Impact of Brexit on finances

The unexpected – and unplanned for – Leave vote cast when over 70% of the UK electorate last week turned out to vote has cast financial markets and Forex markets into meltdown, given a virtual carte blanche to far-right extreme racist activity, triggered the worst UK constitutional crisis in living memory, and, more worryingly for the average households, is likely to significantly hurt UK consumer finances and UK government finances over the next 2 to 5 years as an absolute minimum (although 10-20 years is probably more likely).

Government finances

Let’s start with the impact on the government. In the immediate aftermath of the Leave result being announced, investors looked for “safe havens” for their investments and shifted their money into government bonds and gold (always a safe bet!). This pushes down the “yield” on the bonds making government borrowing cheaper – helpful in terms of reducing the value of debt interest.

However, as the initial rush to purchase bonds petered out, the ratings agencies made their move, initially lowering their “outlook” forecasts to negative, and eventually by Monday afternoon starting to lower the credit ratings. These, miraculously, had stayed high throughout the entire financial crisis from 2008 – the downgrade today indicates that investors believe the impact on the UK from the Brexit vote will be greater than that of the Great Recession.

Ratings downgrades make government bonds less desirable for investors – demand for bonds falls and this then pushes up the yields on these bonds, increasing the amount that the government must pay in terms of debt interest. That’s money that can’t then be spent on the NHS, on education, on pensions, at least for the next few years.

NHS Funding

Now, the Lord Ashdown Poll indicated that around 80% of Leave voters made their voting decision based on concerns over NHS funding. So let’s take a look at the financial impact on the UK’s health service.

It was clear throughout the bitter campaign that the statistic splurged all over the side of the Leave bus – that the £350m sent to the EU each week could be spent on the NHS instead – was actually blatantly false.

Once the rebates are added back in, the absolute maximum financial gain would fund the NHS for (drum roll please…) a pitiful 19 days. The huge decline in the value of Sterling since last Thursday (which is set to continue until, banking experts from HSBC and Deutsche Bank believe, it hits a painful low of around $1.10 to the Pound, and around €1.15 to the Pound) is disastrous for the NHS. The NHS purchases many of its essential medicines from the Euro area and the US – on Friday last week alone, the cost of its medicines increased by £2bn. The NHS can ill afford this at the best of times.

Whilst it has benefited from “ring fenced” funding protection in recent years, it’s difficult to see how this ring-fencing can continue in the face of other significant increases in government spending, and the fall in tax revenue that inevitably results from recession. Finally, with 10% of NHS doctors and around 5% of nurses and midwives being EU citizens, there is a massive threat to the long term viability and existence of the NHS – resources are already stretched thin, and many of these workers may simply not want to stay in a country that has effectively told them to ‘go home’.

A number of Brexiteers have muttered that NHS spending will fall if we reduce immigration ; but estimates suggest that the cost of “health tourism” last year was less than £0.5m. On balance, immigrants to the UK contribute more in terms of tax revenue than is spent on them through direct benefits and benefits-in-kind (such as the NHS and state school education).Time for the high-income Brits to look into taking out private health insurance…

So what are these other likely increases in government spending? The first is a direct result of the Brexit vote. The UK government is currently putting together a new “Brexit Unit” of civil servants. This needs funding, and there’s no money spare anywhere else – borrowing will have to rise (unless, of course, tax goes up – but no Chancellor in their right mind facing recession and a lack of business and consumer confidence is going to do that!

Osborne has confirmed that he is ready to steady the ship, and tax rises cannot feature in that plan). There’s also the enormous cost of trade negotiations and diplomatic missions – the UK civil service simply does not have the expertise to take on the might of the Brussels bureaucracy on this front, so will clearly have to buy in the expertise, but at what price?

And, to make matters worse (especially for the Leave supporters, who are deluded if they think renegotiating will be straightforward…we don’t have the British Empire anymore!), the deal that looks most likely to be on the table is the “Norway Model”, in which the UK will still be able to be part of the Single Market and trade freely, BUT it will still cost us the same amount in membership but without any say at all in Brussels about where our money will go.

That kills the support from Brexiteers who wanted to tackle the (admittedly large) democratic deficit in the EU, and also to regain control of our spending. It also kills the immigration argument, because to be part of the Single Market (i.e. to still be able to trade freely with EU countries) we will have to accept open borders with the rest of the EU. Many Leave supporters have told me that they are relying on “strong negotiating” to get the deal that we deserve.

You will find more statistics at Statista

The absence of a trade deal

The biggest problem, though, is that there is no “deal” that will actually give all Brexiteers what they want. Angela Merkel has made it painfully clear already that the UK cannot simply “cherry pick” the features of a trade deal that they would like. Any deal with the EU will involve UK spending, no change in immigration, and even less clout at the negotiating table in Brussels. If a sensible deal cannot be reached within the 2 years of negotiating that will follow the invoking of Article 50, then the UK will automatically face large tariffs on its trade with the EU, and a continued need to adhere to the many regulations required to trade in the EU. What will happen economically and politically when it becomes painfully clear to Brexiteers that what they wanted simply cannot happen remains a worrying mystery.

