Brexit Collection (Part 1)
Research Articles
Beyond Brexit: A Programme for UK Reform
Maintaining Stable Macroeconomic Conditions
- Russell Jones, John Llewellyn
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R7-R14
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The UK economy faces more than usually uncertain times. Outside the European Union, and in an increasingly challenging global environment characterised by ageing populations, climate change, populism, protectionism, and more, the country needs to chart a new course. This may well require policymakers to consider unconventional approaches to monetary and fiscal policy and, at the very least argues for important modifications of the current policy regime, including the autonomous mandate of the Bank of England.
At some point, there will be a major slowdown in economic activity. Yet the Bank of England has very little leeway to respond by cutting interest rates, and it has already adopted an armoury of unorthodox tools that may be decreasing in effectiveness. More radical monetary approaches would be likely to be politically controversial; and are not without risks. In these circumstances it would be a mistake to rely solely, or even largely, on monetary policy to maintain demand. It would be better to conduct monetary and fiscal policy in tandem, and for discretionary fiscal policy to be required to play a much more active role in demand management than hitherto. This would, for example, imply major extension of the automatic stabilisers and efforts better to calibrate discretionary initiatives with the business cycle.
But given the long-term pressures on the public finances, more fundamental changes in the structure of spending and taxation are needed, along with a redrawing of fiscal rules and targets, under independent budgetary oversight. The current, historically low, share in GDP of public spending is itself unsustainable in light of the demand for services of an ageing population; plans should be made to raise it closer to the European average. In the most extreme circumstances it might become necessary to waive the fiscal rules entirely and for the Bank of England directly to underwrite fiscal stimulus in order to sustain aggregate demand. It would be wise for the authorities to consider the options in detail now, while the environment is still relatively stable.
Supporting Dynamic Economic Adjustment
- John Martin
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R15-R21
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Economic policymaking in the UK has historically focussed more on the demand side than on the supply side of the economy. Yet it is on the supply side – the way in which an economy adapts to change while growing productive capacity on a sustainable basis – that medium- to long-term economic performance largely depends. There is an urgent need now to rebalance policy by focussing, in particular, on measures to enhance labour-force productivity, including radically enhanced support for training and skills development.
This does not involve wholesale structural reform of the economic framework. The UK benefits from having one of the most flexible economies in the OECD, with competitive product markets, relatively low labour costs and historically high employment levels, accompanied by a so-far-successful adoption of an escalating minimum wage. We suggest that in the post-Brexit era politicians would do well to avoid changes in the regulatory regime that would create undue misalignments with EU standards. Nevertheless, the concomitants of the UK's form of flexibility are a dismal performance on productivity and stagnating living standards. Productivity is now actually falling quarter on quarter ten years after the last economic downturn – a position unprecedented in the past 250 years. This problem must be addressed if the UK is to progress towards fulfilling its economic potential.
Central to this are both so-called Active Labour Market Policies (ALMPs) to provide people who have become unemployed with new skills that help them remain in the workforce, and investments in effective upskilling of mid-career and older workers. ALMPs can help raise average per capita income over time, yet UK spending on this area is well under half the OECD average and a fraction of the sums spent in the more successful Nordic economies, Germany, Austria, Switzerland, and Australia. The UK's many attempts to develop new training and apprenticeship schemes in recent decades have been dogged by poor quality and a lack of support from employers and labour unions. This needs to change: we propose a concerted effort to raise UK spending on ALMPs to the OECD average, especially for 16–24 year-olds. Improving labour-force mobility – for example by radically improving availability of affordable housing – is also critical. Structural reforms of this kind will require sustained political effort and support.
Developing Trade
- David Vines, Paul Gretton, Anne Williamson
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R22-R29
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The UK faces no easy options in determining how to develop its approach to international trade post-Brexit. If it finally decides to leave the European Customs Union and Single Market, it faces the possibility either of simply crashing out of the EU without a deal; trying to form market-access agreements and Free Trade Areas (FTAs) with the EU and other countries; or unilaterally reducing tariffs and liberalising trade with all countries. Each course raises significant practical difficulties, and entails major disadvantages compared with staying in the Customs Union and Single Market.
