In a historic referendum, Britain has voted to leave the European Union. Some of the polling suggests that a backlash against globalisation played a role in what has been dubbed Brexit, alongside issues such as sovereignty and immigration. The government has insisted that Britain will maintain its global outlook, but how challenging will that be in the face of disengaging from the world’s biggest economic entity while forging a new path? The UK is doing so with some notable weaknesses in its large trade deficit, which has hit a record high after its 2008 financial crisis.
What does the economic future hold for Britain? Of course, the dust has not yet settled, as there are a lot of unknowns facing the first country to leave the European Union. There is no question that the decisions to be taken will involve re-defining Britain’s trade relationship not only with the EU, but also with the rest of the world, for years to come. This article explores the economic uncertainties of Brexit and potential ways forward. The economic impact of Brexit Some hiring and investment decisions had been delayed even before the vote on 23rd June 2016; in fact, since February, when the announcement for the referendum on continued EU membership was made by the British government (Economic Policy Uncertainty, 2016). Investors’ expectation of sterling volatility in the period before the referendum was the highest since the 2008 financial crisis when the entire banking system could have brought the economy down. The market reaction reflected uncertainty about what would happen to the pound, which dropped sharply, as predicted, after the UK voted to exit. Investors apparently placed their money on just one outcome – a hit to the economy, regardless of the referendum results. That was reflected in gilt yields, that is, the interest rate that the UK pays on its government bonds. Gilt yields had fallen even before the vote took place. After the results were in, yields on benchmark 10-year government debt fell to record lows, as have those on 20-year and 30-year debt. Bond yields reflect where markets expect interest rates to be, which is affected by the Bank of England (BOE) base rate and the state of the economy. And those are related. If the economy is contracting or weak, the BOE would be expected to cut rates. Indeed, that is what has happened as the BOE cut interest rates just a couple of months after Brexit to a record low 0.25 per cent. It’s the first time that the central bank has cut rates and also extended quantitative easing (QE) since the 2009 recession that followed the banking crash. QE was not only revived, it was also expanded as the BOE announced that for the first time it would also purchase corporate debt as part of its programme. Conversely, bond yields are also influenced by the world economy, which in turn affects Britain. The global outlook doesn’t look too rosy either. Worldwide, developed economies’ government bond yields have dropped dramatically. Slow growth and aggressive easing by central banks, along with Brexit for the UK, are among the factors driving real yields lower. A lower interest rate in the future signals that investors are concerned about a weaker economy. But, they are not concerned about the ability of the British governments to pay its debt, which would send yields higher. Confidence in the government alone of course doesn't move yields on longer-term debt as much as interest rates, economic growth, and inflation. Now that Britain has voted to leave, there will be at least two years of uncertainty, which is the period allowed under Article 50 of the Lisbon Treaty to negotiate a new relationship with the EU. Uncertainty tends to dampen economic activity (Baker, Bloom, and Davis, 2015). Investors may or may not be getting it right, but uncertainty tends to make businesses cautious. And, for the economy, that tends to mean being conservative about where it’s headed. Amidst the uncertainty, there is also some clarity about the next steps. The basic trade-off is between remaining within the Single Market and wresting back ‘control’, notably over migration. Therein lies the problem, however, as the European Union views the freedom of movement of people as one of the four pillars of the Single Market (the others being the free movement of capital, goods, and services). Under this privilege, the EU grants the right to people within it to live and work freely anywhere within its boundaries. In other words, as a member of the EU Single Market, the British have the right to live and work in the EU, just as other EU citizens have the right to live and work in the UK. Is it possible to retain access to the European market but not be subject to EU laws, including the freedom of movement of people? So far, the EU has not granted that status to the non-EU countries which have negotiated the right to access the Single Market. There are three countries (Norway, Liechtenstein, and Iceland) in the European Free Trade Association (EFTA) plus Switzerland, which also has unfettered access to the Single Market via a series of treaties. All four members accept the pillar of ‘freedom of movement of people’ in principle, in exchange for which they get varying degrees of access to the largest economic bloc in the world. The nation of Liechtenstein with its tiny population of 36,000 was allowed to retain an immigration quota, but it must be reviewed every five years. Thus, the free movement of people is described by EFTA as ‘perhaps the most important right for individuals, as it gives citizens of the 31 EEA countries [EU plus the above mentioned states] the opportunity to live, work, establish business and study in any of these countries’ (EFTA, 2016). To give a sense as to how integral free movement of people is, Switzerland’s two year struggle to impose a quota on EU migrants is telling. In February 2014, the Swiss voted in a referendum for controls on EU migration. But the EU would not budge, so the negotiations have dragged on with no conclusion in sight. Ironically, they are exploring the