10%. The
boosted trade between the U.K and EU members by 10%. benefits could be even bigger during eco-
nomic downturns.
Now that the U.K. has voted to leave the union those trade
flows and the associated benefits to the British economy There is no evidence that trade with EU
members has come at the expense of busi-
are at risk. An inability to negotiate favorable alternative ness with other countries.
arrangements and a gradual divergence of policies and
If Brexit were to erase the benefits of EU
institutions could cost the U.K. about 2% of national in-
membership totally for goods and services
come in years to come. trade, the level of GDP per person in the U.K.
economy could be reduced by about 2%.
The U.K. is an open economy, which makes as a catchall for specific characteristics riers within the EU and the synchronicities
the possible impact of Brexit on trade that don’t change over time and help ex- of the single market. Moreover, there is
flows an important one. In 2015, imports plain trade patterns with the U.K. With that little evidence to suggest that higher trade
and exports of goods and services to and included, it is then possible to see whether with the EU has come at the expense of
from the rest of the world amounted to countries inside the EU trade more with trade with others (see Eicher et al, 2008).
just under 60% of GDP, and the EU ac- the U.K. than one would expect, given Taken together, it appears membership of
counted for about half of that. Those in their other features and idiosyncrasies. the EU has created trade in goods overall,
favor of Britain leaving the EU claim there The model suggests that they do. not just displaced it from elsewhere.
will be little impact on trade. The argument The results from this exercise suggest The central estimate takes the period
hinges on the U.K. being able to renegoti- that, because of the EU, the level of U.K. 1980 to 2008 in order to prevent the re-
ate favorable bilateral trade agreements trade with other members is about 10% sults being distorted by the impact of the
with the EU and others that, over time, higher than trade with countries that aren’t financial crisis on trade flows. However, it’s
compensate for the benefits surrendered part of the single market. That’s probably interesting to note that including the years
from exiting the union. To understand how to be expected, given the lack of tariff bar- after 2008 has a material impact on the
big that challenge might be, it’s first worth
asking how much trade is actually up for EU Accounts for Largest Portion of U.K. Trade
grabs. That the U.K. trades a lot with the EU Americas Asia Australasia and Oceania Africa Other
EU is unsurprising; many other members 100%
are relatively wealthy and on Britain’s
90%
doorstep. But the question is, do those
factors alone explain why so much trade 80%
Share of Total Trade
is done with the EU, or is trade with the EU 70%
higher than one would expect even after 60%
controlling for those factors?
50%
BI Economics has built a gravity model
to try to explain the amount of goods trade 40%
between the U.K. and 60 of its trading 30%
partners. The size of each economy gets 20%
part of the way there, but other factors
10%
matter, too. Some of these are observable
and quantifiable, such as EU membership, 0%
but many aren’t. The model therefore in- 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
cludes a variable for each country to act Source: Bloomberg Intelligence, ONS BloombergBriefs.com
September 2016 BI ECON Bloomberg Intelligence: Brexit Special 11 model’s estimate for how much the EU has Financial Sector Helps U.K. Run a Surplus in Services
boosted trade – instead of a gain of 10%, Financial Services Surplus Total Services Surplus
the model suggests gains of around 20%. 5.0
One possibility is that, during the crisis,
being a member of the EU helped protect 4.5
trade between member states. Still, a lot 4.0
was going on at that time, so an estimate 3.5
of 10% seems more central, at least dur-
% GDP
3.0
ing normal times.
A further issue to bear in mind is that 2.5
the data included in the model are for 2.0
goods trade only – it ignores services, 1.5
which constituted about a third of total 1.0
trade in 2015. It seems reasonable to as-
sume that the estimates for the impact of 0.5
EU membership on services trade may be 0.0
broadly similar to the estimates set out 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015
for goods. On the one hand, the single Source: Bloomberg Intelligence, ONS BloombergBriefs.com
market in goods is more developed than
that of services, meaning benefits such as raise efficiency through specialization and ing trade may take time to diverge. The
common regulatory standards might be the adoption of new technologies, all of estimates suggest that it takes about 10
smaller to services trade than to trade in which is likely to manifest itself in the form years for half the effect to be felt. What’s
goods. On the other, a big chunk of U.K. of higher productivity. more, the U.K. will undoubtedly strike
services trade relates to the finance in- Using a wide variety of estimates for some form of deal with the EU and po-
dustry, where the EU has taken a num- the link between income levels and trade tentially with other nations, which is likely
ber of steps to improve the functioning suggests that if Brexit were to totally to soften the impact somewhat.
of the single market, which has probably erase the benefits of EU membership In short, membership of the EU appears
boosted trade between member states for goods and services trade, the level to have delivered significant benefits to
relative to trade with those outside. In of GDP per capita in the economy could Britain in the form of higher trade flows.