The economic costs of a ‘no-deal’ approach stand to be very large, including inevitable tariffs, obstruction of UK access to EU markets, physical disruption at borders, a damping of investment and the much-discussed problem of the Irish border. Assuming ‘no-deal’ does not happen, negotiating FTAs with other countries would be possible only after a lengthy transition period, as in the Withdrawal Agreement voted down in Parliament, and would depend on the shape of the ultimate post-Brexit trading relationship between the EU and the UK. The process would be difficult, costly, and protracted; would likely be concluded on disadvantageous terms; would be even harder to apply to trade in services; and would yield extremely small gains given the volume of UK non-EU trade that is already covered by FTAs. Finally, unilateral liberalisation, while ameliorating some of the drawbacks of the first two options, faces the same problems of loss of access to European markets and disruption to trade; and would entail severe economic pain with only very gradual gains.
The UK needs to conduct a much more profound and considered debate on these issues before deciding to set aside the large benefits of membership of the Customs Union and Single Market for the significant difficulties and tenuous gains offered by the alternatives. Public debate on the economic effects of trade policy has so far lacked the detailed but necessary analysis of these questions. It seems essential to establish a national policy review institution, modelled on the Australian Productivity Commission, in order to stimulate such a debate.
Developing Trade in Services
- Alexis P. Lautenberg
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R30-R33
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Services are simultaneously the most important sector of the UK economy and the sector facing the biggest challenge as a result of Brexit. The prospective departure from the European Single Market reduces the UK to the status of ‘3rd country’ in respect of services. Accessing the internal market will depend on both subjective and objective conditions that differ from sector to sector, requiring detailed and highly specific arrangements for such industries as aviation and financial services.
In practice, the EU can be expected to use these circumstances to discourage the UK from significantly diverging from European regulatory norms, as a matter of policy. In view of the weakness of, and uncertainty surrounding, international moves to oversee, let alone to further liberalise, trade in services, Brexit will thus leave the UK's services sector – and especially financial services – uniquely isolated and exposed. The government will hence need to consider carefully the costs of decisions to diverge from EU regulatory standards, and should be giving great priority to establishing clear objectives for close cooperation between the UK and the EU policy makers and regulators.
Research Article
BREXIT AND IMPACT ROUTES THROUGH GLOBAL VALUE CHAINS
- Jyrki Ali-Yrkkö, Tero Kuusi
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- Journal:
- National Institute Economic Review / Volume 252 / 2020
- Published online by Cambridge University Press:
- 28 April 2020, pp. R33-R44
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We analyse the trade routes between the UK and EU countries. Our results show that the relative importance of the UK as a trading partner in the EU has slightly decreased. We further decompose the total value added into components that quantify the value added that is generated through direct trade with the UK and the indirect trade that is channelled through third countries. Close to one third of the total value added is generated through indirect trade and two thirds through direct trade. Furthermore, 18 per cent of EU countries’ value-added trade to the UK passes through the UK onto other countries.
Research Articles
Beyond Brexit: A Programme for UK Reform
Reorienting Foreign Policy
- Jeremy Greenstock
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R34-R39
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After Brexit, the UK must show that it has a voice. It will need to re-earn international respect, and in particular establish the concept of a ‘global Britain’ on the basis of performance, not rhetoric. That means re-establishing a strong network of relationships around the world in support of its security and economic health, but also continuing to play a leading role in support of the international rules-based order. For example, it should make the most of its continuing status as a Permanent Member of the UN Security Council to act as a problem-solver and system-enhancer in the collective interest.
An early, first-order priority will be establishing a new, mutually beneficial partnership with the European Union, which continues to form our economic and political neighbourhood. Reconstructing a modern relationship with the United States is not secondary to that, but cannot substitute for it and must be undertaken in recognition of the differing interests and instincts of the two sides. A further challenge is building the right relationship with China based on mutual interest in trade, peace, and international respect and on confronting expansionist or opportunistic practices. With Russia, too, it is possible to design a predictable set of behaviours on either side, and with both countries good communication channels will need to be maintained.
Brexit gives the UK the scope to construct a more deliberate diplomatic approach to the rest of the English-speaking world than was explicitly possible as an EU member – notably in working with Canada, Australia and New Zealand to promote the international rules-based order. But this should be complemented by more effective outreach to non-English-speaking countries, notably in support of trade and investment opportunities with emerging nations. But with them as with all the UK's interlocutors, the need to earn its place, and to show that it realises that, will be vital.
