What effect will Brexit and slower immigration really have on the British economy?
Given that the UK has voted to leave the EU (Brexit) it is useful to consider what the implications will be of a slower rate of immigration. In the past decade the UK total population has grown at 0.8% per annum lifting the total from 60.4 million persons in 2005 to an estimated 65.3 million persons in 2015. Of this increase 1.9 million is from births minus deaths and the other 3.35 million is net migration – which has been running at 313,000 persons pa for the last five years based on estimated total population and adjusting for births and deaths. This is 0.49% per annum of the total population.
What will be the demographic and economic implications of this migration rate dropping to 100,000 persons per annum, and has the high rate of the past decade really influenced the economy? This Insight looks at these two questions.
The Immediate Past and the Present Situation
From 2010 to 2015 the net rate of immigration (i.e. change in population size not accounted for by births and deaths) has run at an average rate 0.49% per annum. That is 313,000 persons per annum. This has impacted the size of the total population and the size of the labour force. By 2015 the total labour force is estimated at 31.2 million with a GDP per worker of £59,777. This productivity per worker (which is high by world standards) is achieved as a result of the good education standard of its labour force and the Accumulated Fixed Capital Investment per worker of £51,611. (Accumulated Fixed Capital Investment is the sum of Fixed Capital Investment over the last 10 years depreciated at 10% per annum and is effectively a measure of the ‘tools’ available to the worker. Across 75 countries, the higher this number per worker the more productive is the worker).
However, as shown in Figure 1, Fixed Capital Investment in total per annum did slow after 2007. That, combined with an increase in the number of workers (from 29.5 Mn in 2015 to 31.18 Mn) meant that Accumulated Fixed Capital per Worker showed almost no growth after 2008. This meant that the ‘resources’ available to increase the productivity of the individual worker did not increase at all for the last 8 years.
Figure 1: Relationship Between Total Fixed Capital Investment per annum, workforce size and Accumulated Fixed Capital Investment Per Worker: 2004 to 2015
While, fortunately, the ‘other’ contributor to individual worker productivity, education standard of the work force, did increase over this time period, the reality is that the education profile of a country increases slowly and hence this lack of growth in Accumulated Fixed Capital Investment per worker had a devastating effect on productivity growth. This is shown very effectively in Figure 2 below.
Figure 2: The relationship between YOY growth in Education and Accumulated Fixed Capital Investment per Worker and GDP per worker (Productivity). 2005 to 2015
So the net result was that productivity per worker for the period 2010 to 2015 showed very little growth at all. (From £56,905 to £59,777).
So while the overall economy (GDP) grew in real terms from £1,679 Bn to £1,864 Bn, a CAGR of 2.1%, the average productivity per worker and ultimately wages grew at a much slower rate of 0.99% per annum. So the UK had more (foreign) workers – but at the same pay rate over the last 5 years. Growing an economy by increasing the number of workers (artificially) but not their incomes is not a good scenario. People like to feel that they are getting better off, and that was not apparent to the average worker in the UK, whereas the migration was. Hence the decision to leave the EU.
So what happens when the supply of migrant labour slows from the present 2015 level of 313,000 per annum to a Government (apparently) targeted figure of 100,000 per annum by 2025? (It is assumed that the number of net immigrants will decline gradually as it will take time to extract from the EU and there will be a variety of other issues that will prevent a draconian immediate stop to migration.)
First, and rather obviously, the growth in total population will be slower, such that by 2025 the total is estimated to be 69.2 million persons versus 70.18 under the no change scenario. This in turn means that the labour force will increase by 0.9 million workers from its present level of 31.2 million in 2015 to 32.1 million in 2025, rather than by 1.4 million to 32.6 at the continued higher rate of migration. So the net effect on the labour force is 500,000 fewer workers in 2025.
This then leads to the question what will happen to the productivity of the workforce. Assuming the education profile continues to improve (and that migrants were no better or worse educated than the non-migrant population so the change in immigration rate has no impact on the trend in this variable) then the critical issue is what happens to the Accumulated Fixed Capital Investment per worker?
