Publication - Publication

No-deal Brexit: economic implications for Scotland

Published: 21 Feb 2019
Directorate:
Chief Economist Directorate
Part of:
Brexit, Economy
ISBN:
9781787816138

Illustration of the potential impact that a no-deal Brexit - leaving the EU on the 29th March 2019 without a transition period or agreement on any future trade deal and wider economic relationship - could have on the Scottish economy over the next 12-24 months.

35 page PDF

1.4 MB

35 page PDF

1.4 MB

Contents
No-deal Brexit: economic implications for Scotland
Section 4 - Macroeconomic Impacts of No Deal Brexit

35 page PDF

1.4 MB

Section 4 - Macroeconomic Impacts of No Deal Brexit

The following section provides an illustration of the potential scale of the shock that Scotland could face in the event of a No Deal Brexit based on the scenarios outlined in Section 2. The analysis draws on the impact that previous economic shocks have had on the Scottish and UK economies, analysis by the Scottish Government, and studies by other organisations of the implications of a No Deal Brexit.

There is broad consensus that a No Deal Brexit would have a negative impact on the Scottish and UK economies. However, there is huge uncertainty about the duration, composition and potential scale of the shock. This is compounded by the fact that the response that such a shock would elicit from the UK government and EU is also unknown.

As such, the following analysis should not be considered a forecast. Nor should it be viewed as an upper or lower bound on the range of possible No Deal outcomes. Instead it illustrates a number of potential outcomes and in particular their relative economic impact in both aggregate terms and across different industries and geographies.

Trade Disruption: In the event of a disorderly No Deal Brexit, Scotland's trade with the EU would be significantly impaired. The introduction of tariffs, and non-tariff barriers such as new licensing requirements, would increase the cost, and reduce the competitiveness, of Scottish goods in the EU. Companies' ability to trade with other countries under free trade agreements negotiated by the EU would be reduced.

There is also the potential for disruption and delays at UK ports if the infrastructure required to undertake new custom checks are not in place. For example, the Financial Times reports that analysis by University College London for the Department for Transport estimates that if new customs checks delayed each vehicle boarding ferries at Dover by 60 seconds it would result in queues of six to eight hours, whilst if checks per lorry took 70 seconds, delays could extend to six days[13]. This would reduce the viability of exporting some products, such as fresh produce or those which are feeding into complex, just in time supply chains, where goods need to arrive at their destination in very tight timeframes.

There is considerable uncertainty over the impact that such an outcome could have on overall exports. Given that Scottish exports to the EU, and countries with which the EU has negotiated free trade agreements, account for 57%[14] of Scotland's international exports the scale of the impact could be significant, and may be in the range of 10% - 20% given the potential changes to market access and free movement of goods. Imports from the EU would fall too, which may provide some opportunity for Scottish companies to refocus on domestic markets.

Figure 17 - Scotland's International Exports to EU and Countries with EU Free Trade Agreements

Figure 17 - Scotland's International Exports to EU and Countries with EU Free Trade Agreements

Source: Export Statistics Scotland 2017

Investment: The economic uncertainty which a No Deal Brexit would bring is anticipated to result in companies choosing to either pause investment decisions until the UK's future economic relationship with the EU becomes clearer, or devote investment to mitigating the impact of No Deal Brexit, as opposed to supporting growth enhancing projects.

Previous analysis by the Scottish Government has quantified the potential impact that economic uncertainty can have on business investment[15]. This suggested that heightened economic uncertainty as a result of Brexit could reduce business investment in Scotland by £1 billion in 2019. No Deal Brexit would also make the UK a less attractive destination for Foreign Direct Investment (FDI). Analysis by the Bank of England suggests that FDI into the UK could fall around 20% under a No Deal scenario[16].

Sterling Exchange Rate: A fall in exports and overseas investment would reduce the demand for Sterling. A broader downward reappraisal of the UK's near term economic prospects would also reduce financial flows into the country.

During the Global Financial Crisis, Sterling declined by approximately 30%, whilst in the first 9 months of 2016 Sterling fell by approximately 18%. Whilst the economic shock which the UK would face in a No Deal Brexit would differ from these events, it implies that a 10% - 30% depreciation in Sterling could occur.

Figure 18 - Sterling Effective Exchange Rate

Figure 18 - Sterling Effective Exchange Rate

Source: Bank of England Database (Series XUDLBK67)

Inflation and Interest Rates: A depreciation of Sterling, and the wider economic disruption that a No Deal Brexit may generate, would increase inflation. This may result in a rise in interest rates. Such an outcome could put pressure on households and businesses ability to service existing debt and discourage new borrowing and investment.