possibility of using the ‘emergency brake’ that the former British Prime Minister David Cameron had negotiated prior to the EU referendum in the UK that would have restricted in-work benefits for new migrants and potentially lessened the ‘pull factor’ of economic migration to a higher income country. Remaining in the European Single Market has also been touted by a range of businesses and policymakers, including the Mayor of London, as being crucial in Britain’s future relationship with the EU. Not all Leave campaigners may agree, of course, since some had advocated leaving the Single Market and just having a free trade agreement (FTA) with the EU. An FTA, however, would not confer the right on British citizens to live, study, and work in the EU, so it remains to be seen what can be delivered. It is important to note that the Single Market is much more than a free trade agreement. By applying the same rules and standards on goods and services, it frees up trade and investment in ways that allows a business to treat the half a billion people in the EU as a single market for their business. So, it is not about tariffs but what economists call non-tariff barriers (NTBs) that matter in some instances more, especially for small businesses where the ease of selling across borders can be heavily affected by standards and rules (Breinlich et al., 2016). And, for businesses, small and large, the European market is important. The Institute of Directors based in London surveyed its members directly after Brexit. Of the 1,092 UK firms, a quarter were freezing recruitment, some 20 per cent were considering moving their operations abroad, and 5 per cent even said redundancies were possible. This reaction reflects the uncertainty that has been seen most vividly in markets, but also importantly for the economy, the big question marks over the UK’s future relationship with Europe. It may well be that the cost of gaining access to the Single Market will be considered by the policymakers to be too great if it means accepting the free movement of people. Of course, it is not just about immigration policy. Like the other non-EU countries that have free access to the Single Market, the UK would also have to accept the rules set by Brussels. And that may well be unacceptable as some in the Leave camp also campaigned on the basis that Britain will no longer be governed by EU laws. But, that is the unavoidable trade-off: unfettered access to the EU Single Market versus control over migration. At publication time, it seems the British Prime Minister doesn’t expect to retain much access to the Single Market precisely because the UK government will prioritise immigration controls. As stated earlier, the EU has yet to compromise on migration with any major country, though there is still much debate on the issue. Some have argued that Britain is a more important economy than, for instance, Switzerland or Norway, and that the EU indeed may want to sell and thus offer more concessions, while others insist that granting Britain the benefits of the Single Market without the free movement of people would set the wrong example for other EU countries and who may also want to control migration and then exit, too. A break-up of the European Union is an outcome that the EU leaders certainly want to avoid. There is no doubt that this is a challenging trade-off with a lot at stake for the British economy. There is also a lot at stake for Europe in its negotiation of Brexit, since the process will affect how it reforms its own institutions. Europe’s economic paths Brexit was a seismic political event, but there have been other rumblings across Europe, which highlights the challenge of negotiating with an economic bloc that is still in the process of formation and subject to some of the same anti-globalisation pressures evident in the UK. To take an example, the former French prime minister described the votes won by the far-right National Front and Eurosceptic parties as a ‘political earthquake’. And the gains made by anti-EU and anti-Euro parties in the last European elections in countries ranging from Denmark to Greece have generated debate over the European project and Europe’s economic future. In general, the growing influence of Brussels has also led to debates over a ‘democratic deficit’. That said, the pro-Europe mainstream parties – the centre-right European People’s Party (EPP) and the centre-left Socialists and Democrats (S&D) – still retain a majority, having worked toward further integration that had been challenged during the Euro crisis in May 2010, when Greece was rescued. But EU policymakers should take heed of the views of more critical voters as they shape the emerging institutions of the Eurozone. Seen from a historical perspective, the EU has already changed a great deal. Beginning as the European Coal Community after WWII, it then expanded when the UK joined the European Economic Community (EEC) in 1973 (Venables, Winters, and Yueh, 2008). The motives were political: to tie together nations previously at war. But the EEC later evolved into the European Union and, in fact, the biggest economic unit in the world, larger than the United States both in terms of output and population. The creation of the single currency in 1999 split the EU into Eurozone countries and the rest, though all of the remaining non-euro EU members – with the exception of Denmark and the UK – are slated to join the euro area in the coming years. After the Greek crisis erupted in 2010, the reaction by Eurozone leaders was ‘more Europe.’ The ensuing euro crisis, which saw other countries get rescued in addition to Greece, revealed the fragility of a monetary union that lacked a banking union, as banks had lent large amounts to peripheral countries such as Ireland. Rescuing the banks also led to the need for Ireland itself to be rescued. Since then, a Banking Union has been created, but this measure has in turn raised operational questions for non-euro EU countries with large banking systems, such as Sweden. Eurozone leaders also reinforced the need for member countries to pay better attention to fiscal discipline. Before the crisis, Greece borrowed at the same rates as Germany, since bond markets seemed to view the Eurozone as one entity. The result was too much borrowing. Though that situation is unlikely to happen again in the future, additional reforms were implemented in an effort to enforce fiscal restraint. The outcome was the European Semester, by means of which there was greater monitoring of national budgets by Brussels to ensure that countries sharing a currency did not run large deficits. Building on these developments to continue the transfer of economic decision-making power to supra-national entities, other institutions were created, such as the Single Supervisory Mechanism (SSM), which gave the Frankfurt-based European Central Bank (ECB) more powers to oversee banks, and the Luxembourg-based European Stability Mechanism (ESM), a permanent rescue fund that is like a European IMF. For economists, the euro crisis raised the prospect of a euro break-up and opened the door to consider whether the peripheral countries belonged to the same ‘optimal currency area’ (OCA) as Germany and its northern European neighbours (Krugman, 2013). In other words, they asked, should all euro countries – including the EU countries that are slated to accede –share a currency? And have the criteria of trade integration and convergence in business cycles and incomes been met? European countries trade a great deal with each other, but convergence is a different matter. If a country is not converging with the rest of the member countries, then it is a high cost to lose control over its interest rate and currency. Could reforming the euro institutions improve the prospects of convergence? There is a middle path: a European single market that does not share a single currency. This type of connection could lead to deeper integration and a linking of markets, but without countries giving up their currency. The UK, Denmark, and the other non-euro EU countries are examples of those who operate in a shared market while retaining their own currencies. This is an old debate that has again moved to the forefront, particularly among observers outside the single currency who watched the euro crisis unfold. Indeed, the deep integration of the European Single Market goes beyond a free trade area, which is what the US has developed with Canada and Mexico in the form of NAFTA (North America Free Trade Area). The Single Market eliminates not just tariffs, but non-tariff barriers. Common standards enable a firm located in the Single Market to sell anywhere within it as if it were a domestic market. For small countries in particular, that advantage allows its firms to gain economies of scale when competing against multinationals from America and China which count huge domestic customers as their home market. These considerations are what make the debate over Britain’s continuing access to the Single Market so acute. But, as mentioned before, free access to the Single Market appears to require the acceptance of free movement of people, which is the antithesis of the Brexit vote seeking to wrest back control over migration. Undoubtedly, the rise of both anti-EU and Eurosceptic parties will trigger more discussion about all of these possible paths for the Union. Upcoming elections in major European countries will not be determinative, but the economic future of the European project will surely be discussed in the coming years. So, as Europe continues to evolve and the political landscape on the continent shifts, Britain’s exit will be tricky. What’s needed now is a parallel pursuit of free trade agreements with the world’s other major economies. Britain’s future outside of Europe Global trade is far from free, so negotiating market access for trade and investment for British businesses is important, especially if the UK is to retain the international outlook that has contributed to its economic growth and positioning as the world’s fifth largest economy. The European Single Market’s deep integration eliminates non-tariff barriers through common standards. A vast market on Britain’s doorstep is certainly economically valuable and should be a priority for a new FTA after Brexit. But developing trade agreements takes years, as will Britain’s negotiations on its future with the EU, so the sensible approach is to start informal talks now with the US, China, and Japan. Of course, there are other trade partners worth considering, but focusing on these three largest economies and the EU is a good start. New trade agreements are also being pursued by other countries seeking to open up markets and raise economic growth. And they’re getting a lot of buzz, such as those led by China (RCEP or Regional Comprehensive Economic Partnership), TPP (Trans-Pacific Partnership) between America and Asia, and TTIP (Trans-Atlantic Trade and Investment Partnership) between the United States and Europe. In this context, then, Britain would do well to start parallel talks as soon as possible. As far as the United States is concerned, the Republican Speaker of the House of Representatives of the US Congress has expressed a strong interest in speaking with Britain while the Brexit sorts itself out. In the case of China, the world’s second largest economy, a UK leaving the EU may appear less attractive as a gateway to Europe, but that outcome will depend on the Brexit negotiations. In the meanwhile, it would be sensible for Britain to build on its existing strong links with China to secure a free trade agreement. In many respects, Britain and China have complementary strengths and needs in their economies. China is seeking expertise in services and high tech industry, which Britain can offer. In turn, Britain needs to maintain sizeable investment inflows due to its persistent and large current account deficit, which could be achieved by China’s outward investment push. Unlike the EU, which has a larger industry and agricultural sector to consider, the UK is in a comparably better