In defence and security, the UK will continue in its commitment to the strength of NATO as its essential alliance under US leadership, while also liaising carefully with EU Member States as they seek to improve their own capacities to contribute to European security. But it cannot simply rely on old institutional structures. It needs to lead, for example by playing a stronger role in the control of non-military forms of aggression, such as cyber warfare, economic sanctions, rivalry in space, and commercial espionage.
A strategy for realising the UK's interests in the international arena will require the Prime Minister's constant attention, but also a specific mandate for a very senior minister to supervise the interlinked policy areas of foreign affairs, international development, and international trade within a single government department.
Updating Security and Defence Policy
- Mark Lyall Grant
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R40-R46
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Threats to the security of the UK are evolving with the changing nature of conflict and balance of power in the world. They are multiple and fragmented, and domestic and online as well as overseas in nature: principally state-based threats such as posed by Russian activity; terrorism; cyber-attacks; and serious organised crime. To respond, the United Kingdom will need flexible capabilities aimed at fostering infrastructural and societal resilience as much as conventional defence. Above all, the UK needs to focus on maintaining, promoting, and defending the international rules-based order, as represented by the UN and NATO among other institutions.
The UK possesses significant assets to these ends, including its continuing status as one of eight acknowledged nuclear powers – a status that it should not abandon unilaterally; permanent membership of the UN Security Council; membership of the ‘Five Eyes' intelligence community; and its internationally respected armed forces.
But effort and resources are required to support these commitments, for example in helping to encourage other European states to spend more on defence; in contributing to UN peace-keeping operations or other collaborative overseas actions; and most of all in ensuring that army and navy manpower is rebuilt. Two per cent of GDP is no longer sufficient for the proper defence of the nation. Even allowing for the demands of other parts of government, the target for defence spending should be raised in the next review to 2.2 per cent.
The principal focus will need to be on efficiency and redeployment of resources as the current equipment-heavy procurement cycle comes to an end. In particular, investment needs to continue to be rebalanced towards new capabilities such as drone technology, offensive and defensive cyber and intelligence manpower.
But, to avoid any weakening of the country's security, priority should be given to negotiating a new agreement on security and intelligence cooperation with its European allies to replace the arrangements it had within the EU.
Formulating Industrial Policy
- Tim Besley, Richard Davies
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R47-R53
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Alongside the challenge of maintaining economic competitiveness in the face of great uncertainty, Brexit brings an opportunity for the government to set out a new industrial strategy. The case for doing so rests on the need to address areas of persistent structural weakness in the UK economy, including low productivity. But it is important that any new industrial strategy be based on appropriately granular data reflecting the real structure of the UK corporate sector: the overwhelmingly preponderant role of services as opposed to manufacturing, for example; the importance of young, fast-growing firms as opposed to SMEs; the relatively high failure rate of companies in the UK; and the relative lack of successful mid-sized firms. Such a data-driven approach might spawn an industrial strategy quite different from the piecemeal programmes of recent years.
Internationally, the UK is a laggard in this area, and the recently-created Industrial Strategy Council does not look strong enough to change that position. To move forward, the government needs to make industrial strategy a central plank of economic policy, embedded at the heart of the administration with its own staff and funding, and operations based on a comprehensive review of the economic contribution and potential of various types of firm. Needless to say, it cannot be a substitute for a continuing commitment to competition and markets, or a stalking horse for protectionism: interventions should be justified by carefully-argued market failure arguments, be time-limited, and transparently evaluated.
Securing Decarbonisation and Growth
- Dimitri Zenghelis
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R54-R60
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The need to decarbonise the economy in order to slow the pace of climate change is now recognised as one of the most pressing international policy challenges. While the UK cannot by itself materially affect global climate change, it has an opportunity to play an influential role, both by persuading others of the need for action but also by reshaping its domestic economy to benefit from a low-carbon transition.
Far from hampering competitiveness, adoption of a coordinated policy approach to climate change today would generate positive benefits for the UK economy, especially if it addresses the multiple market failures that promote pollution and places decarbonisation at the heart of structural economic policy.
