Archive for the ‘Economics of Brexit’ Category

The European Investment Bank is becoming increasingly politicised

The European Investment Bank (EIB) is intended to provide finance and expertise for investment projects that further EU policy objectives. But as Daniel Mertens and Matthias Thiemann explain, a steady expansion of the bank’s operations over the last two decades has prompted greater political debate over its governance and activities. They highlight three recent developments that underline this politicisation of the EIB.

Over the past two decades, the European Investment Bank (EIB) has become the world’s largest multilateral financial institution. In 1999, the EU member states’ ‘policy-driven’ bank counted around 1,000 staff members. This number is now close to 3,000. In 1999, the EIB’s balance sheet stood at 200 billion euros. It now stands at 550 billion euros.

While this has given the bank an enormous push in its organisational capabilities, it has also come with higher visibility, calls for transparency and accountability, and mounting political tensions. This process of politicisation is characteristic for the post-crisis evolution of the European Union, and apparently does not stop at the European Commission’s door or the European Central Bank (ECB). Three recent episodes in particular highlight why more attention should be focused on the EIB.

The EIB and investment policy under austerity

The proximate cause for the EIB’s increasing politicisation lies in the financial and economic crisis that started ten years ago. Faced with an outsized aggregate demand shock, the EIB took up the role of a counter-cyclical investment vehicle, increasing lending from 2008 onwards (in the years 2008-2011, balance sheet growth was 50 per cent, from 310 to 471 billion euros). While it first followed up on requests by member states and the Commission to ‘contribute to the recovery of the real economy’, and then, in the wake of the Eurozone sovereign debt crisis, provided support to the Europe 2020 Project Bond Initiative, the EIB quickly moved into debates over the stronghold of austerity policies.

European Investment Bank, Credit: Forgemind ArchiMedia (CC BY 2.0)

Former staff began promoting the bank as a powerful tool to address deficient growth in the EU. With structural funds as buffers, the EIB was to facilitate riskier projects to close the investment gap and offer an alternative draft to fiscal orthodoxy. This idea, mirroring a similar proposal by progressive economists Varoufakis, Galbraith and Holland, was taken up by the incoming Commission in 2014, where a compromise between the S&D and EPP before Jean-Claude Juncker’s election led to the establishment of the Investment Plan for Europe.

At this point, the bank gained political attention as a tool for some sort of consolidation-friendly investment policy – or in the words of the bank: ‘doing more with less’. But it also drew attention to how this investment policy would actually be conducted: civil society actors such as the NGO Counterbalance increasingly criticised the bank’s policy on a range of issues from environmental impact to tax avoidance and the widespread use of PPPs. This undesired political spotlight on the part of the EIB was only to intensify in the coming years. And currently, the EIB faces pressures from the Commission’s proposal for a reformed investment policy, investEU, that could break its privileged access to the EU budget.

The EIB and Brexit

The EIB’s expanded role in the crisis could not be realised, however, without an increase of the paid-in and callable capital provided by its shareholding member states. Currently, Germany, France, Italy and the UK are the four largest shareholders accounting each for more than 39 billion euros or 16 per cent of total capital. Unsurprisingly, the outlook of Brexit has led to several sites of political tensions around this fact and the future of the EIB. In Britain, it has stirred a discussion and parliamentary inquiry over how to compensate for the withdrawal of EIB funding that in 2015 still was at 5.6 billion euros, but fell to 2.1 billion euros in 2017.

While close observers of the EIB such as Stephany Griffith-Jones have suggested the UK could stay in the EIB, the bank has conversely asked its remaining shareholders to prepare for filling the capital gaps Britain bequests. This has opened up two debates: first, a group of seven countries, as the Financial Times reported, demanded extensive reforms before they would agree on contributing more capital, leading the EIB to negotiate over supervision by the ECB. Second, Poland has argued that post-Brexit contributions should include an adjustment of the relative shares in the bank, more adequately reflecting the changing economic weight of member states – a demand which, expectedly, has met with resistance from the larger countries. What this tells us is that recent politico-economic developments have produced a rift through member states prompting questions of principle about the governance of the bank and its future activities.

The EIB and diplomatic conflict

The third episode of ongoing politicisation grows out of the unilateral withdrawal of the U.S. from the agreement on Iran’s nuclear programme. Subsequently, the EU has tried to save the deal and safeguard European companies and financial institutions doing business in Iran from associated U.S. sanctions through several measures, one of which is the expansion of EU guarantees for EIB lending in Iran within the so-called External Lending Mandate.

As the European Parliament’s Research Service explains, adding Iran to the list of ‘potentially eligible regions and countries’ for EIB lending does not oblige it to do any business. EIB president Werner Hoyer has indeed made clear that extending the mandate for the EIB does not lead to any actual EIB activity in Iran. Quite to the contrary, he asserted that Iran is a place “where we cannot play an active role… [and] have to take note of the fact that we would risk the business model of the bank if we were active in Iran.” In turn, the bank is facing headwinds from politicians claiming a stronger role for the EU as a global actor, such as Carl Bildt.

Although global diplomacy is a peculiar playing field, the processes at play are instructive for the political tensions around the EIB at large. First, the EIB faces a similar problem in all three cases: how does it shield itself from a pool of political demands that has grown as much as its own capacities? Second, it commonly responds to those by referring to its dependence on (U.S.) capital markets for raising funds and emphasises its conservative risk management for maintaining a high investment grade (AAA). Any significant move into riskier waters, as policymakers have called for, would also risk its rating, the bank states. This is also the reason why EIB lending within the Investment Plan for Europe or the External Lending Mandate entails guarantees from the EU budget.

