Why did the economy grow post-Brexit?

Wed 11 January 2017

Note: The main point of this post is on sketching a simple and plausible reason why growth held up in 2016 despite uncertainty from the result of the June 2016 Brexit vote together with the ensuing speculation on when (or if) Article 50 would be triggered. This is quite distinct from longer term analysis such as that made by the Treasury on differences to the economy a decade or so after the UK has left the EU. Thanks to Peter Shaw for alerting me to this potential confusion.

Some economists, politicians and other commentators warned we might see negative short-term consequences of Brexit by the end of 2016. And the reasoning was perfectly sensible, going something like this:

  1. Uncertainty will knock business confidence slowing investment and prompting cost cutting on wage bills.
  2. And that will fuel loss of consumer confidence as people become nervous of the future and their job security.
  3. Which will in turn cause them to slow their spending and save more: a car purchase is postponed, a holiday skipped, a tired kitchen lived with for another year and suchlike.
  4. This lack of spending erodes business profits... go to step 1.

In this way a vicious cycle can be established that slows the economy, possibly into recession.

But this did not happen in 2016. Why not?

There's a simple reason which was so obvious I didn't realise it until recently: people who are worried by Brexit are in a minority. Roughly speaking, a third of the electorate in the UK voted Leave, a third voted Remain and a third did not vote. So about two thirds of the electorate (65.3% if you want precision*) were either in favour of Brexit or weren't sufficiently motivated to vote against it. This is a plausible explanation of why a majority of the population just carried on as normal.

Although a defence of the statement "non-voters don't matter" can just about be made in the context of an election or referendum, it's clear they do matter when it comes to the economy: non-voters may not feed the ballot box but they have to feed themselves and are consumers in the shops.

And while there are some very vocal individuals railing against Brexit, it's a fair bet that many Remain voters have not altered their lifestyles very much. I voted Remain but I don't believe Brexit will necessarily be a disaster, though my imagination is stretched in seeing it as a positive development. I carried on living my life much as I did before. In fact, I've brought forward big ticket purchases as I believe prices will rise due to the pound devaluing post-Brexit. (This provides another possible explanation for recent economic growth, and is touched on in the FT article on consumer spending mentioned below.)

The same argument works in Scotland too. Although the Leave vote percentage was lower than in the rest of the UK, the proportion of non-voters was higher, so there's still a clear majority of the electorate (precisely 58.3%) are either in favour of Brexit or insufficiently motivated to vote against it.

Scotland's slower economic growth relative to the UK is almost certainly due to the oil price shock and nothing to do with Brexit. There's some good evidence for this which I'll set out in another post. But in brief, according to the Scottish Government's Quarterly National Accounts (see table C), Scotland's economic divergence began in early 2015, just after the oil price shock hit. Also, the FAI/SCER's Labour Market report shows that unemployment in the Aberdeen area — the hub of Scotland's service industry to North Sea oil and gas — has now risen to near 2009 peak levels.

Across the whole UK, it's also clear that economic growth is being driven by consumer spending which is in good part enabled by a growth in credit, i.e. people are taking out more loans. We are now heading back to 2007 private credit levels and that should be a real cause of concern.

And if you're not willing to take my word for it, then listen to the Governor of the Bank of England, Mark Carney, who has just said he doesn't see Brexit as the biggest risk to the UK economy; instead he cites financial instability and external (i.e. foreign) factors as his main concerns.

So while the longer term warnings of Brexit's impact on our economy may still come to pass — remember, we've not yet left the EU — it may well be swamped by bigger issues that extend across Europe and the rest of the world. I doubt the Euro monetary union, and perhaps even the EU itself, could survive another crisis. The memory of 2008 and the fact that interest rates remain stuck near zero means we won't simply see a repeat of that crisis. Predicting when it might occur or what form it will take is a mug's game, but we can anticipate that a troubled time lies ahead, prepare for it and perhaps even address its causes. But it seems our governments — both central and devolved — along with most politicians and commentators are fixated with Brexit and missing the bigger and much more worrying picture.