Ever since the referendum in 2016, there has been an increasingly depressing dialogue of the deaf over what is undoubtedly the defining socio-economic issue of the century for the UK. We have substituted reasoned argument over the pros and cons of belonging to the European club with rants over ‘the will of the people’, what the Germans did to the grandfathers of the present-day European Research Group (ERG) and a wholesale dismissal of ‘experts’ and ‘elites’ – after all, what do they know? Any debate about our future in or out of Europe must start with the current state of the economy – not a bald GDP number, but an analysis of what we do well and what we don’t. This is an attempt to put some context into the debate.
Wimbledon, an analogy for our economy
Wimbledon has long been seen as the pinnacle of the tennis playing world, though it rarely features any home-grown talent. Yet the history, organisation and unmatched grass courts attract the best in the world, year in and year out, and this has made the club a very wealthy institution. This would clearly not be the case if we restricted access to the competition to those that the Brits could beat. The descent to global insignificance would be rapid. I think this is an analogy in microcosm for our economy. It has become a platform model which businesses around the world value for ease of doing business, reasonable workers’ rights, highish environmental standards, a solid legal framework, a free press, an attractive time zone for dealing with most of the world, a language spoken by more of the globe than any other but crucially also as a convenient place to base a pan-European business. Honda, Toyota, Airbus, Siemens (turbines), Hitachi (trains)…the list goes on. All of these businesses have been vocal over the consequences of any kind of impediment post Brexit to their ability to access the European market (they will leave, and rapidly, taking their supply chain with them), but no-one seems to have joined up the dots over what this means for manufacturing more broadly.
The end of quality manufacturing
The answer is that a hard Brexit means the end of high-end manufacturing in the UK. We basically screw together imported components for global brands who then sell the finished article in Europe. It will come as a nasty shock to politicians just how quickly an assembly line can be relocated to another European destination. The Brexiteers will tell you that we can stand on our own two manufacturing feet without those pesky foreigners. They are ignorant, deluded or both. Over the last 36 years as a fund manager I have lost count of the number of discussions I have had with industrialists in Asia, the USA and Europe over their competitive landscape. With the honourable exception of ARM (sold in panic to Softbank in the aftermath of the referendum when any buyer of Sterling was welcome), I cannot remember when anybody mentioned a genuinely British firm as a strong competitor outside of a few niche areas (I am excluding UK listed multinationals such as Shell or Astra from this analysis as they contribute relatively little to the UK economy in either tax or activity). We may be quite good at original science, but we can’t commercialise it. This is a perennial issue for the Brits, but one that has been ameliorated by foreign companies investing here instead. Brexit is an existential threat to this model, and even our scientific research is now threatened by a hostile attitude towards visiting academics. Our top educational establishments are world class, but this is in large part due to foreign researchers and students. About 3% of our population benefits from a world-class education. The remaining 97% are in a global second division of academic excellence, with Asian countries increasingly in the vanguard, and we are incapable of producing the doctors, engineers and scientists that we need in the requisite numbers. We are truly dependent on the kindness of strangers, and they increasingly perceive that they are not welcome. The 87% fall in the number of nurses from the EU (60% fall from overseas) coming to the UK post the referendum should give us all cause for concern.
The issue of services
The manufacturing issues referred to above have at least had some airtime in the debate, even if it has been a rather uninformed one. Yet the issue of services has been roundly ignored by nearly everyone, and given that the UK makes most of its money and generates the lions’ share of taxes from this sector (with financial services pre-eminent in the calculation), it is a scandal that the issues have not been addressed properly. This is in large part due to the politically toxic consequences of saying anything positive about financial services, and in particular the embodiment of evil, bankers. When it has been referred to it is usually either in the context of ‘only a few thousand people have relocated so far’ or more commonly: good riddance, we are too dependent on them anyway. While it is clearly true that the UK economy is massively over-dependent on finance, reducing the sector without replacing it with something of equal financial clout is not very clever. It is also true that only a small number of people have (so far) been relocated. However, all large financial firms have now set up European legal structures that are likely to be needed post Brexit, and individuals (if not their families) can relocate overnight, taking their tax with them to their new domicile. The people who are relocated are senior: an investment banking MD on a mid-seven figure package generates as much tax as around 400 manufacturing personnel – and this excludes from the analysis the support staff that are then sacked in the UK so local replacements can be hired in the new location. Support services such as IT, legal and accounting functions have to follow the money, and Europe has been bending over backwards to make individual taxation comparable to the UK. The big investment banks are not British and do not care where their European hub is, providing they can make money. London will, of course, remain an important hub – but it will be less important than it was, and the cluster effect that has been so successful in making London a favoured destination for finance will also work in reverse.