However, this will not reduce the political contention about the tasks of and control over the bank. Rather, the EIB has now repeatedly positioned itself as an institution able to tackle global challenges from climate change to migration; and in this sense, it is likely that the bank has fuelled its own politicisation.

This article gives the views of the author(s), and not the position of LSE Brexit, nor of the London School of Economics and Political Science. It first appeared on EUROPP – European Politics and Policy.

Daniel Mertens is a Researcher and Lecturer at the Institute for Political Science at Goethe University Frankfurt and currently Acting Professor in Internationally Comparative Political Economy at the University of Osnabrück.

Matthias Thiemann is Assistant Professor at Sciences Po CEE. He is also an external fellow at the Research Center SAFE (Sustainable Architecture for Finance in Europe), Goethe University Frankfurt.

Britain can once again be the master of its own trading destiny

Wherever one stands on the question of Brexit, it undoubtedly presents opportunities, denied to Britain for almost half a century, to embrace its historic role as a global trading power. Britain can once again be the master of its own trading destiny, argues George Brandis QC (Australian High Commissioner).

A short distance from Australia House on the Strand, a commemorative plaque marks the location of the offices of the Anti-Corn Law League. The repeal of the Corn Laws was the great issue of 19th century politics. And, while it produced endless controversy in the Parliament and split the Tory Party, there are few today who would doubt that Britain made the right decision to throw off the chains of protectionism.

In fact, it is hard to think of a nation in history whose prosperity was more directly the product of free trade. For centuries, Britain was a land of merchant adventurers, for whom the oceans were highways of global commerce. Wherever one stands on the question of Brexit, it undoubtedly presents opportunities, denied to Britain for almost half a century, to once again embrace its historic role as a global trading power.

Australia, too, is a nation whose modern prosperity is the product of free trade. Trade between our two nations has diminished in the 45 years since Britain’s accession to the European Economic Community. Brexit gives Britain the opportunity to revive that trade – as it does with other like-minded nations in the Indo-Pacific region: the engine of the 21st-century global economy.

Endeavour, Thomas Luny 1768. C00 Public Domain

When the UK joined the EEC in 1973, it was Australia’s most significant trading partner. Thereafter, we found ourselves shut off from your market. At first, our response was to keep high tariff walls around ourselves, as protection from international competition. It was a manifest failure. We made poorer products at a higher cost than we should have. By 1980, Australia’s GDP per capita ranking had fallen to 19th in the world – from 7th in 1950 and 2nd in 1913.

By the mid-1980s, our policymakers realized their mistake, and we began to gear our industrial and trade policy to respond to international competition, not industry protection. Far from killing our national economy, the removal of protectionism renovated it: new industries emerged. Old, inefficient and uncompetitive industries fell away.

There were costs resulting from economic reform: some people lost their jobs or struggled to adjust to work in the new services industries that emerged. But we implemented strong social security safety nets, industry transition programs, and a commitment to education and training to help people find new careers. As demands on our labour force grew, policies facilitating immigration and the further participation of women rose to meet them. By 2017, even after the waning of the mining boom, we had once again resumed our position among the most prosperous nations. We are now in our 28th consecutive year of annual economic growth.

Our embrace of free trade is undoubtedly key to that economic success. Six years ago just 26 per cent of Australia’s trade enjoyed preferential access into export markets under negotiated FTAs. Today, that stands close to 70 per cent and is set to keep rising. The hungry middle classes of Asia provide us with markets for our agricultural exports that we will forever struggle to satisfy – which, incidentally, puts paid to the notion that British markets would be swamped with Antipodean beef and lamb under a bilateral trade deal.

The UK has once again arrived at a point in which trade will play a pivotal role in its destiny. It is not for Australia to encourage one outcome over another in the Brexit debate. We will stand by the UK regardless; our ambition to build on our already robust relationship (economic and otherwise) remains undiminished. Nevertheless, for those who look for precedent in these unprecedented times, the Australian experience – that the outside world is not a threat, but an opportunity – is surely instructive.

When confronted by change, it can be comforting to seek to shield oneself from the outside world. This was the sentiment Australia fell victim to in the 1970s, and what shaped the attitude of those who resisted repeal of the Corn Laws in the 19th century. They were wrong then, and they are wrong now.

For the first time in almost half a century, Britain can once again be the master of its own trading destiny. It is an exciting opportunity – but only if it is bold enough to seize the day.

This article gives the views of the author, and not the position of LSE Brexit, nor of the London School of Economics. An earlier version of this blog was published as an op-ed in The Daily Telegraph on 11 February 2019. 

The Hon George Brandis QC is Australian High Commissioner to the United Kingdom. He has had a distinguished political career in Australia as a member of the Federal Parliament. His appointments have included Attorney-General, Vice-President of the Executive Council, Leader of the Government in the Senate, Federal Minister for the Arts, and Deputy Leader of the Government in the Senate.

Inflation at 3.5% and a two-year recession: the impact of no deal

ana boatamichael heiseWe hear a great deal about the risks of a no-deal Brexit, but what would the economic effect really be? Ana Boata (Euler Hermes) and Michael Heise (Allianz) look at the economic hit the UK has already suffered as a result of Brexit and forecast the likely effect of a disorderly departure in March, as well as the impact on EU exports to the UK.

Over the past two years, Brexit-related uncertainty has had a strong impact on the United Kingdom’s economy. In our analysis, the high level of uncertainty has shaved growth by about -0.3% of growth per year via a multitude of channels to the real economy.

Firstly, the dampening effects of Brexit uncertainty have come from a lower (and highly volatile) valuation of sterling, which has diminished households’ real purchasing power and company margins through higher import prices. In order to compensate for the loss of purchasing power, UK households have reduced their average savings rate to a record low of 4.2% of gross disposable income in Q3 2018. This has more than halved since the referendum. Furthermore, non-financial corporates’ margins in the third quarter of 2018 reached their lowest level since early 2014.

