An “uncertainty tax” linked to the economic realities of Brexit developments in the U.K. and trade tensions in the United States is damping overall economic activity in both economies. These issues, which are strongly linked to the breakout of economic populism around the world, are creating conditions for slower growth and recession if the current protectionist actions are sustained.
This uncertainty tax can most clearly be seen by looking at British business investment over the past three years. Investment was up 2.92 percent year-over-year on the eve of the June 23, 2016 referendum that resulted in a majority calling for the U.K. to exit the European Union; investment closed out 2018 down 3.8 percent. This marked decline, along with exhausted British consumers coping with rising food and fuel prices, define an unsure U.K. economy.
The lack of direction and leadership within the U.K.’s political economy over the past three years has created a sense of paralysis. My colleague Simon Hart, lead Brexit partner in RSM UK, points out that despite his country’s protracted movement toward withdrawal from the E.U., business leaders appear to be taking few steps to prepare. “A paralysis has set in in as everyone waits to observe what actually happens and if there is a short extension to Article 50,” says Hart, referring to the voluntary departure clause contained in the E.U. agreement.
Stalled U.K. growth and productivity
Whatever the Brexit outcome, the net effect of the reticence by businesses to invest amid significant uncertainty and lack of economic direction has been to suppress U.K. economic growth and productivity. In the near term, turning this trend around will be imperative, and forward-looking policy is key.
Given the strong probability there will be another two years before Britain’s relationship with the European Union can be redefined, it is paramount that whatever the post Brexit- landscape looks like, the administration of Prime Minister Theresa May and her Conservative Party move to unlock held-back business investment that will stimulate overall economic activity.
Moreover, because it will likely be years before new trade agreements between the United States and the U.K. can be negotiated, it is critical the British government follow through on plans to reduce tariffs on imports of essential agricultural, biologic and earlier-stage production goods and intermediates as close to zero as possible.
In the United States, a confluence of favors brought economic growth to a crawl in the first quarter: trade policy, the government shutdown and financial headwinds from a tumultuous global economy. The lagged impact of trade policy alone has caused the U.S. economy to flirt with negative growth in the first quarter of 2019. By comparison, at mid-year in 2018 year-over-year growth was tracking at 3.4 percent.
U.S. tariffs, glowing GDP
What caused the U.S. slowdown? The precipitous decline in global financial conditions during the last six months of 2018 and the impact of tariffs on cash flows of large multinational corporations led to significant financial volatility, causing a 14 percent decline in the broad S&P 500 Index during the final three months of the year. In reaction, U.S. corporate and household sectors slammed the brakes on spending, dimming domestic investment. To date, U.S. manufacturing activity remains soft and overall industrial production is tepid. This unwelcome combination of factors has resulted in a consensus view that corporate earnings will contract in the first quarter of 2019.
GDP growth in the current quarter is tracking just below 0.5 percent, with the risk of a sharper slowdown. Unresolved trade conflicts with China, an uncertain future for NAFTA modernization and the strong possibility that the Trump administration may use a recent Section 232 ruling by the U.S. Commerce Department to impose tariffs on all auto imports from the E.U. and Asia leave significant questions to be resolved before giving the all-clear signal for the U.S. economic outlook.
More favorable outlook depends upon rolling back tariffs associated with NAFTA (a new United States Mexico Canada Agreement that contains those rollbacks is under review by Congress) and resolution of the protracted trade spat with China. Moreover, it is critical that the current administration does not place a new round of tariffs on all auto imports.
We estimate rolling back tariffs on the Chinese would result in a $30 billion increase in cash flows to U.S. corporations. As well, if no tariffs are imposed on auto imports that alone would prevent the equivalent of a $90 billion tax increase, which would almost certainly be passed on to U.S. consumers.