This of course is the uncertainty that has been debated so strongly by the different groups in the UK (and IMF) with often quite dire warnings being given. Few have been positive!
Clearly Global Demographics is no better informed but we are in a position to show the impact on productivity and hence wages and household incomes under different scenarios. The ability of the UK to attract investment or maintain domestic public and private investment is going to a function of its ability to be competitive in wages and taxes. In terms of wages it is competitive to the larger remaining economies in the EU and increasingly so in taxes. Its ability to reach trade agreements with other major economies is also positive.
Finally, the government itself has indicated that it will relax fiscal budget constraints and hence increase investment in infra structure and social development (eg education).
Scenario 1: Absolute Level of Fixed Capital Investment Maintained.
So what happens if investment in Fixed Capital is maintained at its present absolute level irrespective of the number of employed persons. This is shown in Table 1.
Table 1: No Change from Base Case in Absolute Level of Fixed Capital Investment per annum
As shown, total GDP would contract due to the reduction in number of workers but the GDP per worker (productivity and wages) would increase by 0.4% in total by 2025 driven by an increased amount of resources per worker (Accumulated Fixed Capital Investment per worker). So slightly more for the individual, but smaller total economy. Also note that Fixed Capital Investment as a proportion of total GDP increases to 18% versus 17.9% under the base case.
Scenario 2: Total Fixed Capital Investment Declines by 5% by 2025
This is where investment is not attracted such that by 2025 it is 5% below what would have otherwise been the case. Not surprisingly this lowers Accumulated Fixed Capital Investment per worker – but by just 2% as there has also been a reduction in the number of workers – and productivity per worker is 1.4% lower than it otherwise would have been in 2025. This is shown in Table 2 below.
Probably the key issue here is that productivity per worker (and hence ultimately incomes) is down by 1.4% or £1,059 pa – which given the average number of workers per household means that by 2025 the average household would be around $1,500 pa worse of in real 2015 values. In addition, the total GDP would be 2.8% smaller than the base case scenario.
Table 2: Absolute Level of Fixed Capital Investment per annum is Down 5% by 2025
Scenario 3: Fixed Capital Investment per annum increases by 5% in total by 2025
There is no reason to believe the pessimistic scenario above (scenario 2) is the most likely outcome. There is also reason to believe that there is an upside potential – and this scenario considers the impact of that and the result is shown in Table 3 below.
Such an increase in Fixed Capital Investment means lifting it to 18.3% of the total GDP (compared to 17.2% in 2015) but results in GDP per worker (productivity) lifting to £68,957 which is 2.5% above the base case and an additional £1,500 potentially in wages per annum per worker (probably less as wages are typically less than productivity per worker). In addition, by 2025 total GDP would be 1% greater than the base case scenario. In short, everybody wins.
Table 3: Absolute Level of Fixed Capital Investment per annum is Increased by 5% by 2025
SO WHAT IS THE IMPLICATION FOR COMPANIES AND INVESTORS?
This analysis indicates that the most critical variable for the UK in terms of leaving the EU is its ability to maintain or increase its level of Fixed Capital investment. If that can be done then employment will remain high (as one would expect given the reduced labour supply) and, more importantly, productivity per worker would increase and with that incomes and consumption.
Clearly there are many opinions about the UK’s ability to attract such investment. Some can be generated by the Government, some by domestic private investment and some will be from overseas, with the latter being the most problematic. However, the UK does remain a stable democracy with a positive attitude to business (for example, a corporate tax rate of 20%) which does position it attractively relative to many other economies, including those within the EU, as a country in which to invest. So doom and gloom may not be justified and optimism may be warranted.
In addition, the analysis indicates that while there will be change (be it negative or positive) it probably will not be catastrophic in nature. Furthermore, the scenario shown in Figure 2, earlier in this document, where wages and productivity are not increasing in real terms is not a good picture. The status quo of larger GDP but no gain in individual earnings is not appealing. So Change might be for the better.
DON’T AGREE WITH THE SCENARIOS?
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