Second, investment will remain weak as long as significant uncertainty persists. In Q4 2018, business investment is likely to have contracted for the fourth consecutive quarter. This would be the first time such prolonged contraction since 2009.

Third, the labour market should remain tight as net migration flows from the EU remain negative and push wages higher (+3.3% year on year in Q4).

Fourth, real estate prices are adjusting downwards contributing to negative wealth effects and deteriorating consumer confidence. Consumer confidence has returned to the low levels seen in the aftermath of the Brexit referendum. The construction sector has been impacted by accelerating business insolvencies (+15% in 2018, second highest increase after accommodation and food services).

Fifth, contingency stockpiling by companies has intensified since Q3 2018 and will pose downside risks in 2019 given the weakness of domestic demand. In some sectors, such as agri-food companies have planned four to seven months of stocks.

Sixth, UK attractiveness as an investment location has deteriorated, notably for foreign investors. Total M&A deals fell by 60% to £42.4bn on average since 2016. Several EU companies seem to be switching from a British supplier to an EU supplier which feeds into higher insolvencies in the UK market: +9% in 2019 after +10% in 2018. In addition, insolvencies of companies with a turnover of above 50m euros have risen in Q4. In total, 19 cases in 2018 against 15 in 2017.

Seventh, worsening business and consumer confidence coupled with higher risk aversion have triggered tighter loan availability by banks. The prevailing uncertainty could push the Bank of England to delay its rate hike expected in Q2 (+0.25 base points to 1%).

Given the economic effects that the Brexit uncertainty has already had, a disorderly Brexit seems a big risk for the economy. Fortunately, the risk of a disorderly Brexit on March 29 could be reduced with an extension of Article 50 until July or December. With more time for logistical preparation the disruption of supply chains and financial business could be reduced. But if a disorderly Brexit does happen, it would have grave consequences. In our view, it would push the GBP/EUR exchange rate below parity rather quickly and thus increase the inflation rate to 3.5%.

As a consequence, purchasing power would decline and consumer spending and imports would contract. Overall, the economy would enter into something like a two-year recession. For the UK’s trading partners, goods exports to the UK could go down by £30bn in a year. Top EU losers on goods exports include Germany (~EUR8bn in the first year following the EU exit), the Netherlands (~EUR4bn), France (~EUR3bn) and Belgium (~EUR3bn). If we add to this the expected losses in investment, the negative impact on GDP growth would be above -1% for Belgium and Ireland and above -2% for the Netherlands for a time span of two years.

Should a “hard Brexit” come later, the impact would be lower as it would be possible to better prepare the introduction of WTO tariffs (5% on average) and to mitigate negative effects through uncertainty. Looking at existing WTO tariffs that the EU has in place with countries with which there is no Free Trade Agreement in place, export losses from the tariff introduction would be highest for the automotive sector, followed by chemicals and agri-food products. Overall, they would be half of what we would see in a “disorderly Brexit” – i.e. for Germany, we would expect them at EUR3.5bn.

But what should be noted is that even before Brexit happens, trade and investment connections between the UK and the EU have started to adjust. Real imports in the UK have presumably grown by less than 1% in 2018, which is the lowest rate of growth since 2011. This translated into lower outlets of Western European companies into the UK. We estimate that the eurozone as a whole missed around EUR60bn of potential outlets into the UK market since the Brexit vote.

Overall trade exposure of European countries to the UK has been reduced since 2015. The UK used to be the third biggest export market for Germany. Due to the slowdown of economic activity, it has dropped to the fourth rank. Exports in EUR terms fell by almost -6% in 2016-17 cumulated (or EUR5bn in value terms).

For the long term development of the UK economy and its trading partners, the success of the negotiations on a Free Trade Agreement is absolutely essential. From a normative point of view, it should involve a free and open border on the Irish island, zero tariffs on goods trade between the UK and the EU, as well as “passporting rights” for the UK`s financial sector. As the UK`s political ambition is to exit the customs union and to negotiate Free Trade Agreements with non-EU countries on its own, an economically viable and beneficial solution that takes account of the above seems to be a Norway-type of agreement.

However, given that political opposition to such an agreement seems strong in the UK, the negotiations over the future trade agreement will prove no less difficult than the negotiations on the exit deal. Therefore, we expect an extension of the transition period beyond 2021.

Brexit will continue to generate uncertainty about the prospects for trade and investment and will therefore continue to keep UK growth below potential. Assuming a moderate growth of the world economy, we expect the UK to reach around 1.5% over the transition period – half the 2000-07 average, for example.

This post represents the views of the authors and not those of the Brexit blog, nor the LSE. It is based on Heise, M. & Boata, A. Int Econ Econ Policy (2019): Economic costs of Brexit.

Ana Boata is European economist at Euler Hermes.

Michael Heise is the chief economist of Allianz.

Neglected options for a Brexit deal in the UK

andrew hughes hallettEven the government’s preferred deal gives us no idea of the trade and investment arrangements after the transition period. Yet it – or no deal at all – appear to be the only options on offer. Andrew Hughes Hallett (George Mason University and the University of St Andrews) looks at the impact they would have on the UK economy, and Scotland in particular, concluding that ruling out every other option is, to put it mildly, unwise.

A careful reading of the UK government’s proposals for a new deal with the EU gives the impression that everything comes down to a choice between two “no deals”. One is the no deal case (leaving without any agreement with the EU) and the other is the government’s preferred option, which is a ‘no trade’ deal with two restrictions (that the Irish border shall be allowed to settle in the Irish Sea; and that the UK shall remain in an EU customs union till 2020 and perhaps beyond).