Of course, Brexiteers argue, we can improve our trade relations with other parts of the world. Ok, but the UK on its own is not actually a big enough market to interest large economies. The US is currently negotiating the TTIP trade deal with the EU – we would have to join the back of the queue, and it would easily take 15 years to have any sort of deal with the US. What about Africa? Unfortunately, years of post-colonial arrogance when it comes to trade and aid with the region will, I think, come back to bite us. African companies and governments have already struck deals with the Middle East, China and South America i.e. economies with huge prospects for growth, and that aren’t as worried about imposing their high-handed views about free markets and democracy. I can’t imagine any possible scenario in the near future in which we want to engage in more trade with Russia. And China is rebalancing its economy in favour of supporting greater domestic demand, not trade. So good luck with that one, trade negotiators!

Furthermore, the wave of hate-crime unleashed in some parts of the UK will increase policing costs, and likely raise the price of insurance. The government will end up spending more on benefits to the poor and unemployed – many pensioners will struggle to live on their reduced private pensions which have taken a battering as a result of the financial nosedive of the markets, and will have to turn to the government for help. Costs of border policing may have to rise, if the French follow through on their suggested threat of allowing migrants in Calais to face the UK border in the UK rather than France.

Spending on the security services will have to increase if we are to keep the UK as safe as possible from the rising threat of terrorism – in leaving the EU, we are unlikely to be able to have access to the shared intelligence across the region. Either the government undoes the work of austerity and accepts that a budget surplus is simply not achievable by the end of the decade thereby borrowing more (and making life more difficult for future taxpayers), or some areas will suffer even bigger hits – I can’t imagine that the populace will put up with more cuts to benefits or essential public services. However, exactly what gets cut, or what gets borrowed, will ultimately depend on who gets elected as the new Tory leader, and also whether a general election ends up being called well ahead of the next planned election in 2020.

Growth and the risk of recession

Overall, negative economic growth in the near term, and the associated job losses, is extremely likely – we were warned about this by all of the alphabet-soup agencies, including the IMF. Sadly, their sophisticated expert arguments were either not understood, or derided as being the views of rich capitalists. For many people, the arguments were too complex to bother looking into.

Typically in recession, the low-skilled and easily-replaceable workers are the first to get the boot – many of these are the people who voted Leave. And they will be deeply unhappy. Those who voted Leave as a protest vote in an attempt to get the government to understand that they are unhappy have effectively made their lives worse. And this can only be a catalyst for further social unrest. Some Marxist commentators I’ve spoken to are effectively rubbing their hands with glee – could this be the time for the proletariat to rise up and undermine capitalism as an economic system? I suspect not, but the impact on capitalism generally needs some thought.

Pensioners have already lost huge amounts of income, and the high risk of recession will make incomes fall generally. Now, some Brexiteers have told me that they believe this is a short-term loss worth having, in order for a longer term gain.

To some extent, they could be right – we don’t know exactly what form of agreements we will be able to make with other countries – but as an economist, I do know that long-term growth is dependent on investment by businesses (domestic and/or international), the building of essential infrastructure, and sound legal and financial institutions. Business confidence has already fallen amongst most business leaders, and inflows of foreign direct investment are extremely likely to fall – this is likely to be exacerbated by a decrease in FDI because overseas businesses will be unlikely to be able to use the UK as a “springboard” into the rest of the EU.

Given that the UK already has frustratingly low productivity levels, and inadequate infrastructure, the prospects for decent growth look very limited. Solving that problem is likely to take decades, and require major reform of the education system and a significant shift in mindsets to encourage Brits to work harder. The government could, of course, slash the rate of corporation tax to attract big business, but that’s going to be distinctly unpopular with those who already believe Big Business to have too much power and influence.

Even for those that manage to keep their jobs, the spectre of inflation is on the horizon again, after many years of below-target inflation, and this will reduce household purchasing power. HSBC has released a conservative estimate that inflation will be at least 4% by early 2017, mostly caused by the drastic increase in the price of essential imports such as food and fuel (which we simply cannot produce enough of in the UK) caused by the astonishing fall in the value of Sterling.

You could argue that this is a short-term blip. But without guaranteed access to EU markets, UK food producers may well go bust and worsen the food issue, making us even more reliant on food imports. Typically when food prices rise, people switch to cheaper, less nutritious processed foods – this is a fairly bold statement, but it’s entirely possible for Brexit to lead to greater obesity, already a huge strain on the NHS. And the UK is a net importer of oil (we certainly will be if Scotland leaves the UK!) and rising oil prices lead to increased production costs in pretty much every industry, feeding through to higher cost-push inflation. We don’t have much choice in terms of where we buy our oil from, either – trade deals with the US, for example, will do nothing to alleviate UK fuel issues. Expect the price of petrol, heating and all UK manufactures to rise.

On the plus side, now might be the time to invest in green technology! Either way, inflation is highly likely to lead to an increase in interest rates by the Bank of England, and this in turn will raise the cost of mortgages, reducing house prices. Good news for first-time buyers, but bad news for home owners attempting to sell their property in the hope of capital gain – and bad news in terms of the “negative wealth effect”, whereby a reduction in the value of assets reduces household spending, increasing the risk of recession.

Brexit-proofing your finances

So how can you Brexit-proof your finances? Short of attempting the Good Life (living off-grid and growing your own food), the only option is to grit your teeth and sit tight – don’t try to sell your assets such as houses or shares, avoid overseas holidays, and hope that those pesky EU Directives that protect your working rights will actually help you to keep your job. Alternatively, try to find a job abroad – Australia always sounds appealing. Just a shame they don’t want immigrants.