position to agree on an FTA with China. Of course, the detail and protection of losers from globalisation would have to be taken into account in an FTA, as would a range of other political considerations. And China, a tough negotiating partner, has only a few FTAs and is currently going through a challenging time while it re-aligns its external and internal priorities to reform its slowing economy. In any case, moving towards an FTA with China would help with Britain’s negotiations with the EU if the UK can become the gateway to over a billion Chinese customers for EU businesses. The same rationale of securing FTAs applies to the world’s third largest economy, Japan, as well as to other major economies. There is also another grouping worthy of mention: often overlooked, the Commonwealth is a network that Britain is well placed to pursue more trade with. After all, economic studies consistently show that among the determinants of greater trade are historical ties and shared language and institutions (Makino and Tsang, 2011). The 52 nations of the Commonwealth have that strong advantage. Trade among these nations, which range from wealthy, such as Britain and Singapore, to poorer nations in Africa, has grown rapidly. Even without being a formal trade bloc, intra Commonwealth trade was estimated at USD 592 billion in 2013 and is forecasted by the Commonwealth Secretariat to surpass USD 1 trillion by 2020. That is due to the rapid economic growth, including in trade in these countries, over the past few years. Since 2000, global exports of Commonwealth countries have nearly tripled from USD 1.3 trillion to USD 3.4 trillion, accounting for 14.6 per cent of world exports in 2013. In other words, if it were one economic entity, the Commonwealth would be the world’s largest trader, surpassing China. But it must be noted that just six Commonwealth countries account for 84 per cent of Commonwealth trade: Australia, Canada, India, Malaysia, and Singapore as well as Britain itself. So, these five nations are partners for Britain to focus on, which it can do more efficiently by turning its attention to the Commonwealth. There are also yet untapped smaller export markets within this network, including some of the fastest growing economies in Asia and Africa. A shift in UK trade is already silently underway, with both current and previous governments seeking to develop greater links with fast growing emerging economies. To take an example, in 1999, 55 per cent of exports went to the EU. Now, the scale has tipped and Britain exports more to non-EU countries than to the EU. And Britain’s trade with the Commonwealth is less than 25 per cent of that of the EU, so there’s room to grow. Certainly, the faster economic growth of Commonwealth countries offers greater opportunities than ever before. In terms of share of global GDP, the Commonwealth overtook the European Union in 2010. A lot has to do with demography: the United Nations estimates that population growth in the Commonwealth is expected to increase by 29.4 per cent until 2020, while the Eurozone is expected to fall by 1.4 per cent. Finally, it is worth recalling in 1973, the UK had to end its special trade ties with the Commonwealth because it joined the EU, which is a customs union that has common trade rules with the rest of the world. That won’t be a constraint anymore after Brexit. So, with a combined population of 2.3 billion across six continents, many of them faster growing than the rich economies of the West, fostering greater trade and investment links with the Commonwealth could prove to be helpful. The next section reviews the rapid growth of FTAs around the world and what it means for post-Brexit Britain. The global push for free trade areas What’s happening around the world in terms of existing free trade deals that are in the works is an important shift in global context. In different regions around the world, there’s a noteworthy push for free trade areas that reduce tariffs and adopt other measures to ease trade and investment. Of course, the election of Donald Trump adds uncertainty to America’s push, but the rest of the world, notably China, are keenly pursuing regional and bilateral trade agreements not only encompassing goods but also services and investment. First, here’s a reminder of what tariffs encompass and why they are economically inefficient: tariffs are the charges that governments impose on imports and exports. They are a tax; wherever they are imposed, they can distort the prices of goods and services. Because tariffs add a cost and thus reduce economic efficiency, they can be a drag on growth. So, free trade areas aim to eliminate most of them. Of course, a number of governments use them to protect their industries from competition from big global companies until they are more mature. Labour groups also want protection for domestic jobs. It’s a messy area. Non-tariff barriers (NTBs) also add to the mix. NTBs are the other ways to be protectionist without imposing tariffs, such as through standards for certain industries that can restrict imports. For instance, Thai prawn exporters found it hard to meet American standards for the type of net that allowed them to sell to the US. Indeed, the still to be ratified Trans Pacific Partnership (TPP) would be the world’s biggest free trade area that links North America with parts of Latin America and Asia. The Americans had hoped to gain from this new free trade area since 61 per cent of US goods exports and 75 per cent of US agricultural exports go to the Asia Pacific region. The TPP would allow partner countries to access the world’s largest market in return by reducing (perhaps eventually eliminating) the tariffs they would have to pay to export to the United States. As part of a broader foreign policy shift, President Obama has been re-orienting toward fast growing Asia. Obama’s ‘Asia pivot’ could be viewed as a counter-balance to China’s economic and strategic impact that stretches from the North China Sea to the Persian Gulf. However, it is proving a difficult task to