We are living in turbulent times. The British vote will change the map of Europe in more ways than one. Already the two Treasury reports one short term, one long term prepared by the team under the leadership of the UK’s chief economist indicate that the effects will be severe and uneven. Although much criticised by the ‘Leave’ campaign, the broad findings of the work on Brexit was supported by the vast majority of economist across the world including those at leading institutions such as OECD, IMF and NIESR. There is reason to suppose that the findings, at least for the short-term, are in the right ball-park and already the predictions of pressure on the pound and turbulence and losses on the stock exchanges across the world have come to pass.
Uneven impacts across the UK
Like any economic shock the effects are different across different parts of the economy and across the geography of the UK. Taking sectors first, those most likely to be affected are manufacturing, construction and financial services while other services are less likely to be touched except indirectly for example if demand is depressed. These sectors are affected by different factors resulting from Brexit. Manufacturing is affected by the threat to the UK’s membership of the single market, especially if it goes for a deal outside of the EEA – the European Economic Area. Even with such a deal in prospect, growth is forecast to be 4.5% lower than with full membership by 2030.
This deal which can be dubbed ‘the Norwegian option’ relies on free movement of labour on the same terms as members of the EU. It also requires financial contributions on a par with those for Members. Both these points were critical elements of the Brexit debate and it would be deeply ironic of the UK was to accept free movement in particular given the attention paid to immigration by the leave campaign let alone continue to pay the £350 million a week that they also claimed. As well as the regulatory impact of more trade barriers with the EU, there are also major effects on confidence and resulting investment which are already being seen. Investment decisions will be kicked into the long grass until more is known about the nature of the deal. Who would invest in a car plant until it is known what will happen to car imports between the EU and the UK.
Manufacturing: declining investment
The distribution of manufacturing in the UK is very uneven. Cities that were once most dependent on heavy industry are likely to be those areas most affected by a Brexit. Despite the loss of manufacturing over 50 years these areas still have much of what remains either in their cities or in their city regions. This includes Newcastle and Sunderland in the North East, Glasgow, Sheffield, Manchester and Birmingham. To take one example of the car industry, Sunderland plays host to Nissan, the West Midlands to Toyota (at Burniston near Derby), while BMW has production in Oxford and Land rover in Liverpool, Solihull and Wolverhampton. None of these plants are immediately threatened, but future waves of investment are more likely in Eastern Europe than in UK following a Brexit. Jaguar Land Rover already opened a plant in Slovakia while Toyota chose a coalfield location near Lille. One can only guess which choice would be made next.
Financial Services: a question mark hangs over London
In contrast the service economy is less affected by Brexit except in the case of financial services where the loss of the right of banks in the UK to EU ‘passporting’ privileges could have a long term corrosive effect on UK financial services. This is likely to affect the City of London most rather than regional financial centres such as Leeds and Edinburgh. Already HSBC announced that in the event of UK quitting the single market it would move a thousand jobs related to Euro trades from London to Paris. Other banks are likely to be similarly affected particularly the US investment banks which are based in London because of its looser regulatory framework compared to Frankfurt or Paris, but who will wish to be inside the EU.
Other financial service cities such as Bristol, Leeds and Edinburgh deal more with domestic markets and are likely to be less affected.
In the longer term the London could continue to attract hot money being taken out of corrupt economies. This is an area that the Panama Papers have shed light on, and numerous reports from OECD and from the EU have tried to deal with. However, it is likely that European Union will seek to take further action to clamp down on nearby tax havens that affect the Eurozone. This is likely to be to the detriment of London as a financial centre. It is also questionable whether UK citizens will continue to accept large scale money-laundering[2] that has been the watchword of the City.
In the longer term the city might find some advantage to having a looser regulatory framework than the European Union. But this would come at a price and as Emmanuel Macron said, could make the city more like Guernsey. The Union will be able to enact whatever legislation it wishes to control liberal financial markets without interference from the UK. This is something that the UK has contained by having its Commissioner, Jonathan Hill, in charge of financial regulation. Hill resigned on Saturday. On almost any scenario, it will be harder to grow jobs in London’s financial service sector post-Brexit than before and some jobs will undoubtedly move.
Property will crash first
London’s property market has often been seen as a cash machine for property investors for three decades regardless of where the money comes from. Since the financial crisis, London property prices have been rising by around 10% per annum in many districts. The immediate effects of the Brexit vote are likely to turn the property market negative and there were already drops in value in the run-up to the vote. Continued political instability is anathema to international investors and they are likely to look elsewhere. The UK economy is heavily dependent on its housing market, more so than most other EU27 economies except perhaps Ireland. It will be London that is most affected by a housing market crash. While some will welcome the ‘correction’ the effects are likely to be uneven and could leave many families in negative equity, after borrowing up to their limit to afford soar away prices. This will be exacerbated if interest rates have to be raised to control inflation which is likely to rise because imports will be more expensive with a weaker pound. However, in the short term interest rates are more likely to be cut.
