The post-referendum economy: unscathed, so far

Now we know. Project Fear did live up to its name—insofar as its post-referendum economic forecasts were concerned. While the Treasury had predicted that the economy would stall, the first “hard” economic evidence published today by the Office for National Statistics shows that the economy (or GDP) rose by 0.5 per cent in the third quarter of this year, or 2 per cent annualised: 2.3 per cent higher than a year ago. This means that a long-term trend in which UK economic growth has been plus or minus 2 per cent continues. So, no change there then.

But as always there are caveats.

The normal caveat is that this was the first estimate made by the ONS, just a month after the end of the quarter, and the data will almost certainly be revised, though we cannot say which way. The ONS says it has less than half the data it will eventually have.

In what is becoming an increasingly normal caveat, there is no evidence that the UK economy is rebalancing, i.e. that a modest shift is happening in terms of the economy’s heavy reliance on services output, which accounts for four-fifths of GDP. The ONS says that service producing industries boosted output by 0.8 per cent. There were less than average gains for business and financial services, but a strong 2.2 per cent gain for transport, storage and communications, with the last item including a vigorous performance by the entertainment industry. And there was a robust 1.1 per cent again by the category of distribution, hotels and restaurants, in which anecdotal evidence of strong tourism post-referendum in the wake of the fall in Sterling was borne out.

Construction, about 6 per cent of GDP, fell by 1.4 per cent as private home dwelling output stalled, after a steady rise going back to 2011, but the level of total construction in the UK has barely moved for about 2 years. Industrial production, including utilities and accounting for about 14.5 per cent of GDP, fell by 0.4 per cent. The latter recorded its third fall in four quarters, and it wasn’t growing very much in the prior two years.

The performance of production industries, especially manufacturing, is particularly worrying because Brexit Britain will need to show a prowess in manufacturing that we have under-exploited for too long. The UK has a rich vein of both large-scale foreign-owned manufacturing, and of small-scale, home grown, science- and engineering-based firms. The former is now under a cloud given the uncertainty of Brexit outcomes and the distinct possibility that foreign direct investment will divert away from the UK or be partially reversed. Nissan and Toyota seem to be committed to produce in the UK for now, but other foreign firms have been less optimistic. Home-grown manufacturing is not to be sneezed at, but as good as is it is, the country isn’t very good at scaling these firms up and exploiting global export opportunities. We have nothing in the same league as, say, the German “Mittelstand,” small to medium size manufacturing companies that are the bedrock of German export industries. The structure of our financial services industry and its governance regime has a lot to do with this.

The structural caveat is something about which Brexiteers remain in denial, as much as Remainers were in denial about the post-referendum economy. The major economic issue for the UK surrounding Brexit was never going to be the short-term or cyclical consequences of the referendum. And so this has proven to be. Rather, it is the glacial and more corrosive undermining of the UK’s supply potential, or trend growth of productivity—and therefore people’s living standards. This will flow from the disruption of trade and investment (home and foreign inward investment) accumulated in the run-up to and after actual Brexit. This remains very much in situ.

Much depends, of course, on the terms of Brexit, about which the government is clueless for now, and also on the extent to which the government can mitigate the negative consequences, which doesn’t even figure on its agenda as yet. Consequently, we can welcome the third quarter’s GDP estimate as good news, but should also remain cognisant that it tells us where we have come from, not where we are going. And as things stand—an important qualification—the future path of GDP will be defined by forces and circumstances that are more likely to be growth-destructive than creative.

For the immediate future, we should assume that the Bank of England is done with monetary easing, and I would go so far as to say that the lifespan of the QE programme announced after the referendum may not be that long. The coming Autumn Statement couldn’t have had a better overture: the Chancellor certainly does have some economic space to boost infrastructure and contribute to the Prime Minister’s stated social goals. The questions of whether he will choose to take any fiscal space, and how, given a likely significant overshoot of public sector borrowing this year, are moot.