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A report by The Economist Intelligence Unit A year to go: how Brexit will affect UK industry eiuThe world leader in global business intelligence The Economist Intelligence Unit (The EIU) is the research and analysis division of The Economist Group, the sister company to The Economist newspaper. Created in 1946, we have over 70 years experience in helping businesses, financial firms and governments to understand how the world is changing and how that creates opportunities to be seized and risks to be managed. Given that many of the issues facing the world have an international (if not global) dimension, The EIU is ideally positioned to be commentator, interpreter and forecaster on the phenomenon of globalisation as it gathers pace and impact. EIU subscription services The worlds leading organisations rely on our subscription services for data, analysis and forecasts to keep them informed about what is happening around the world. 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Through a distinctive blend of interactive conferences, specially designed events, C-suite discussions, member briefings, and high-calibre research, The Economist Corporate Network delivers a range of macro (global, regional, national, and territorial) as well as industry-focused analysis on prevailing conditions and forecast trends.A YEAR TO GO: HOW BREXIT WILL AFFECT UK INDUSTRY The Economist Intelligence Unit Limited 2018 1 Introduction 2 Our core scenario: a comprehensive free trade deal 5UK industrial strategy 2017 6 Alternative scenario: a no-deal Brexit 7 Hitting hard: comparing the scenarios 9 Finance: braced for a challenge 14The corporate response 17 Healthcare: exit wounds? 18The corporate response 21 Automotive: grim prospects 22The corporate response 24 Consumer goods and retail: hard realities 25The corporate response 27 Energy: connections and climate 28The corporate response 30 Telecoms: the virtual realities 32The corporate response 35 ContentsA YEAR TO GO: HOW BREXIT WILL AFFECT UK INDUSTRY The Economist Intelligence Unit Limited 2018 2 Introduction This report explores how Brexit will affect trade, regulations and jobs within six sectors of the UK economy. In June 2016 the UK electorate voted to leave the EU. On March 29th 2017 the UK prime minister, Theresa May, wrote to the European Council president Donald Tusk, notifying him of the UKs intention to leave the EU, in accordance with Article 50 of the Treaty on European Union. A summit of EU leaders on March 23rd agreed the terms of the transition agreement reached by the UK and EU negotiating teams on March 19th. Talks on the substantive issue of the future trading relationship have yet to start in earnest and a deal is supposed to be done by October 2018 to allow time for ratification. With a year to go before the UK leaves the EU and the 21-month transition period beginsduring which time the UK will maintain access to the single market and will be bound by the obligations of membership- this report analyses the possible impact on six sectors of the UK economy. The transition agreement provides businesses with some certainty that they will have time to adjust to the new UK- EU relationship. However, Brexit will nevertheless entail some disruption. In three sectors, we expect the impact to be direct and difficult to managefinancial services, healthcare and life sciences, and automotive. In consumer goods and retailing, telecoms and energy, the impact is likely to be more diffuse but still disruptive. The first part of the report discusses The Economist Intelligence Units current core forecast for Brexit, which involves the UK agreeing to a Canada-style free-trade-agreement (FTA) with some special terms for sectors that are particularly important to the UK economy. This so-called Canada- plus-plus deal will probably emerge during the transition period. We then outline a “hard Brexit” or “no- deal Brexit” scenario that involves talks breaking down during the transition period, and the UK leaving the EU without a trade agreement. Using the usual modelling techniques that underpin our industry forecasts, we compare how the economic growth projections for these two scenarios would affect key indicators for our six sectors, unless policies are adopted to mitigate those effects. The second section of this report is more qualitative and focuses on how Brexit will affect companies and other organisations operating in our six sectors. The issues at stake mainly involve trade, regulation, employment and skills and access to investment with much riding on how the UK coordinates its policies with those of the EU and its institutions. Our key forecasts are: l We expect the UK economy to carry on growing in 2018-22 under our core scenario of a Canada- plus-plus deal and our hard Brexit scenario. However, if the UK leaves the EU without a trade deal we estimate that by 2022 the UKs nominal GDP will be 2.7% lower than in our core scenario. Given that inflation would also rise under a no-deal Brexit, real GDP growth in 2020-22 would probably be halved. However, our long-term outlook for the UK economy remains positive, regardless of the terms of the UKs departure from the EU. l After Brexit our view is that London will retain its status one of the worlds leading financial centres, along with New York and Singapore, and that it will also remain Europes leading financial hub after A YEAR TO GO: HOW BREXIT WILL AFFECT UK INDUSTRY The Economist Intelligence Unit Limited 2018 3 Brexit. There is also a large degree of inter-dependence between the UK and EU financial services sectors, just as there is for the trade in goods between the UK and the EU. This inter-dependence matters and means that there is to some degree a mutual interest in achieving a deal that works for both sides. Even under the core scenario, however, a financial services deal will be partial and some financial institutions will consider relocating some personnel and parts of their business after Brexit. The sector is more reliant on global than on EU trends, and will remain a robust driver of the UK economy. l The healthcare and life sciences sector is likely to see exports shrink under our core scenario, but the worst-case scenarioa shortage of much-needed medicineswill be avoided through regulatory agreements. The slower economic growth predicted under a no-deal Brexit