View of Glasgow. Photo: ben matthews via a CC-BY-NC-SA 2.0 licence

There are discussions of other topics, but, as yet no material on the trade and investment arrangements. The government’s preferred “deal” therefore describes a transition out of the EU, but allows us to forget that there are decisions to be made in the transition period – and that making certain decisions now may rule out those options after the transition.

The options

Any discussion of what arrangements could or should be made between the UK and EU must be based on the arrangements that the UK government adopts with respect to the EU. That will remain unknown until a parliamentary vote in London. But on past experience, this is unlikely to pay little attention to regional interests generally (jobs, investment) or specifically (eg fishing)

i) A number of models to replace the single market have been in discussion, but they all involve trying to achieve the near-impossible feat of maintaining free EU market access (including for investment and passporting), while limiting the free movement of labour. This implies a difficult compromise, especially in the EU – for whom free movement of labour is a “fundamental freedom” that, if lost, would sit badly with the continued free movement of capital and investment that the UK values so highly. This explains why the negotiations have been so difficult with so little room for improvement.

ii) The main contenders are the Norwegian model (stay in the Single Market, contribute to its costs but with no vote on its regulations); the Swiss or Canadian models (bilateral free trade deals in selected sectors, allowing the UK the freedom to exploit her comparative advantages); stay out with bilateral free trade deals with the EU and other outsiders (not feasible so long as the UK has to remain in an EU customs union); a rules of origin approach much like NAFTA (cumbersome and hard to implement in industries whose inputs are mostly human capital, knowledge or skills-based — eg financial services).

(iii) A more explicit compromise would be to stay outside the EU but make bilateral free trade deals with the EU and outsiders to replace the Single Market without invoking WTO membership; or to stay inside with compromises on certain articles in the Single Market itself — for example, with quotas to replace the free movement of labour in return for concessions on aspects of EU membership outside the Single Market. This model has been proposed in the unofficial French–German ‘‘Continental Partnership’’ idea.

iv) The “no deal” option in which the UK leaves the EU without any agreement. Under this option, the UK would progress to WTO membership in her own right. However, all WTO members have to agree. Currently seven countries, including the US, say they oppose UK membership. Even if that obstacle is overcome, the UK would have to accept the WTO’s rules on international and bilateral free trade. The cost of the latter might be reduced by invoking the “most favoured nation” status between UK and EU, but how much benefit that would bestow is not known.

The gains in trade from the single market for the UK

Estimates have been made of the impact of Brexit on the UK, but few for regional economies such as Scotland. They produce UK losses of about 1% to 2% of GDP. These losses are about the same as reversing the gains estimated for membership of the single market when it was first set up. The Cecchini report estimated gains of 5% in GDP over five years in 1992. The EU’s post-mortem study completed in 2000 showed GDP gains of 1% by the time the euro arrived. Later estimates put the figure at 2.15% of GDP in 2006, or 2.13% of GDP in 2014. For Scotland, the Fraser of Allender Institute has estimated the costs of Brexit (gains lost) at about 2.8% of GDP or 80,000 jobs. These gains will not have been distributed evenly, of course. So the gains in the single market (or losses under Brexit) will hit some sectors, such as manufacturing, and some countries much harder than others depending on their industrial structures and trade patterns.

For the UK, the UK Treasury now estimates (rather late in the day) that UK GDP will be lower by 3.9% after 15 years of Brexit (an average of ¼% lower each year) if the government’s preferred plan is used; but 9.3% lower (or 0.62% each year) if there is no deal at all. This is costly in terms of losses, given that it does not yet account for the potential investment or productivity increases foregone. Interestingly, none of the Treasury’s calculations evaluate any of the compromise models available.

Scottish government figures for Scotland alone suggest losses of 7.4% after 12 years, or 0.62% per year. This lies half way between the government’s proposal and the “no deal ” solution. So Scotland would appear to be made worse off than the rest of the UK (rUK); although that damage could have been less, on UK Treasury figures, with any of the compromise arrangements that are currently ruled out (5% under a free trade association with the EU, 1% in a Norway type deal). Interestingly, the Treasury’s argument is that the smaller losses would arise because Scotland is partly sheltered by the energy sector. I am not aware that London has announced any plans to devolve oil or gas revenues to provide any financial sheltering, so it is not clear where this result is coming from.

Nevertheless, the argument is of interest because it shows how easily the economic outcomes can shift with rather small changes in the rules governing trade in any new association with the EU. On this basis, the loss of productivity improvements will explain 60% of the losses between no deal and continued EU membership by 2030; restricted migration 26%; but new trade barriers and tariffs only 14% [Scottish Government]. Clearly the loss of investment and productivity gains are the major driving force here, with restrictions on EU migration second. Comparable figures for the UK as a whole are not available. The reason why the trade impacts are not larger is that EU tariffs against outsiders average 2-3%. Since the pound has depreciated 15% post the 2016 vote, the cost of UK exports to the EU has fallen. As a result, UK firms are now reporting increased business. But imports cost more (23% more so far), raising the prospect of inflation. Since UK inflation is still within its 2%-3% target range, this is not (yet) a problem. So, reversing the argument across the EU as a whole, there will have been some downward pressure on prices as a result of Brexit, but rather small.

How important is investment in the Brexit deal?

Investment spending plays three key roles. First it builds capacity: the ability to produce competitively in the future. The specific quantity spent therefore has a magnified effect on output and employment going forward; and investment lost through Brexit would likewise have a magnified effect in lost growth. It is hard to put numbers on the investment gains where we lack comprehensive investment data. But, in the Scottish case (a region in an existing union), we can make estimates: grossing up the figures for public investment in the same proportion as the UK shows that new investment runs at around 3.3% of GDP annually, a little over half the UK rate (6%). On these numbers, Scotland could ill afford further losses in investment from Brexit, whether due to a slowdown or lost passporting. They also show the investment gains are almost certainly larger than the trade gains in the Euro project.