Desirable strategies would include public support for research, development, and deployment of new technologies, and measures to foster an environment where innovation can rapidly shift the economy from dirty to clean production systems. Focusing UK industrial strategy on securing strong domestic supply chains for green products and services, for example, could help create an early mover advantage in rapidly growing global market sectors. Interventions could include the establishment of a National Infrastructure Bank to support decarbonisation in crucial sectors such as energy and transport, and would also need to encompass measures to assist structural adjustment in affected industries and their workforces.
Improving Infrastructure
- Russell Jones, John Llewellyn
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R61-R68
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Infrastructure investment can substantially increase a nation's capital stock and thereby boost productive, or supply-side, potential. It can also be useful as a tool in macroeconomic stabilisation, while public spending on quality infrastructure projects has been shown to have significantly greater multiplier effects than tax cuts – so the case for an increasing spend is not undermined by a country's overall debt level.
These arguments are especially apposite for post-Brexit UK. Britain's investment performance in general has been especially poor since the 2016 EU referendum. Fixed capital formation as a proportion of GDP is low by international standards, while the government's share of fixed capital formation, at 2.5 per cent, is also below average. It would make sense to target an increase in public and private infrastructure spend to 3.5 per cent of GDP which is the OECD's recommended level.
While major infrastructure projects continue to generate controversy on grounds of cost overruns and other issues, UK policy-makers have recently taken a more constructive approach to infrastructure development, notably with the creation of an independent National Infrastructure Commission.
But the UK's infrastructure remains unsatisfactory, with significant parts of its energy, water, transport and communications networks in need of renewal or replacement, and infrastructure project delivery remains poor. In summary, much of Britain continues to operate well into the 21st century largely with 20th century, sometimes 19th century, infrastructure assets that are creating bottlenecks, crimping productivity, putting off potential foreign investors, undermining the economy's competitiveness, increasing inequality, and leaving the economy ill-equipped to face future challenges such as Brexit and climate change.
The government needs to be bolder, setting out a more ambitious set of priorities including energy projects, regional spending, and fostering capital recycling and private sector investment. A still more ambitious, but eminently feasible, proposal would be to establish a National Investment Bank to offer project guarantees, recommend user fees, lend to projects with the proceeds of National Investment Bonds and simplify planning among other tasks. In a serious downturn, with monetary policy exhausted, the NIB could also help to co-ordinate and finance a response.
Redesigning Housing Policy
- Kate Barker
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R69-R74
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Discussion of the UK's housing crisis is of long date, and tends to focus on a simple story about a mismatch in housing supply and demand and the consequent need to build more homes. Yet the reality is more complex with multiple sub-plots including social housing, stress in the private rented sector, benefits, subsidies and ultimately taxation of home ownership.
At the bottom of the market, the crisis is real and acute, as manifested in a sharp increase in homelessness and rough sleeping. The inescapable answer is to increase the depleted stock of social housing and widen eligibility criteria. An increase of 100,000 social units a year in England would help address this problem, as well as alleviate the financial squeeze on tenants of the private rented sector, whose number has grown sharply in the past 15 years in tandem with a steep rise in the housing benefit bill. Recent efforts to curb housing benefit have further increased distress, so it will be necessary to consider increasing benefits again alongside regulatory interventions with private landlords.
In the home ownership market, recent government intervention has taken the form of the much-criticised Help-to-Buy Equity Loan scheme. This market policy to support new-build homes should be wound down and replaced by a scheme to endow all young people with a capital sum that they could use for second-hand homes as well. More generally, a more sophisticated approach to planning home-building is needed, both for assessing overall numbers and their regional distribution and in financing the supporting infrastructure.
But none of these measures is a panacea for a housing crisis that is in large part a symptom of problems in the wider economy, such as low relative wages for young people, a lack of clarity about environmental issues, and failing places. A successful policy package to address the distorted structure of the housing market must also grasp the most difficult nettle of all – namely the way the tax benefits of owner-occupation incentivise overconsumption of housing and a widening wealth gap between renters and home owners, and between owners in different parts of the country. If we spend more to help those who struggle to afford decent housing, then it is only just to raise more taxation from those who benefit from restrictions on housing supply – whether through reform to council tax, a wider wealth tax or a limited form of Capital Gains Tax on principal residences.
