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The Economist (Intelligence Unit) - A year to go how Brexit will affect UK industry (2018)

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A year to go:
how Brexit will affect UK industry
A report by The Economist Intelligence Unit
www.eiu.com
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A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Contents
Introduction2
1
Our core scenario: a comprehensive free trade deal
5
UK industrial strategy 2017
6
Alternative scenario: a no-deal Brexit
7
Hitting hard: comparing the scenarios
9
Finance: braced for a challenge
14
17
The corporate response
Healthcare: exit wounds?
18
21
The corporate response
Automotive: grim prospects
22
24
The corporate response
Consumer goods and retail: hard realities
25
27
The corporate response
Energy: connections and climate
28
30
The corporate response
Telecoms: the virtual realities
32
35
The corporate response
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Introduction
This report explores how Brexit will affect trade,
regulations and jobs within six sectors of the UK economy.
In June 2016 the UK electorate voted to leave the EU. On March 29th 2017 the UK prime minister,
Theresa May, wrote to the European Council president Donald Tusk, notifying him of the UK’s intention
to leave the EU, in accordance with Article 50 of the Treaty on European Union. A summit of EU leaders
on March 23rd agreed the terms of the transition agreement reached by the UK and EU negotiating
teams on March 19th. Talks on the substantive issue of the future trading relationship have yet to start
in earnest and a deal is supposed to be done by October 2018 to allow time for ratification.
With a year to go before the UK leaves the EU and the 21-month transition period begins—during
which time the UK will maintain access to the single market and will be bound by the obligations of
membership-- this report analyses the possible impact on six sectors of the UK economy. The transition
agreement provides businesses with some certainty that they will have time to adjust to the new UKEU relationship. However, Brexit will nevertheless entail some disruption. In three sectors, we expect
the impact to be direct and difficult to manage—financial services, healthcare and life sciences, and
automotive. In consumer goods and retailing, telecoms and energy, the impact is likely to be more
diffuse but still disruptive.
The first part of the report discusses The Economist Intelligence Unit’s current core forecast for
Brexit, which involves the UK agreeing to a Canada-style free-trade-agreement (FTA) with some
special terms for sectors that are particularly important to the UK economy. This so-called Canadaplus-plus deal will probably emerge during the transition period. We then outline a “hard Brexit” or “nodeal Brexit” scenario that involves talks breaking down during the transition period, and the UK leaving
the EU without a trade agreement. Using the usual modelling techniques that underpin our industry
forecasts, we compare how the economic growth projections for these two scenarios would affect key
indicators for our six sectors, unless policies are adopted to mitigate those effects.
The second section of this report is more qualitative and focuses on how Brexit will affect companies
and other organisations operating in our six sectors. The issues at stake mainly involve trade, regulation,
employment and skills and access to investment with much riding on how the UK coordinates its
policies with those of the EU and its institutions.
Our key forecasts are:
l We expect the UK economy to carry on growing in 2018-22 under our core scenario of a Canadaplus-plus deal and our hard Brexit scenario. However, if the UK leaves the EU without a trade deal we
estimate that by 2022 the UK’s nominal GDP will be 2.7% lower than in our core scenario. Given that
inflation would also rise under a no-deal Brexit, real GDP growth in 2020-22 would probably be halved.
However, our long-term outlook for the UK economy remains positive, regardless of the terms of the
UK’s departure from the EU.
l After Brexit our view is that London will retain its status one of the world’s leading financial centres,
along with New York and Singapore, and that it will also remain Europe’s leading financial hub after
2
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
2022 projections under a hard Brexit
(% lower than core forecast)
0
0
-2
-2.7
-2.9
-4
-2
-3.2
-4
-6
-6
-8
-8
-9.8
-10
-10
-12
-13.1
-14
-12
-13.4
-14
-16
-16
Health spending
Energy
Mobile telecoms
per head (£)
consumption (ktoe)
revenue (£)
Bank assets
(£)
New vehicle
sales (units)
Retail sales
(£)
Source: The Economist Intelligence Unit.
Brexit. There is also a large degree of inter-dependence between the UK and EU financial services
sectors, just as there is for the trade in goods between the UK and the EU. This inter-dependence
matters and means that there is to some degree a mutual interest in achieving a deal that works for
both sides. Even under the core scenario, however, a financial services deal will be partial and some
financial institutions will consider relocating some personnel and parts of their business after Brexit.
The sector is more reliant on global than on EU trends, and will remain a robust driver of the UK
economy.
l The healthcare and life sciences sector is likely to see exports shrink under our core scenario, but
the worst-case scenario—a shortage of much-needed medicines—will be avoided through regulatory
agreements. The slower economic growth predicted under a no-deal Brexit scenario would dent tax
revenue and consumer spending. Unless policies are adopted to mitigate the effect, this would result
in total health spending per head being £90 (US$125) lower in 2022 than it would be under a softer
Brexit. However, the UK government could potentially use some of the fiscal savings from ending
contributions to the EU budget to mitigate the impact on these sectors.
l The automotive sector faces a huge challenge: without a UK-EU FTA, large-scale production in the
UK would become difficult. UK vehicle-makers will try to expand in other export markets, but will also
need to stimulate domestic demand. Under a no-deal Brexit, we forecast that vehicle sales would be
13.1% lower by 2022 than they would be under our core scenario. Cumulatively, the industry would sell
around 840,000 fewer vehicles between 2019 and 2022 than under our core scenario.
l The loss of EU workers and disputes over regulation will affect most consumer goods
manufacturers, as well as the food sector. Unless agreements are reached over mutual recognition, the
effect is likely to push down exports and push up the prices of imports still further. The biggest impact
of a no-deal Brexit would be on retail spending, which could be 13.4% lower in nominal terms in 2022
compared with our core scenario.
3
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
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l In terms of energy policy, the UK will continue to forge ahead on emissions reductions and
decarbonisation. However, the task will become more difficult and energy costs may will rise if it exits
Europe’s internal energy market. Energy consumption would be 2.9% lower by 2022 if the UK leaves the
EU without a deal and the economy slows as expected.
l The UK’s exit from the “digital single market” will primarily affect telecoms operators with significant
business on the continent. However, there may also be an effect on investment in innovation, as well
as on the prices that UK consumers pay when using their mobile phones abroad. Investment in mobile
technology could be 3.5% lower by 2022 under a no-deal scenario.
4
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Our core scenario: a comprehensive free
trade deal
Despite difficult negotiations, we expect a trade deal to
emerge by 2021.
In line with the government’s intention to honour the Brexit vote by taking control of laws, borders and
the budget, the UK will formally leave the single market and the customs union at the end of the Article
50 process in March 2019. However, a transition period lasting 21 months will mean little change to the
relationship between the UK and EU while negotiations over the terms of new trading arrangements
continue.
There are numerous obstacles to the successful conclusion of the negotiations, but we believe that
compromises will make a deal possible, particularly given the economic incentive to maintain existing
trade ties. Realistically, only the framework of a trade deal will be agreed by the time the UK withdraws
in 2019, as completing the withdrawal agreement will take priority in 2018. However, we expect a deal to
be agreed by the end of the transition period, coming into force in 2021. During trade talks the EU will
resist attempts by the UK to cherry-pick from the benefits of membership, but the end result is likely to
be a more comprehensive trade deal than that negotiated by the EU and Canada in 2016.
The economic impact
In the meantime, the UK’s departure from the EU will encourage policymakers to address some of
the structural deficiencies that have held back the economy in recent years, including lacklustre
productivity growth, insufficient innovation and poor infrastructure. The government has drafted an
industrial strategy that prioritises skills, research and development (R&D), and business productivity
(see below). This also includes sectoral deals, starting with life sciences, construction, artificial
intelligence, and automotive. We expect these measures to support a recovery in productivity, but they
are still too modest in size and scope to close the UK’s productivity gap with its G7 peers.
The UK economy has been resilient in the aftermath of the Brexit vote. Average annual real GDP
growth was firm in 2016 and 2017, at 1.9% and 1.8% respectively. However, the annual pace of growth
slowed throughout 2017, from 2.1% in January-March to 1.5% in October-December. We forecast
a further modest growth slowdown in the next two years, to 1.5% in 2018 and 1.4% in 2019, led by a
slowdown in domestic demand. In 2018 we expect consumer spending to weaken in response to slower
employment growth, and greater uncertainty about the economic outlook to push up precautionary
savings.
We forecast that growth in investment spending will decelerate in 2018-19 as a result of heightened
uncertainty during the Brexit negotiations and higher cost pressures due to sterling’s depreciation.
Consumer spending will recover in 2019-22 as inflation eases, uncertainty recedes and unemployment
edges lower. However, increased borrowing costs arising from tighter monetary policy will hold back
the pace of the recovery in these years.
Moreover, the export boost from sterling devaluation will ease in 2019. Indeed, we expect the trade
balance to exert a drag on GDP growth as a recovery in domestic demand pushes up import growth
5
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
again. A business-cycle downturn in the US in 2020 and tougher terms of trade with the EU will also
constrain exports in 2020-22. Nevertheless, we expect real GDP growth to pick up to 1.8% a year on
average in 2020-22.
