Britain’s brittle strengths

Brexit will be bad for Britain, but could it also be good? The country has important strengths and advantages, and everybody should wish for it to make the most of them after weakening its links to the European regional economy. To do so, however, one must be keenly aware of the risks Brexit poses even to the most promising opportunities and strongest sectors.

Some Leavers — and, no doubt, many Remainers trying to make lemonade of lemons — hope that Brexit, and the reduced immigration it brings, will encourage greater investments in the skills of native Britons, and capital investments to increase labour productivity. Those are the right things to hope for. But how likely are they to happen?

There are, in fact, reasons to fear the opposite. If Brexit, as seems likely, adds to the production costs of businesses (because of dearer imported inputs, or added bureaucracy and obstacles to sell to the EU), then it will be harder for them to free up resources for investing in either skills or machines. Instead, other economic effects of Brexit could lead British companies to rely even more on the low-paid, low-productivity labour-intensive model than they currently do. The immediate effect of sterling’s fall is, of course, to make UK wages lower in real terms (relative to inputs and international credit), which should induce a shift to more labour-intensive production methods.

There are signs this is already happening. LSE economics professor Swati Dhingra has shared with me preliminary research with her co-authors into how the post-referendum sterling slide affected the amount of training received by workers. They establish that the more a company relies on imported inputs — thus the more squeezed it was by the depreciation — the more it has cut the training its workers received. The effect is more pronounced for men than women, for those below 40, and in northern rather than southern parts of the country. This lower investment in skills risks leading to lower wages and productivity in the future.

This is bad news, and means a skills policy to counteract such effects is badly needed. But policies intended to encourage capital deepening by forcing up low wages — such as George Osborne’s higher minimum wage for over-25s — will only meet stronger political resistance from a private sector already feeling under pressure.

What about services as a source of strength for Britain? The UK undoubtedly has a comparative advantage in many services, being one of the world’s prime services exporters. The bulk of the financial sector does not depend directly on access to the EU market, so while it is likely to lose much of that, it may still be able to thrive serving the rest of the world. But we don’t know. In particular, we don’t know how much of the City’s competitiveness in the rest of the world depends on the gains from scale it enjoys from being Europe’s banker. We will only find out when it is put to the test.

British services are much more than finance itself, however. There are the auxiliary businesses that surround the financial industry, in particular the legal profession. But London as a legal centre relies on the attractiveness of English courts (as opposed to English law), which rely on the degree to which their judgments will be enforceable in the rest of the EU after Brexit. Then there are cultural industries in the arts and entertainment. But these, too, turn out to rely much more on Europe’s single market than many realised: broadcasting and fashion are just two significant sectors that will suffer from losing passporting and intellectual property protection, respectively.

Finally, research and innovation. Britain is at the cutting edge of research-intensive industries from IT to biotech. But its innovation nous is not just the homegrown products of some uniquely British abilities. On the contrary, it reflects how the UK is a hub for international research networks and attracts programming and engineering talent from elsewhere. That depends at least in part on both free movement rights for those talented people, and the cultural openness Britain presents or is perceived as presenting. Both are threatened by Brexit.

There is a risk in misunderstanding the sources of Britain’s own strengths as being more British than they are. Many examples of British outperformance are really examples of top-performing European jobs and sectors based in Britain. The big question is what it takes to make them want to remain.

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Britain’s brittle strengths

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