The event of Britain’s exit from EU has an immediate and long-term impact on growth, prosperity and trade in the United Kingdom. The economy wide impact of Brexit can be seen from the performance of different macroeconomic indicators including GDP growth, movement of price level, labor market condition, strength of domestic currency and other related indicators.
The GDP growth rate in UK constitutes a mixed performance. GDP growth recovered marginally in the third quarter of 2017 to 0.4 percent from 0.3 percent in the previous quarter. UK after Brexit referendum is lagging behind most of the G7 countries. UK’s growth in the post Brexit period is 0.5% lower on an average than prior to the referendum (McGrattan and Waddle 2017). The construction sector is UK has undergone successive recession after Brexit.
The pound exchange rate against Dollar and Euro has risen significantly indicating a weak domestic currency. Day after the Brexit referendum, the exchange rate has continued to surged upward. The weak currency by raising import cost of the companies has led to a decline in business growth.
The price level has accounted a steady rise following a weak pound that imposes a higher cost of import. Because of an inflated level of price, the living standard has deteriorated. The increasing price of essentials such as food, fuel and clothes has pushed up the price level to 2.9% from 2.6% in the last quarter (theguardian.com 2018).
The weak currency gives a ray of hope that that expected increase in trade volume will help to offset the downturn in consumption demand. However, the recent trade statistics has revealed that expansion of trade, outside the EU border has knocked down (Economics 2016). The overall trade deficit in UK has remained unchanged.
The labor market condition has improved as revealed by a declining unemployment to 4.3% in recent years. The left workers though suffered from a decline in real wage by 0.4% the average earnings have risen by 2.1% (theguardian.com 2018). This is the only optimistic sign of Brexit until now.
Since 2012, the net migration from EU has grown to more than double. The immigrant labor force from European Union plays an important role in UK’s economy. The strength of the labor force has allowed UK maintained a sustained economic growth without increasing wage and helped the economy to keep interest and price to a considerable low level (Obstfeld 2016). The Brexit has imposed uncertainties about the future of immigrant labor force. The gain to UK from restricting immigration depends on future of UK’ relation with EU. In case Britain want retain its access to the single market, it has to allow free movement of labor between UK and EU. Brexit has a potential threat on available labor supply. This might hampers productivity of the economy.
The UK’s trade statistics show that more than half of the UK’s exportable is channeled to the expanded market of European Union. Being the member of custom Union, UK previously enjoy several trade benefits for trading with other EU members. After Brexit, UK is less likely to enjoy benefits from a favorable trade agreement. However, prior to Brexit UK exporters would have to bear some additional expenses to comply with the rules of EU. As far as impact of Brexit is concerned, there is doubt whether UK will be actually hurt from the breakdown of trade relation with EU (Portes and Forte 2017). In view of deterioration of manufacturing sector and declining importance of Europe in the global economy, the benefit of being an EU meme now is lower as compared to that few years ago. The effect of Brext will vary across different sectors of the economy. Brexit comes with an opportunity for Britain to establish an independent unilateral trade policy with countries outside EU. The production sector of UK economy has faced a bigger challenge than service sector. The production units, dependent on UK-EU trade relation is likely to suffer more. Some economists hold optimistic view about the possible impact of Brexit (Begg and Mushövel 2016). They believe that after leaving EU, the external sector of UK may be better off if the freedom from independent trade could be used optimally.
The finical service is the most vulnerable sector to Britain’s exit from European Union. After Brexit, UK would loss its influence over single market. The City though hurt in the short run but it would not spell much disaster. This is because of the competitive advantage that City enjoys (Economics 2016). Exit from EU would encourage UK to involve it trade relation with the emerging markets, which would pay dividends in the long-run for financial services.
Foreign investment
Policymakers are extremely concern about the possible dry up of foreign investment in the post-Brexit period. The foreign investment in UK will hurt from losing access to the single market. UK could experience a long period of weak inflow of foreign funds because of renegotiation of UK’s new relationship. However, single market access is not the only benefits that foreign investors enjoy. The investors enjoy several advantage in the form of having a foothold over the country (Jonathan and Forte 2017). The foreign investment could recover its lost ground if investors can utilize other favorable terms in the post Brexit period.
The sudden exit of Britain from EU is likely to bring some possible shocks for the UK economy. In the Brexit transition, possible supply shocks can be resulted from an interrupted labor supply through migration of jobless residents in EU to Britain. In the post Brexit period, the financial sector of UK may get a hit dropping GDP by 5%. The effect of possible supply side shocks can be analyzed using the open economy model build with a framework of AD-ERU- BT.
