Growth: Brexit Affects It

The British referendum result sent a seismic shock across the globe, and the aftershocks are still being felt. Analyzing the implications of the unexpected result is no small feat. Key events immediately following the vote shrouded the UK’s near future in an inky darkness, and at this point it’s unclear if anyone is close to finding the light switch. Concern among Canadians is high. Both Canadian and international CEOs cited the impact of global forces on business among their top three concerns in a recent KPMG study, and questions about Brexit ranked second overall on my recent cross-Canada speaking tour. Is it possible at this point to assess the impact on Canadian exporters?

Clearly, there’s a lot at stake. $15 billion of Canadian goods are shipped to the UK annually, enough to rank as our third-largest international market. In addition, the UK accounts for 5.5 per cent, or $5.5 billion, of Canada’s total export of services. These are big numbers, but our largest exposure actually comes from a third source. Canadian firms with operations in the UK generated over $30 billion in annual sales during 2013, the last year of official foreign affiliate sales data. No wonder we’re concerned.

It’s critical to know how much of this is at stake. This is where the political murkiness makes things especially difficult. First, Britain is left in a state of electoral fragmentation. Voters in the UK were almost evenly split on the issue, and separately, Scotland, Northern Ireland, London and other zones voted conclusively for the ‘Remain’ side. The fractious outcome could have implications on future political stability. Second, there was an immediate political void. The Prime Minister resigned, succession came down to the last person standing, ‘Leave’ advocates were in disarray and had no plan, and dissent wracked the pro-Remain opposition. Amid the chaos, post-referendum rhetoric suggested that many voting to leave weren’t quite sure what it meant or how far it was to go, suggesting that the new leadership has a very unclear mandate. To complicate matters, the surprising British outcome has emboldened Euro-dissenters on the Continent and either boosted or inaugurated anti-establishment rhetoric elsewhere. Political uncertainty has spread beyond the UK.

The new paradigm is already affecting the economy. The pound sterling immediately lost 10 per cent of its value, and has in the intervening weeks plumbed new depths. If sustained, this, together with increased business uncertainty, is expected to lower Canadian exports by as much as 8 per cent in 2017. That same uncertainty has thrown investment plans into limbo. Unsure what form the eventual commercial arrangement between the UK and the EU will take, international investors are likely to be extra cautious before embarking on significant new British ventures. Skittishness is likely to spread, and Canadian investors will be no exception. Delays and deferrals can be expected to persist until there’s greater clarity on UK-EU relations. At that point, more permanent investment decisions will be made. For Canadian investors, this will be contingent on the nature of their commercial relationships, supply-chain activities, intended sales destinations, dependence on official trade agreements and the extent to which we are prepared to invest into commercial voids left by other exiters. Lack of strategic clarity makes it almost impossible to measure likely effects.

To these direct effects must be added the broader existential questions that the UK outcome raises. Is this the first of a wave of international challenges to globalization? And if not a direct challenge, does it at least suggest a more fractious political environment in the EU and beyond? Might it reinforce the anti-trade rhetoric in the US election? Are multilateral trade deals in danger, and can we expect more bilateral efforts? Suddenly, basic assumptions that businesses made just a few weeks ago are now in question, and at a time when the world can ill afford it.

Still, money continues to flow and business decisions must be made. Doing so in the dark raises the risk, and consequently the need for risk mitigation – at least until things get clearer.

The bottom line? The Brexit debacle will have negative near-term effects on Canadian exporters and investors. The ultimate impacts await the re-crafting of the UK-EU relationship, which itself may be complete before the full costs of fragmentation are broadly understood. In the meantime, it will pay to proceed with caution and communicate clearly with all affected clients.