scenario would dent tax revenue and consumer spending. Unless policies are adopted to mitigate the effect, this would result in total health spending per head being 90 (US$125) lower in 2022 than it would be under a softer Brexit. However, the UK government could potentially use some of the fiscal savings from ending contributions to the EU budget to mitigate the impact on these sectors. l The automotive sector faces a huge challenge: without a UK-EU FTA, large-scale production in the UK would become difficult. UK vehicle-makers will try to expand in other export markets, but will also need to stimulate domestic demand. Under a no-deal Brexit, we forecast that vehicle sales would be 13.1% lower by 2022 than they would be under our core scenario. Cumulatively, the industry would sell around 840,000 fewer vehicles between 2019 and 2022 than under our core scenario. l The loss of EU workers and disputes over regulation will affect most consumer goods manufacturers, as well as the food sector. Unless agreements are reached over mutual recognition, the effect is likely to push down exports and push up the prices of imports still further. The biggest impact of a no-deal Brexit would be on retail spending, which could be 13.4% lower in nominal terms in 2022 compared with our core scenario. Source: The Economist Intelligence Unit. 2022 projections under a hard Brexit (% lower than core forecast) -16 -14 -12 -10 -8 -6 -4 -2 0 -16 -14 -12 -10 -8 -6 -4 -2 0 Retail sales () New vehicle sales (units) Bank assets () Mobile telecoms revenue () Energy consumption (ktoe) Health spending per head () -2.7 -2.9 -3.2 -9.8 -13.1 -13.4A YEAR TO GO: HOW BREXIT WILL AFFECT UK INDUSTRY The Economist Intelligence Unit Limited 2018 4 l In terms of energy policy, the UK will continue to forge ahead on emissions reductions and decarbonisation. However, the task will become more difficult and energy costs may rise if it exits Europes internal energy market. Energy consumption would be 2.9% lower by 2022 if the UK leaves the EU without a deal and the economy slows as expected. l The UKs exit from the “digital single market” will primarily affect telecoms operators with significant business on the continent. However, there may also be an effect on investment in innovation, as well as on the prices that UK consumers pay when using their mobile phones abroad. Investment in mobile technology could be 3.5% lower by 2022 under a no-deal scenario.A YEAR TO GO: HOW BREXIT WILL AFFECT UK INDUSTRY The Economist Intelligence Unit Limited 2018 5 Our core scenario: a comprehensive free trade deal Despite difficult negotiations, we expect a trade deal to emerge by 2021. In line with the governments intention to honour the Brexit vote by taking control of laws, borders and the budget, the UK will formally leave the single market and the customs union at the end of the Article 50 process in March 2019. However, a transition period lasting 21 months will mean little change to the relationship between the UK and EU while negotiations over the terms of new trading arrangements continue. There are numerous obstacles to the successful conclusion of the negotiations, but we believe that compromises will make a deal possible, particularly given the economic incentive to maintain existing trade ties. Realistically, only the framework of a trade deal will be agreed by the time the UK withdraws in 2019, as completing the withdrawal agreement will take priority in 2018. However, we expect a deal to be agreed by the end of the transition period, coming into force in 2021. During trade talks the EU will resist attempts by the UK to cherry-pick from the benefits of membership, but the end result is likely to be a more comprehensive trade deal than that negotiated by the EU and Canada in 2016. The economic impact In the meantime, the UKs departure from the EU will encourage policymakers to address some of the structural deficiencies that have held back the economy in recent years, including lacklustre productivity growth, insufficient innovation and poor infrastructure. The government has drafted an industrial strategy that prioritises skills, research and development (R&D), and business productivity (see below). This also includes sectoral deals, starting with life sciences, construction, artificial intelligence, and automotive. We expect these measures to support a recovery in productivity, but they are still too modest in size and scope to close the UKs productivity gap with its G7 peers. The UK economy has been resilient in the aftermath of the Brexit vote. Average annual real GDP growth was firm in 2016 and 2017, at 1.9% and 1.8% respectively. However, the annual pace of growth slowed throughout 2017, from 2.1% in January-March to 1.5% in October-December. We forecast a further modest growth slowdown in the next two years, to 1.5% in 2018 and 1.4% in 2019, led by a slowdown in domestic demand. In 2018 we expect consumer spending to weaken in response to slower employment growth, and greater uncertainty about the economic outlook to push up precautionary savings. We forecast that growth in investment spending will decelerate in 2018-19 as a result of heightened uncertainty during the Brexit negotiations and higher cost pressures due to sterlings depreciation. Consumer spending will recover in 2019-22 as inflation eases, uncertainty recedes and unemployment edges lower. However, increased borrowing costs arising from tighter monetary policy will hold back the pace of the recovery in these years. Moreover, the export boost from sterling devaluation will ease in 2019. Indeed, we expect the trade balance to exert a drag on GDP growth as a recovery in domestic demand pushes up import growth A YEAR TO GO: HOW BREXIT WILL AFFECT UK INDUSTRY The Economist Intelligence Unit Limited 2018 6 again. A business-cycle downturn in the US in 2020 and tougher terms of trade with the EU will also constrain exports in 2020-22. Nevertheless, we expect real GDP growth to pick up to 1.8% a year on average in 2020-22. UK industrial strategy 2017 Ideas: l Raise total R&D investment to 2.4% of GDP by 2027. l Increase the rate of R&D tax credit to 12%. l Invest 725m (US$1bn) in new Industrial Strategy Challenge Fund programmes to capture the value of innovation. People: l Establish a technical education system that rivals the best in the world.
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