re-focus away from the Middle East and Russia. As well, it is certainly still unclear what the future Trump administration will do in terms of foreign and trade policy. In any case, Europe is also pursuing an equally ambitious free trade agreement with the US: the TTIP is the trans-Atlantic FTA that would link the US with an EU that will eventually exclude Britain, if it comes into force. The rise of these massive regional FTAs is also a reaction to stalled expansion of the World Trade Organisation (WTO). After all, it has been well over a decade since the last big WTO initiative – the Doha Round – was launched and there are no signs of significant progress. So, instead of trying to get to a deal with almost the entire world, these regional trade agreements have sprung up. Bilateral agreements, too, fill the void. It would be better for all countries to trade on equal terms with all others, but a multilateral trade deal under the WTO has been put on hold, so countries are going for second best options. The problem with this approach is that if a country has not signed up to the rules (or hasn’t even been invited to join) for any of the new free trade areas, it gets excluded and cannot share the benefits. This prospect might face Britain. China is also confronted with it: being left out of TPP and TTIP means doing its own thing, so China is currently negotiating with ASEAN (Association of Southeast Asian Nations) to form its own regional free trade agreement. There is also an offer on the table to set up a Free Trade Area of the Asia Pacific (FTAAP) in reaction to President-elect Trump’s announcement that the US will pull out of TPP. These regional FTAs are not the best outcome, but they are perhaps better than not having any new trade deals. The result is the potential creation of sizeable free trade areas where domestic companies can gain economies of scale by selling to a much larger customer base than otherwise possible. The competitive advantage to be gained is potentially sizeable. That is why Southeast Asia is also pursuing an ambitious free trade area. But the single market launched by the 10 nations of Southeast Asia (ASEAN) at the end of 2015 will not include a single currency. Nor will the ASEAN Economic Community (AEC) have an equivalent to the European Central Bank in the foreseeable future. The ASEAN single market rivals the EU in terms of population. With over 600 million people, ASEAN links together 10 countries – ranging from rich Singapore to poor Laos – into a free trade area with free movement of labour, removal of tariffs, and common standards. The AEC is even aiming to rival the EU and perhaps overtake it by 2020 based on the 5 per cent plus economic growth rate of ASEAN as compared to the 1-2 per cent growth of the EU. Still, there are numerous challenges facing the AEC. For one thing, there are not many pan-regional institutions to learn from. There is also no entity comparable to the European Commission. The AEC also lacks institutions to protect human rights and workers, including a court like the European Court of Justice. That will be challenging, as political differences in the region, which includes non-democratic states, will make it tough to integrate both politically and socially. Besides institutions, the region also faces challenges in terms of what economists call ‘deep’ integration, so, for instance, NTBs aren’t typically removed (Baldwin, 2008). There are many trade links in the region, but intra-regional trade in ASEAN is only around a quarter of total trade as compared with the EU or, in particular, the euro zone, where the biggest trade partners are the other European economies. Trade has increased in the past few decades in Southeast Asia, but there are still non-tariff barriers that protect some home industries. ASEAN policymakers emphasise that the impetus behind the AEC is to compete with the sizeable markets of the EU, the US and neighbouring China and India. The rise of regional free trade agreements being negotiated such as the TPP linking America to Asia, and TTIP tying the US to the EU, highlight the urgency for Southeast Asia to link their economies in order to compete. With twice the population of the United States and one that is similar to the scale of the EU, the AEC has the potential to become one of the largest economic entities in the world. We’ll soon see if the AEC becomes a common reference point for the rest of the world, like the EU, and a market like the US, where global businesses have to be a part. It seems that Southeast Asians certainly have that ambition. So, within this context of countries joining regional FTAs, Britain is rather unusually leaving one and embarking on bilateral trade deals. The question is whether Britain will be successful going at it alone outside the EU. On the other side, Britain does have a long track record of benefitting from its global outlook. Britain’s long-standing international orientation Britain is ‘open for business.’ That is the message that has been sent out by successive UK governments, particularly after the Brexit vote. It is already the case that many British brands are foreign-owned. The stock of foreign direct investment in the UK is around half of GDP, which is appreciably higher than the global average of one-third. But it is a two-way street: The UK also has its share of global companies and makes a tidy return from overseas investments. In recent years, many of Britain’s iconic brand names have been snapped up by foreign companies. The car industry is a particularly good example. Britain’s most prestigious marques, Rolls Royce and Bentley, have been respectively owned by BMW and Volkswagen since 1998. Four years earlier, BMW had acquired the ailing Rover group. Unable to turn it around they broke it up in 2000 and only kept the Mini, which proved to be a commercial success. Ford bought Land Rover while MG Rover was sold first to the Phoenix Consortium before being rescued by China’s Nanjing Automobile Group in 2005. In 1990 Jaguar had been purchased by Ford, who then sold