UK industrial strategy 2017
Ideas:
l Raise total R&D investment to 2.4% of GDP by
2027.
l Increase the rate of R&D tax credit to 12%.
l Invest £725m (US$1bn) in new Industrial
Strategy Challenge Fund programmes to capture
the value of innovation.
People:
l Establish a technical education system that rivals
the best in the world.
l Invest an additional £406m in maths, digital and
technical education.
l Create a new National Retraining Scheme,
beginning with a £64m investment for digital and
construction training.
Infrastructure:
l Increase the National Productivity Investment
Fund to £31bn.
l Support electric vehicles with £400m for
charging infrastructure and £100m for plug-in
grants.
l Boost our digital infrastructure with over £1bn in
public investment.
Business environment:
l Launch and roll out sector deals—starting with
life sciences, construction, artificial intelligence,
and automotive.
l Drive over £20bn in investment in innovative
businesses, including through a £2.5bn investment
fund.
l Launch a review of how to improve productivity
and growth at small and medium-sized enterprises.
Places:
l Agree local industrial strategies.
l Create a new Transforming Cities Fund providing
£1.7bn for intra-city transport.
l Provide £42m to pilot a Teacher Development
Premium, to test the impact of a £1,000 budget per
teacher for professional development in areas of
the country that are falling behind.
6
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Alternative scenario: a no-deal Brexit
Our baseline forecast assumes that the UK and the EU
will agree a comprehensive FTA. However, there is a
significant risk that the negotiations could break down.
Our baseline forecast is that the UK leaves the single market and the customs union and signs a
comprehensive FTA with the EU that maintains a lot of existing trade ties, with mutually beneficial
bilateral carve-outs for important sectors where the UK has agreed to maintain regulatory alignment.
At present, both sides still have a strong incentive to maintain close trade ties and co-operation on a
number of fronts, including defence and security, within the constraints of the UK’s determination to
leave both the single market and the customs union.
On March 7th, the European Council, circulated draft guidelines to the EU27 on the bloc’s approach
to negotiating the future relationship with the UK. The guidelines reject proposals put forward by
Mrs May, in a landmark speech on March 2nd and state that there can be no “cherry-picking” from
the four freedoms of the single market, for example in the form of a deal based on sector-by-sector
participation. Mrs May had argued that all FTAs involve varying levels of market access.
According to the guidelines, services trade will be limited by the fact that the UK “will no longer
share a common regulatory, supervisory, enforcement and judiciary framework”—ignoring Mrs May’s
call to “break new ground” in this area. The guidelines also reject the possibility of the UK participating
as a partner country in EU institutions or agencies. Mrs May had suggested that the UK could remain
aligned to the agencies for medicines, chemicals and aviation safety, and would pay a financial
contribution for doing so.
The guidelines offered an exceptionally rigid interpretation of the framework for FTAs and
the outright rejection of the UK government’s proposals. They therefore suggest that the trade
negotiations will be extremely difficult, and the risk of a collapse is high. Talks on the terms of the future
Exchange rate
Real GDP growth
(%)
Baseline
Hard Brexit
2.5
2.5
2.0
2.0
1.5
1.5
1.35
1.35
1.30
1.30
1.25
1.25
1.20
1.20
1.15
0.5
0.5
1.15
0.0
1.10
2017
2018
2019
2020
Source: The Economist Intelligence Unit.
2021
2022
Hard Brexit
1.40
1.0
2016
Baseline
1.40
1.0
0.0
7
(US$:£)
2016
2017
2018
2019
2020
2021
1.10
2022
Source: The Economist Intelligence Unit.
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
relationship will be the most complex and challenging phase of the negotiations. Under our no-deal
scenario, we assume that they are not successful, leading to a total breakdown in negotiations.
As negotiations for the Withdrawal Agreement will dominate UK-EU talks in 2018, the most likely
timing of this breakdown is late 2019, when trade talks are taking place during the transition period,
after the UK has formally left the EU. The transition period will last until end-December 2020, resulting
in a “cliff-edge” withdrawal in 2021.
The first economic impact would be a heavy depreciation of sterling against the euro in late 2019,
but it would probably stabilise during the course of 2020 as the government focuses on contingency
planning and on laying the groundwork for FTAs with non-EU countries.
The UK will also have to start installing the physical and technological infrastructure necessary
to cope with a vast increase in the number of customs procedures associated with UK-EU trade
from early 2021. There may be an emergency agreement with the EU to phase out customs union
membership gradually, as an abrupt end would disrupt the operations of businesses on both sides.
Nevertheless, under a no-deal scenario we would expect a sharp drop in UK export sales growth in
2021, with only a slight pick-up in 2022. We assume that new trade deals will not compensate entirely
for the loss of EU trade, and certainly not as soon as 2022. The drop in the value of sterling in 2019 would
push up inflation, particularly in 2021, weighing heavily on household purchasing power and therefore
triggering a fall in household spending.
Higher input costs and a spike in economic uncertainty would also weigh on gross fixed capital
investment as capital spending plans are delayed and businesses devote more resources to
contingency planning. Employment growth would stall, and possibly contract, also weighing on
household confidence and spending. Looser monetary policy from the Bank of England (BoE, the
central bank) and expansionary fiscal policy would only partially mitigate the drop in domestic
demand, not least because the room for manoeuvre in both policy tools is very limited.
The timeline of a no-deal Brexit
2018: Baseline assumptions intact.
2019: Negotiations start to go badly and break down in the second half of the year. The pound
depreciates sharply in response. The BoE cuts interest rates and possibly resumes its quantitative
easing (QE) programme.
2020: The UK remains in the transition period so the UK-EU trading relationship has changed little.
Confidence slumps, however, hurting both private consumption and investment. To support the
economy the BoE loosens monetary policy further, and the government factors more spending into the
budget.
2021: The UK withdraws at the start of the year. Exports fall as the UK loses access to the single market
and the number of customs procedures increases. Unemployment starts to rise as businesses slow
hiring or cut staff. Consumer spending and business investment slow further. However, the economic
impact is mitigated by an increase in government spending. The pound stabilises.
2022: Economic conditions stabilise somewhat. Pent-up domestic demand pushes up consumer
spending and investment. Exports grow at a slower pace. The value of the pound begins to recover but
remains well below its level before the negotiations broke down.
8
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A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Hitting hard: comparing the scenarios
Whether the UK ends up with a comprehensive FTA, as in our core scenario, or a no-deal Brexit, as in
our alternative scenario, will make a huge difference to the six industry sectors covered in this report. In
all cases the sector’s growth is likely to be slower under a no-deal Brexit than under our core scenario.
Finance: losing its shine
Bank assets
(£ bn)
Baseline
Hard Brexit
12,000
12,000
10,000
10,000
8,000
8,000
6,000
6,000
4,000
4,000
2,000
2,000
0
0
2016
2017
2018
2019
2020
2021
2022
Source: The Economist Intelligence Unit.
The loss of free trade in services under a no-deal Brexit will lead, in our five-year forecast, to fewer
loans being made from the UK and fewer deposits being held there as demand from EU27 clients shifts
to EU-licensed institutions. Some activities and funds should also flow back to the UK, but the net
effect is likely to be mildly negative in the short term since UK financial firms have a greater presence in
the EU27 than their EU27 rivals have in the UK.
We expect growth in UK bank assets to be slower under a no-deal Brexit as the sector loses its
European heft. By 2022 we expect bank assets to rise by 4.4% under our baseline scenario, but by only
0.3% under a no-deal scenario.
A second impact is the likely fall in overall UK economic output, which is an important driver of
banking indicators. As the automotive, pharmaceutical, aerospace and services sectors suffer from
reduced trade, lower profits and wages will be generated for use by the UK financial system and banks
specifically. However, these effects will be fairly modest; we do not expect Brexit to drive the UK
economy into recession, but merely to trim growth rates.
Healthcare: strain on funding
A no-deal Brexit could lower funding to the NHS. Although the sector will be comparatively protected
from spending cuts, lower corporate tax revenue and an ageing population—meaning lower income
9
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HOW BREXIT WILL AFFECT UK INDUSTRY
Health and pharma spending
(£ per head)
Health: Hard Brexit
Health: Baseline
Pharma: Baseline
Pharma: Hard Brexit
3,500
3,363
3,000
3,273
3,259
3,178
3,106
3,071
3,059
3,005
3,005
2,921
2,921
2,759
2,500
2,759
3,000
3,167
3,500
2,500
343
331
335
327
325
319
309
308
500
293
1,000
293
1,000
285
1,500
285
1,500
272
2,000
272
2,000
500
0
0
2016
2017
2018
2019
2020
2021
2022
Source: The Economist Intelligence Unit.
tax receipts—will leave the government with little room to expand healthcare funding. Even if some of
the UK’s net contributions to the EU budget are redirected towards the NHS, spending will be tight.
We expect spending to be marginally lower in 2019 under a no-deal Brexit, but the gap will widen
from 2020 onwards if economic growth slows as expected. In 2022, unless policies are put in place
to mitigate this, we would expect total healthcare spending to be 2.7% lower than under our core
scenario.
