ROI-It's Brexit U-turn or bust for Britain's flagging economy: Peacock

By Mike Peacock

LONDON, Dec 17 (Reuters) - Britain’s Labour government has made faster economic growth its central goal, yet finance minister Rachel Reeves' autumn budget contained no meaningful measures to boost activity, according to the Office for Budget Responsibility.

That leaves only two obvious hopes for a listless economy: an artificial intelligence-driven productivity boom or closer trading ties with the European Union.

Yet neither prospect got much airtime in Reeves’ budget speech last month. In fact, there was little discussion of any measures likely to move the UK economic needle.

The OBR does not "score" government measures unless they are expected to add at least 0.1% to GDP over a five-year period. No policies reached that bar in last month’s budget, including trade agreements with the U.S. and India.

Reeves' main achievements were to avoid worsening the inflation outlook and to placate the government bond market by announcing tax rises that should limit the expansion of the country's debt.

That did potentially give the Bank of England more scope to ease policy. The BoE is widely expected on Thursday to cut interest rates by another quarter point. But with UK rates at 4% – double the euro zone level – that won't be enough to transform the country's growth outlook.

And even though inflation fell to 3.2% in November, it's still too high to allow Reeves to bank on much more monetary easing.

The consensus is for interest rates to fall to 3.25% by the end of 2026, which would be helpful but not a game changer.

AI SILVER BULLET?

So what about AI? The technology likely will have an impact on the UK economy over time.

Britain's private sector is dominated by services, notably accountancy and finance, so the UK could benefit more than other countries if it rapidly adopts AI, according to economists cited by Reuters.

But a productivity "quantum leap" in the next few years looks like wishful thinking. If it were more than that, a visionary government would surely have made it the centrepiece of its budget.

Estimates vary but the OBR’s central forecast is for AI to boost productivity growth by only 0.2 percentage points over the next five years.

EDGING TOWARD A BREXIT RECKONING

So is a closer EU relationship the only major lever left?

After years of silence, the ruling Labour Party is more openly criticising Brexit.

“For economic renewal we have to keep reducing frictions. We have to keep moving towards a closer relationship with the EU, and we have to … accept that that will require trade-offs,” Prime Minister Keir Starmer said in a post-Budget speech.

Meanwhile, a recent study by the U.S. National Bureau of Economic Research has caused ripples in Westminster.

It calculated that Brexit has so far cut Britain's GDP by 6-8%, more than the OBR's assessment that post-Brexit trading arrangements would reduce long-run productivity by 4% relative to remaining an EU member.

Even Brexit supporters now concede it has hurt growth, though many insist the problem is poor implementation rather than the decision itself.

“I fear we’re moving towards being a European economy in terms of tax and regulation, but outside the single market,” former Prime Minister Rishi Sunak said.

As a supporter of Brexit, his answer is to use freedom from EU rules to deregulate and lure investment. The counterargument is simple: if Britain's approach to tax, welfare and employment rights ends up mirroring the EU's, what exactly is the downside of closer trade ties?

Proximity clearly remains the key driver of trade, as the EU continues to account for the bulk of UK imports and exports, with the U.S. in a distant second place for both.

THE FARAGE FACTOR

Two obvious ways to boost trade are rejoining the EU's single market – which would require accepting free movement of people – or negotiating a customs union. The latter would eliminate all EU-UK tariffs on goods and apply a common external tariff to imports from elsewhere.

While the economic case for freer trade with the EU is strong, the politics are daunting.

The Liberal Democrats, Britain’s third-biggest party in parliament, are pressing for a bespoke customs union, claiming it would add 25 billion pounds ($33.5 billion) a year to government coffers. Some Labour lawmakers agree, but such a deal would curb Britain’s ability to forge independent trade deals elsewhere.

At the same time, the anti-EU Reform UK party, led by Brexit architect Nigel Farage, enjoys a consistent double-digit lead in opinion polls, and it would obviously make hay with any move that looks like revisiting Brexit.

Also, like it or not, Brexit was what the UK electorate asked for in the 2016 referendum, so major backtracking without a popular mandate is no easy matter, regardless of the economics.

Labour's election manifesto thus ruled out membership in the single market or a customs union, as well as any return to free movement of labour, a stance reiterated by the prime minister earlier this month.

STUCK BETWEEN REFORM AND REFORM UK

So where does this leave the UK?

The existing trade agreement between the EU and the UK works for the bloc, so it's clearly not desperate for change. Starmer’s positive engagement could encourage some flexibility, but the EU will not be eager to bend its rules.

Brussels also has to weigh what it would gain from hugging Britain closer if Farage could be prime minister by 2029 and then potentially rip up any new deal.

Starmer’s newfound willingness to attack Brexit thus appears to be a device to target Reform, rather than a harbinger of an uncharacteristically bold leap back into the EU orbit. If so, the price he will pay is likely to be continued anaemic growth.

(The views expressed here are those of Mike Peacock, the former head of communications at the Bank of England and a former senior editor at Reuters)

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