it, along with Land Rover, to India’s Tata Motors in 2008. A notable exception is Aston Martin, which is now back in British hands. The Oxfordshire-based Prodrive led a consortium to purchase the company from Ford in 2007. However, Ford maintained a 10 per cent stake and the financing for the deal mainly came from US and Kuwaiti backers. Later on, 37.5 per cent was sold to an Italian private equity company. Such is the way with big business today. A company from somewhere might be owned by another company from somewhere else, whose investors in turn come from all around the world. It makes the question of ownership hard to pin down. A survey conducted by the trade magazine The Grocer and the research firm Nielsen found that of the biggest 150 biggest grocery brands in the UK, just 44 are domestically owned. And of the 91 brands created in the UK, only 36 were still owned by British companies. The rest are owned by foreign multinationals and private equity groups. This follows a series of high profile takeovers of famous British brands. HP brown sauce was the inspiration of Frederick Gibson Garton, a Nottingham grocer in the late 19th Century. The product got its name after Garton learned of its being consumed in the Houses of Parliament. In June 2005 the brand became part of the Heinz empire. And to show what goes around comes around, Heinz itself was purchased by Warren Buffet’s Berkshire Hathaway and the Brazilian global investment fund 3G Capital. The Chinese company Bright Foods took a controlling 60 per cent stake in Weetabix Ltd, which also owned the Alpen and Ready-Brek brands. Branston Pickle, of which 28 million jars are sold every year in the UK, was acquired by the Japanese firm Mizkan who, by the way, already owns Sarsons Vinegar and Hayward’s Pickled Onions. Cadbury, founded in Birmingham in 1824, was bought by the American Kraft Foods in 2010. It was then spun off into Mondelez International, Kraft group’s international snack and confectionary business. Britain’s other large confectioner Rowntree Mackintosh, founded in York in 1862, was bought by the Swiss conglomerate Nestlé in 1988 only one year after becoming a public company. In 2008, the alcoholic drinks company Scottish & Newcastle was jointly purchased by Heineken of The Netherlands and Carlsberg of Denmark. Traditionally British brews such as Newcastle Brown Ale, John Smiths Bitter and Strongbow Cider are now part of Heineken UK, so they are basically owned by the Dutch. One of the clear trends is that international brands are becoming increasingly owned by a small number of very large conglomerates. For instance, Pepsico, Coca-Cola, Kraft, Nestlé, Mars, Procter & Gamble, and Unilever own a staggering number of the world’s most recognisable brands between them. Unilever, the Anglo-Dutch conglomerate, alone owns over 400 brands. This goes to show that big business increasingly dominates the global landscape. But it is also the case that Britain has a number of its own global titans. When it comes to acquisitions involving British and foreign companies is not just a one-way street. For instance, Guinness is synonymous with Dublin and Ireland, while Smirnoff originated from a Moscow distillery in the 1860s and is now one of the best-selling brands of vodka around the world. Both brands are owned by Diageo, a British company listed on the London FTSE and headquartered in London. The company also owns 34 per cent of Moet Hennessy. So, the iconic French champagne brands Moet & Chandon and Veuve Cliquot, as well as Hennessy cognac are now one-third British. Among the big British companies that have expanded aggressively around the world, the Vodafone group is notable. In terms of numbers of subscribers, it is second only to China Mobile and has a presence in over 70 countries. It has gobbled up several foreign rivals and rebranded them along the way. In 2000, Vodafone bought the German company Mannesmann for GBP 112 billion. At the time, this was the largest corporate merger and is still the largest by some considerable distance in UK corporate history. The deal caused unrest in Germany as never before had such a large company been acquired by a foreign owner. Further disquiet was caused when Vodafone reneged on a pre-merger deal to maintain the Mannesmann name and rebranded the company Vodafone D2. Tesco is the third largest retailer in the world after Walmart and Carrefour. It has as many outlets outside the UK as it does within it, with operations in 14 countries across Europe, Asia, and North America. Tesco has already been in China for nearly a decade where it has over 100 stores. But Britain’s really big beasts are in oil and finance. BP, formerly British Petroleum, started life as the Anglo-Persian Oil Company in 1909 to manage the empire’s oil discoveries in Iran. It now has operations in over 80 countries and is the second largest producer of oil and natural gas in the US. In 2008, it merged with Amoco and largely rebranded their US operations as their own. Shell is an Anglo-Dutch company with operations in over 100 countries. According to the Fortune Global 500 list, which ranks firms in terms of revenue, it is the largest company in the world ahead of Wal-Mart. British banks and insurance companies are also massive players on the world stage. Britain’s biggest bank is HSBC, the Hong Kong and Shanghai Banking Corporation. It’s also the second largest bank in the world in terms of assets held only after the Chinese state-owned Industrial and Commercial Bank of China (ICBC). It was founded in Hong Kong in 1865 as the British Empire expanded trade into China. It essentially became a British bank in the early 1990s. The takeover of Midland Bank was conditioned on it moving its headquarters to London that was part of the calculus in any case as the handover of Hong Kong back to China loomed then. However, it remains predominantly a global bank with subsidiaries and operations in over 80 countries. And Britain’s fifth biggest bank, Standard Chartered, operates in over 70 countries but has no retail business in the UK. In fact, most British people would have never heard of the bank if it did not currently sponsor Liverpool football club. This makes sense given the popularity of the English Premier League in its key overseas markets. 