A further drop in sterling against the euro and the US dollar would increase the cost of
pharmaceutical imports, putting an even greater strain on the NHS’s resources. Our expectation is that
pharmaceutical spending will be 3.5% higher per head by 2022 under a no-deal scenario compared with
our core forecast. Staff costs, too, would rise as the ability to recruit EU nationals diminishes, affecting
frontline care.
Automotive: production constraints
Automotive production in the UK could potentially be one of the biggest losers from Brexit, given the
threat of trade tariffs, a disruption of supply chains and regulatory disputes. New vehicle sales are
already falling from a record high in 2016. Even if the UK leaves the EU with a trade deal, we expect car
sales to continue to drop in 2018 (-6.5%) and 2019 (-0.3%), before recovering in 2020 (+4%).
Under a no-deal Brexit, however, the recovery would be delayed, with passenger vehicle sales
increasing by only 0.6% in 2022, compared with 4.4% under our baseline scenario. This would largely
reflect the increased cost of cars, as tariffs and other trade barriers take effect, as well as lower
consumer confidence.
Sales of commercial vehicles (CVs) would be similarly hit. Under a no-deal Brexit, we expect CV
sales to fall by 1.8% in 2019 and to continue to fall, by 0.1%, in 2020. This contrasts with an expected 4.7%
upturn in 2020 under our core forecast. Overall, we currently expect CV sales to rise by 6% in 2022, but
by only 2.3% under a no-deal scenario. In total, leaving the EU without a deal would reduce cumulative
vehicle sales by nearly 840,000 units between 2019 and 2022, compared with an FTA, unless the
government were to step in to support the market.
10
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A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Car and commercial vehicle sales
('000 units)
2,730
2,371
2,356
2,614
CVs: Baseline
2,369
2,369
2,362
2,375
2,541
2,000
Cars: Hard Brexit
2,462
2,500
2,375
2,500
2,541
CVs: Hard Brexit
3,000
2,693
Cars: Baseline
2,693
3,000
2,000
471
411
444
402
419
399
399
400
407
420
500
407
1,000
420
1,000
440
1,500
440
1,500
500
0
0
2016
2017
2018
2019
2020
2021
2022
Source: The Economist Intelligence Unit.
Consumer goods: pressure from tariffs
Retail sales growth
(% real change, year on year)
Baseline
Hard Brexit
2.5
2.5
2.0
2.0
1.97
1.97
1.5
1.5
1.0
1.12
1.0
1.12
0.5
0.5
0.43
0.0
-0.36 -0.36
-0.5
0.35
0.46
0.06
0.0
-0.41
-0.20 -0.20
-0.63
-0.5
-1.0
-1.0
2016
2017
2018
2019
2020
2021
2022
Source: The Economist Intelligence Unit.
Given slow wage growth and uncertain consumer confidence, we expect retail sales volumes to
contract by 0.2% under both scenarios in 2019. However, in 2020 retail sales would recover less strongly
under a no-deal Brexit than under our baseline scenario, owing to the weaker pound and higher import
tariffs on goods from the EU.
However, the biggest difference between the two scenarios would come in 2021. If our core scenario
holds, then the UK should secure an FTA, protecting consumer confidence as the transition period
ends. As a result, retail sales would rise. However, under a no-deal Brexit, the hit to confidence,
together with higher inflation in 2021-22, would trigger a fall in household spending and retail sales in
11
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those years. Slower economic growth and a weakened jobs market would further undermine consumer
confidence.
Energy: falling consumption
Energy consumption
('000 tonnes of oil equivalent; ktoe)
Baseline
Hard Brexit
195,000
195,000
190,000
190,000
185,000
185,000
180,000
180,000
175,000
175,000
170,000
170,000
2016
2017
2018
2019
2020
2021
2022
Source: The Economist Intelligence Unit.
A no-deal Brexit scenario, in which the UK’s GDP growth slows significantly to an annual average of
0.9% in 2020-22 compared with our baseline scenario of 1.8%, would result in energy consumption
falling by an average of 0.5% during that period.
Falling household incomes and lower industrial and economic activity would mean lower
consumption of oil, gas and coal compared with the baseline scenario, while growth in electricity
consumption would also be lower. Although energy trade is unlikely to take a direct hit from the UK’s
exit from the EU, any disruption in the supply chain could push up costs and prices in the sector.
Overall, we expect energy consumption to be 2.9% lower in 2022 under a no-deal Brexit than it would
be under our core forecast.
Telecoms: regulatory uncertainties
The challenges facing the telecoms industry would be exacerbated under a no-deal Brexit. We expect
telecoms investment to tail off sharply in 2020 in such a scenario, with growth slowing to 3.3% from
4.4% in 2019. By contrast, if the UK were to exit the EU with a trade deal in place, we expect investment
growth to slow marginally to 4.6% in 2020 from 4.7% in 2019. By 2022 the gap is expected to widen, with
growth of 4.4% under a hard Brexit and 4.9% under our baseline scenario.
Mobile revenue would also be hit. We expect growth in mobile revenue to slow from 2.4% in 2018 to
1.8% in 2019 under our core forecast, and to 1.3% under our alternative scenario. Although the pace is
expected to pick up in 2022, to 3.7% under a no-deal Brexit, it would still trail the 4.2% forecast under
our baseline scenari0.
12
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Telecoms investment and mobile revenue
(% change, year on year)
Telecoms investment: Baseline
Mobile revenue: Baseline:
Telecoms investment: Hard Brexit
Mobile revenue: Hard Brexit
7.0
7.0
6.0
6.0
5.0
5.0
4.0
4.0
3.0
3.0
2.0
2.0
1.0
1.0
0.0
0.0
2016
2017
2018
2019
2020
2021
2022
Source: The Economist Intelligence Unit.
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Finance: braced for a challenge
The financial services sector drives the UK economy but
will not escape completely unscathed.
Passporting rights to the EU’s single market have been the key way for financial services firms in one
country to serve customers in other markets without securing national licences. As we forecast two
years ago, the Brexit vote will lead to the loss of such privileges for UK-based companies. The EU
authorities are unreceptive to requests for cherry picking of appealing aspects, like passporting, of the
single market, while Theresa May, the UK prime minister, has also ruled this out.
Instead the UK government wants financial firms in the UK to retain EU market access through an
agreement based on broad recognition of the regulatory regime both sides of the channel. This would
involve deals over “mutual recognition and regulatory equivalence”, backed by dispute resolution
mechanisms overseen by both sides. This would include a requirement that each side is given fair
notice of any changes in the agreement, so that firms have time to adapt.
However, the EU has not yet agreed to this proposal, which would form a new precedent. There is, in
fact, no existing bilateral trade pact that liberalises access to financial services, although such measures
had been contemplated in the now-abandoned talks on a US-EU FTA. Instead the EU wants to limit the
deal to the kind of “regulatory equivalence” it already has with the US, which keeps regulatory power
firmly in the hands of EU institutions. That would encounter opposition from Brexit campaigners in the
UK, who are equally keen to keep UK autonomy in this crucial sector.
Small shifts make a big impact
Forecasting how these delicate negotiations will affect the UK’s financial sector is fiendishly difficult
because of the huge number of possible scenarios. With a year to go until the formal split, many
UK-based financial firms with substantial EU business are already scrambling to obtain the necessary
licences to incorporate somewhere in the EU27 and relocate needed personnel.
EU finance officials have continued to insist that any new EU27 subsidiary requiring a licence will
need to be fully functioning. By definition, an incorporated financial services firm has its own base
capital, board of directors and full financial accounts, and answers to regulators. The biggest banks,
insurers and money managers—whether headquartered in the UK or in third countries like the US or
Japan—appear to be well prepared as they already own subsidiaries elsewhere in Europe. Alternatively,
they could upgrade an existing branch operation fairly simply. However, small and medium-sized
financial firms that are reliant on their passport to conduct business anywhere in the EU will find it
more difficult to adapt.
Few financial jobs would be lost immediately—financial executives are likely to move operations and
staff only slowly initially given the high costs. An analysis of company announcements by the Financial
Times in late 2017 found that only 4,600 positions would be relocated out of the UK right away in March
2019. That is a very small proportion of the 1m employees in the UK’s financial sector, according to
Eurostat. However, at present, the sector employs about 3.2% of UK workers, well above the overall
EU level of 2.6% and the median of 2.8% in the four comparable economies of France, Germany,
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Ireland and the Netherlands. High salaries also mean that they have a disproportionately big impact on
economic output and tax receipts.
The four competitor economies may pick up some of this employment, as economic activity shifts
from UK-based to EU27-based firms. Some positions could also be relocated to specialist hubs such
as Luxembourg for insurance and fund management, or Poland for back-office functions. Some posts
might migrate to headquarters located outside of Europe in New York, Tokyo or Beijing. Company
announcements over the past year and a half indicate that Frankfurt, Germany’s financial centre, is
picking up the bulk of the relocations. Some jobs may also move outside Europe, to financial centres
such as New York and Singapore.
However, even if banks move their European headquarters not all jobs will move from the UK.
Financial services businesses in London benefit from other attributes, such as a convenient time
zone, the international business language, and an existing concentration of associated business
services (accountancy, consulting and law).The strength of London as a financial centre is that it
possesses a unique infrastructure to support the sector. That infrastructure combines an hospitable
legal framework, a deep knowledge and a skillset based on an established financial services tradition.