2015, the EU accounted for over 45% of be reduced by about 2%. That doesn’t The choice of the British people to vote
the U.K.’s financial services trade surplus mean the benefits will disappear as soon to leave has placed a heavy burden on
with the rest of the world. as the two-year negotiation is over - evi- the government to deliver a deal with both
It’s worth thinking about the link with dence from the International Monetary the EU and others to mitigate the risk that
trade and living standards. Countries Fund suggests that changes in the trade trade flows are permanently lower in the
which trade more benefit from being more share of GDP take time to affect incomes. long run.
open in a variety of ways. For example, After all, trade patterns change relatively
firms face greater competition, which can slowly and policies and institutions affect-
Methodology Note
The model used in this analysis is known as to name a few. It is possible to throw the kitchen The model, which is estimated using trade
a “gravity model.” The framework draws on sink at the model and include as many vari- flows between the U.K. and 60 of its biggest
Newton’s law of gravitation, which posits that ables as possible, but that will inevitably re- trading partners between 1980 and 2008, is set
the gravitational force between two objects is sult in some variables being missed, which, in out below:
directly proportional to their masses and in- turn, would bias the estimates for the impact
versely proportional to their distance. In the of EU membership on trade. To deal with that
same vein, a vast number of economic papers issue it is possible to include a catchall vari-
have shown that GDP (used a proxy for size) able, which captures idiosyncratic features of
and the distance between two countries can go the trading relationship between the U.K. and
a long way to explaining bilateral trade flows. each of the countries included in the data set
Of course, there are a variety of other vari- – these are known as “fixed effects.” As well as
ables which help explain the flow of goods and GDP, a time trend is also included to capture
services between countries: common language, the rapid growth in the amount of trade the U.K.
contiguity, colonial links and trade agreements, does with China.
Decomposing the ‘Fixed Effect’ variation in the catchall variable, and when com-
One thing to note in the equation above is that mon language and colonial links are included,
distance is excluded. That’s because distance is 60% of the variation can be explained. That
captured in the catchall for time-invariant char- there is a portion left unexplained suggests
acteristics between the U.K. and country j. It is there are some unobservable characteristics
possible to decompose that variable using a set which help explain bilateral trade flows between
of time-invariant characteristics between the the U.K. and each of its trading partners. That
U.K. and each of the 60 other trading partners The result of the exercise above shows that finding provides some support for the estima-
in the sample. distance alone accounts for about 40% of the tion approach taken.
12 September 2016 BI ECON Bloomberg Intelligence: Brexit SpecialBrex and the City —
London Risks Slow Burn
BY JAMIE MURRAY, SARAH JANE MAHMUD, JONATHAN TYCE
AND DAN HANSON, BLOOMBERG INTELLIGENCE
Now that Britain has decided to leave the Key points:
European Union, access to the single mar- Language, a big pool of talent, trust in institutions and a conve-
ket could be curtailed. That would reduce nient time zone make London an attractive location for international
banks.
the attractiveness of the City of London as
a global financial center and might prompt Access to the single market is also valued by finance profession-
als, and leaving the EU has the potential to make business harder
the relocation of some activities. Thankfully, in up to 30 countries for companies based in the U.K.
the single market is not the only thing Lon-
London’s dominance in wholesale finance means international
don has going for it, and there are plenty of
banks are highly likely to retain a front-office presence in the City
reasons for companies to stay. That means even if they have to set up subsidiaries elsewhere to maintain mar-
ket access.
the economic and fiscal impact is likely to
be manageable. The long-standing commit- Financial services output is greater than the construction industry
and the sector accounts for a significant proportion of tax receipts.
ments many firms have in the City and the
time required for the U.K. to make post-EU The economic and fiscal impact of Brexit through the City will
depend on how much of the financial services workforce is relocated
arrangements mean that it could take many and the extent to which regional headquarters are shifted elsewhere.
years for the full effect of Brexit to be felt.
