Economics & StrategyEmail
What is the cost of heightened economic uncertainty? This question has come to the fore as global measures of it hit their highest level for more than 80 years. The breakdown in international co-operation across a number of economic and political axes has already hit global growth. However, many policymakers are concerned about the longer-term impacts of unilateralism. Disruption to supply chains, soft business investment and the reorienting of trading relationships are visible and measurable impacts. Understanding the legacy of overtly nationalist economics is rather harder.
Understanding uncertainty really matters at a time when President Trump is advocating a more hawkish stance on China’s trade practices and Mexico’s policing of its border. American firms cannot be certain of the scale of disruption resulting from the president’s unconventional approach. Mr Trump appears as likely to double down on tariffs as he is to cut a deal. His unpredictability puts trading partners on alert and lends credibility to his threats. Businesses, however, fear disrupted access to key components in the production process. There is growing evidence of stockpiling by US firms and a pullback in new investments. Recent conversations I have had with investors leave me with the impression that for many, the most important data informing their decision-making is the president’s next tweet. This kind of uncertainty impairs access to finance for companies across the world.
A paper from researchers at the Bank of England seeks to quantify the impact of economic uncertainty. Examples are easy to observe amid the power dynamics of a global trade war or the ambiguity of Brexit. The paper concludes that economic uncertainty leads to declining investment in research and development, higher mark-ups from businesses and precautionary savings by households. Together, these reduce an economy’s overall productivity. Most worryingly, the research estimates that these impacts can last in excess of ten years after the initial shock. The rhetoric may pivot on a sixpence but the economics may not.
In the UK, three years on from the referendum, investors are still no clearer on the opportunities and frictions that will emerge after Brexit. A company without clear direction on the regulatory landscape will kick investment decisions into the long grass. It will add a larger mark-up to its prices to cover the risk of disruption. The recent data on this is very clear. Investment spending declined throughout 2018. Business investment in Britain is expected to generate the longest run of declines in the postwar era. The Bank of England’s Inflation Report estimates that the level of investment may be between 6 per cent and 14 per cent lower than it would have been without Brexit uncertainty.
While some of this will return when greater clarity emerges on Brexit — something often referred to as contributing to a “Brexit dividend” — the long-term implications of the investment hiatus are more important for sustainable growth and for public finances. Ben Broadbent, one of the frontrunners to succeed Mark Carney as Bank of England governor, has warned that resolving Brexit in a way that leads to a disorderly departure is more likely to eliminate than unlock business investment.
There is also evidence that the economic uncertainty is not confined to the private sector. There are signals emerging from the Treasury that the summer spending review, traditionally designed to set public sector spending for the coming three years, will be abridged to a single year. The pledges of tax cuts from potential prime ministers mean it is hardly surprising that financing decisions on infrastructure projects such as the HS2 rail line cannot be agreed. The public sector’s role in creating value by financing long-term projects means that such indecision is set to have long-term implications for growth.
The dog that has not yet barked is precautionary saving by consumers. Indeed, the opposite has occurred. The Great British Consumer has responded to recent events by saving less, not more. UK households are putting aside less than £1 of every £20 they receive in income. This is the lowest level for more than 60 years. This is partly driven by very low interest rates and a 40-year low in unemployment. However, the concern is that this is not sustainable at a time when companies are taking a more cautious outlook. This is not UK households fixing the roof while the sun is shining in the jobs market — this is actively removing tiles and hoping it will not rain.
So what is the way forward? Well, often the best way to separate career politicians from those with true business experience is to listen closely when they talk about uncertainty. Those who have run businesses, mortgaged their houses and stayed up all night worrying about cashflow rarely talk about “eliminating uncertainty”. They know that profit is the reward for taking risks in an uncertain environment. However, one can minimise unnecessary uncertainty. And guess what? This is rather boring. It requires rejecting headline-grabbing spending pledges, unrealistic negotiating aims and plans to suspend parliamentary procedure. It necessitates addressing the world we live in, not the world we would like to inhabit. Credibility, coherence and consistency are the currencies of true value.
Whoever takes over as prime minister should recognise that businesses are not asking for absolute certainty. Such an outcome would involve massive overreach by the public sector. Rather, they look for an end to the self-harm. Failure to do so risks undermining the UK’s economic performance for years to come.
A version of this piece was published in The Times.