It also offers access to a very large talent pool, strong technical and IT capacity and a deregulated
business environment that has spurred innovation and new product development. These strengths
are not readily or easily replicated in the other financial centres of Europe such as Paris, Frankfurt and
Amsterdam, or smaller centres such as Dublin or Luxembourg.
Financial stability risks seem manageable
Regulators have expressed concern about how Brexit could damage the financial system. Mark Carney,
the governor of the Bank of England, has said that there is potential for a “Jenga moment” as the
removal of a pillar of the current structure leads to a general collapse.
There are certainly reasons for concern across the financial sector. An abrupt departure of the UK
from the EU without a deal could lead to the voiding of insurance contracts, some of them long term in
duration, written by firms that lose their passporting rights. Likewise, the EU has warned that UK-based
sellers of unit trusts would lose their UCITS (undertakings for collective investment in transferable
securities) classification. Also imperilled is the common arrangement called delegation, where funds
are established (or domiciled) in one country but actually managed from another.
A no-deal Brexit would also have a potentially negative impact on the market for derivatives, a
key activity for firms in London. With firms lacking proper licences, crossborder contracts might no
longer be legally valid. The clearing of euro-denominated securities would probably move at least
partly away from its current hub in the UK capital. EU authorities will not want a key element of their
financial systems, and a major linchpin of financial stability, to remain located outside their regulatory
jurisdiction. Eurex—a unit of the German market operator, Deutsche Börse—recently launched a
competitive clearing platform based on profit-sharing with the banks that are its customers.
The damage may also extend to EU27 firms, which would lose access to financing in their customary
UK hub, although this blow is likely to be temporary as suppliers arise to meet the demand for services.
However, if current benign economic conditions endure, they will help to reduce any risks to financial
stability. These conditions include Europe’s recent return to sustained growth, widening financial
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margins and a rise in share prices. Financial firms themselves are much better prepared for disruptions,
with stronger capital positions, stricter regulations and more vigilant oversight.
Moreover, UK financial services firms are not only dependent on EU business. Globally London ranks
alongside New York as one of the world’s leading financial centres, and its financial firms will continue
to cater to demand from outside the EU, as well as within.
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Finance: the corporate response
Several UK financial services firms have said that
they will relocate at least part of their London
businesses to other EU cities in order to retain
access to the single market after Brexit. Barclays,
the biggest UK bank by assets, is re-licensing all
its European branches under its Irish subsidiary,
which is set to become its EU hub. Standard Life
Aberdeen, a UK asset manager, has also touted
either Dublin or Luxembourg as its new EU base,
which is currently located in Edinburgh. Insurer
Aviva is reported to be in the process of converting
its life and general insurance branches in Dublin
into fully-fledged subsidiaries.
EU financial firms are also migrating back home.
Frankfurt-based Deutsche Bank will shift hundreds
of its UK jobs to its offices in Frankfurt or Berlin.
Last year, the European Banking Authority (EBA)
said that it would move its headquarters from
London to Paris, which is also the headquarters
of the EU’s securities regulator—the European
Securities and Markets Authority. The EBA plans
to start transferring staff to the new location by
March 2019. Euroclear (Belgium) will move its
headquarters and tax residency to Brussels in 2018.
17
Among US and Japanese lenders and insurers,
Citigroup, Goldman Sachs, Mitsubishi UFJ
Financial Group (MUFG) and AIG have all named
subsidiaries in Europe that will pick up their
London-based operations. Citi (US) is expanding
its offices in Dublin, but will also establish a trading
hub in Frankfurt in addition to an existing one in
London.
Meanwhile, Goldman Sachs (US) has zeroed in
on Paris and Frankfurt as the main locations for its
EU business. The bank, which has about 6,000 staff
in the UK, will also retain its operations in London
and will give employees a choice of location. By
contrast, MUFG ( Japan) has chosen to shift its
European investment banking headquarters to
Amsterdam from London after Brexit takes effect.
The lender’s domestic rivals—Nomura, Mizuho and
Sumitomo Mitsui—have picked Frankfurt as their
EU headquarters.
Luxembourg has emerged as a prime choice
among insurers. AIG (US) is establishing an
insurance subsidiary there that will become its
European hub after Brexit. The move is expected
to be completed by the first quarter of 2019,
after which the insurer’s UK outpost will focus
exclusively on its UK clients.
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Healthcare: exit wounds?
Brexit poses risks for the UK’s healthcare funding and the
success of its pharmaceuticals industry.
Of the hundreds of ways that Brexit could affect the UK’s healthcare and life sciences industries—from
blood banks to stem cell research—there has only been one concrete one so far. In February 2018
the EU Parliament approved an earlier decision that the European Medicines Agency (EMA), which
regulates medicines across the trading bloc, will leave London for Amsterdam. The decision was
greeted with relief at the agency, yet the EMA’s departure will increase the uncertainty over the longterm impact of Brexit on the nation’s healthcare system.
Health spending
The biggest question is over how Brexit will affect overall healthcare funding in the UK. In the run-up
to the 2016 Brexit referendum, the Leave campaign claimed that leaving the EU would free up £350m
(US$490m) a week, which could be channelled to the NHS. The claims became notorious, yet there is
no doubt they were popular. Once the UK’s contributions to the EU budget tail off, probably around
2021, the government will come under pressure to announce another NHS funding boost, in addition to
the one announced in October 2017. This may include redirecting some of the UK’s net contributions to
the EU, which are estimated at £9.4bn in 2016, towards the NHS. A far bigger issue, however, is whether
government tax revenue will be affected by Brexit, and therefore whether funding for both the NHS
and social care will need to be constrained further.
We currently expect GDP growth to average 1.6% a year in 2018-22, down from 2.2% over the
previous five years. As part of its efforts to improve the UK’s competitiveness, the government is also
cutting the corporate tax rate: it fell from 20% to 19% in 2017 and will fall again to 17% in 2020. These two
factors combined are likely to bring down corporate tax revenue at a time when the ageing of the UK’s
population could also affect revenue from personal taxes, particularly if net immigration falls.
If the government is forced to tighten its belt, then health spending will continue to be protected
from the worst of any cuts. Even so, spending growth will be slow. The annual NHS budget is projected
at £124.7bn in financial year 2017/18 (April-March). The Office for Budget Responsibility expects that
to rise to £128bn in real terms in 2020/21, implying an average annual growth rate of just 1.1%—low in
historical terms. Local governments, which fund most social care, will continue to be squeezed far
harder, particularly in areas with EU-dependent companies or elderly populations.
NHS employment
With a total staff of over 1.5m, the NHS is the UK’s largest employer, with wages accounting for around
65% of its budget. Around 10% of hospital doctors and 7% of nurses are EU nationals, according to a
recent parliamentary briefing (although the British Medical Association puts the EU share of doctors as
high as 21%). Around a third of these EU health workers are in the London area, which puts the capital’s
healthcare system at particular risk.
In December 2017 the government finally issued a long-awaited guarantee that EU nationals already
in the UK can stay. However, the UK is still likely to become a less attractive location for them, not
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least because of the fall in the pound. Not many
NHS employment by origin, 2016
('000 people)
EU nationals seem to be leaving the NHS yet,
but fewer are joining, particularly in the nursing
Doctors
Nurses and health visitors
350
350
profession. Entry will become even more difficult
after Brexit.
300
300
These trends are concerning because Health
250
250
Education England, which manages NHS
recruitment, is already struggling to keep up with
200
200
demand for staff as the UK population ages and
150
150
care needs become more complex. Pressures
became even greater after the 2013 Francis
100
100
enquiry, which recommended higher staffing levels
50
50
to ensure patient safety. Meanwhile, nearly one in
three NHS nurses is due to retire within ten years
0
0
and the numbers going into training are falling.
UK
EU
Other
Sources: Health and Social Care Information Centre; NHS England.
After Brexit, the NHS will undoubtedly direct
extra funding towards training and trying to lure
back former NHS employees. More categories of healthcare workers may well be added to priority
immigration lists, and managers will step up recruitment drives in non-EEA markets. However, the
UK will be competing in a global recruitment market against other countries, from Australia to Brazil,
which also need health workers. And many of the “supplier” countries, such as the Philippines, are
putting legislation in place to prevent their health workers emigrating.
All of this means that it will become harder and costlier to recruit NHS staff. Hospitals and clinics are
likely to become even more reliant on agency staff to fill gaps—if enough agency workers are available.
That could exacerbate recruitment problems if existing NHS workers take advantage of this demand to
leave their full-time jobs for more lucrative agency work. These are among the factors that have already
prompted the government to raise NHS wages, particularly for the lowest-paid.
Life sciences skills
As for the UK’s life sciences sector, it employs around 233,000 people, of whom 17% are EU nationals.
Recruiting skilled staff will therefore become more difficult post-Brexit. Limiting the movement of
students and researchers could also leave the UK with reduced access to international talent, while
funding problems may even drive some UK researchers out of the country. EU bodies account for
around 15% of public research funding across the region.