Reducing Inequalities
- Russell Jones, John Llewellyn
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R75-R82
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A backlash against numerous inequalities – and in particular against perceived unfairness in society – is a significant driver of the UK's current political malaise. Addressing inequalities between income groups, regions and generations will thus be key to re-establishing faith in government and avoiding further decline or even the threat of social unrest.
In income terms, the UK has become much more unequal than in the immediate post-war decades, and it should be a goal to reverse that trend – targeting the OECD average for income inequality and a halving of the number of those living below the poverty line. Measures to deal with perceived unfairnesses could include tighter scrutiny of competition in high-yielding sectors such as technology, and incentives for the appointment of worker representatives to company boards. But a government intent on tackling inequalities will inescapably need to raise public spending and direct taxation of income and capital from their current historically low levels. In particular spending on education and active labour market policies needs to increase, while gaps in the benefits system and regional imbalances are addressed.
Given the scale of technological change and the severe implications for the labour market, the risk is that policy will be insufficiently bold to deal with widespread disenchantment, which could ultimately pose a threat to democracy.
Effective Devolution
- Angus Armstrong
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R83-R88
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Brexit creates deep challenges for the UK's structure of governance; not least concerning the degree and manner in which powers are devolved within one of the most centralised countries in the world. Departing from the EU is likely to exacerbate regional inequalities and possibly social divide, while at the same time leading to further centralisation of powers, at least in the short term. Most Brexit analysis looks at the reorientation of the UK's external relationships, but the most significant impact may be on its internal constitutional affairs.
While it is generally agreed that the UK needs more devolution, there is little discussion about how and why it sometimes succeeds, but also sometimes falls short of expectations. Ever since Adam Smith it has been known that economic prosperity, justice, and social cooperation are mutually reinforcing. Therefore, policy must be built around community and a sense of belonging, rather than a collection of anonymous individuals. The Core Design Principles set out by Elinor Ostrom provide a framework to transform governance structure at every level from the smallest communities all the way to parliament.
Necessary institutional changes include giving local authorities much greater control over revenue-raising powers and therefore the services they wish to support. National legislatures must have the power to borrow for investment without limit, but with sole responsibility for repayment, to enhance local political accountability. A statutory body should be established, including representatives of the devolved assemblies and English regions, to address regional disparities, and there should be a much stronger regional presence in decision-making by HM Treasury and the Bank of England.
Improving Governance
- Martin Donnelly
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- Journal:
- National Institute Economic Review / Volume 250 / 2019
- Published online by Cambridge University Press:
- 01 January 2020, pp. R89-R93
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Government post-Brexit will face sustained and difficult challenges as the UK adjusts to its new situation. Yet these challenges risk being exacerbated by fundamental changes in UK political debate that are affecting the perceived legitimacy and effectiveness of the system and structures of government. These include erosion of the clear distinction entrenched for the last 150 years between political choices by elected representatives and impartial administration by the civil service; the disruption of traditional deliberative processes by digital and social media; and increased centralisation of decision-making in No. 10 Downing Street combined with inadequate scrutiny of that decision-making either by the Cabinet or by Parliament.
The centralisation of executive power reduces its perceived legitimacy across the UK, with devolved government in Scotland and Wales seen as contingent on the Westminster Parliament and Northern Ireland under control by central government. Fiscally, the UK has become the most centralised democratic country in the world. As government faces up to the challenge of unwinding membership of the legal and regulatory framework developed during 45 years of EU membership, it is vital that the UK's political structures restore their legitimacy and efficiency.
Necessary reforms start with greater transparency about how government really works today. A PM's Department should be created, separate from the Cabinet Office; senior appointments including the Chief of Staff and ‘Advisors’, as well as instructions from No. 10 to departments, should be subject to effective Parliamentary scrutiny. Legally entrenched structures are required to confirm that devolved powers cannot simply be overridden by the Westminster Parliament. Greater fiscal autonomy should be guaranteed to local government.
Finally, politicians should choose either to recommit explicitly to the original system whereby the civil service remains separate from politics and take steps to make it effective; or acknowledge the drift towards greater political control of the civil service and introduce safeguards to minimise political abuse, for example by taking steps to increase scrutiny of appointments and expenditure.