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UK Retail after Brexit
What Will Happen?
(13 July 2016)
What will the new world look like now that the people have finally decided to leave the EU? It is very difficult to decide. There are now fifty times as many uncertainties as there are certainties in life after Brexit, so this piece is mostly about what to us seems most likely. The Centre for Retail Research is less pessimistic about what will happen than many others, but ultimately it depends on what politicians, businesses and consumers do after Brexit rather than what we forecast.
Some of the issues:
European Economic Area. We will still want to keep trading with the EU, because it is 45% of our external trade (once 65%). We may join EFTA (Norway. Liechtenstein and Iceland) to have continued tariff-free access to the EU's single market via the European Economic Area (EEA), but that would involve agreeing to free movement of people and most of the regulations that helped people to vote Leave.
- Bilateral Agreements with EU, rather like Switzerland. This would take some time to negotiate and would involve accepting the free movement of peoples.
- A Set of UK Trade Agreements with other counties. It is (probably) most likely that a UK Government attempting to implement the referendum result would seek trade agreements with the EU and several other countries in North America and Asia to give it some access to their markets. This would allow independent economic trade and business policies to be adopted. These would take a long time to negotiate, but countries unwilling to permit low or zero-tariff access would have to face similar restrictions entering our markets.
- Because the referendum result was a defeat for every major party, there is no specific set of trade policies that we can discuss or indeed any thrust to current policy. Both of the main parties are focused on changing leaders rather than developing solutions to the problems that popular democracy has put them in.
It is all very difficult therefore. Brexit is not a single thing, but the start of many different changes the nature of which we have not yet started to discuss with our European partners. Will the new government take the opportunity to develop new business and trade policies or simply mimic what is there now? For the last forty years our business and trade policies (including agriculture and fisheries) have been structured around agreed EU policy, EU court cases and EU regulations. Whether leaving the EU is a success or failure is not primarily a matter of saving the money that we send to Brussels, but whether there is the enthusiasm and dynamism in the political system to think again about developing business and trade. This would be a long term project.
What Will Happen To Retailers and Consumers?
Public discourse post-Brexit is dominated by feelings of frustration and betrayal, I-told-you-so, and what biblically would be termed 'wailing and gnashing of teeth'. As we said at the time, if it is so damaging, don't hold a referendum. Market turbulence has followed the referendum result: this has been viewed as disastrous, rather than a market correction.
As well as calming the markets, the new Government will have to show it has viable plans for the UK and that, at last, someone is in charge.
- UNCERTAINTY. Falls in share prices and the international value of the pound sterling reflect the fact that the future is unclear: the default position for massive uncertainty of this kind is usually negative. We can expect some asset prices to drop in the medium term, say by 8%, but the short-term turbulence is overdone, as Lord King the former Governor of the Bank of England has already suggested. Uncertainty will continue: it will take some time before the progress of the economy post-Brexit becomes clearer.
- WE CARRY ON. Nothing has changed. We are still EU citizens, in the single market, with the same rights as before and that will be the case until somewhere around September 2018.
- THE POUND. The pound sterling was overvalued and some correction was expected. Unless catastrophe occurs, a fall of about 5% against the euro is enough to compensate for any tariff barriers against UK exporters imposed by Europe after Brexit. Sterling has fallen more than that which gives British exporters a price advantage in EU markets against continental rivals. The CCR view is that this is a very good thing, although it is harsh to blame Brexit entirely when the Bank of England is signalling that interest rates will fall further. It helps home producers to substitute their goods for imports and helps tourism. No one knows what the new value of sterling should be. It will settle down eventually.
- TOURISM EXPANDS. Devaluation is marvellous for tourists (who also spend in shops) as the UK becomes a less expensive destination, prompting more visitors from abroad and making staycations comparatively less expensive. Tourism is worth around £135 bn (3 mn jobs) to the UK, so this means much more than a few extra cream teas being served in Stow-on-the Wold.
