Why investment should rebound after Brexit

Why investment should rebound after Brexit

First, the bad news. UK business investment in non-financial assets, which includes factories and machinery, has stalled since the vote to leave the EU in 2016. Indeed, investment has fallen outright in five of the last six quarters, and is now about 1½% lower than a year ago.

This is still not the ‘collapse’ that some would have us believe. The UK’s overall economic performance over the past year has also still been better than many of its peers. But it does make the UK an outlier in terms of capital spending. The level of business investment in the UK is roughly the same as it was three years ago, compared to typical increases of 10% in other major economies. If growth in investment here had kept pace with that elsewhere, our GDP might now be 1% higher.

Foreign Direct Investment (FDI) has also been softening. This is partly a global trend and there are still plenty of bright spots, such as the tech sector. But the UK has seen a relatively sharp fall in cross-border investment in new physical projects.

For once, there is little doubt about the cause. Numerous surveys show that both local and foreign businesses have been deterred from investing in the UK by the extended Brexit uncertainty. Given that their main concerns are about new barriers to trade, it is no surprise that cross-border investment has been hit particularly hard.

Nonetheless, the current weakness of investment is not a good argument for cancelling Brexit altogether. For a start, it need not have been like this, if the negotiations had been handled better. Investment began to pick up again shortly after the referendum once firms had overcome the initial shock of the result, and as the warnings of an immediate recession were proved wrong. The high point in capital spending did not actually come until the end of 2017.

Since then, unfortunately, the needlessly prolonged and botched process of leaving the EU has led many firms to put spending back on hold. The mixed signals about the preparedness to leave without a deal – summed up in the Yellowhammer leaks – have only compounded this problem.

It would also be wrong to argue that the solution is to delay the departure from the EU even further. This would presumably require some combination of an early general election, another referendum, and a takeover by an interim government, perhaps led by Mr J Corbyn. This would surely prolong and increase the uncertainties over Brexit, and add others.

There are much better reasons to believe that investment will rebound once Brexit finally happens. There is plenty of evidence, such as EY’s UK Attractiveness Survey, that the UK remains the top destination for FDI in Europe, and that many firms have only ‘paused’ projects rather than cancelled them altogether. Similarly, London is still well ahead of other European cities in the Global Financial Centres Index (GFCI).

What’s more, even if the UK does leave on 31stOctober without a deal, many businesses would surely prefer the certainty of some short-term disruption, for which both sides will now be much better prepared, than continued dithering with no idea what happens next. As the Aston Martin CEO, Andy Palmer, succinctly put it, ‘I’d rather leave with No Deal than drag negotiations on’.

Of course, leaving on 31st October without a deal would not end all the uncertainty, especially about the long-term relationship between the UK and the EU. It is possible that, in a few areas, it might simply confirm some of the worries about the short-term impact, and provide certainty of a bad outcome. But even in these areas, businesses would finally know what they have to cope with, especially in terms of any new tariffs and red tape.

The investments that are currently only on hold will then gradually be restarted, just as in 2016 when the economy initially stalled, then accelerated again. This time the UK would actually be leaving the EU. But this also means that businesses will have even harder evidence that the nightmare scenarios – including those apocalyptic Yellowhammer headlines – are more ‘Project Fear’.

Leaving sooner rather than later would also allow the new administration under Boris Johnson to crack on with a broader package of measures to maintain – and enhance – the attractiveness of the UK as a place to do business. This should include additional investment in infrastructure, and tax cuts. And even if sterling fails to recover, the benefits of a more competitive currency will gradually outweigh the increase in the cost of imports.

Finally, there is already evidence that all this is more than just wishful thinking. For example, the July services PMI reported that ‘a number of survey respondents commented on improved sales to clients in external markets, helped by the weak sterling exchange rate against the euro and US dollar. Moreover, the latest survey indicated the fastest increase in new work from abroad since June 2018.’

And in the July manufacturing PMI, ‘manufacturers maintained a positive outlook in July. Over 46% expect output to be higher in one year’s time, compared to less than 10% forecasting contraction. Optimism was linked to new product launches, an expected rebound in export sales, strong order pipelines, reduced uncertainty following Brexit and improved infrastructure (including 5G networks)’.

In summary, Brexit uncertainty may mean that investment is down, but it is not out. Provided the UK does indeed now leave as promised on 31st October, and as the worst fears about the consequences are again shown to be exaggerated, investment will soon recover.