90 per cent of its profits come from Africa, Asia and the Middle East. It is a good example of a British company with a stronger presence overseas than at home. The Office for National Statistics (ONS) estimates that over half the shares in quoted UK companies are currently owned by foreign investors. Ten years ago, a third of the shares were foreign owned. Twenty years ago, the proportion was only 13 per cent. So, Britain is indeed open for business and British companies are clearly attractive to overseas buyers. Why? Perhaps it is because they are relatively easy to buy. A high proportion of companies are publically listed (PLC), so the shares can be bought and sold freely. Furthermore, fewer British firms are controlled by family trusts than in the US and Europe. These can form powerful controlling groups that make direct takeovers difficult if the family does not want to sell. In addition, the British government rarely blocks deals even if there is a ‘strategic’ argument for doing so. The privatisation programme starting in the 1980s has made many utility and infrastructure companies into PLCs and foreigners are free to buy shares. Four of the big six energy companies, including most of the nuclear industry, are foreign owned. The same goes for British seaports, airports and railways. Not least, since the Brexit vote, the fall in the value of the pound has made British companies cheaper to acquire. When foreigners buy shares in or takeover a British company, the profits and dividend payments are transferred overseas. There is a suspicion that these earnings are enhanced by outsourcing jobs to cheaper parts of the world and re-routing profits through jurisdictions with lower tax rates. Thus, there is a recent push for tax reform and the current government is seeking to publish a roster of ownership. Among the possible benefits of foreign ownership, statistics show that foreign-owned plants are on average more productive than domestically-owned establishments (Bloom, Sadun, and Van Reenen, 2012). Multinationals can also bring in fresh ideas and expertise, such as new technologies and management practices. Of course, the same applies in the case of British multinationals setting up in foreign countries. Not surprisingly, foreign investment is also welcome when there is a need for cash. The Spanish bank Santander already owned the Abbey National, but there were few complaints in 2010 when it absorbed the Bradford & Bingley and the Alliance & Leicester building societies to become one of the largest UK retail banks. To the contrary, there was considerable relief following Santander’s announcement to use its balance sheet to avert two further potential Northern Rocks. In any case, Britain still owns far more direct investment assets overseas than vice versa. The ONS estimates that Britain has GBP 1.1 trillion direct investment assets overseas, which is GBP 300 billion more than the rest of the world owns in the UK. Britain also typically enjoys a surplus in investment income. Since 2000, inflows of investment income have averaged 13.5 per cent of GDP compared to outflows, which have averaged 12.4 per cent of GDP. This means that each year Britain has received a net flow of investment income equal to 1.1 per cent of GDP from the rest of the world. Such capital inflows are of course essential to continue to finance Britain’s significant current account deficit. It also explains why the British government is so keen to stress the country’s long-standing openness to investment from around the world. And that leaving the European Union does not change its openness. It does have a long track record to draw upon, and the UK government is indeed touting its openness in order to convince the rest of the world that the vote to exit the EU will not lead to greater protectionism. Post-Brexit path forward for the UK Few things are as uncertain as Britain’s economic relationships in the years ahead. Still, one important factor will be attitudes towards globalisation and their impact on the UK’s ability to maintain its global outlook. It is one of the main issues that its major trading partners will be looking for, given the perception that Britain has turned inward by leaving the EU. The UK government, though, has focused on maintaining the country’s long-standing international outlook. The tussle between the UK and China over the nuclear plant at Hinkley Point is an example of the uncertainty going forward. After Brexit, the new British government under Prime Minister Theresa May announced that it wished to re-consider the agreement to build the Hinkley Point nuclear plant that would be financed by the French company EDF and China. This step shouldn’t have come as a surprise, considering that nuclear energy is a strategic sector that usually warrants additional scrutiny; and Britain approved the deal once again shortly thereafter. However, from a Chinese perspective it became a flashpoint for where the UK might be headed. In response, the Chinese ambassador warned that the decision comes at a ‘crucial historical juncture’ and China hopes Britain retains its openness. As China wishes to maintain good relations both with the EU, its largest export market, and with the UK, which is a more welcoming Western hub than the US, it will continue to monitor what happens in the new post-Brexit UK. As will many other countries. For Britain, convincing its trading partners and businesses that Brexit is not a rejection of globalisation will be key. In its favour is Britain’s long history of being open to trade and international investment, as discussed earlier. The UK’s internationalist outlook has undoubtedly contributed to its position as the world’s fifth biggest economy with a relatively small population of 63 million. Pursuing free trade deals will be the clearest signal that Britain retains