- eCOMMERCE GAINS. UK-based online retailers will be able to sell a lot more goods abroad priced in sterling, as their prices are much cheaper now compared to overseas rivals. UK online retailers will benefit although they need to be careful when hedging their currency bets. Alternatively they can increase their profitability by raising their international prices if that helps them more. The disadvantage is that UK-based online retailers will now face EU controls over sales to EU countries, which will disadvantage them. The boost from devaluation should help to overcome the new duties to be imposed, but we may find that the larger ecommerce companies will create a base within the EU to sell into the EU: Luxembourg might be nice and it also has very low tax rates. Some may move completely from the UK to France or Germany, but would naturally then have to face UK restrictions on online sales from Europe. Although UK costs over the next year will rise more sharply than their main competitors (inflation will rise), the fall in the pound should keep their new price advantage.
- GDP GROWTH SLIGHTLY DOWN. Whatever happens, growth will be slightly down for the next year or so. The UK economy was weakening before the Brexit vote was called, so it may be wrong to accuse Brexit of being totally responsible for slower growth, particularly as China, the US and Europe have all been underperforming. We expect GDP growth and consumer spending to be lower than forecast in 2016 and 2017. The CRR's previous forecast (rightly less optimistic than the OBR's) expected retail growth in 2016 to be 1.9% compared to 2.1%-2.3% of other forecasters. Last month (pre-Brexit) the OECD revised its original forecast down from 2.1% to 1.75%.
We are not expecting another recession, although recent gloomy pronouncements from all and sundry suggest otherwise. Do not discount the idea that a new Chancellor will create his/her own recession by introducing a macho budget later this year in the way that Osborne ended a modest revival when he raised VAT to 20%. What is needed now is (a) some sense of purpose and policy announcements and (b) an accelerated housebuilding programme to breather live into the economy, providing jobs and new homes.
- RETAIL SPENDING GROWTH DOWN. Our forecast is that retail spending should grow this year by 1.6% (2016) and 1.4% in 2017. This is -0.3% percentage points lower than originally forecast for 2016 and 2017, though it is admittedly lower than the extravagant forecasts of the Chancellor in his Autumn Statement 2015 and Budget 2016. Consumer confidence and shopper footfall have dropped a lot. But retail spending has fluctuated considerably for the past three years and there is evidence that shoppers are spending less overall on clothing/footwear and spending more of their income on holidays, entertainment, restaurants, visits and events and less on shopping for merchandise. We do not see this pattern changing.
- INFLATION UP. We expect inflation to rise, but this was already expected as a result of Sterling's depreciation starting in mid-2015. It is always difficult to forecast the rate of inflation. Fuel prices will rise, which affects distribution but not to the levels of 2014. We would expect over the next twelve months for it to rise by 2.1%, which is slightly more than the Bank of England's Consumer Price Index target. Naturally this will increase costs for all retailers and comes at a time when costs were already due to rise with the introduction of the 'living wage'. It will be difficult in some markets to pass these increases on, in grocery for example, so profit margins and employment will decline.
- UNEMPLOYMENT RISES. One would expect unemployment to rise because the economy will grow less quickly. Employers in this economic cycle have proved much less willing to make staff redundant than in previous economic cycles, but may now use Brexit as an excuse to eliminate employees because of weaker demand and higher costs. The widespread availability of contract, temporary and part-time workers should enable retailers to operate with fewer permanent staff, as will the expected growth in retail automation and outsourcing of functions.
- EXISTING MIGRANT EU WORKERS. The new UK Government must announce very quickly its policy regarding EU workers who have come here under 'free movement' rules (some going back many years) and have regular employment. Many of these are now very concerned about what will happen to them and it is only fair that the Government should regularise their position, by providing a general right to stay based on visa applications.
- NEW MIGRANT WORKERS. Brexit will not eliminate migration to the UK. The most-likely policy will be a points system that will mean retailers (and other businesses) should have little problem in offering jobs to skilled or professionally-qualified workers from abroad, but bringing in or finding workers from abroad for unskilled manual posts will be more difficult. Retailers may have better applicants for IT jobs than now, but suffer problems in finding enough applicants in warehousing and distribution and high-demand areas such as London. Wages probably need to rise to encourage applications (including UK citizens) for what are now low wage jobs. We expect that unskilled migrant workers (as pickers in agriculture) will still be able to come here on short-term visas, but will have to return home for six months of the year: there will still be British strawberries and sprouts.