However, the government is determined to prevent a brain drain and has promised to invest heavily
in UK education, and to prioritise immigration rights for scientists. It is also promising to raise spending
on R&D from 1.6% of GDP to 2.4% by 2027. Meanwhile, an agreement with the EU in December
2017 pledged that the UK will remain a member of Horizon 2020, the major EU research funding
programme. That means researchers can continue to apply for grants until Brexit takes effect, and the
funding will last for several years beyond that. Again, a hard Brexit could scupper that deal.
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Pharmaceuticals trade
The upshot of these calculations is highly likely to affect foreign investment in the UK’s life sciences
and healthcare industries, which totalled US$31.4bn over the past 24 months, according to fDi
Markets. Many foreign pharmaceutical companies are based in the UK because of the ease of EU
trade, and the presence of the EMA, which allows them to monitor and perhaps influence EU policy
on pharmaceuticals. Brexit will force them into a regional reorganisation in order to minimise the
disruption to supply chains.
The Brexit deal will also have an immediate impact on the UK’s pharmaceuticals trade. Even in a
hard Brexit scenario, there will be no tariffs on most medicines, which are exempt under World Trade
Organisation (WTO) rules. However, non-tariff barriers (primarily regulatory differences) could still
be costly for both EU and UK companies. There are also likely to be bottlenecks: with the UK’s trade
infrastructure, including the ports at Dover, currently geared towards free trade, checking paperwork
will be a slow process.
UK's pharmaceuticals trade with the EU
(£ m)
Exports
Imports
25,000
25,000
20,000
20,000
15,000
15,000
10,000
10,000
5,000
5,000
0
0
2008
2009
2010
2011
2012
2013
2014
2015
2016
Source: UK Office for National Statistics.
The crux is the system of mutual recognition, which allows both the EMA and the UK’s Medicines
and Healthcare Products Regulatory Agency (MHRA) to approve products for sale across the EU. This
system will not survive Brexit unless there is a deal. In guidelines published in 2017, the EMA said that
medicines that are already on the market will still be legal across the EU because they were approved
under EU rules. However, any future drugs will have to be approved separately for the UK and the EU.
It is also not certain that the EU will recognise trial data or other evidence collected in the UK as proof
that a medicine is effective and safe.
All this would add considerably to the cost and complexity of bringing drugs to market, and could
even cause medicine shortages. A mutual recognition deal would avoid many of these problems, if it
allows actions by the UK regulator to count towards EU authorisation. In return the UK would have to
agree to conform closely to EMA rules. Even then, Switzerland (which has such a deal) generally gets
new drugs about six months later than the EU.
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Maintaining supplies
If the UK leaves without any deal at all, then it will have little incentive to stick to EMA rules if they
no longer guarantee EU market entry. That could bring advantages. The MHRA could, for example,
introduce rules to allow innovative drugs earlier access to the UK market. Or it could loosen the rules
on clinical trial data, which are becoming more restrictive in the EU, in order to lower research costs.
The situation is similar for the medical equipment industry, with the added twist that the EU has just
started implementing a 2017 directive that will overhaul medtech regulation. Again, the UK will have to
make a decision between staying aligned and opting for greater flexibility, which could bring benefits in
terms of innovation.
The NHS as well as exporters will be affected by these decisions. Although the UK runs a trade
surplus in pharmaceuticals globally, it runs a £2.4bn trade deficit with the EU. That means many NHS
patients rely on EU medicines. Higher trade barriers, possibly combined with another fall in the pound,
could push up medicine costs sharply while patients may find it hard to get particular medicines from
EU suppliers. People suffering from rare diseases could be particularly affected.
Awareness of all these problems has prompted the government to include life sciences among the
five key sectors for which it has drawn up an industrial strategy. A sectoral deal, agreed in December
2017 after a consultation with the industry, will seek not only to protect the UK’s position in this area but
to enhance it. As with NHS funding, however, much will depend on whether the money and the will is
there to support the strategy.
Healthcare: the corporate response
Even before the Brexit referendum,
pharmaceutical companies were worried about
how a yes vote would affect their sector. In
early 2016 senior managers of 50 leading life
sciences companies, including AstraZeneca and
GlaxoSmithKline (GSK), wrote to the Financial
Times to state the case against Brexit. The
Association of the British Pharmaceutical Industry
also warned that leaving the EU could threaten the
UK’s access to medicines.
The warnings have not ended now that Brexit
is a near-certainty. In December AstraZeneca said
that the UK’s exit from the EU without a new FTA
would result in the company paying US$35.5m in
additional duties. The drugmaker said that it would
prefer at least a three-year transition period for the
UK to negotiate new trading arrangements with
the EU rather than the 21-month deal currently on
the table.
21
As for GSK, the drugmaker forecast in January
that nearly 1,700 of its products would be directly
affected by a “chaotic Brexit”. The company added
that it could use up to £70m (US$98m) to cover
the new regulation processes, labs and approval
systems required to cope with Brexit.
It has not all been bad news, however. In 2017
GSK said that it would invest £275m at three of its
manufacturing sites in the UK, while AstraZeneca
is going ahead with its investment in its new R&D
headquarters in Cambridge. In January last year
the Danish pharmaceutical company Novo Nordisk
also said that it would invest Dkr1bn (US$144m) to
set up a new research centre in the UK to develop
innovative diabetes therapies.
The UK remains attractive for R&D because of
tax breaks under its “patent box”. The scheme was
amended in mid-2016 to favour UK-based R&D,
and the government has promised to cover all EU
research funding until 2020 to minimise the impact
of Brexit on R&D.
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Automotive: grim prospects
If the UK leaves the EU without a deal, UK vehicle
production may no longer be viable.
In a report to the UK parliament in early March, the Business, Energy and Industrial Strategy (BEIS)
Committee was uncompromising in its assessment of how leaving the EU will affect the UK automotive
sector. “There is no credible argument to suggest there are advantages to be gained from Brexit for the
UK car industry,” said the BEIS chair, Rachel Reeves, adding that negotiations were simply an “exercise
in damage limitation”. If there is no deal, it warned, UK car production could simply become unviable.
It is a bleak prospect for an industry that had a turnover of £77.5bn (US$100bn) in 2016 and
accounted for about 814,000 jobs, according to the Society of Motor Manufacturers and Traders
(SMMT). If the UK quits the customs union with no deal, component-makers trading in either direction
will face an average tariff of 4.5%, while vehicle-makers will face a tariff of 10%. Non-tariff barriers
would be a further hurdle, depending on how aligned the UK remains with EU regulations.
In total, the UK exported around 1.35m vehicles in 2016, over three-quarters of its total output. A
combined 56% of exports went to EU countries, earning the country revenue of around £42bn. The
SMMT has calculated that export tariffs would add around £1.8bn to exporters’ costs. Even if the pound
drops still further, that could be enough to make UK vehicles uncompetitive in EU markets, leading to a
£4.5bn decline in export earnings.
UK consumers could suffer too, given that over 80% of the cars sold each year in the UK come from
the EU. The SMMT calculates that import tariffs on these vehicles would come to a combined £2.7bn,
potentially pushing up the list price of EU-made cars by an average of £1,500. Although this should give
UK-based carmakers an advantage in the domestic market, it will not be much. They, too, will have to
absorb new costs or put up prices to reflect the higher price of imported components.
A bright side
These dire predictions may seem overblown. After all, in the short term the UK automotive sector
benefited from the Brexit vote and the resulting drop in the pound. Although the cost of imported
cars and components rose as the currency fell, UK exports became more competitive globally. UK
production, sales and productivity all hit record highs in 2016. Exports to the US and China, which are
already the UK’s biggest single-country export markets, rose particularly rapidly.
In 2017, however, the picture dimmed somewhat, as UK vehicle production and exports stalled
once the pound stabilised. UK vehicle sales also slumped, with a particularly rapid decline towards the
year-end. We do not expect a recovery in sales until 2020 even if the UK gets the expected Brexit deal.
If the UK gets no deal, then we expect that recovery to be very weak as incomes fall, prices rise and
consumer confidence wanes.
What to do?
The problems are clear; the solutions less so. The SMMT, the BEIS and most carmakers want a special
deal for the car industry—preferably an FTA, but at a minimum, an agreement to keep the UK aligned
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with EU rules on vehicle safety, emissions, specifications and future technologies. They would also like
a deal on automotive sector immigration, to allow the industry to keep on recruiting EU nationals with
the necessary skills.
The government is unlikely to pay too much attention to this last request: the automotive industry
is not alone in needing skilled labour, and lowering immigration is among the core aims of Brexit.
However, the industry’s warnings about trade have already sparked a positive response. In her Brexit
speech on March 2nd, Mrs May, suggested that sectors such as automotive, which rely on EU trade, will
need to stay aligned with EU rules.
But the UK cannot decide this unilaterally; its producers will need an EU-recognised certificate to
say that vehicles are cleared for sale in the EU. So far, the EU has given no hint that it will agree to this,
let alone to an FTA for automotive. But German carmakers are keen to keep access to the UK market,
which accounts for a fifth of their exports, so some compromise may be possible. The Volkswagen
Group alone accounts for a combined 20% of the UK market, even though its only UK plant is a Bentley
one in Cheshire.
