Blog: Brexit - a growing black hole already the size of Helsinki

Jan von Gerich, chief analyst.
19-04-09 16:05 | Markets and investments | Economic outlook

Brexit seems to be getting messier by the day with no end in sight. At the same time the costs related to the mess are piling up from day to day in the U.K. as well as in the euro area. In the U.K. alone, the price tag is closing in on a hundred billion euros.

When the future costs of Brexit are discussed it is easy to forget that the realized cost is already significant. Economic growth has clearly slowed in the U.K. as well as in the euro area. Even if the growth rate of the global economy has moderated, the prospects in Europe have turned gloomy faster than in the rest of the world. One of the main reasons behind this development is the uncertainty that surrounds the Brexit process.

While it is impossible to estimate the exact cost of Brexit, we are able to estimate the magnitude of its effect. I have tried to assess the effect of the Brexit uncertainty by comparing the economic development in the U.K. with that of the rest of the OECD countries. The U.K. has followed such a proxy closely historically.

The economic development of this synthetic comparison group matched that of the U.K.’s development fairly well up until the end of 2015. From that on, however, the British economy has lost about 3.5 percent compared with the OECD proxy. Translated into euros this corresponds to an annual loss in GDP of 85 billion, compared with what the size of the U.K. economy would have been without Brexit. The negative effect on the U.K. economy thus already exceeds the entire economy of the Finnish capital Helsinki.

Business investments are down

Another way of looking at this is to study the development of business investments. Before the Brexit referendum (2013-2015) business investments grew by an annual average of 4 percent. After the vote (2016-2018) there is practically no growth at all (down at 0.3 percent). Last year investments even decreased. Since investments are the basis of future growth, the full growth impact will be felt with a lag. Fixed investments have accelerated within the euro area during the same time period, thus blaming the global economic development for the situation in the U.K. isn’t a plausible argument.

Uncertainty is poison to an economic outlook. It speaks volumes that many companies within the euro area have indicated to the EU that a hard Brexit, meaning that the U.K. would leave without a deal, is preferable to this constantly prolonged uncertainty. Even if a hard Brexit would likely cause mayhem in the short term, many companies would still prefer it as they would at least be able to plan for the long term with some certainty.

Unfortunately, it looks like the Brexit uncertainty will continue for some time. The British Prime Minister, Theresa May, will once again this week, bite the bullet and ask the other EU countries for more time for negotiations, now also taking place between the U.K. government and the opposition. While May is looking for the shortest prolongment possible, people within the EU are now contemplating a longer time frame, should May have a plausible plan on how to use this extra time. Some, including French President Macron, have been very critical of the British inability to reach a decision on Brexit so a prolongation isn’t a given. Without more time, the U.K will leave the EU without an agreement on Friday, the 12th of April.

Especially from the point of view of the clearly weakened economic outlook for the euro area, it would be desirable that the Brexit uncertainty would evaporate as soon as possible. Unfortunately, this is likely wishful thinking. Brexit is already a costly affair and it is getting more expensive each day that passes.

/Jan von Gerich, chief analyst

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