Policy engagement at Queen’s

How Brexit Referendum Will Impact You

In the aftermath of the recent UK referendum on EU membership, Dr Sergey Popov looks at the economic uncertainty that has happened and how it will affect many UK citizens.

How Brexit Referendum Will Impact You

Overnight, from 23 June to 24 June, the UK citizens learned something new about themselves. It seems 51.9% wants the UK to secede from the European Union. Many reasons were voiced for or against Brexit, ranging from the underfunding of NHS to not giving a boat a silly name. Seceding from the EU suddenly became a reality for many.

QPol covered Brexit before: Dr Lee McGowan provided his expectations from the political perspective, Prof David Phinnemore discusses the implications for Northern Ireland, and Prof Dagmar Schiek covers legal issues following Brexit, especially regarding the absence of the border between Northern Ireland and Ireland. These events might or might not happen, depending upon negotiations that might or might not happen between the UK and the rest of the European Union. That in turn will depend upon whether UK representatives will invoke Article 50 of the Lisbon Treaties. Nothing happened yet, legally speaking, with borders, legislature, or population of the nation. All the referendum did was to provide the new information: there might be changes in the near future.

This information alone however has implications for everyone in the UK, effective right away. It is precisely the uncertainty that happened after the referendum that will cost many UK citizens. The economy is composed of many agents, and these agents need capital to function. Your local barber is an economic agent, he needs to be sure that he won’t be evicted because he does not pay his rent; for that, he needs to be sure that he can borrow from his bank if for one or two months he will suffer a loss in clientele. Same holds for your grocer; same holds for your financial advisor; same holds for your coffee shop. Bank capital is supplied by those who save, and those who save don’t like uncertainty. They will move their savings from the UK banks to other alternatives: US Treasuries market will be happy to accommodate the sudden influx of capital. In the UK, even assuming away apocalyptical scenarios, the shortage of capital will lead to an increase in the interest rate, which might, in turn, make some enterprises, like your local barber or coffee shop, close down. This is the cost of uncertainty, and the UK has to bear it for some time even if nothing will happen regarding the exit from the EU.

How big is this cost now so far? FTSE 100, the stock market index, fell almost 10% between the night of June 23 and the morning of June 24: this provides a crude estimate of the loss in value of stock market portfolios that many UK citizens have, as their direct savings or as their pension fund’s holdings. GBP to USD exchange rate fell down overnight from circa 1.50 to circa 1.30: if you used to earn as much as your US friend on 23 June, you earned 16% less on 24 June . Same happened with GBP/JPY, GBP/RUB, and other currencies. LIBOR, the interest rate serving as a base for the interest of the savings accounts, went down; this is a combination of the run for liquidity, when brokers sell their risky positions in the stock market, and the Bank of England’s desire to keep the interest rate low (the press release claims the Bank has the necessary resources to help the economy; the additional resources are only needed to keep the interest rates low).

The fact that your savings account yields you less does not mean that your barber will need to pay less to the bank for his loan: there is a gap between borrowing and lending rates, called the interest rate spread, and this gap is what makes banking profitable. Higher risk makes banking less profitable; this means that the spread between borrowing and lending rates must become bigger, and the fall in LIBOR rate will be well compensated by the rise in the spread. While some loan rates, such as some mortgages, are linked to LIBOR rate, the decision whether to provide such a loan to the applicant is in the bank’s discretion; new loans linked to LIBOR rates might turn out to be harder to obtain. Riskier loans must provide larger interest rates; GBP loans became much riskier overnight.

Because the Brexit vote outcome increased the country risk, in the near future, UK citizens will earn less for their savings and pay more for their loans. In consumer goods, because of the currency depreciation, UK citizens will pay more for imported goods, whether from Europe, or US, or Japan, and UK imports about 30% of its GDP. This will increase prices for local goods too: there is less competition, so local producers will increase their markups, to compensate for higher cost of their capital. Nominal wages are likely to stay the same, but real wages will go down, because the prices will go up. New investment, in terms of new production plants and jobs, when choosing between UK and other EU countries, is more likely to lean towards other EU countries: financial capital might come over and leave pretty easily, but investment in real jobs is even more averse to potential risks than the financial capital.

There won’t be new jobs, but there even may be less jobs, since higher borrowing rates are likely to lead to closures, especially of smaller borderline unprofitable enterprises. Lower profits are likely to lead to less taxes collected, impacting benefits, NHS and the education system. The demand for all three increases during the economic recession: of particular interest is the link between mental health deterioration and economic recessions. UK citizens will have higher prices in shops and public goods of worse quality.

All these outcomes might be more or less pronounced in the next couple of years, depending upon the actions of elected officials, media, politicians, and extremist groups in the near future. New referendums for separation from the UK, happening in Scotland or Northern Ireland, will affect the UK country uncertainty even more. We still can make everything worse than it is now. Let’s act responsibly.

 

The featured image in this article has been used thanks to a Creative Commons licence.

 

 

Dr Sergey V. Popov
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Dr Sergey V. Popov is a Lecturer in the Management School at Queen's University Belfast. His primary research interest is economics of education, but his contributions include papers in economics of corruption, social choice theory, and international economics.

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