Why London? The U.K. Economy in 2015
London has a long tradition in financial
% of GVA Other Services Agriculture
services, emerging as the major center
for merchant banks as trade took off in 4.0 0.8 Manufacturing
the 19th century. It has remained a world
leader, thanks to the network of compan-
Government,
Health, Education
9.9
Other Production
ion services that has been built around the
City, the respect commanded by British
18.0 4.3
law, the widespread use of the English lan- Construction
guage and a favorable time zone. It also
helps that the regulatory environment is
Admin 6.2
transparent and that the government is 5.0
generally flexible on skilled migration. With
Distribution, Transport,
so many reasons for banks to choose Lon- Other Professional and Hotels & Restaurants
don as their home, it’s hard to isolate the Scientific Services
18.5
attraction associated with access to the
single market of the EU. Survey evidence
3.8
provides some insights. Legal, Accounting,
Management Consultancy Information and
Communication
Access to the Single Market Is 3.9 6.3
a Benefit Financial and Insurance
The market for services is generally less Real Estate
standardized in the EU than that for goods, 7.2 12.1
though the financial sector has been sub- Source: ONS, Bloomberg Intelligence Calculations BloombergBriefs.com
ject to a deeper treatment since the global
crisis. EU rules are incorporated into U.K. book. However, in some cases, national line common rules.
law via updates to existing statute, the Fi- governments will layer extra regulations So rather than perfectly synchronized
nancial Conduct Authority handbook and on top, meaning the requirements can regulation, the main benefit of Britain’s
the Prudential Regulation Authority rule- still differ across Europe despite base- membership in the union could be mar-
September 2016 BI ECON Bloomberg Intelligence: Brexit Special 13 ket access, which is delivered via the Decomposing the Current Account Deficit
EU’s financial services passporting sys-
tem. That allows banks based in the U.K.
6
to provide services across the common
Income Balance Goods Services
market and banks based elsewhere in the 4
EU to provide services in the U.K., without
having to set up subsidiaries that would
% of GDP (4QMA)
2
be subject to additional local regulations.
Though companies must apply for pass- 0
ports, and these depend on the country
and type of service being provided, the -2
regime minimizes regulatory and opera- -4
tional burdens on those that offer cross-
border financial services. Instead of hav- -6
ing to comply with up to 31 rulebooks (for
each European Economic Area country), -8
companies need only comply with one. 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
A survey of opinion among finance pro- Source: Bloomberg Intelligence BloombergBriefs.com
fessionals published in April by the Centre
for Study of Financial Innovation suggests
that this market access is valued. Almost those at the EU level. Two-thirds of City thorities, in many areas, including central
two-thirds of finance professionals believe professionals agree that tighter domestic counterparty regulation and alternative
in the single market, and 86% think the financial regulation has put U.K. firms at a investment market access.
City of London has gotten its fair share disadvantage in the EU market. Leaving the EU is more likely to prompt
of the business associated with it. With banks to shift activity outside of Brit-
nearly 5,500 financial firms authorized in How Will Leaving the EU Affect ain than to attract more to the coun-
the U.K. using so-called passports to sell Banks’ Behavior? try’s shores. Still, should banks leave, it
services and products into the bloc, the About half the world’s largest financial would be a slow process. It is likely to
question of future viability is growing in services companies have their global or be a long time before a post-exit agree-
importance. regional base in the U.K. Whether they ment is reached. Also, many firms have
will stay depends a lot on post-exit ar- long-standing arrangements in London
But Ongoing Membership rangements. The main thing at stake is that would make it hard or costly to move
Could Have Come With Costs market access, and leaving the EU has quickly.
Regulatory costs associated with EU the potential to make business harder in London’s dominance in wholesale fi-
membership may have become bigger up to 30 countries for companies based nance means international banks would
over time. At present, the U.K. enjoys in the U.K., depending on the nature of the be highly likely to retain a front-office pres-
freedom over a range of domestic poli- service they seek to provide cross-border. ence in the City even if they had to set up
cies. The fear was that ever-closer union Should the U.K. retain market access subsidiaries elsewhere to maintain mar-
would see that flexibility eroded in years via a special agreement, then there would ket access. Still, with an eye to cost man-
to come and that some policies would not be little incentive for banks to up sticks. agement, some banks are already shifting
be in Britain’s best interests. Yet given increased tension between the back- and middle-office functions outside
If the EU’s laws could be avoided, it’s EU and Switzerland, whose relationship is of London. The time zone and the Eng-
unlikely to be the case that U.K. regula- based on more than 100 separately nego- lish language remain key attractions for
tory laxness would provide a big lift to the tiated treaties, a passport concession for the U.K. as a financial hub, and the recent
City’s competitiveness. With regulation the U.K. is by no means guaranteed. That weakness in sterling is a positive from a
increasingly being determined on a global a post-exit Britain could be regarded as cost perspective. Still, the jury remains
scale and financial stability the subject a risk to broader financial stability in the very much out on how many banking jobs
of close attention, there’s little chance EU points to tricky market-access nego- are at risk from Britain’s decision to leave
that Britain gaining more policy flexibility tiations. the EU.
