Most “uncertainty shocks” throughout history – like the 9/11 attacks, the 1973 OPEC oil price shock, or the assassination of President John F. Kennedy – generate a surge in uncertainty which subsides reasonably quickly. Markets learn about what has happened and typically gain more confidence over time.
Brexit has been different. It started with a sharp jump in uncertainty after the UK voted to leave the European Union in June 2016. That uncertainty has persisted, and as more time has passed without a deal on the terms of the UK’s withdrawal, firms have become more uncertain about whether a deal will happen at all, what the terms of that deal might be, and whether there will be a second public referendum. The clearest historical parallel that led to such an extended period of uncertainty is the Great Depression, which started with the stock market crash of 1929 and generated continued uncertainty until 1932.
Brexit was also essentially a political shock versus an economic one, and one that was largely unexpected. As has been widely discussed, in the weeks leading up to the vote, betting odds suggested that the probability of Brexit averaged around only 30% and was never higher than 40% (Bell (2016)).
A third way that Brexit is an unusual type of uncertainty shock is that there are many unknown factors that are difficult for businesses to quantify. For example there is uncertainty around the terms on which the UK will leave the EU, what the UK’s longer-term relationship with the EU will look like, how the UK will transition to this end state, what this means for market access, the availability of migrant labor and product regulation and then what all of this will imply for the prospects of individual businesses.
Commonly used uncertainty metrics provide conflicting messages about what has happened to uncertainty since the EU referendum. Media-report-based measures rose to unprecedented levels whilst there was very little increase in other measures such as stock market volatility. This, together with the unique nature of the Brexit uncertainty shock, means that new approaches are likely to be required.
To help better understand the uncertainties created by Brexit, our team from the Bank of England, University of Nottingham, and Stanford University has been running the Decision Maker Panel, a survey of around 7,500 business executives in the UK. The survey collects data on how companies say that they are being affected by Brexit and on variables such as sales, prices, investment and employment. It runs monthly, helping to track businesses’ views in almost real time, and it can be used to help assess the impact of Brexit and associated uncertainty by comparing the performance of businesses that are more and less affected by Brexit.
We find that Brexit has been an important source of uncertainty for many UK businesses. We estimate that this led to a 6% reduction in investment in the first two years after the referendum, with employment also around 1.5% lower. And Brexit is likely to reduce future UK productivity by around half a percentage point via a batting average effect of output being reallocated away from higher productivity firms toward lower productivity ones. The majority of businesses anticipate that Brexit will eventually reduce sales and increase costs.
Responses from Decision Maker Panel survey give us four key findings about how Brexit is affecting UK businesses.
Brexit is an important and growing source of uncertainty for firms
In August 2016, in response to the question: “How much has the result of the EU-referendum impacted the level of uncertainty affecting your business?” 36% of CEOs and CFOs cited Brexit as at least one of the top three current sources of uncertainty. At the time, 9% said that Brexit was the most important factor and 27% said it was one of the top two or three sources of uncertainty but not the top source.
Successive waves of this question have shown that firms continue to place Brexit high on the list of sources of uncertainty. Results since summer 2018 indicate an increase in uncertainty arising from Brexit. The share of firms responding that Brexit was one of their top three drivers of uncertainty rose from 36% in August 2016 to 54% in the period between November 2018 and January 2019, with the proportion who thought that Brexit was their top current source of uncertainty increasing from 9% to 23%.
Firms expect Brexit to eventually lead to lower domestic and foreign sales and to higher costs
The chart below shows the effects that companies expect Brexit to have on their sales, exports, and costs. On average, businesses expected Brexit to eventually reduce their sales by around 3%. The effects on exports were also expected to be negative, while unit costs, labor costs, and financing costs were expected to increase.
Brexit has already reduced investment and employment growth
To estimate the impact of Brexit we analyzed the change in investment and employment for firms more and less exposed to Brexit via both uncertainty and expected sales impacts. There could be effects through both channels, but to the extent it is possible to distinguish between them using our survey data, we find that the strongest effects so far have come through uncertainty. The next chart shows that firms that see Brexit as being an important source of uncertainty have typically had lower investment growth since the referendum than those who see Brexit uncertainty as less important.
We use a difference-in-difference regression analysis of the post referendum survey data combined with accounts data for earlier years to quantify the effect that Brexit uncertainty has had on the growth of investment and employment by firms. Based on that we estimate that Brexit uncertainty was associated with around 6% lower investment in the first year after the Brexit referendum (between July 2016 and June 2017). We also estimate that employment has been around 1.5 percentage points lower with the effect being larger in the second year after Brexit (July 2017 and June 2018) than in the first.
Brexit is likely to lower UK productivity growth in the future
Firms in the UK economy that export more goods and services to the EU, import more materials from the EU and employ more labor from the EU were most uncertain and expected Brexit to eventually have a more adverse effect on their sales. These types of more internationally exposed firms also tend to be more productive than average. Firms that are more productive expect the eventual effect of Brexit on sales to be more negative than for less productive firms.
If Brexit reduces the output of highly-productive firms by more than low-productivity firms that will lead to lower average productivity through a batting average type effect. Our estimates suggest that this reallocation effect could eventually lower the level of UK productivity by around 0.5%. Given that the UK economy has had low productivity growth in the last decade (about 1% in the last few years), this effect is worth around half a year of productivity growth.
For three years now the world has watched and wondered whether Brexit would happen, and if so under what terms. And yet the uncertainty has persisted and has risen over recent months. Our research documents the costs of that uncertainty in the form of lost investment and employment. If the UK reaches a deal, some of that postponed investment might be realized. But if the UK opts for “no-deal” Brexit or for a second referendum, uncertainty may increase again and only add to those costs. And while the main effects from Brexit appear to have come via uncertainty so far, businesses also expect Brexit to lower their sales over the longer term, which is likely to carry important implications for investment, employment, and productivity too.
Bloom and Mizen have received £683,636 in the form of an ESRC standard grant for “Measuring the Impact of Brexit on UK Investment, Productivity, Sales and Employment”. The funding will support an online survey and research into the impact of Brexit on the UK for three years, 1 Sept 2017 – 31 August 2020. The project is carried out with the collaboration of Bank of England, the Universities of Nottingham (UK) and Stanford (US).
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