The external shocks in supply is defined as an unexpected change in global terms of trade between raw material and manufacturers. A depreciation of pound against major trading partners will raise the import cost of manufacturing firms. This kind of external trade shocks along with it supply side impacts lead to a change in price setting real wage curve (Mankiw 2014). Consequently, there will be a shift in AD, ERU and BT curve. All the three curves shift in the same direction. The combined effect of the supply shocks causes a change in output.
Figure 1: Effect of negative external trade shocks
(Source: as created by Author)
In the open economy model, the position of wage setting and price setting curve depend on the world’s terms of trade and exchange rate (Carlin and Soskice 2014). A weak currency means a higher price of imported raw materials for manufacturing firms. The terms of trade raises from T1 to T2. Domestic firms in order to maintain their profit margin reduces real wage paid to the workers. Consequently, the price-setting curve at the new terms of trade shifts downward. In the labor market, equilibrium point shifts from point A to point B. This in turn causes a leftward shift of the ERU curve from ERU to ERU1.
The overall impact of such external shocks can be evaluated in a complete open economy model that captures the effect on aggregate demand (AD), trade balance or BT curve, impact on wage setting and price setting curve and hence a shift of the ERU curve (Baumol and Blinder 2016).
Figure 2: Effect of different shocks in the economy
(Source: as created by Author)
The AD and BT curve shifts following a shock in aggregate demand and trade balances. The positive effect on trade balance from exchange rate depreciation offset by the increased tariff cost of imported raw materials. This causes a leftward shift in both AD and BT curve. The focus is given on the shift of ERU curve. From Brexit, there is a clear upward pressure on price. A is the initial equilibrium point which lies above the new ERU curve ERU1. Corresponding to E2, the prevailing real wage is lower than the wage-setting real wag. The rationale behind the downward movement of wage is that cost to the domestic firms have increased now (Gandolfo 2016). This lead to a higher domestic price cutting the real wage. Under external trade shocks the adjustment through depreciation of exchange rate settle equilibrium at A’ leaving output at the same level Y1. The monetary expansion results in currency depreciation at point A’. There may occur a situation of stagflation as defined as co-existence of high inflation and high unemployment (Carlin and Soskice 2014). As the economy moves from A’ to B’, the unemployment rises because of a declining output at Y0. The increased unemployment co-exists with rising price level.
In order to counter economic shocks, the government uses the tools of fiscal and monetary policy. However, for uncertainties resulted from Brixit referendum the UK economy need monetary easing. One common policy that Bank of England uses is to reduce the interest rate to a reasonably low level (ft.com 2014). This by improving productivity growth might help to correct the gloomy outlook for the economy in future.
References
Baumol, W.J. and Blinder, A.S., 2016. Principles of Macroeconomics. Cengage Learning.
Begg, I. and Mushövel, F., 2016. The economic impact of brexit: jobs, growth and the public finances.
Carlin, W. and Soskice, D.W., 2014. Macroeconomics: Institutions, instability, and the financial system. Oxford University Press, USA.
Economics, C., 2016. The economic impact of ‘Brexit’. Report prepared for Woodford Investment Management, Oxford.
Ft.com. (2018). Brexit uncertainty calls for stable monetary policy. [online] Available at: https://www.ft.com/content/a2454be2-3fb3-11e6-8716-a4a71e8140b0 [Accessed 25 Mar. 2018].
Gandolfo, G., 2016. International Finance and International Macroeconomics: An Overview. In International Finance and Open-Economy Macroeconomics (pp. 3-9). Springer, Berlin, Heidelberg.
Jonathan, P. and Forte, G., 2017. The Economic Impact of Brexit-Induced Reductions in Migration to the UK. Vox EU, January, 5.
Mankiw, N.G., 2014. Principles of macroeconomics. Cengage Learning.
McGrattan, E.R. and Waddle, A., 2017. The impact of Brexit on foreign investment and production (No. w23217). National Bureau of Economic Research.
Obstfeld, M., 2016. The initial economic impact of Brexit: an update to early December 2016. Brookings Papers on Economic Activity, 2016(2), pp.359-366.
Partington, R. and Clarke, S. (2018). How has the Brexit vote affected the UK economy? September verdict. [online] the Guardian. Available at: https://www.theguardian.com/business/2017/sep/26/how-has-brexit-vote-affected-uk-economy-september-verdict [Accessed 25 Mar. 2018].
Portes, J. and Forte, G., 2017. The economic impact of Brexit-induced reductions in migration. Oxford Review of Economic Policy, 33(suppl_1), pp.S31-S44.
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