Second, an inability to passport your services/goods into the EU could be very damaging to investment spending. For obvious reasons we have no data on how much investment in Scotland is made to facilitate passporting. But given that 15.3% of Scottish exports go to the EU (ex-UK), and 63.8% to rUK (surveys report 70% is passported on), the loss of passporting rights directly or via the UK would mean a loss of more than 16% in investment. Scottish government figures are more sanguine (7.7% or between 6.3% and 9% lost over 12 years), the difference being that the loss of passporting exports through rUK is not included.

Third, and most important, investment is the way productivity growth enters into the economy. In fact, productivity growth is the only source for permanent increases in growth and employment (Scotland’s working population is static or shrinking). Hence lost investment for Brexit reasons would inflict greater long-run damage to the Scottish economy than the current weak investment performance because the capacity to incorporate new productivity gains would shrink. Again, this example shows how important investment has been to the EU participants.

The link to productivity

Scotland’s labour productivity  is 3% lower than the UK. Yet wages are roughly 6% lower. This implies that unit labour costs are 3% lower in Scotland. However, overall production costs per unit are not lower, since otherwise the Scottish economy would have grown faster. Hence productivity (meaning the way in which the inputs to production are combined) must be lower in Scotland. Scots work harder than their counterparts, but to less effect because cheaper labour is substituted for capital and productivity increases. In short, we need more investment to exploit trade and Scotland’s comparative advantage, not less, as will happen under any Brexit deal.

Digging deeper, Scotland ranks highly on R&D and innovation in the public sector (higher education) but does less well in business and industry. Most R&D spending is done by US, Scottish and EU owned firms: very little by UK based firms. In figures, 53% is done by US firms, 25% by Scottish firms, 16% by EU firms and 3% by UK firms. The best strategy, then, is to find ways to bring high productivity activities into the economy by investing in productivity growth underpinned by access to foreign trade and ownership – the opposite of what Brexit would bring. In fact, it appears that, by 2030, 60% of the loss of output/jobs under no deal vs. EU membership would be due to an emerging productivity gap; and only 14% from trade barriers and market access issues that have occupied so much negotiation time.

Might it not be wiser to keep the Brexit options in play, rather than rule them all out ex-ante?

This post represents the views of the author and not those of the Brexit blog, nor the LSE.

Andrew Hughes Hallett is University Professor Emeritus of Public Policy and Economics at the Schar School of Policy and Government, George Mason University, and an Honorary Professor in the School of Economics and Finance, University of St Andrews.

Voting with their money: Brexit and outward investment by UK firms

Are firms moving investment abroad because of Brexit? Holger Breinlich, Elsa Leromain, Dennis Novy and Thomas Sampson (LSE) use a ‘doppelganger method’ to estimate how foreign direct investment would have evolved without the vote for Brexit. They find a 12% increase in the number of new investments made by UK firms in EU countries, and an 11% fall in new investments made by EU firms in the UK. Moreover, there is no sign of a ‘Global Britain’ effect that would have seen UK firms investing elsewhere in the world.

The UK’s vote to leave the EU has generated fears that UK firms are moving investment abroad because of Brexit. For example, media reports have documented that both large UK companies such as Barclays, HSBC and EasyJet, and smaller companies such as Crust & Crumb, a Northern Irish pizza maker, have invested in the EU27 in response to Brexit.

Has the threat of reduced access to the EU market after Brexit pushed British firms into setting up shop in the remaining EU member states, rather than serving those markets from the UK?

In new research (Breinlich et al. 2019), we study whether the anecdotal evidence is representative of a wider pattern. We measure new FDI activity through a count of announced greenfield and M&A (mergers and acquisitions) transactions. Greenfield activity refers to investments that create new establishments or production facilities from scratch, for example setting up a new factory. M&A transactions refer to the acquisition of existing facilities. Our analysis focuses on the period from 2010 to 2018, during which we observe around 100,000 transactions in total.

The doppelganger method

We employ the ‘doppelganger method’ to analyse the impact of the Brexit vote. This is a way to estimate how UK FDI to the EU27 would have evolved after the June 2016 referendum if the UK had not voted for Brexit.

We construct a doppelganger for UK FDI as a weighted average of FDI transactions between other developed countries, with FDI into the EU27 from Switzerland and the United States receiving the biggest weights. If the referendum outcome had no discernible impact on UK FDI, then the doppelganger and the actual series should be similar not only before, but also after the referendum.

The referendum increased foreign investment from the UK to the EU27

Figure 1 shows our results. The number of FDI transactions from the UK into the EU27 goes up substantially after 2016 Q2 compared to the synthetic doppelganger, which remains at 2014 and 2015 levels.

Figure 1: UK-EU27 FDI counts (actual vs. doppelganger). Figure 1 plots the actual count of FDI transactions from the UK to the EU27 (solid line) and the corresponding doppelganger series (dashed line). Source: fDi Markets, Zephyr and authors’ calculations.

In terms of the cumulative difference, we find that 181 greenfield and M&A transactions from the UK into the EU27 had taken place by 2018 Q3 that would not have occurred in the absence of Brexit. This represents a 12% increase in new FDI projects by UK firms in the EU27.

In further analysis we find that the increase in outward FDI from the UK to the EU27 is entirely driven by the services sector. This result is consistent with the view that the UK government has prioritised the interests of manufacturing over services in the Brexit negotiations by focusing on reducing customs frictions, while ruling out membership of the EU’s single market.