- Automation, etc. A smaller supply of fresh migrants to fill retail jobs in warehousing, distribution and sales will probably lead to higher wage costs (don't forget the living wage), a push for automation and in reengineering the way work is done in retail. The BRC has produced a report about fewer and better jobs in the sector and suggested that one million jobs may go by the end of the decade. We feel that this is on the high side but think this decline in employees is quite possible by 2024. In other words, retail post-Brexit will have to be more agile, more digital, capital-intensive and more responsive to change. Even in jobs currently low-paid and unskilled, wages are likely to rise and industries such as agriculture, retailing, wholesaling and productive industry will need to become more automated and adapt their production methods to the new world.
- HOUSE SALES. We expect the housing market to pause for a time until consumers have had time to work out how it will affect them. This could lead to a fall in house prices (by 2% to 4%) and could lead to a serious drop in activity in the sector, although the biggest effect on prices will be in London. This pause will harm associated retail categories such as DIY, furniture and homewares.
- RETAILERS NEED TO ASSESS THEIR SUPPLY CHAINS. Leaving the EU means, in theory, that retailers can buy in the cheapest markets. Tariffs that the UK imposes on imports may be lower than the EU ones or even zero - in food imports for example. Every retailer needs to analyse what this new freedom will mean for them and start creating new supply chains. Of course if we end up still in the single market, this will not be possible (probably).
- RIGHTS OF ESTABLISHMENT. Retailers that operate in other EU countries will need to ensure that they comply with each country's legal code before we leave the EU. Normally they will have a local legal identity in each country. The Brexit negotiations should (or may) create clarity about this. Foreign-owned companies operate widely across the west, so it is a matter of conforming to legal requirements rather than fearing prohibition. The position for online businesses is rather different and we expect that they will need to have a legal identity in at least one EU country after Brexit.
- REGULATIONS, CONSUMER LAW AND EMPLOYMENT LAW. During the referendum debate much anxiety was expressed about any diminution of workers' rights, consumer rights and product standards after Brexit. We expect that the new government will incorporate all those rights into UK law without reference to the EU, thus maintaining the status quo. There will be some differences of outcome as the highest courts will be English/Scottish ones, but they will probably still pay attention to arguments based on European law.
- EU PRODUCT STANDARDS AND POLICY REGULATION. The UK will not be completely free of EU regulation, because products sold to EU countries will have to conform to their product standards and many general policies will have to be observed by UK companies in order to avoid problems when trading with the EU. For example the new EU General Data Protection Regulation looks like good practice and the EU will penalise companies that trade with the EU if they collect and hold data in ways that do not conform to the new regulations.
- NEEDED: A NEW ECONOMIC POLICY. The new Government has to create optimism amongst consumers and businesses instead of reverting to I-told-you-so austerity. The game now should be to go for growth and help develop sectors of the economy that can export or substitute for imports. Since the 2008 recession, growth has been well below our average for the last forty years. Whether Brexit was good or bad, it has produced the need to restructure the UK economy which is best done during periods of fast growth. A period of economic stimulation as industries make the best of our exit from the EU, based on additional sales abroad, import substitution and the recasting of agriculture and fisheries policies will end the uncertainty about the UK economy and improve confidence. A budget based on higher growth would provide tax reductions in national insurance (which is a tax on employment), cuts in corporation tax would encourage companies to relocate to the UK, incentives for capital investment, ending the novel double-rate of stamp duty and promoting house building and construction. Our present uncertainties should also mean an end to vanity projects like HS2 and the Hinckley Point nuclear power station and perhaps some rethinking of our defence policies looking at making them more affordable and related more to our national interests.
Retail post-Brexit will have to be more agile, more digital, capital-intensive and more responsive to change. Retailing is an important part of Britain's economy, responsible for 11% of output and 4.5 mn jobs in shops, ecommerce and physical distribution. In retail, as in so many industries, poor training and a weak national infrastructure hold businesses back. The infrastructure, network of roads, communications and transport all need rapid investment and modernisation, based on schemes that will have an impact now rather than in 20 years' time.