Nicholas Bloom, Philip Bunn, Scarlet Chen, Paul Mizen, Pawel Smietanka 25 February 2020
After months of political stalemate, Boris Johnson’s decisive victory in the December UK general election cleared the way for the UK to leave the EU. This column uses data from the Decision Maker Panel, a monthly survey of CFOs from around 3,000 UK businesses, to show that Brexit-related uncertainty has fallen since the election. The fall in uncertainty has been larger among more domestically focused businesses, however, and substantial uncertainty remains around the future trading relationship between the UK and the EU. There are some signs that this fall in uncertainty may lead to a modest pickup in investment, but it is still early days.
After months of political stalemate, Boris Johnson’s decisive victory in the December UK general election cleared the way for the UK to leave the EU (Baldwin 2016). The UK and EU Parliaments passed the necessary legislation and at 11pm on 31 January, the UK left the European Union. As we have discussed previously on Vox (Bloom et al. 2019), the Brexit process created a large, broad, and long-lasting increase in uncertainty in the run-up to this point. This has already left its mark on the UK economy, resulting in lower investment and productivity. In this column, we discuss how the general election result and the departure from the EU that resulted from it has affected these uncertainties and what that might mean for the British economy over the next 12 months.
Our analysis is based on data from the Decision Maker Panel, a monthly survey of CFOs from around 3,000 UK businesses. The latest wave of the survey ran between the 3rd and 17th of January 2020. We use data from successive DMP surveys to generate our Brexit Uncertainty Index (BUI), which is defined as the percentage of businesses that report Brexit to be among the top three current sources of uncertainty for their business.
In the first two years after the EU referendum uncertainty was high. Just under 40% of businesses reported that Brexit was an important source of uncertainty (Figure 1), which was substantially higher than our indicative estimate of how the BUI looked prior to the referendum based on betting odds data. Uncertainty rose further in the autumn of 2018 as the UK and EU struggled to reach an agreement on the terms of withdrawal and then as the UK Parliament rejected the deal that had been agreed. The BUI averaged around 55% during 2019 as the point at which the UK was due to leave the EU was extended a number of times from the initial date of 31 March 2019.
Figure 1 Brexit Uncertainty Index (BUI)
Brexit-related uncertainty has fallen in the aftermath of the UK general election in December 2019. In the January 2020 DMP survey, 45% of panel members thought that Brexit was in their top three sources of uncertainty, the lowest level since August 2018 (Figure 1). This fall was driven by fewer firms reporting that Brexit was their largest current source of uncertainty. Nevertheless, the BUI in January 2020 was still a little above the average of the first two years after the referendum.
Our previous work has shown how Brexit uncertainty has been higher for firms that are more exposed to the EU along a number of different dimensions defined by shares of exports, imports and migrant labour from the EU; exposure to EU regulations; and foreign ownership. That remains the case, but the falls in uncertainty in the latest data have been largest for more domestically focused businesses (Figure 2). We interpret this as an indication that lower uncertainty has been primarily associated with reductions in concerns about how the Brexit process will affect the UK economy in the shorter term, for example by eliminating the risk of a no-deal Brexit, rather than greater clarity among firms about the UK’s future trading relationship with the EU.
Figure 2 Changes in Brexit uncertainty and exposure to the EU
The latest survey results show that there is still substantial uncertainty amongst business around what they think will happen in the negotiations between the UK and EU on a future trade deal. The January 2020 survey asked firms, for the first time, when they think the current transitional period will end and if there will be a trade deal agreed by then. The proportion of firms expecting that there will be no transition period beyond the end of 2020 was estimated at 51%, consistent with government policy. Within this, the average chance of a trade deal being agreed was 31% with a 20% chance of the transition period ending in 2020 with no trade deal agreed (Figure 3). Businesses thought there was 49% chance that the process will take longer than this.
Expecting trade negotiations to continue beyond the end of 2020 may be one reason why some firms do not expect Brexit uncertainty to be fully resolved this year, although even once a deal is agreed there may still be uncertainty about what that means for individual business. Over recent months, businesses have been reporting that they expect the remaining uncertainties around Brexit to take longer to be resolved (Figure 4). In January 2020, two-thirds of businesses affected by Brexit uncertainty thought that uncertainty would not be resolved until at least 2021.
Figure 3 Businesses views on when the transition period will end
Figure 4 When is Brexit uncertainty expected to be resolved?
An important question for the UK economy is whether the recent fall in Brexit-related uncertainty will lead to an increase in investment. Using data from the DMP we have previously estimated that the Brexit process had reduced UK investment since the referendum by around 11% by the middle of 2019. Not all of the reduction in investment was necessarily due to uncertainty; some of it may also have been in anticipation of lower future sales. But a significant proportion of it is likely to have been associated with uncertainty (we estimate around two-thirds, although it is hard to be too precise about this) and so we conclude that when uncertainty falls at least some recovery in investment may be expected.
It is early days yet, and firms take time to make and implement large investment decisions, but there are some tentative signs in the DMP that this fall in uncertainty may lead to a modest pickup in investment. The average probability attached to Brexit having a negative effect on investment over the next year fell a little in January 2020 to 26%, down from 29% in November 2019 (Figure 5). And the weight on a positive effect rose a little from 9% to 11%.
Figure 5 Expected impact of Brexit on investment over the next year
Figure 6 Nominal investment growth
Some increase in overall investment growth was also expected by panel members in the latest data. Firm-level investment data can be volatile, but based on data collected between November 2019 and January 2020, average four-quarter nominal investment growth was expected to be 4.6% in 2020 Q3, up from the 2.4% expected for 2020 Q2 a quarter earlier (Figure 6). That was also higher than recent achieved growth, which was -1.8% over the year to 2019 Q3. Part of that improvement in expected investment growth was in data that pre-dated the general election, although there was some tentative evidence of an improvement in investment intentions for those companies that had been more uncertain about Brexit.
During 2019, realised investment growth has been consistently lower than expectations for the same period taken a year earlier (as shown by the solid line in Figure 6 being below the dotted line). One reason for this difference could be the expectation that the UK took longer to leave the EU than was anticipated at the time those expectations were formed. Successive cliff edges may have reduced the investment that was expected to take place.
Looking ahead, we plan to continue to use the DMP survey to monitor developments in Brexit uncertainty and to carry out further analysis of its impact on investment and the economy as more data emerges. The survey will also ask companies about their expectations for the future relationship between the UK and EU, the extent to which they are prepared for the changes that this will bring and the effects they expect it to have on their businesses. Watch this space.
Authors’ note: The January DMP data are available at https://www.bankofengland.co.uk/decision-maker-panel/2020/january-2020. More detailed information on the Decision Maker Panel can be found on the survey website: www.decisionmakerpanel.co.uk.
Baldwin, R (ed.) (2016), Brexit Beckons: Thinking ahead by leading economists, A VoxEU.org eBook, CEPR Press.
Bloom, N, P Bunn, S Chen, P Mizen, P Smietanka and G Thwaites (2019), “The Impact of Brexit on UK Firms”, NBER Working Paper No. 26218 and summary on VoxEU.