In terms of value, we estimate that these additional FDI outflows from the UK to the EU27 are worth approximately £8.3 billion in total by 2018 Q3. Moreover, the persistence of the gap in Figure 1 shows that the referendum effect has not yet died away, meaning the increase in outward FDI due to Brexit is likely to grow further as more data becomes available.

As a note of caution, we stress that the FDI outflow can only be interpreted as ‘lost investment’ for the UK under the assumption that the investment transactions would have taken place in the UK, instead of the EU27, were it not for the leave vote. It could also be that the referendum outcome simply triggered additional investment by UK firms in the EU27. We therefore regard £8.3 billion as an upper bound on lost investment.

No ‘Global Britain’ effect

Is the increase in FDI from the UK specific to the EU27 as a destination, or do we observe similar changes in UK investment flows to other countries? To evaluate this possibility, we construct a doppelganger for UK investment into non-EU OECD countries.

In contrast to the EU27 as a destination, we do not observe an increase in UK investment activity into these non-EU OECD countries. That is, UK investment in advanced economies outside the EU27 has not experienced a post-referendum surge. In other words, we find no sign of a ‘Global Britain’ effect.

Finally, we show that increased outward investment in the EU27 has been accompanied by lower investment coming into the UK from the EU27. We estimate that the referendum reduced the number of new EU27 investments in the UK by 11%, amounting to £3.5 billion of lost investment.


We show that the Brexit vote has led to a 12% increase in the number of new investments made by UK firms in EU27 countries. We find no such increase in UK investment in countries outside of the EU.

Although it is not possible to be certain about the reasons behind firms’ investment decisions, our results are consistent with the idea that UK firms are offshoring production to the EU27 because they expect Brexit to increase barriers to trade and migration, making the UK a less attractive place to do business. In the event of a no-deal Brexit, more firms are likely to activate contingency plans for moving production abroad, accelerating the outflow of investment from the UK.

This post represents the views of the authors and not those of the Brexit blog, nor the LSE. The full report is available here.

Holger Breinlich is a Research Associate in the Trade Group of the Centre for Economic Performance, LSE. He is also a professor at the University of Surrey and a Research Fellow at the Centre for Economic Policy Research.

Elsa Leromain is a research officer in trade at the Centre for Economic Performance, LSE.

Dennis Novy is an associate in trade at the Centre for Economic Performance, LSE and an Associate Professor of Economics at the University of Warwick.

Thomas Sampson is an Associate Professor of Economics at the LSE and a CEP Trade Research Programme Associate.

Long read: Brexit uncertainty must not prevent strategic planning and longer-term economic re-orientation

Brexit is not a simple story of disruption. Policy-makers in the throes of Brexit should not forget another driver of structural economic transformation: the so-called ‘Fourth Industrial Revolution’. Analysing the two drivers of labour market disruption together demonstrates the unique challenge of reconciling future planning with handling immediate shocks. Current uncertainties must not prevent strategic scenario planning and longer-term economic re-orientation, write Christopher Pissarides, Anna Thomas (IFOW), and Josh De Lyon (LSE).

The UK economy is experiencing two major forces of disruption. The first, Brexit, will involve a sharp change in the structure of economic activity. Membership of the European Union has shaped the British model of capitalism and the structure, and operation, of core industrial sectors. Factors listed in the World Bank ‘Ease of Business’ index, including those that influence trade across borders, are a stark reminder that the UK’s high current rating is linked to near-frictionless trade and investment flows with the European Union. Whichever form Brexit takes, this is set to change.

The impact of technological disruption, the second great force behind change in the British economy, is less immediate but nevertheless drives a different sort of structural transformation. In the longer run, technological innovation ought to be our main driver of growth. The positive and negative effects of technological disruption are not, however, evenly distributed across sectors and regions. Evidence of this unequal distribution can be seen in the recent experiences of communities formerly dependent on traditional manufacturing, who have suffered the impacts of deindustrialisation since the 1980’s. Research suggests that voting and turnout patterns in the Brexit referendum may well have been linked to this: the relationship between our two forces runs deep.

This article discusses how differentials are likely to be exacerbated by the onset of Brexit. As the ‘double disruption’ works together, the challenges will be deeper than those faced by other European countries that have only technological disruption to deal with. Further, they will be experienced at an individual, community and national level, inviting a period of policy activism by Government targeted at our most vulnerable regions. This will need to address the dampening of technological progress, as well as the growth of in-work poverty, and will demand critical shock management combined with a range of longer-term policies aimed not only at generating good local jobs in new and growing sectors, but also at supporting worker transition.


It is now common knowledge that a No Deal Brexit is likely to cause living standards to fall sharply, with a probable reduction in UK income per capita by around 8%. The economic effect of other forms of Brexit are less certain, but the Government’s analysis predicts that GDP would be 1.6% lower if the UK remains in the Single Market compared with 7.7% lower in the WTO scenario over a 15-year period. This will impact individuals mostly through lower wages but is likely to affect other aspects of ‘good work’ too. These are identified in the Institute for the Future of Work’s Charter for Good Work and include: access to work, terms and conditions of employment, conditions of work, work quality, and choice.

The short-term adjustment process will be profoundly disruptive, especially in the case of a No Deal Brexit. Transitions tend to involve job change or displacement across sectors and regions as resources are reallocated and the economy adjusts to its new structure. Inevitably, this has implications for the skills that employers demand, as well as productivity and salaries. It is concerning that wages and job-related education and training have already been cut in sectors most likely to be exposed by Brexit and therefore are most in need of these policies [Centre for Economic Performance, research not yet published]. Other Brexit-related trends already biting include a rise in prices due to devaluation of the pound, which has caused real wages to shrink; and businesses cutting back on EU exports due to increased uncertainty.