would translate into relaxed regulatory While withdrawal negotiations take
standards. place, the U.K. is bound to integrate all How Important Is the City to
The financial crisis prompted a major new and comply with existing EU law. Re- the British Economy?
shake-up in the British regulatory frame- gardless of whether Britain is or is not able Quite important, as the chart on the
work, and the new regime, led by the Bank to secure continued access to the single previous page illustrates. Finance and in-
of England, has been tough on banks lo- market after it leaves, rules equivalent to surance services accounted for about 7%
cated in the U.K., in some cases setting those in the EU would probably need to be of economic output in 2015 — a little more
more onerous policies than those in Eu- in place to facilitate trade. Lack of equiva- than the British construction industry, for
rope. Strict market abuse rules, for ex- lence has been at the center of regulatory example. The trouble is that this classifi-
ample, were in place in the U.K. before disputes between the U.S. and the EU au- cation captures some activities that are
14 September 2016 BI ECON Bloomberg Intelligence: Brexit Special unlikely to be significantly affected should Financial and Insurance Services Have Become More Important
Britain leave the single market, such as
retail banking. And for similar reasons 5.0
there might be an impact on other related Surplus in Financial and Insurance Services Services Surplus
4.5
sectors, such as legal services, account-
4.0
ing and management consultancy — in-
clude those and the share of output at 3.5
risk jumps to about 11%, bigger than the 3.0
% GDP
manufacturing sector. Finance and insur- 2.5
ance is also a high-productivity business:
while it accounts for 7.2% of output, it pro- 2.0
vides only 3.4% of jobs. 1.5
The financial-services sector also plays 1.0
an important role in supporting Britain’s
0.5
balance of payments. As is well known,
the U.K. is running a current-account 0.0
deficit, meaning more is consumed each 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015
year than is earned. The headline deficit Source: Bloomberg Intelligence BloombergBriefs.com
masks a persistent trend: a widening of
the goods deficit has been partly offset by
an increase in the services surplus since If the jobs were to leave Britain but most
the beginning of the 2000s. Economic Impact of Britain of the labor stays instead, those people
The City has been one driving force Leaving the Union would simply find new work. What hap-
behind this trend in the current account. As with trade, migration and capital pens to output would depend on whether
In 2000, the value of exports of financial flows, how Britain’s departure from the they are as productive in those new jobs
and insurance services was about 1.5% of EU affects the economy via the banking as they were in the old ones. It seems
GDP bigger than the value of the imports sector depends entirely on what sort of likely that this would be a challenge, and
of those services, and in 2015 that figure arrangements are in place afterward. The so productivity and earnings would prob-
had risen to 2.9%. Should an exit from City of London occupies a dominant posi- ably be lower as a result.
the EU prompt weaker financial services tion as a global financial center. That re- Beyond labor dynamics, a smaller
output, the result would be not only lower flects many advantages unrelated to EU problem would be if some financial firms
national income, but the current account membership, such as language, a big pool relocated their head offices to the conti-
would look worse, as well. of talent, trust in institutions and a conve- nent, pushing down on the tax take. Since
nient time zone. Even if Britain’s post-EU banking sector corporation tax is equal
Taxation settlement results in significantly reduced to about 0.5% of total receipts and it is
The City of London makes profits and single-market access, it seems likely that very unlikely that all banks paying tax in
pays wages, and a levy is raised on the many international banks would retain a the U.K. would relocate, the loss to the
size of banks’ balance sheets. It’s not presence. Exchequer from this source would easily
easy to gauge the broader contribution Still, the fear is that the loss of single- be manageable.
of the financial services industry to the market access would prompt a relocation In summary, there are a lot of reasons
Treasury’s coffers, but there is good in- of some activities away from London. Ties why the U.K. has a large financial services
formation available for the banking sector. to the City and existing obligations mean industry, and many won’t change when
In the 2014-15 financial year, banks paid that would be a slow process, so any im- Britain leaves the EU. While loss of access
22.9 billion pounds, with pay-as-you-earn pact on national income associated with to EU markets might prompt some relo-
taxes (payments from labor income) by the financial services sector would prob- cation of activities elsewhere, the impact
far the largest source of revenue. To put ably be felt over a number of years. on GDP would probably be small, and it
that into context, receipts associated with Should leaving the EU prompt shrink- would take many years for the full impact
the banking sector are slightly bigger than age in financial services, the impact on to be felt.
