LONDON – Nearly a year ago, the British voted – 52% to 48% – to leave the European Union. Many expected the vote to produce severe economic volatility. But the economy, so far, has proved resilient, though as we head into this week's snap general election, there are signs that higher inflation is taking its toll on consumers and some businesses. The question is whether the economy can withstand the actual divorce proceedings.
In the wake of the Brexit vote, swift action by the Bank of England helped to calm financial markets and keep credit flowing. Unlike during the global financial crisis of 2008, the cost of credit for most firms and families in the United Kingdom hasn't risen; if anything, it has fallen. All the while, British consumers have done what they do best: spend their money in stores and online. Household spending supported overall growth close to 2% last year.
The big change in financial markets has been the steep decline in the value of the pound. The weaker exchange rate has helped UK-based exporters' competitiveness. The April industrial trends survey, conducted by the Confederation of British Industry (of which I am chief economist), showed the strongest rise in manufacturing export orders since 2011. But this is a double-edge sword: British manufacturers also face the fastest rise in average unit costs since 2011, owing to the rising prices of imports.
The decline in the pound's value may also start to hurt households. Consumer price inflation is set to peak at close to 3% this year. Yet, given the changing dynamics of the labor market and subdued productivity growth, average wage gains are not likely to be much more than 2.5%. In real terms, therefore, average household incomes are likely to remain flat or even shrink, undermining the UK economy's crucial consumer-spending engine.
Worse, these impending macroeconomic challenges may well be dwarfed by those arising from the coming Brexit negotiations, though perhaps not for the reason one might expect. The key danger for businesses, as the leader of a construction-engineering firm put it to me, is that planning for all of the possible Brexit scenarios can become an all-consuming affair, causing companies to lose sight of their larger strategic goals.
The good news is that, so far, the business community seems confident. Entrepreneurs and CEOs have plenty of experience making decisions in an uncertain world. So, despite the Brexit unknowns, they are continuing to invest in future-oriented areas like cloud computing, artificial intelligence, and data analytics.
The truth is that it is the technological revolution and the surge in consumption in Asia – not the UK's relationship with the EU – that will transform the way business is done over the next couple of decades. As the UK-EU negotiations get underway, it is critical that companies bear this in mind, by ring-fencing Brexit working groups and keeping the rest of the firm's management focused on broader business strategy.
This is not to say, of course, that we should shrink from the complexity of the task ahead, much less disregard the challenges that Brexit will bring. On the contrary, we must confront those challenges head-on, including by facing some hard truths and demanding that some difficult decisions are made as soon as possible.
From a business perspective, one of the biggest Brexit-related concerns relates to people. As it stands, the UK economy is beset with skills shortages: more than two-thirds of firms are not confident they can fill vacancies for high-skill jobs over the next 3-5 years. The long-term solution is better education and skills training throughout the UK. But, in the short term, migration must play a role.
Already, EU migrants – from seasonal workers harvesting fruit and vegetables to academics broadening the minds of the next generation and doctors and nurses protecting our health –make a major contribution to the UK economy. In many organizations and firms, EU citizens comprise more than 40% of employees. These EU citizens and their families are now facing real uncertainty.
The business community, by and large, advocates the immediate guarantee that EU citizens currently working in the UK will be able to continue doing so. Likewise, UK citizens working across the EU should be granted the right to remain where they are. This is not only the right thing to do; it is the smart economic play, as the skills and talents of the workforce will be the engine that propels companies forward in the coming decades.
But EU citizens already in the UK will not be sufficient, on their own, to power that engine. That is why the UK also needs a new, evidence-based immigration system – and fast. Businesses, workers, and families need to know by the end of this year what such a system will look like, including the criteria for entry.
Another critical decision that must be made now is that "no deal" is not an option. Far from keeping that possibility open, as Prime Minister Theresa May's government has done, the UK and the EU must commit to establishing a clear agreement on regulatory issues, thereby ensuring that companies on both sides of the English Channel can continue to do business. A "cliff-edge" scenario – in which the end of the two-year negotiating period brings a sudden change to an unclear or even undecided regulatory regime – must be avoided at all costs.
If the British economy is to cope with Brexit as well as it has coped with the Brexit vote, the government, like businesses, must minimize the impact of uncertainty by managing that uncertainty effectively. Whatever the political case for delaying the start of serious Brexit negotiations, it must not be allowed to overshadow the economic case for moving the conversation forward.
Rain Newton-Smith is Chief Economist at the Confederation of British Industry.
© Project Syndicate 1995–2017