The UK labour market will be affected in two main ways. First, downward pressure on labour demand is anticipated due to rising trade barriers and a fall in the inflow of foreign investment. Evidence to date suggests this will hit some industries dramatically: manufacturing, retail and transport stand out. These adverse effects will be most severe in the event of a No Deal Brexit. The consequences of other scenarios are less clear but foreign investment and trade flows will almost certainly decrease in the immediate aftermath.

Second, British migration policy is set for an overhaul. The Government has proposed a “skills-based immigration system” based on an independent report by the Migration Advisory Committee. The thrust of the proposal is to encourage high skill workers to immigrate to the UK and restrict immigration of low skill workers. An example can be seen in the new ‘tech talent’ visa scheme. In theory, this approach could put upward pressure on the wages of resident lower income workers. However, as we explore below, potential benefits are likely to be offset by a significant overall contraction.


Meanwhile, technological innovation continues to affect the UK economy at an increasing pace as costs diminish and rapid adoption continues. This should be good: technological progress increases aggregate productivity and is the main driver of long-term economic growth, as our Industrial Strategy recognises. Under appropriate conditions, technological innovation ought to translate into higher pay, increased average living standards and a reduction in poverty. But change and gains from technological progress are not spread evenly, meaning that technological disruption has important implications for both regional and wage inequality: technology grows the economic pie but alters the way in which the pie is cut. Managing a smooth transition for displaced workers, re-distributing resources into growing, more productive industries and redistributing new wealth and benefits are key. Focus on building a sustainable future of good work across the UK is central the success of these objectives.

The economic outcomes of workers displaced by technology are a good indicator of current trends and trajectories. Workers in shrinking occupations tend to experience a significant hit to their earnings relative to comparators in constant or growing occupations. The need for investment in human capital to facilitate training, reskilling and other support so that displaced workers can adapt to new lines of work is already increasingly pronounced. If and when Brexit kicks in, this need will become acute.

Brexit and technology

The exact manifestation of these shocks, and their interaction, is impossible to predict. We can, however, identify and map the UK sectors and regions already which are fielding the adverse effects of technological disruption, and are set to be hardest bit by Brexit (and therefore most likely to suffer the ‘double disruption’ we have identified). Brexit and technology, acting together, will increase the speed and process of disruption to the UK labour market. Divisions will be exacerbated, whilst the positives of technological change will be muted in the immediate aftermath. Growing in-work poverty experienced in front-line sectors is set to increase further. Those feeling the pain most sharply may be further exposed by employment law provisions that may not survive Brexit: protection for collective redundancy, working time, and agency work.

Restriction on immigration may well cause a tighter labour market, increasing the cost of labour and encouraging the adoption of technology. Bank of England intelligence has already observed that tight labour markets have encouraged the adoption of new technologies in some sectors, even though the UK has lagged behind its neighbours over the last decade. Were this increase in adoption a stand-alone trend, it would be very welcome.

Falling inward investment linked to Brexit will, however, dampen this positive emerging trend. The resultant economic contraction is likely to result in a fall in labour demand. This will stretch the labour market, making it less tight, exerting downward pressure on wages, and reducing incentives to adopt new production technologies. Inward transfer of technology may also fall because technology is known to move with firms. Increasing trade barriers and the greater administrative cost of trade may erode profitability and reduce the potential market size for British businesses. The absence of trade agreements is likely to add barriers to the exchange ideas, information and to conducting internationally collaborative work beneficial to technological innovation on a global playing field. Together, this will the hamper adoption and innovation use of technology, and the UK’s ability to respond to disruption with agility will be impaired. The UK’s ranking on the new ‘Global Labour Resilience Index’ (Whiteshield Partners in collaboration with the Institute for the Future of Work, Oxford, HSBC and ManPower Group) will fall.

In short, recent progress the UK has made with regard to technological innovation, and leadership in AI-related technologies in particular, is likely to reverse.

The two major outcomes of this reversal are very significant for the future of work in the UK, and the national economy after Brexit: firstly, technological growth will be muted, and secondly, existing regional inequalities will worsen.

Sectoral analysis

We have analysed the ‘double disruption’ in 3 major UK sectors and identified regional spread.


Traditional manufacturing employment has been declining for nearly four decades, with  many struggling regions never recovering. Technology has repeatedly altered the way in which production has taken place, and facilitated the fragmentation of the production process, so that labour-intensive tasks can be moved off-shore. Although the quality of remaining jobs may have improved with the reduction of more routine tasks, it is no coincidence that many Leave-voters reside in the areas most affected by deindustrialisation.

The story of British manufacturing does not end there though. The manufacturing industry is heavily dependent on international supply chains across the globe, especially for the production of more complex goods. If tariffs are introduced for border-crossing then the cost of importing and exporting final and intermediate goods will increase. In the short run, this will mean higher costs to firms, and reduced foreign demand for exports, both of which will put more jobs at risk. In the medium and longer term, there are abundant signs that manufacturing firms may decide to locate production plants outside the UK to reduce the frictional costs of trading. For example, Nissan has just chosen Japan as its location to build the next X-trail car and Airbus (which employs 14,000 people in the UK) has threatened that it could leave the UK in the case of No Deal, and a recent survey suggested that nearly a third of businesses are considering moving operations overseas due to Brexit. Pay and quality of work in remaining jobs will be at risk, likely leading to a higher level of in-work poverty. More research is needed on in-work poverty trends by sector, but pay and work quality are known to be key indicators.

The map below shows the proportion of employment in manufacturing and motor trades for each Parliamentary Constituency. Regions with high dependence on manufacturing employment are particularly exposed to the changes described above. Some constituencies in the North East, Midlands and Wales have over 30% of their employment in manufacturing.

