UK will take time to adjust to Brexit

Why is Britain the worst-performing major economy in the world? Leaving aside the possibility — never far away from the fecund minds of the Brexiteers — that the UK is a victim of a global conspiracy against the UK led by a cabal of resentful globalists, Europhiles and Eurocrats, the answer is indeed Brexit. The British are getting poorer because of the decision to leave the EU in 2016, which was implemented three years ago today. Quite the birthday present. This is how Brexit works — or, rather, doesn’t work. In the words of the IMF: “Higher interest rates and taxes along with government spending restraint will exacerbate a cost of living crisis.” As we all know, we’ve had to implement those policies because of the rise in inflation.

Now, inflation does indeed have a lot to do with the consequences for energy and food costs of the war in Ukraine, and the after-effects of the pandemic, especially in China. Yet the UK has the added difficulties imposed by Brexit. How so? You need to think of it in terms of supply and demand, which is how all prices are in the end determined.

If there’s a shortage of grain, because Ukraine cannot export, and people still need it to make bread, then the price tends to shoot up (as it has). The same principle applies to all the goods and services in the British economy. We’ve got a major shortage of labour compared to where we might otherwise be because of the loss of freedom of movement of workers from the EU (one of the main selling points of Brexit). Long Covid is also a factor, as is people taking earlier retirement; and migration from abroad has partly offset the Brexit effect on the labour force; but the impact is still apparent, and has hit sectors such as hospitality, health and agriculture hard.

Hence wages going up so fast – and higher wages mean higher labour costs, which mean higher prices. Breaking that cycle is essential, but the cycle in the UK is more pernicious because we’ve lost a ready supply of workers — from the EU. Then there’s the loss of investment. The damaging effects of Brexit are often invisible — the new gigafactories and warehouses not built, for example. Investors don’t want to put their money into Britain because it has worse prospects these days — outside the single market and struggling with inflation — and so they invest elsewhere instead. It’s not personal.

Investment flatlined after the 2016 referendum because of the uncertainties, and it still hasn’t recovered. Less investment means less new equipment, and the new working practices that arrive with new software and technologies; as such, less innovation, and lower productivity. Productivity, in the end, drives wages. As we learned back in the 1970s, we cannot pay ourselves more than we produce, and to make the workforce more productive you need that investment and innovation. Failing to do so means that you just fall behind, which is what happened in the 1970s, and is happening again now.

It’s slow and insidious. It doesn’t matter how entrepreneurial you are if you’ve lost easy access to markets and wage costs are too high. There’ll still be brilliant business success stories; there’ll just be fewer of them. We need to get prices and costs in the economy under control and – without an influx of new workers and massive investment suddenly materialising – we’ve no choice but to squeeze the economy hard, and take the spending power out. That is the way we adjust demand levels down to match a lower level of supply, and we match our material aspirations with our ability to earn them. It takes time, and it’s painful.

What we’re going through now is the Brexit adjustment process. If a people is to become poorer, then there are big questions about who bears the adjustment. Usually it’s the workers with the most bargaining power who do best, and those who’ve got the least who struggle. We are, in effect, scrapping over a smaller pie (or rats in the Brexit sack, if you like).

Despite all the strikes, it’s workers in the public sector who are taking the bigger hit, with their earnings falling further behind inflation compared to the private sector. Those who are going to be laid off in the coming recession will take the hardest punishment of all. The upsurge in industrial unrest is simply a symptom and a crude way of distributing the pain of living with a smaller economy.

Because of their political power, Britain’s pensioners are faring relatively well, but overall this process of adjustment is naturally quite arbitrary (not to say unfair). Thus if you happen to be sick then you’re losing out big time, because the British nation prefers to keep tax rises down rather than protect real terms health spending and pay the nurses the wages required to end the shortage of labour. If you’re old and rely on investment income from abroad, you’re quids in from the weak pound.

The only real way to make Brexit work is to reduce business costs so far that exports start to respond, and the economy starts to grow again, thereby generating the profits needed for investment and higher productivity. Employers will also need to substitute expensive workers for cheaper machinery, if they can, simply to survive. Perversely, simply because the British haven’t got a large number of young people coming through to fill the vacancies, the UK probably will see much more hi-tech automation and AI (similarly to migration-phobic but slow-growing Japan). Areas such as the city might do well out of that trend, where there remains a comparative advantage to build on.

But the depressed, sluggish economy overall means that relatively few sectors will be able to achieve that, because it needs profits and investment – and there’s not much of that around. Otherwise, then, in other sectors, the UK will just have to try and compete with lower real wages, in order to compensate for the additional costs and barriers to trade imposed by Brexit. So the British will have to be more like the Chinese, Koreans or Vietnamese, carving out new markets with value-driven exports of goods and services. That isn’t what we voted for in 2016.

Generally you’d also need to loosen environmental standards, climate targets and animal welfare laws, shred workers’ rights, scrap swathes of health and safety rules to get costs down, just as the right demand. Yet the British aren’t really ready for that; the necessary corollary of a successful Brexit. At best, Brexit means that the UK will need a long and painful adjustment to its new situation. Eventually the economy will restructure, and things will stabilise, but at a rather lower level of income and public services than we’ve been used to, when compared to our European neighbours.

In a decade or so the Poles and Slovenians will, on average, be richer. We will have fewer EU migrants, and more people down at heel; but we will have regained nominal control of many areas of national life. It will be a far less equal society even than today. So the British will be poorer but, in some quarters, happier. Happy Brexit birthday.