Global prospects
UK's automotive trade with the EU
(£ m)
Exports to EU
Imports from EU
40,000
40,000
35,000
35,000
30,000
30,000
25,000
25,000
20,000
20,000
15,000
15,000
10,000
10,000
5,000
5,000
0
0
2013
Source: UK Office for National Statistics.
2014
2015
2016
2017
(Q1-3)
If there is no EU deal, the UK could in theory take advantage of its regulatory freedom to start loosening
regulations on vehicle emissions, fuel economy and other areas. After all, carmakers often complain
that EU regulations are too onerous and eat into their profits. However, the government seems to
be heading in the opposite direction; its industrial strategy pinpoints the development of ultra-low
emission, connected and autonomous vehicles as a priority, which suggests that it will want to keep up
the pressure on the industry.
As for trade, the UK’s chances of finding markets elsewhere are limited without an EU deal. In theory,
it can strike FTAs with the US, China, India or the new Trans-Pacific Partnership (TPP) of 12 Pacific
Rim countries. However, the UK’s supply chains are so integrated with the EU that such a deal would
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be difficult. Of the components fitted in an average UK car, 44% are currently sourced from within
the country, according to the SMMT, below the 60% usually required for FTAs. Take into account the
components that go into those components, and the UK’s share falls to around 25%.
With regulations, the UK is far better negotiating FTAs as an EU-aligned country—unless it is
prepared to adopt US or Chinese regulations. A unique set of UK rules would simply add complications
for volume carmakers, which need to minimise the amount of variation in their vehicle platforms. The
only exceptions may be in low-volume sectors, such as ultra-luxury cars, where EU alignment is less
important.
Automotive: the corporate response
To minimise the threats from Brexit, companies are
already starting to change the way they operate.
A survey of component-buyers for the Chartered
Institute of Procurement and Supply found that UK
and EU supply chains are starting to break apart.
That process may bring opportunities for a few UK
suppliers—there are plans to build a new supply
base around Nissan’s Sunderland plant—but for
most component-makers it is an additional stress.
Vehicle-makers, however, have so far been
cautious in their reactions. Nissan and Toyota
(both Japan), BMW (Germany) and Vauxhall’s
new owner PSA (France) have all made concrete
commitments to UK production, including
allocating new models to their UK plants. In
Nissan’s case, it appears to have done this on the
back of unspecified government promises, which
may have included support for electric vehicle
technology.
However, when the Japanese prime minister,
Shinzo Abe, came to the UK in February, he made
it clear that leaving was still an option for Japanese
vehicle-makers if there was no EU deal, given they
rely on EU trade. Nissan Sunderland produces
more than a half a million cars a year, of which 80%
are for export, mostly to the EU. At Toyota’s two
plants, exports account for 90% of output.
PSA is in a slightly different position. Its 2016
24
acquisition of Vauxhall and its German sister
company, Opel, has given it a good UK market
position to protect. However, the group can
only turn around the loss-making Opel-Vauxhall
business by cutting costs. That being the case, Opel
and PSA will probably restructure their operations
to divide the post-Brexit EU market between
them. Whether Vauxhall has a future depends on
whether PSA can revive it as a UK brand, selling
domestically or to non-EU countries.
Other traditional UK brands are also exploring
their options. Jaguar Land Rover, owned by India’s
Tata Motors, is a company that trades globally off
its British heritage and has invested heavily in UK
expansion. Still, it is building a plant in Slovakia.
BMW has given its Mini plant in Oxford the right
to build the new electric Mini, but is also building
another Mini plant in China. BMW’s other iconic
UK brand, Rolls-Royce, should stay in Cheshire, but
may expand production at the company’s Munich
plant, which also churns out Minis.
In short, managers are hedging their bets if
they can, while they wait for the terms of Brexit to
become clearer. Although the transition agreement
should ease their most immediate concerns, the
threats are beginning to look more realistic than
the opportunities. Aston Martin, which is UKowned and UK-based, has fewer options than
most; it says that it may have to stop production
altogether if there is no EU deal at all.
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Consumer goods and retail: hard realities
Brexit will affect trade, employment and confidence in the
consumer goods and retail sectors.
Consumer markets are vulnerable to uncertainty and few things inspire as much of that as Brexit. As
they plan their investments, companies in agriculture, manufacturing and retail are watching keenly for
the outcome of negotiations over UK-EU trade and the future regulatory regime. Another vital blank to
be filled in is the rules governing employment. Since antipathy toward current levels of immigration has
powered support for Brexit, the question is not whether, but how much, new visa rules will choke off
the supply of labour from the EU.
Whether hard or soft, Brexit will be a setback for many retailers, farmers and manufacturers.
Consumers face paying higher prices for many goods. Little wonder that consumer confidence is shaky
and many consumer-centric companies have reason to fret. The weak pound has already complicated
matters by making raw materials more expensive, thus forcing up the prices of some goods. However,
the biggest effects will be felt in trade, employment and regulation.
Brexit breakdown
Take trade first. Even if the UK signs a wide-ranging FTA with the EU as we expect, trading consumer
goods and intermediate materials between the two jurisdictions will be more costly and complex
than before—at the very least because of non-tariff barriers. Much depends on how difficult the
requirements for border inspections, such as phytosanitary checks on plant matter, will be.
Indeed, when it comes to food and farming, which contributes over £100bn (US$140bn) to the UK
economy, domestic farmers produce under two-thirds of the UK’s food. The rest is imported, mainly
from the EU. Therefore, like other manufacturers, food industry players fear losing access to essential
inputs that are not readily available at home. Preserving this ease of access is a priority, not least
because it also affects trade with third parties with which the UK trades under EU treaties.
Arrangements for the border between the UK and the Republic of Ireland are another cause of
concern. UK-based food producers are among those campaigning vociferously to keep Northern
Ireland’s border free of tariffs and barriers, although it is not all bad news for the UK food industry.
Coca-Cola, for instance, has hinted that it may need to move its operations out of Ireland if tariffs are
imposed on exports to the UK. The UK is the biggest market for Irish farm produce, with nearly 90% of
Ireland’s fruit and vegetable exports heading there.
As with Coca-Cola, several companies are being forced to reassess investments in their supply
chains. Some manufactures that count the UK as a key market will be forced to shift production
there. However, for those without factories in the UK, or with smaller market shares, costs could be
prohibitive. The harder the Brexit, the harder the choices.
25
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Tighter border controls
UK's food, beverage and tobacco trade with the EU
(£ m)
Exports
Imports
30,000
30,000
29,208
27,581
27,493
25,256
20,000
13,159
11,937
11,116
11,793
11,800
11,669
14,043
10,150
9,764
10,000
5,000
25,000
15,000
11,887
15,000
23,425
22,556
21,404
20,000
25,866
25,000
31,878
35,000
28,293
35,000
10,000
5,000
0
0
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Source: UK Office for National Statistics.
A second large concern is the looming end of freedom of movement between the UK and the rest of
the EU. Around a quarter of the UK’s workforce in food and drink manufacturing, or nearly 100,000
people, come from elsewhere in the EU, according to the Food and Drink Federation, a lobby group.
The inflow is certain to slow: concerns over migration were, after all, a main reason that UK citizens
voted to leave the bloc. A stricter visa regime looks all but inevitable, and the supply of workers is set
to be tighter in sectors ranging from fruit-picking to logistics. Wages will need to rise to attract enough
local staff to meet demand, inflating salary bills as well as consumer prices.
A third large unknown is the state of regulation and oversight, including the potential need for
border checks noted above. Such new requirements would cause cost and logistical headaches.
Admittedly, in some areas, efficiency gains should follow from leaving the EU, as a result of being
outside of the Common Agricultural Policy, for example. UK farmers will be able to alter prices more
quickly in future (although some will suffer from receiving lower subsidies). At least in areas such as
food safety, standards are already set internationally. Yet imposing a different set of rules in spheres
such as consumer protection and quality would make doing business in the UK more onerous for
companies offering similar goods and services both there and in the EU.
Forecasting Brexit
Given the uncertainties involved, gauging the effects of Brexit is difficult. What is clear, however, is
that the impact will vary according to the form of departure. Different parts of the retail and consumer
goods sector will be affected to varying degrees, but almost any form of Brexit will have negative
consequences.
Our core forecast is that retail sales volumes will contract slightly in 2018-19 as Brexit talks lay bare
the UK’s weak bargaining position. Slower economic growth and a tougher jobs market would further
rattle consumer confidence. We forecast that an expected retail sales recovery in 2020 would be more
26
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HOW BREXIT WILL AFFECT UK INDUSTRY
feeble under a hard Brexit than it would under our baseline scenario, owing to a weaker pound and
higher import tariffs on goods from the EU.
A final worrying factor under a hard Brexit is inflation, which will be faster, as our forecasts show.
More expensive labour and imported materials would cause a steep fall in household spending and
retail sales in 2021-22, when the latter will contract by around 0.5%. A softer Brexit would produce a
better outcome. Even then, growth in household spending and retail sales will be far from strong.
However, the effect of price rises, particularly in the food sector, means that food retail sales would
be much more robust under a hard Brexit than non-food sales. Demand for food is relatively inelastic,
so as import prices rise, domestic manufacturing should also gain pace. Yet exports of food stand to be
hit by especially high tariff and non-tariff barriers under WTO conditions.
