UK Economy Already 2% Smaller

One  would have to look pretty hard to find an economist who believes Britain's exit from the EU will be—at least in the short and medium term—anything other than a negative for the UK economy.

With the exception of the group Economists for Brexit, every bank, research house and think-tank has modeled a significant decline in British economic output because of the Leave vote, with scenarios where the UK falls out of the EU without a deal showing significantly more economic damage, Business Insider reported.

Britain may be just six months away from leaving the EU, but it has not happened. And yet, according to a new model from economists at UBS, the damage to the economy compared to an alternate reality where Britain had voted to stay in the EU, is already clear for all to see.

Economists at the Swiss banking giant created what they call a "Frankenstein" model of the British economy, cobbling together a huge amount of data from different economies to effectively show what the UK would have done without the Brexit vote.

The economy is already 2% smaller than it would have been without a vote for Brexit, according to research by UBS released on Monday. The bank’s calculations also estimate that investment is 4% lower and consumption 1.7% down.

The research predicts that the real effective sterling exchange rate, or the value of the pound in terms of other currencies and relative to the price of goods, is 12% depreciated. This weaker currency fed into  analysts' predictions of inflation being 1.5% above where it would have been, partly caused by higher costs of imported goods.

It added that things would be even worse if it weren't for the strength of the global economy as a whole over the same period—something that has dragged UK growth higher.

"To put that 2.1% cumulative decline in real growth into context, that's roughly a quarter to a third of the total Brexit costs estimated in the most pessimistic assessments done prior to the EU referendum (e.g. HM Treasury, OECD) and almost equal to the full costs of some of the more optimistic assessments (e.g. LSE, IFO, Open Europe)," the UBS economists Pierre Lafourcade, Arend Kapteyn, and John Wraith wrote to clients on Monday. "But the UK has not even left the EU yet!"

The decline in the UK economy relative to a Remain outcome in the referendum has been masked by other events going on around the world, the trio said.

Going Unnoticed

"Why is it going largely unnoticed? Because the global economy started to accelerate strongly right after the mid-16 referendum, allowing UK GDP growth to move sideways rather than dive lower," the team wrote. "Without Brexit, however, we think UK GDP could have been 100 basis points per year higher."

The modeling of such a scenario, UBS said, effectively encompassed "building a 'Frankenstein' UK out of bits and pieces of 30-odd other countries in such a way as to mimic as closely as possible history up to Brexit."

"Essentially, using a partial least squares regression we can construct a UK 'clone' entirely from other OECD country data not affected by the Brexit vote," the team wrote.

“As is natural for anyone driving towards a cliff—in this case UK firms likely facing a sharp increase in tariffs and non-tariff barriers—one would expect them to start hitting the brakes: i.e. scale back employment and investment decisions as uncertainty mounts”, states the report.

Household Debt Higher

As a consequence, economies such as the US and the UK are being kept afloat by an asset-price bubble and high levels of private debt, rather than by productive investment which actually serves to create new wealth.  In the UK, the top 10% have become more richer through monetary policy.

With government’s insistence on huge public-sector cuts through austerity coupled with the worst decade for wage growth since the Napoleonic wars, more people are struggling to get to payday without going into debt.

This reinforces a vicious cycle, where households are increasingly relying on short-term and high-cost sources of credit in order to pay for everyday essentials. Unsurprisingly, household debt in the UK is at its highest on record, currently more than £1.8 trillion ($2.38 trillion), while unsecured debt is rising at a faster rate than in the run-up to the last crash.

If Brits want to get out of the debt trap, tinkering around the edges won’t cut it. Britain needs a new vision for its economy, and one that does not rely on gigantic banks and debt mountains.