As the uncertainty surrounding a Brexit from the European Union (EU) rumbles on, the Economies team examine the potential implications of Brexit from the Business Dynamics, Cities, Economy and Industrial angles. Insights include a sharp recession on the horizon in the event of a disorderly Brexit, architectural services to be hit hard, the future of the UK’s dominance in attracting foreign students to be at risk, while Frankfurt and Paris could emerge as major rivals to London for financial services in Europe.
Business Dynamics: Brexit threatens the UK’s reliance on foreign students
The UK has the highest number of foreign students in the EU (439,200 in 2015). UK graduates are more numerous in business studies, science and humanities, compared to more technical fields such as engineering and health, in which Germany, its strong contender, is ahead. In the event of new immigration controls in the post-Brexit world, the UK’s skill gap could widen. The UK relies heavily on foreign students, making up 57.0% of total graduates compared to 25.9% in Germany in 2015. Any changes to the free movement of people as part of a Brexit deal will have implications on the future number of foreign students in the UK, potentially impacting higher education funding and leading to a skills shortage across the board, but particularly in high-tech engineering or manufacturing, which Germany excels in.
Graduates by Educational Disciplines vs. Number of Foreign Students: 2015
Source: Euromonitor International from National Statistics/OECD/Eurostat/UNESCO
Note: Educational disciplines are based on International Standard Classification of Education 97
Cities: will Brexit cause London to lose financial dominance in Europe?
The latest revision of the Global Financial Centres Index (GFCI) in March 2016 by Z/Yen Group ranked London first globally for financial centre competitiveness. The business services sector in London created US$450 billion in value added in 2015, or nearly 50% of the city’s total GDP. Brexit threatens London’s financial dominance in Europe. Frankfurt is seen by many as an obvious competitor given that it’s already the financial centre of Germany and home to the European Central Bank. However, strict labour laws and its relatively small size drag its potential down. Some industry specialists point to Paris as the next best option with the megacity being a major financial centre and, in contrast to Frankfurt, a cultural melting pot. Paris has a large concentration of business services activities, the only one to rival London’s. Nonetheless, Paris lacks fluent English speakers, has rigid labour laws (including a 35-hour working week) as well as high taxes and a reported antagonistic nature towards the wealthy. No EU city is a direct substitute for London, which will maintain financial supremacy for years but undoubtedly, the gap other with cities will reduce following a Brexit. A level playing field will incite greater competition amongst EU member cities and may cause the financial industry to fragment in Europe.
Business Services Sector Size in the Top 10 Financial Centres of the European Union: 2015
Source: Euromonitor International
Note: Top 10 financial centres as according to the March 2016 Global Financial Centres Index (GFCI) by Z/Yen Group which measures financial centre competitiveness.
Economy, Finance and Trade: sharp recession predicted in a disorderly Brexit scenario
While the outcome of the UK Referendum in June 2016 was final in the vote for Brexit, there remains much uncertainty about the future of the economy, depending on the outcome of negotiations which could take two years to finalise once Article 50 has been triggered. A disorderly Brexit scenario can’t be ruled out, which is the eventuality that the UK will leave the EU without reaching an agreement, despite Article 50 being triggered by early 2017. Euromonitor’s Macro Model has assigned a 30-40% probability to this. What is certain is that if this scenario plays out, the UK economy would enter a sharp recession, driven by capital flight and a plunge in the value of the pound, although we do not expect the downturn to be as severe as when real GDP growth contracted by 4.2% in 2009 following the global financial crisis. A real GDP contraction of up to 2.0% compares to a baseline scenario forecast of 1.6% and 0.6% in real GDP growth in 2016 and 2017 respectively. A return to recession will impact business and consumer confidence through more uncertainty, which will limit business expansion, resulting in higher unemployment, lower consumer confidence and weakened consumer market potential.
Source: Euromonitor International Macro Model
Industrial: architectural services would be hit hardest by a disorderly Brexit
A disorderly Brexit scenario will result in an economic recession in the UK, with real GDP contracting by as much as 2.0% in 2017. While some industries can weather recessions relatively easily, some B2B industries would be hit hard by even a small contraction in the country‘s GDP. In the event of a disorderly Brexit scenario, (30-40% probability based on Euromonitor’s Macro Model), architectural services, advertising and legal services are expected to be hit the hardest in terms of revenue loss. Architectural services might come as a surprise in this list, when many would expect construction instead. However, construction is likely to be hit less severely as it is cushioned by demand for necessary repairs and maintenance. Architectural services are tied up with the most vulnerable, new constructions segment. Advertising would suffer as it is a non-necessary cost and is one of the first categories businesses would economise on. Legal services would be hit by lower demand from the public sector and industries depending on public spending.