Consumer goods and retail: the
corporate response
The 2016 referendum result, and the subsequent
fall in the pound, forced many consumer goods
companies operating in the UK to raise prices. In
the wake of the Brexit vote, PepsiCo (US), which
makes and sells Walkers crisps in the UK, raised
its prices by 10% because of the increased cost of
the seasonings and oil used to produce the crisps.
Switzerland’s Nestlé increased prices for its
Nescafé instant coffee by 14%, while Mondelez,
which owns the confectionary company Cadbury,
said that it may have to make its chocolate bars
smaller.
However, Tesco, the largest UK retailer,
warned its suppliers not to pass on increased
commodity prices in the form of higher prices
for their products. Tesco pulled some Unilever
and Heineken goods from its shelves after they
had raised prices, although it eventually reached
an agreement with Unilever. Meanwhile, Reckitt
Benckiser said that its profit was boosted by
the Brexit vote as the weaker pound drove up
business in international markets including India,
South Korea and China.
27
Those, though, were the short-term reactions
to devaluation, and many companies are still
mulling their options for Brexit itself. For retailers,
there are few choices; they need to be in the UK
to serve their UK customers. However, Nestlé,
Colman’s and Britvic (among others) have
decided to move production of some products
to other EU markets over the past year. Brexit
may be one reason for that, although production
efficiency is another. Some commentators have
also blamed Brexit for a decision by Unilever to
move its headquarters to Rotterdam. However,
the Anglo-Dutch company, which has long been
under pressure to simplify its dual corporate
structure, denies the link.
Nevertheless, some companies have not been
shy about pinning their decisions on Brexit. In
November 2017 the US beverages giant CocaCola said in a letter to the Irish finance minister
that it would be forced to review its operations
in Ireland if tariffs on imports into the UK were
introduced following Brexit. The company
expects this move to “compound the enormous
pressure” from a sugar tax to be imposed in
Ireland from April 2018. Coca-Cola employs over
1,700 staff in Ireland.
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Energy: connections and climate
Although energy will not be a key issue in the
negotiations, the sector will undoubtedly feel the impact
of Brexit.
Within the EU, the UK has been a strong advocate for deeper integration of the European internal
energy market (IEM), which aims to enhance energy security, reduce energy costs and enable decarbonisation of supply. All these issues, as well as direct energy trade, are now subject to greater
uncertainty as the UK prepares to leave the EU.
Connected to Europe
Trade is perhaps the least of the issues, although its importance is far from negligible. The UK is a net
importer of oil and gas, with Norway (a member of the European Economic Area) a key supplier. This oil
and gas trade is unlikely to be directly affected by the UK leaving the EU. Nevertheless, any disruption
to supply chains resulting from a hard Brexit could have an indirect impact on the natural gas sector in
terms of operational and investment costs. There are four gas pipelines that connect the UK with the
continent.
A bigger issue will be trade in electricity, with the UK’s dependence on imported electricity from
Europe on the rise. There are currently four existing interconnectors that facilitate the import of
electricity to the UK from Europe, with a total capacity of 4 GW. In the first three quarters of 2017
electricity imports accounted for over 5% of the UK’s electricity supply. According to National Grid, up
Project
Year of operation/contracted year
Capacity (MW)
Connecting country
IFA
1986
2,000
France
Moyle
2002
500
Ireland
Britned
2011
1,000
Netherlands
EWIC
2012
500
Ireland
NEMO
2018
1,000
Belgium
North Sea Link
2019
1,400
Norway
IFA2
2019
1,000
France
ElecLink
2020
1,000
France
Aquind
2020
2,000
France
FAB Link
2020
1,400
France
NorthConnect
2021
1,400
Norway
Viking Link
2022
1,000
Denmark
Neuconnect
2022
1,400
Germany
Greenlink
2022
500
Ireland
Gridlink Interconnector
2022
1,500
France
Currently in operation
Contracted
Source: UK National Grid, Electricity Ten Year Statement 2017.
28
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to a further 13.6 GW of contracted interconnector capacity could be added, with 11 projects at various
stages of the planning or construction phase. The UK will be leaving the EU, but its connectivity with
the European electricity market is set to deepen.
Brexit also raises issues for the management of the single energy market (SEM) that exists
between the Republic of Ireland and Northern Ireland. The SEM has been in existence since 2007,
and will become the integrated single energy market (ISEM) in May 2018, bringing in a new wholesale
electricity market arrangement for all the island of Ireland. It, in turn, is based on the integration with
EU electricity markets. (A crossborder electricity interconnector between Northern Ireland and the
Republic of Ireland was approved in January 2018.)
Integration regulations
Energy companies have almost universally recommended that the UK maintain its full participation
in the IEM, as well as the ISEM. It makes no sense, they argue, for the UK to reverse course on its
integration of the European and Irish energy markets—doing so would push up the cost of energy and
make transmission less efficient on all sides.
But staying in the IEM is unlikely to be possible if the UK leaves the single market and the jurisdiction
of the European Court of Justice (ECJ). Without that framework, the UK may not be allowed to retain
membership of some of the bodies that govern the IEM. These bodies include the European Network of
Transmission System Operators (one each for electricity and gas), which in turn are monitored by the
Agency for Co-operation of European Regulators (ACER).
The UK has faced a similar dilemma over Euratom, the body that governs within Europe the
transport of nuclear materials and the handling of waste, and performs research. However, in this case,
the UK government has already decided to leave Euratom because the organisation is subject to ECJ
jurisdiction. It appears confident that it can establish an alternative governing structure—one that its
European partners will accept—although its success is far from assured.
Brexit and climate
Brexit supporters often blamed EU climate and energy policies for placing undue burdens on UK
energy consumers and businesses. The UK was an active participant in the setting of EU-wide 2020 and
2030 climate targets (covering emissions reduction, energy efficiency and renewables deployment), the
establishment of Europe’s Emissions Trading Scheme (ETS) and the development of other policies such
as air quality directives.
However, the UK has also relied on its own suite of policies, which have probably had more impact
on its performance on tackling climate change. The UK’s Climate Change Act from 2008 mandates a
cut in emissions by 80% from 1990 levels by 2050 (as of 2016 emissions had fallen by 41%). The UK will
also phase out unabated coal-fired power by 2025, set its own carbon floor price and become a leader
in offshore wind development.
All these domestic policies have resulted in the UK being one of the better performers on the
climate policy front. Moreover, given the release of the Clean Growth Strategy in 2017, the government
does not seem to be using Brexit as a pretext to backtrack. The UK can continue to forge ahead on its
climate goals. However, doing that may be more difficult if the UK cannot stay in the ETS, which again
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involves accepting ECJ jurisdiction. The UK may need to establish its own scheme, and then link it to the
ETS, or to re-evaluate its own carbon pricing policies to fully take its place.
The UK’s departure from the EU will also affect the chances of the remaining 27 member states
meeting the EU’s 2030 climate and energy targets. These include cutting emissions by 40% from 1990
levels—so far the UK’s progress in this area has been a big contributor to the overall EU goals. Germany
can take up some of the slack but the pressure on coal-dependent countries such as Poland to clean up
their act will increase. France may also come under pressure not to retire its nuclear plants too quickly.
In short, the EU may find it misses the UK as much as the other way around, when it comes to the
energy sector. The UK has been instrumental in laying the groundwork for a liberalised and integrated
energy market in Europe in the first place, as well as pushing for progress on climate change. The
latter may not change after Brexit, but it is hard to see how the UK can stay part of the IEM and other
organisations if it wants to leave the jurisdiction of the ECJ.
In the meantime, uncertainty about the market environment may also deter much-needed
investment in the UK’s generation capacity and other infrastructure, such as electricity connectors. This
may ultimately lead to higher energy prices for the UK consumer.
Energy: the corporate response
Given the scale of uncertainty around how Brexit
will affect UK-EU trade, energy companies have
adopted a wait-and-watch approach before
announcing any major relocations or staffing
decisions. BP (UK), Total (France) and Vestas Wind
Systems (Denmark) have said that they do not
expect the vote to have a significant impact on
operations or investment plans. BP has said that its
headquarters will remain in London, with no major
disruption to its workforce.
Although Gazprom (Russia) has also maintained
that its marketing and trading unit would not
be affected by Brexit, anonymous sources told
the Financial Times last year that it could move
those operations out of London after the UK
leaves the EU. Meanwhile, Royal Dutch Shell
(UK-Netherlands) and ExxonMobil (US) have
stressed the importance of barrier-free movement
of goods, people and capital across borders. The
companies have highlighted the North Sea as
an area of strategic importance and expect to
continue to invest in their assets there.
30
One outcome of the Brexit vote has been an
increase in energy prices for consumers. The six
biggest energy suppliers in the UK—Centrica’s
British Gas (UK), EDF Energy (France), E.ON
(Germany), Npower (UK), ScottishPower (UK)
and SSE (UK)—all raised prices in 2017, blaming
government policies and subsidies for renewable
energy and smart meter installation. British
Gas has called for the UK government to scrap
plans to cap standard variable tariffs (SVTs)—the
default rates charged if a customer does not opt
for a specific payment plan for gas and electricity.