Trading arrangements cannot get any better
The slogan ‘take back control’ has been stamped on every Conservative politician’s soul by Dominic Cummings, and it is an article of faith for the Brexiteers that we will control our own destiny, even if there are some economic ‘hiccups’ in the short term. Unfortunately, the word hiccup here is a euphemism for ‘depression’. The clear reality is that in any negotiation, might is right, and virtually every trading arrangement the UK has is as good as it can be – The EU is a big trading beast, and the only one able to stand up to the US. We will need to negotiate trading arrangements with EVERY country in the world. For a small number of trading partners (South Korea, Iceland, Switzerland) which are happy with the current arrangements, the status quo ante will continue – no upside there. Every other country will expect a better deal than they currently have, and they all have the luxury of time and the ability to default to current arrangements. The US and Australia want unfettered access for agricultural products, but will offer nothing in return because they do not have to. Japan and Canada have explicitly stated that they expect an improvement in their current market access when we have left the EU. We will not be taking back control – we will be on bended knee to everyone for the next decade as they line up to take advantage of the figurative blood in the water.
violence is likely
The social consequences of Brexit have received more airtime, particularly the likely consequences for the Union and the likelihood of sectarian violence in Northern Ireland. These are real issues, and it seems inconceivable that the more extreme members of the loyalist community in Northern Ireland will remain supine if Ireland remains a de facto member of the EU while the rest of the country is out of the customs union and regulatory alignment. There are already disturbing signs of paramilitary activity returning near the border, and the depressing reality is that it only takes a few hundred extremists to destabilise a country. As with most things Brexit, the question remains – why are we doing this to ourselves?
Big changes, but in the wrong direction
No Brexiteer has been able to make a convincing argument for what will be better after Brexit – it is all a matter of ‘it won’t be that much worse’ (and in reality it will be a LOT worse). I cannot think of a single material sector of the UK economy that benefits from leaving the EU – even fisheries will suffer as they are prevented from accessing the European market. Food security is threatened by US pressure and the lack of seasonal workers. Tax take will fall, preventing much needed increases in social spending, and a weaker currency is unexpurgated bad news for a country with a chronic import habit. Any boost to exports will be negated by access restrictions to the EU markets and the lack of demand elasticity for our services exports. Britain will remain a nice place to live (selectively, anyway), but Brexit threatens big changes, and all in the wrong direction.
The information contained herein is provided for discussion purposes only, is not complete and is not, and may not be relied on in any manner as, legal, tax or investment advice or as an offer to sell or a solicitation of an offer to purchase an interest in securities. QUAERO CAPITAL believes the information contained herein to be reliable and has been obtained from sources believed to be reliable, but no representation or warranty is made, expressed or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of the information and opinions.
The estimates, investment strategies, and views expressed herein are based upon current market conditions and/or data and information provided by third parties and are subject to change without notice. There is no obligation to update, modify or amend these materials or to otherwise notify a reader in the event that any matter stated herein, or any opinion, projection, forecast or estimate set forth herein, changes or subsequently becomes inaccurate.
These materials include certain opinions, statements and projections provided by Quaero capital with respect to the anticipated future performance of certain asset classes. Such opinions, statements and projections reflect significant assumptions and subjective judgments by QUAERO CAPITAL’s management concerning anticipated future events. these forward-looking statements are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond QUAERO CAPITAL’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. The data as presented has not been reviewed or approved by any party other than QUAERO CAPITAL.
Nothing contained herein shall constitute any representation or warranty as to future performance of any financial instrument, currency rate or other market or economic measure. Opinions expressed herein may not be shared by all employees of QUAERO CAPITAL and are subject to change without notice.