Following the UK’s referendum result in June 2016 to leave the European Union (EU), pro-longed uncertainty is the number one factor dominating the country’s business climate, given the different Brexit scenarios on the table and the length of time it will take to put the exit into place. If the UK can overcome the immediate shock and secure the passporting rights of financial institutions, it can leverage its well established business infrastructure to continue to attract investors. However, challenges remain and Germany is likely to be a strong competitor in the longer term.
Favourable business fundamentals but uncertainty over financial sector’s future
The UK has a favourable business climate and its well-structured financial system is one of its key strengths, but this is at risk in the Brexiting process:
- The UK’s favourable business environment includes a flexible labour market, well protected minority interest and ease of getting credit;
- At a time of uncertainty, the strength of the financial system is one of the most important considerations for businesses. At US$460 billion, the UK represented 28.0% of the EU’s total bank reserves in 2015 and the UK’s bank assets accounted for 34.0% of the total EU bank assets. This means the economy is in a position to inject money supply to stabilise the market;
- One thing the country, however, needs to address is the anxiety of financial institutions over losing their passporting rights, the ability to do business freely with the EU. Accounting for 18.9% of the total employment in the economy in 2015, financial and related institutions comprised a substantial part of the overall economy, with London being the financial capital of Europe.
Germany set to become a major competitor in the long run
One of the key arguments in favour of Brexit was to open doors to the rest of the world for trade and commerce. The key question is how well-placed is the UK to attract business in the post-EU period? The UK needs to be wary of competition from its peers, such as the USA and especially Germany and France, both of which are EU members, giving investors access to the largest trading bloc in the world:
- The UK’s score in the Index of Economic Freedom 2016 is on par with Germany, but ahead of France. When compared more closely with Germany, the UK has a more favourable regulatory environment in relation to recruitment, redundancies and minimum wages;
Economic Freedom vs. Global Competitiveness: 2015/2016
Source: Euromonitor International from the World Heritage Foundation/the World Economic Forum
Note: Ranking out of 140 countries for the Global Competitiveness Index and 186 for the Index of Economic Freedom. The higher the score, the stronger the country’s position in the given indicator, placing it higher up in the ranking order.
- The UK, however, scored lower than the USA and Germany in the Global Competitiveness Index 2015 for factors relating to education and technology. PISA scores reflecting education standards, and capital investment in telecommunication were lower in the UK compared to Germany;
- Germany and the USA had higher numbers of engineering graduates, while the concentrations of graduates in the UK were in science and humanities. Restrictions in the free movement of labour could exacerbate skills shortages in the UK;
- Wage per hour is lower than Germany and the USA but this could change in the light of Brexit. At 5.3%, the UK’s unemployment rate was one of the lowest in Western Europe in 2015. In the event of EU citizens needing to leave the UK or future immigration controls, there could be upward pressure on the wage rate amid a shortage of labour as well as skills;
Total Tax Rate vs. Wage per Hour: 2015
Source: Euromonitor International from World Bank/ILO
- The UK has the lowest tax rate compared to France, Germany and the USA. There are plans to further cut corporate tax from its current rate of 20% to 15%, which is expected to add to the country’s competitiveness.
Key considerations for the long run
There are many interlinked variables, which make it difficult to ascertain whether the UK will continue to remain an attractive investment zone. The future of the UK economy is highly uncertain and the process of a Brexit can only take place once Article 50 has been triggered and will likely last two years. No initial changes are expected in the way people travel, goods move and services are sold until deals are finalised in the next two years. Meanwhile the key considerations are:
- The long term prospects of the UK’s investment attractiveness and the future of the financial sector rest on the country being able to secure the right of the financial sector to conduct business freely across the EU;
- Germany is expected to be the strongest contender of the UK’s main peers. The regional position of the USA weakens its position as a direct competitor, while France lags behind in multiple business dynamics indicators for now;
- In order to counter challenges from Germany, the UK needs to offer more attractive wage and tax rates, improve educational standards for a better quality labour force, fill any skills gap in the face of labour movement restrictions and increase investment in telecommunications;
- The biggest challenge remains uncertainty over the exact nature of a Brexit scenario – will there be a complete Brexit, partial Brexit similar to that of Switzerland and Norway, or even no Brexit at all? Until final agreements are reached, trade and investment hang in a thin balance, waiting to find out the exact terms and conditions of the types of business they can conduct between the UK and EU.