Construction: sharp drop followed by prolonged flat lining
Construction is the sector most immediately affected by a likely property crash. The construction sector is heavily dependent on residential and commercial property markets and on public projects. Few of the latter will be affordable once the lower growth and other budget impacts of a Brexit start to kick in. Some of the larger projects over the past decade such as Crossrail, Europe’s largest construction project, are nearing completion. Future large projects such as the Heathrow third runway, High Speed 2, the world’s most expensive nuclear reactor and even the replacement for Trident may well be delayed indefinitely as budget constraints kick in. Meanwhile investors will be frightened away from residential and commercial property markets and depending on whether we see a correction or a crash will remain so for up to a decade.
EU cohesion policy ‘Money can’t buy you love’
Cornwall and Wales, both areas that received the most EU funding under cohesion policy voted for Brexit. These areas have had their economy shredded by globalisation. Port Talbot in South Wales faces closure of its last major steel plant. But it was the UK government that resisted imposing higher EU import tariffs on Chinese steel, not the EU.
Once the UK has left the Union it will no longer benefit from EU policies including cohesion policy agriculture/rural development, Research and development. All areas of the UK benefit under either more developed or transitional status but with lower intervention rates and less money than Cornwall and Wales. Since 1975 Cohesion policy has been important for UK cities which lack independent sources of revenue compared to most cities in the rest of the European Union. On average the cities only raise 22% of revenues from their own Council tax and rely on ever diminishing government handouts for the rest. Without EU funds their room for manoeuvre will be further limited. In addition, the ability to access European Territorial Cooperation programmes such as Interreg Europe and URBACT will cease unless special arrangements are made and funding provided.
British Universities and businesses win a share of the research and development funds out of all proportion to our share of EU population. Countries outside the EU can participate but at a price.
A key issue is the timetable. Assuming that the UK government asks the EU for exit under Article 50 within the next few months, the final year of Structural Fund payments would be the final year in which the UK pays into the EU budget, and probably either 2018 or 2019 depending on how quickly discussions are concluded. This is three or four years ahead of the normal programme payment period which ends in December 2022. In reality it means that only projects committed very quickly are likely to be implemented. The programmes are late starting and few commitments are already in place. In effect the programmes will be stillborn. Whether UK central government is able to substitute for EU funds will clearly depend on national priorities and budget decisions. But it is difficult to forecast a bright scenario for the cities. During the last period of Tory rule, it was the EU that put the most money into cities, not the UK government.
City deals
One particular policy, the City Deals that Chancellor Osborne has been making to city regions starting with Manchester and the West Midlands may also be affected. Other city regions have either signed or are close to signing their own City Deals. The main policy areas that have been included are transport, housing and training with health being included in the Manchester deal. Some of the finance in the city deals depends on EU funds, most depends on funds from the UK Treasury which may be constrained if tax receipts go down and another round of austerity budgets is required. The public do not know how watertight the financial commitments made by central government in these deals are. Their future will also be less secure with the likely departure of their main champion in government, George Osborne, who as a ‘Remain’ supporter is likely to leave the Treasury when the new leader of the Conservative Party is selected and subsequently becomes Prime Minister.
Conclusions
UK Cities will be affected differentially depending on their mix of industries and services and according to the overall nature of the final deal on single market access that is made between the UK and the EU. The weakest cities will face the greatest challenges. What is clear is that in the short to medium term there are few upsides to the UK leaving the EU. Cities will suffer from the housing and commercial property market slowdown and associated construction industry lay-offs as well as from declining public investment on major projects. London will suffer from decline in financial services compared to what would have happened if we had stayed in the EU. Some regional cities will be affected by further decline in manufacturing industry and potentially by reductions in demand for local services. Cities will survive but they may find it harder to improve, harder to face the next set of challenges whether around becoming low carbon, pollution free, vibrant or inclusive.
What is clear is that in an era of multi-level governance, where challenges are enormous and solutions are complex, placing too much power at national level without any constitutional protection for cities is asking for trouble. In a country with no written constitution and the likely speedy withdrawal from human rights protection there are no checks and balances to protect cities and citizens against the centre. If cities had full fiscal autonomy including a half share of income tax, their future options might be wider. But politically, economically and fiscally, the UK is the most centralised Member state of the twenty-eight, and by leaving The EU it will become only become more so. There are no guarantees that the national government will step in to help cities restructure after economic change or help them to address the problems of those most vulnerable social groups left behind by globalisation. From now on there seem to be no guarantees of anything.
[2] See for example Nicholas Shaxson Treasure Islands