that outlook despite voting to leave the world’s biggest economic bloc. Britain will also need to convince its potential FTA partners such as China that the Brexit vote will not change its course. Admittedly, some backlash against economic globalisation figured into the Brexit vote. So it is a bit ironic that leaving the EU has led to an aggressive push on the part of the new government to agree to more free trade deals to secure Britain’s economic future. In any case, continuing global integration will be important for the UK’s economic growth. The challenge will not just be in agreeing on deals quickly, but how Britain will compete in a world where major economies are pushing for regional trading blocs just as the UK is leaving one. There’s no doubt that Britain’s future is uncertain, but its long-standing global orientation will help to overcome the concern that Brexit is a statement against globalisation. The General Election, which saw the Conservatives lose their majority in Parliament, has widened the potential future economic relationships with the EU. The start of formal Article 50 negotiations between the EU and the UK this week has cast into stark relief the Brexit dilemma.
In economics, there is a concept known as the impossible trinity or the macroeconomic policy trilemma. It says that you cannot achieve all three aims of monetary policy autonomy, fixed exchange rates, and capital mobility. Only two of the three are possible. For instance, as capital moves freely across borders, then a country has to choose between managing the currency or independent monetary policy. So, if monetary policy raises interest rates, then more money will flow into the economy and erode the pegged currency. Fixing the exchange rate means that monetary policy is geared at the currency since money supply must adjust to meet the peg and not to fine-tune the business cycle. From the recent developments in the Brexit negotiations, it seems that there is a Brexit dilemma or even trilemma. After leaving the European Union, Britain will have to choose between the EU Single Market, forming a customs union with the EU, or negotiating its own trade agreements. All three are unlikely to be possible. At present, the UK is in the EU Single Market and Customs Union, so it has not set its own trade policy since 1973 when it joined the European Economic Community. Thus, not all three aims are possible. Just before Article 50 talks kicked off, European leaders such as French President Emmanuel Macron, German Finance Minister Wolfgang Scheuble, and European Parliament Brexit coordinator Guy Verhofstadt said that if the UK changes its mind, then the door is “open” for it to remain in the EU. According to the panel of economists and politics experts that I chaired at the London Business School last night, that did not seem likely politically for Britain where both major parties have opted for Brexit. In which case, the Brexit dilemma will require tough choices to be made. After Brexit, if the UK were to negotiate a customs union agreement, then it would share a common external tariff with the EU. It would maintain frictionless goods trade with the EU which also means that no “hard border” would be imposed between Northern Ireland and Ireland. With the Northern Irish party, the DUP, in talks to support the minority Tory government, the border issue in Ireland has come to the forefront. But, a customs union would preclude Britain from doing its own free trade deals, which has been one of the benefits frequently mentioned after Brexit, i.e., establishing trade agreements with the rest of the world for the first time in over four decades. Turkey’s customs union agreement with the EU has precluded it from negotiating a free trade agreement with the United States since they must have the same outward facing tariff. So, the EU has insisted that Turkey must accept what it negotiates with America in the on-going TTIP (Trans-Atlantic Trade and Investment Partnership) agreement even though Turkey does not have a say. But, Turkey also controls its borders and sets its own migration policy. Thus, in this scenario, independent trade policy aim is not feasible. If the UK were to negotiate instead to remain in, or have largely unfettered access to, the Single Market, then it could negotiate its own free trade agreements so that would rule out a customs union. For instance, Norway does so as part of the European Economic Area that includes countries that have entered into the European Free Trade Association (EFTA) but are outside the EU. Norway negotiates its own free trade deals, but is subject to what can be sold into the EU. In return, Norway pays into the EU Budget, has no say in Single Market rules, and accepts free movement of people, which is a sticking point for Britain as the Prime Minister has said that she wants to control migration. But, the German Foreign Minister Sigmar Gabriel has hinted that the UK may be able to remain in the Single Market if it accepts free movement of workers. So, free movement only for those with jobs. He also suggested that a joint EU-UK court may be feasible, which also addresses another British concern about sovereignty. Like the EFTA court which governs the EFTA countries, any such court would be expected follow the European Court of Justice in principle. Therefore, the UK must decide whether it wishes to do its own trade deals, which rules out remaining in the Single Market, leaving the Norway option. Then, there’s also the choice of aiming for a comprehensive free trade agreement with the EU that must include services which are excluded from a customs union. That would also mean prioritising trade deals over a frictionless border for goods trade in a customs union. But, if it needs a customs union, particularly for the Irish border, then it’s unlikely to be able to negotiate free trade agreements with the rest of the world. Of course, as the saying goes, “politics is the art of the possible.” Still, hard choices are likely needed among these aims given the Brexit dilemma or trilemma. |