Assessing the UK economy’s position in the world 14 years hence would be difficult at the best of times, but it is close to impossible following the decision to withdraw from the European Union.
With the new government of Theresa May only getting its feet under the table, it is still too soon to be certain as to the UK’s eventual negotiating stance let alone the response it will elicit from the EU’s other 27 member states (the EU27). Our initial projections are as follows:
- In the short term we expect major economic disruption in the UK, with a sharp downturn next year leading to rising unemployment, a widening budget deficit and increased government borrowing costs.
- In the medium term, we expect a broadly favourable outcome from Britain’s EU negotiations. We view all potential outcomes as being worse in economic terms than staying in the EU, but we expect Britain and the other 27 member states to work in the best traditions of European diplomacy and secure a messy compromise.
- In the long term, the picture begins to brighten up again. The economy adjusts to the post-Brexit world and growth returns to something close to what we had previously been forecasting as its long-term trend.
As chart 1 − a list of the top 10 economies, with GDP figures for 2015 and 2030 − illustrates, we still expect the UK to be in the middle rank of the world’s ten largest economies by 2030.
We think it will slip just one place between 2015 and 2030, from fifth to sixth. That said, this one-place move doesn’t fully capture the relative changes that we are projecting.
For example in 2015, the UK was $400 billion larger than France and $1 trillion smaller than Germany. By contrast, in 2030 the UK will only be ahead of France by a tiny $4 billion while the gap with Germany will have widened to $1.5 trillion. To look at it another way, the United States goes from being six times as big as the UK in 2015 to eight times as big in 2030. These are significant divergences.
Nevertheless, headline growth in the UK will recover between now and 2030. Some of the differences in chart 1 reflect foreign exchange effects, with the UK’s weakened currency weighing on its size in US dollar terms. If we look at growth in local-currency terms, as in chart 2 − Europe’s largest economies 2008-2030 − we see Britain pulling away from the other four largest European economies towards 2030. This reflects the persistence of many of the UK’s economic advantages even after the wrenching short-term disruption that Brexit will entail.
We expect 2017 to be a very difficult year for many households and businesses in Britain, but in a longer-term perspective like the one offered by chart 2, that sharp slump appears more as a pause before something close to normal service resumes.
So we expect a dreadful short-term performance and a relatively resilient long-term performance. The medium-term transition between these two phases will be crucial, and particularly the negotiation of the terms of the UK’s post-Brexit relationship with the EU. We are forecasting a version of membership of the European Economic Area, the so-called ‘EEA minus’ deal, under which the UK would have modified membership of the single market, giving it limited controls on immigration from the EU, but at the cost of restrictions on its important trade in services.
That is a broadly optimistic scenario, but it’s worth noting the vulnerabilities in charts 3 and 4, which are likely to build in the next few years and which could exert a drag on the UK’s long-term performance if they are not brought swiftly under control. The budget deficit (chart 3) will widen sharply again next year as tax revenues fall and unemployment rises. The current-account deficit (chart 4) is more of a medium-term worry. It will narrow initially − because slumping demand will keep down imports − but we expect it to widen again as domestic demand picks up, leaving the UK vulnerable to any swings in investor sentiment. Between now and 2030, the UK will be more reliant on the kindness of strangers than has been the case until the decision to leave the EU.