Manufacturing and motor trades employment in 2017 by Parliamentary Constituency[1]


[1] The map plots employment in the manufacturing and motor trades industries as a share of total employment in the Constituency in 2017, using data from the ONS Business Register and Employment Survey (BRES).

Manufacturing and motor trades employment in 2017: Top 10 Constituencies


The transport sector operates hand-in-hand with manufacturing: a decline in the manufacturing sector caused by technological disruption will also put pressure on the transport sector. A particular threat facing workers in the industry is driverless vehicles. In spite of significant developments in trialling autonomous vehicles, the timing of this shift and the proliferation of the technology remains unclear. Employment in the sector has settled over the last decade.

This is likely to change. Transport is particularly susceptible to Brexit where, for example, just two extra minutes spent on each vehicle at the border could triple queues on the M20 and see nearly 5 hours of delays in Kent at peak times. This may result in a vicious circle, impacting on manufacturing costs which translate back to the transport sector. The double disruption will bite vulnerable transport workers twice over. We note that a high proportion of transport workers, logistics and couriers are precarious workers outside the basic floor of protection for employees. At the time of writing, the future of the additional protection afforded by some EU-based rights, including the Temporary Agency Work, Working Time Regulations and the Information and Consultation of Employees Regulations, is unclear. Early scoping suggests these protections are of particular relevance to this sector.

For more than half of Constituencies, transport and storage comprises less than than 5% of total employment. But many constituencies rely heavily on the sector, with as much as 31% of employment deriving from jobs in transport.

Transport and storage employment in 2017 by Parliamentary Constituency[2]

[2] The map plots employment in the transport and storage industry as a share of total employment in the Constituency in 2017, using data from the ONS Business Register and Employment Survey (BRES).

Transport and storage employment in 2017: Top 10 Constituencies


The retail sector has already undergone a series of major shifts as the way people purchase good changes from in-store to on-line. This has caused a move away from high-street jobs towards lower-quality warehousing and delivery jobs. On top of this, the sector is dependent on consumer spending which will reduce as real wages fall. Added trade costs could also push up prices which may filter through to the retail sector. The textiles, clothing and footwear industry will be among the hardest hit of UK industries, with Brexit likely to reduce the gross added value by up to 7%. Trust for London analysis notes that in-work poverty in retail appears to be growing.

Wholesale and retail employment is above 10% for most areas of the UK. It is crucial to the UK economy, with the retail sector alone worth £92.8 billion in 2017. Yet some areas are still significantly more exposed than others, as shown in the map.

Wholesale and retail employment in 2017 by Parliamentary Constituency[3]

[3] The map plots employment in the wholesale and retail industries as a share of total employment in the Constituency in 2017, using data from the ONS Business Register and Employment Survey (BRES).

Wholesale and retail employment in 2017: Top 10 Constituencies


By looking at the effects of two major structural changes in the round we are able to identify two major challenges. First, that immediate downward pressure on wages caused by Brexit against the background of technological disruption will impact industries and regions extremely unevenly. In particular, there is likely to be a reduction in employment and an increase in in-work poverty in key sectors such as transport and retail. Low-skill workers in these sectors across the country are most exposed, facing a ‘double disadvantage.’

Second, Brexit is highly likely to dampen the adoption of technology and technological progress, at least in the short term. This will interfere with the progress of a main pillar of Industrial Strategy. At the same time, the UK’s resilience and ability to respond with agility to technological disruption will be reduced, benefiting our competitors. In both instances, the impact of No Deal Brexit will be more pronounced.

In these demanding circumstances, how can policy makers cope with immediate demands from the double disruption, whilst re-orientating the economy to address the underlying flaws that are the backdrop to the Brexit vote? We think that only bold and targeted policy-making will work. The need to create good new jobs and to facilitate the transition of workers must drive long-term planning. But the immediate area for attention should be critical social, economic and educational support for, and investment in, our most vulnerable communities and countering in-work poverty. This is not a tactical matter. These areas should be prioritised and integrated as we reposition good work to be at the centre of a ‘moral’ British economy.

The Good Work Plan is a good start and an excellent pointer. But to plan for a future of good work, we will need to extend our remit to all those things we discuss in this paper on top of emergency measures: training, reskilling, new job creation across the regions, immigration and trade by sector incentivising private investment, increasing public investment and opening access to finance. We will also need to discuss the infrastructure needed to achieve sustainable good work in our post-Brexit world, including how we pay for and administrate these measures. We anticipate that increased Government investment (including widespread use of beefed-up transformation funds across all vulnerable regions and piloting new types of incentivised private-public partnerships aimed at re-skilling workers) will feature heavily.

A comprehensive, forward-looking vision and strategy aimed at future good work is a prerequisite to addressing the twin challenges of double disruption. Whatever the outcome of Brexit, the best way to start this process is to draw from Germany’s Work 4.0 framework, and initiate a White Paper on the Future of Work.

This post gives the views of its author, not the position of LSE Breixt or the London School of Economics. It is an extended version of the article that appeared on LSE Business ReviewFor the full report and sectoral analysis please visit and read here.

Christopher Pissarides is the Regius Professor of Economics at LSE, a professor of European studies at the University of Cyprus, chairman of the Council of National Economy of the Republic of Cyprus and the Helmut & Anna Pao Sohmen Professor-at-Large of the Hong Kong University of Science and Technology. 

Anna Thomas is founding director of the Institute for the Future of Work (@_futureofwork). 

Josh De Lyon is a Research Fellow at the IFOW and a PhD student in economics at Oxford University. He is also a research assistant in trade at LSE. He tweets @joshdelyon.

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