The Bank of England forecast that CPI could peak at 4.25% - 6.5% in 2020 in the event of No Deal[17]. They forecast that this would require interest rates to average 1.5% - 4% over the next three years. The upper end of this band would still mean that interest rates were lower than they had been prior to the financial crisis in 2008. However, it would represent a material increase from the Bank of England's policy rate over the past decade. However, the Bank's immediate response may be to reduce the Bank Rate to support demand in the economy.

Business Failures: The rate of business deaths is expected to increase under a No Deal Brexit, whilst the number of new businesses starting may also decline. This is likely to be driven by a number of factors such as rising input costs as a result of depreciation, the ability to attract and retain EU workers and uncertainty around potential cash flow deteriorating access to finance conditions for businesses.

During the Global Financial Crisis, business deaths increased by 16% - an increase of 2,100 - whilst the number of business births fell by of 9% (1,500)[18]. The latest data show that business births, business deaths and corporate insolvencies are potentially already being affected by Brexit. The latest Office for National Statistics Business Demography data, comparing 2017 with 2016, show a fall in business births against a rise in business deaths in Scotland and UK-wide.[19]

Migration: International net migration into Scotland has been positive for a number of years, and stood at 13,400 in 2016-17.[20] A decline in the Sterling exchange rate, coupled with a wider slowdown in economic activity in the UK is expected to lead to a fall in international net migration into Scotland. This could occur because people choose either not to move to Scotland, or because people currently living in Scotland consider relocating overseas.

Between 2015-16 and 2016-17, net migration into Scotland fell by 9,500 on the back of improving economic conditions elsewhere in the EU and the decline in Sterling[21]. Were such trends to continue, an economic shock on the scale outlined above could result in international net migration into Scotland falling further and potentially turning negative. This would return international net migration into Scotland to the levels seen prior to the enlargement of the EU in 2004.

Figure 19 - International Net Migration to Scotland

Figure 19 - International Net Migration to Scotland

Source: National Records for Scotland

Labour Market: An economic slowdown would reduce demand for workers. This could manifest itself in a number of ways. For example, companies may choose to reduce the hours offered to staff, reduce overtime or put workers on more flexible contracts. Companies may also choose to reduce overall employment, or pause plans to hire additional workers. Collectively, such actions would reduce household incomes and increase economic insecurity.

During the global financial crisis, the unemployment rate in Scotland more than doubled from a low of 4% in the spring of 2008 to 8.5% in 2010. This provides an indication of the impact that a major economic shock could have on the labour market. However, if a No Deal Brexit also results in a reduction in net migration into Scotland this may mitigate any rise in unemployment, although it could also create skill shortages in specific industries and regions. Based on the response of the labour market to previous economic shocks, unemployment in Scotland could increase to between 5.5% and 8% under a No Deal Brexit. The top end of this rate would be equivalent to an additional 100,000 people being out of work compared to current levels.

Figure 20 - Unemployment Rate Projected Path

Figure 20 - Unemployment Rate Projected Path

Source: Scottish Government Analysis

Overall Economic Implications: Collectively, the above pressures would be expected to push the Scottish economy into recession during 2019.

Based on the response to the Scottish and UK economies to previous economic shocks, there is the potential for GDP to contract by between 2.5% - 7% by the end of 2019 depending on the way in which a No Deal outcome evolves.

The chart below illustrates how a shock on this scale would compare to previous recessions experienced by the UK economy. The top end of this range is broadly equivalent to the contraction observed in the UK during the global financial crisis, whilst a 2.5% contraction would be in line with other major economic shocks faced by the UK over the past 40 years. The key difference is that because a No Deal Brexit would result in an overnight change to Scotland's ability to trade with the EU, the impact could be more immediate than previous shocks which have tended to increase in intensity more gradually.

Figure 21 - GDP Index: Previous UK Recessions and No Deal Scenarios

Figure 21 - GDP Index: Previous UK Recessions and No Deal Scenarios

Source: Scottish Government Analysis and ONS UK GDP Index

Over time, the economy would be expected to return to growth, albeit at a lower level than would occur if the UK remained in the EU. The speed with which the economy returns to growth would depend on the time taken for the UK Government and the EU to reach agreement to mitigate the disruption caused under No Deal. The longer that the initial shock persists, the greater the risk that it develops into a wider economic slowdown from which it would take longer to recover.


Contact

Email: OCEABusiness@gov.scot