However, the legislation is unlikely to take effect
before 2019.
For EDF, losing access to the EU’s labour pool
could risk construction delays at the US$23bn
Hinkley Point C project in south-west England.
The nuclear project is expected to support about
7% of the UK’s power consumption for 60 years.
Furthermore, although E.ON had earlier said that
Brexit would be manageable for the company
as its business in the UK was mainly regional, it
has since warned that the weakened pound and
“interventionist” energy policies were likely to
© The Economist Intelligence Unit Limited 2018
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HOW BREXIT WILL AFFECT UK INDUSTRY
affect its UK operations.
Wind energy could be a bright spot for the
opportunities to export wind energy, contributing
£5bn-7bn to the UK economy by 2050. Vestas, the
industry in the aftermath of Brexit. Orsted, a
largest wind turbine-maker in the world, expects
Danish power company that operates eight wind
growth in the wind energy sector as older turbines
farms in the UK, expects to use clean energy
in mature markets will be replaced with newer
for 95% of the power that it generates by 2023.
models.
The company has said that Brexit would present
31
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HOW BREXIT WILL AFFECT UK INDUSTRY
Telecoms: the virtual realities
The UK’s exit from the digital single market raises more
questions than answers.
Even now, more than a year and a half after the referendum took place, clarity about what the postBrexit future holds for the UK’s telecoms sector is hard to come by. Although there have been extensive
analyses of the possible effects on trade-reliant sectors, there have been fewer for those sectors where
the trade is virtual. Nonetheless, it seems clear that Brexit will bring significant challenges for the
telecoms sector.
Perhaps the biggest of these is regulation, given the crossborder nature of digital services. In early
March the UK government confirmed that the country will be leaving the digital single market, despite
warnings from a House of Commons select committee. Roaming charges, data sharing and data
protection were among the issues brought up by the Digital, Culture, Media and Sport Committee. The
committee argued that the government needs to protect UK and EU consumers from data localisation,
a form of digital protectionism that could stifle digital investment and revenue.
The government has countered this by arguing that the important thing is to ensure that regulations
remain largely unchanged. In June 2017, for example, the UK government stated that it would
incorporate the EU’s General Data Protection Regulation into UK law in May 2018, in order to protect
data flows that are responsible for over 70% of trade in services. Meanwhile, the UK’s Intellectual
Property Office has said that current regulation surrounding trademarks, patents and copyrights will
remain intact, with the UK continuing to comply with EU directives post-Brexit. This will provide some
much-needed stability for R&D, and will ensure that the UK remains competitive as a location for
digital innovation.
Even so, questions will remain. One is over the UK’s ability to influence EU law after Brexit and to
ensure that UK operators get a fair deal in terms of their business on the continent. There is as yet
no real indication of how a data-sharing arrangement may work, which could jeopardise the free
movement of data required to enable trade between the two regions to flourish. The UK’s decisions to
stick with the EU intellectual property rules, meanwhile, will not prevent EU member states from trying
to lure start-up companies and innovators away from the UK’s shores.
Freedom to roam
Even if the UK does align all its telecoms legislation post-Brexit, much will depend on the powers of
the UK regulator, Ofcom. Take the eradication of roaming charges, which has capped the amount
that EU operators can charge each other for using their networks. Greeted with enthusiasm by EU
consumers, because it makes using mobiles abroad much cheaper, the caps have eaten into operators’
margins. Operators argue that the loss of roaming revenue has threatened investment in crucial mobile
infrastructure, including the development of next-generation 5G technology.
Even if the UK decides to transfer the current roaming arrangements into UK law using the EU
Withdrawal Bill, it would not be enough. Last April another House of Commons select committee,
the European Scrutiny Committee, concluded that although UK authorities can cap the wholesale
32
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
rates that UK operators impose on EU operators for use of their domestic networks, they would be
powerless to ensure that wholesale charges were capped for UK consumers in Europe. As a result, UK
operators would be at a financial and competitive disadvantage.
If roaming charges are reintroduced, then Ofcom could compensate consumers by capping other
charges, but only if its powers allow it to do so. That means that the UK would have to diverge from
EU policy on state intervention in retail markets. The European Commission is currently planning to
impose a ban on retail regulation by 2020, but Ofcom argues that such a ban might prevent it from
intervening in the retail telecoms market post-Brexit.
A new framework?
UK's telecoms trade with the EU
Exports
Telecoms equipment
Consumer electronics
(£ m)
Imports
Telecoms equipment
Consumer electronics
18,000
18,000
16,000
16,000
14,000
14,000
12,000
12,000
10,000
10,000
8,000
8,000
6,000
6,000
4,000
4,000
2,000
2,000
0
0
2011
2012
2013
2014
2015
2016
Source: UK Office for National Statistics.
To this end, the UK’s Broadband Stakeholder Group, the government’s advisory group on
broadband provision, has recommended that Ofcom continue to maintain its independence from
government, while enlisting a third party to scrutinise its activity. Such a move, it argues, would allow it
to take an active role in discussions with EU bodies such as BEREC (the Body of European Regulators
for Electronic Communications), whose decisions have a bearing on the UK digital market.
Even then, though, there are questions about the regulatory framework that Ofcom would operate
under. Currently, Ofcom’s regulatory weight derives to a considerable degree from EU guidance,
particularly the EU Regulatory Framework for Communications. This framework is currently under
review, which means that the UK government will have to choose to either mirror the conclusions
drawn, or forge its own way. The same is true with the plans for a digital single market, which are being
rolled out across the EU—and will do so in the future without UK influence.
33
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Non-virtual trade
Regulation is not the only potential sticking point, however. The UK telecoms sector is the largest in
Europe, contributing £30.2bn (US$42bn) to the UK economy. Although much of that comes from
telecoms services, there is also a significant trade in telecoms components and equipment. The EU is
by far the biggest recipient of UK telecoms exports, as well as a source of telecoms imports, at £3.8bn
and £5.1bn in 2014, respectively.
As well as working with the EU to try to avoid threats to this trade, the UK will also need to nurture
closer ties with a range of international organisations, including the WTO and the International
Telecommunication Union. This will help the sector to maintain a robust trading position, while giving
the UK a say in international telecoms policies that will undoubtedly have an effect on domestic
industry.
On the labour side, the government’s industrial strategy aims to avoid the skill shortages that are
likely to appear after Brexit, when it becomes harder to recruit EU workers. Training initiatives will
help to ensure that UK workers have more innovation skills, but the UK will still need access to foreign
workers. This will give the UK the ability to pursue R&D in a range of burgeoning technologies, such as
the internet of things and next-generation 5G connectivity. Maintaining a consistent funding stream for
these technologies will also be essential once the UK’s access to EU funding for the digital single market
comes to an end.
Telecoms is not one of the sectors picked out as a priority by the government, so it is unlikely to
figure highly in the EU negotiations. That means that the telecoms sector needs to face the risks
and opportunities of Brexit head-on, without waiting for a special deal. On all of the issues at stake,
however, there are still more questions than answers. The same, unfortunately, is true for all of the
sectors covered in this report.
34
© The Economist Intelligence Unit Limited 2018
A YEAR TO GO:
HOW BREXIT WILL AFFECT UK INDUSTRY
Telecoms: the corporate response
UK telecoms operators have two main concerns
over Brexit: one, that it will curtail freedom of
movement of people and data; and two, that it
will shrink the pool of funds for investment in new
technologies. Although BT (UK) has not formally
stated how it thinks Brexit will affect its operations,
the telecoms operator has asked the government
to prioritise access to the EU’s workforce, to
impose no bans on crossborder data flow and
to seek to preserve the availability of funding
for investment in R&D. BT, which is 12% owned
by Germany’s Deutsche Telekom, employs over
7,000 people and has operations in all the EU27
countries.
Meanwhile, O2 (UK) has said that the
uncertainty over a trade deal could hamper
business investment in the UK. The country’s
second-biggest wireless carrier has warned that
a slower economy and weakening consumer
sentiment could dent mobile spending. Both O2
and Virgin Mobile (UK) have said that Brexit would
also raise questions about roaming charges for
UK consumers. Although O2 said that it could
35
not guarantee that consumers would continue
to benefit from a ban on roaming charges in the
EU post-Brexit, Virgin Mobile said that customers
might lose some of their data allowance. The
company currently offers 5.5GB of monthly
roaming data.
Vodafone (UK) said in 2016 that it could move its
head office from London if the Brexit negotiations
did not result in the retention of free movement
of people, capital and goods. The company,
which employs about 13,000 people in the UK,
had said that it would decide on the matter after
negotiations had been finalised. Meanwhile, it
plans to boost its regulatory and public policy
activities in the EU.
Consumers also face paying higher prices for
their favourite gadgets. Apple (US) has raised the
prices of some products and mobile applications
in its UK stores by about 25% in light of the
pound’s weakness. Still, the company has been
quite optimistic about the UK’s future post-Brexit,
and has announced plans to build a new UK
headquarters in London. Finally, Microsoft (US) has
said that it will not rethink its investment in the UK
because of Brexit.
© The Economist Intelligence Unit Limited 2018
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