spending on Justice and the Home Office. GDP would depend on a couple of key
Overall, the banking sector accounts factors. Most important is whether the
for a disproportionately large share of labor follows the financial services activ-
PAYE taxes, at a bit over 7% in 2014-15, ity -- that would be associated with the
and contributes about 5.6% of all on- biggest loss of output. If workers were
shore corporation tax receipts. The share relocated internationally, so too would be
of taxes paid on profit was higher in the the value-added and revenues from labor
past, but losses associated with the finan- income. Since financial services jobs tend
cial crisis have served to lower profits in to be high-productivity, it wouldn’t just be
Photo: Matthew Lloyd/Bloomberg
the sector. GDP that would be lower but GDP per
capita as well.
September 2016 BI ECON Bloomberg Intelligence: Brexit Special 15Winners and Losers as
Vote Realigns Global Flows
FIELDING CHEN AND TOM ORLIK,
BLOOMBERG INTELLIGENCE ECONOMISTS
In the brief two months after the Brexit for the people-to-people ties that are the weaker ties, data on FDI, finance and tour-
vote, U.K. Chancellor of the Exchequer basis of goods and capital flows. China, ism are estimated.
Philip Hammond paid visits to Beijing and Australia and India generate the most
Hong Kong. Business Secretary Greg tourist revenue for the U.K. each year. To be sure, much about the U.K.’s fu-
Clark headed to New Delhi. No surprise ture relations with Europe and Asia re-
about what was on the agenda — expand- Exchange rate: a sharp drop in the mains unknown. Negotiations over the
ing business ties. pound following the Brexit vote has put single market will be protracted, as will
As Brexit throws the U.K.’s relations the U.K. on sale, a boon for U.K. export- any trade deals the U.K. develops in Asia.
with Europe into confusion, strengthen- ers, and for foreign visitors and investors. Trends in trade and investment play out
ing links with Asian economies that are the In the period since June 23, Japan, South over years, not months. That said, busi-
main engines of global growth has seldom Korea and Thailand have seen the biggest nesses and investors are not going to wait
been more important. appreciation in their currencies relative to too long before grasping the Brexit op-
Where is the potential for strengthening the pound. portunity. The BI Economics score card
U.K.-Asia ties greatest? To answer that provides a first stab at identifying where
question, Bloomberg Intelligence Econom- Overall scores are based on the sum those opportunities might be greatest.
ics has assembled a scorecard on which of each country’s ranking across each of
Asian economies have the strongest trade, the five metrics. For some countries with
investment, financial and tourism ties with
the U.K., and which might gain most fol-
lowing the plummet in the pound. Japan,
Hong Kong, and China stand out as the
biggest potential winners. At the other end Scoreboard (Lower numbers mean higher ranking)
of the spectrum, Malaysia, Indonesia and
the Philippines currently have weaker ties.
BI Economics’ scorecard is based on
five factors:
Trade: countries with stronger ties to
the U.K. are more likely to benefit from
any realignment in the international flow
of goods following Brexit. China, Japan
and India have the most significant trade
ties with the U.K.
Investment: countries with significant
foreign direct investment in the U.K. are
well positioned to gain as the U.K. looks to
maintain its reputation as open for global
business. Japan, Singapore and Hong
Kong are the biggest channels for invest-
ment in the U.K.
Finance: one of the U.K.’s main exports
is financial services. Strong financial ties
also provide a basis for enhancing trade
and investment flows. Japan, Hong Kong
and Australia are the biggest destinations
for the U.K.’s overseas sales of financial Notes: ‘Trade’ = total imports and exports (IMF); ‘FDI’ = inflows to the U.K., inflows from
services. Taiwan, Thailand, Indonesia, Philippines and Malaysia estimated at zero (ONS); ‘Tour-
ism’ = U.K. tourism exports (ONS); ‘Finance’ = U.K. financial services exports (ONS);
Tourism: inflows of visitors are a major ‘Exchange Rate’ = appreciation of local currency versus the British pound since June 23
revenue generator for the U.K. and a proxy (Bloomberg)
16 September 2016 BI ECON Bloomberg Intelligence: Brexit SpecialYou can also read
