"Businesses and markets hate uncertainty”. How many times have we heard that recently? In the aftermath of the referendum result, when the value of the pound fell and the FTSE 100 and 250 indices contracted, “uncertainty” was the buzzword. This suggests that the market reaction was a manifestation of investors asking the question: “what is the plan?”
Yet much business activity is by its nature uncertain. New products or expansion can be researched, but firms constantly take risks. Likewise in investments. No, business and markets do not hate uncertainty per se. What they do not like is policy uncertainty, as the work of the economist Nicholas Bloom has shown. His index of uncertainty for the UK, tracking the use of the words “economic”, “policy” and “uncertainty” in newspaper articles, increased significantly before the referendum.
If his previous analysis of the US economy translates across to the UK, this will lead to materially lower GDP growth in the immediate future as firms delay investment decisions until clarity is given. This was not unexpected by those of us who campaigned for Brexit. Our argument for Leave was that the risks of remaining and opportunities for better policy with Brexit freedoms would lead to better outcomes in the longer term. Dr Gerard Lyons, a fellow Economist for Brexit, has talked about a “Nike tick” effect – with the economy initially growing more slowly than expected but then with robust catch-up growth.
In essence, “uncertainty” can be unpicked into two components: a “pure” uncertainty that reflects not knowing what future policy and relationships will be, which will disappear when this becomes clear; second, an uncertainty effect which reflects an expectation that new policy will be worse than today, meaning lower long-term growth. This distinction allows us to propose measures to make the uncertain certain.
“Pure” uncertainty was inevitable. There always needed to be negotiations. The Conservative leadership candidates, and indeed MPs of all parties, could help here by outlining clearly that they are committed to delivering on the outcome of the referendum and would vote to respect it if necessary. The Conservative four should also outline a deadline by which they would trigger Article 50, alongside their starting points for the trade arrangements they envisage and any major regulatory or migration policy changes a government under them would make. They could set out broad contours of their fiscal policy too.
The chancellor and the Remain camp helped create uncertainty here. They said no preparatory work was done by government. Osborne suggested a Brexit vote would mean an emergency budget of higher taxes and lower spending. Since, he has offered unclear statements implying he will not meet his aim of a budget surplus by 2020, suggesting a willingness to borrow more. It is not apparent whether he has abandoned his fiscal framework entirely or merely thinks he will not hit it. Add to this his talk about cutting corporation tax and fiscal policy is utterly unclear, particularly given his willingness to junk fiscal frameworks entirely in the last Parliament when the going got tough.
Likewise, while the official Leave campaign was clear that EU residents already here would have their rights respected and be allowed to remain, Remain campaigners constantly and deliberately created doubt. Theresa May, who was on the Remain side, has accentuated this by questioning resident rights and claiming that they would be used as a negotiating chip. This is an economic own-goal and exactly the sort of thing that unnecessarily creates further uncertainty. The government now needs to get a fresh team in place and get on with outlining clear policy choices and creating institutions to deal with the process.
On the second uncertainty component – the negative expectation effect – some of the blame can be laid at Osborne’s door too. Even post-referendum, the desire to protect his reputation has proven too strong in certain interviews, emboldening the doom and gloom pronouncements he previously made. The work he commissioned from the Treasury which implied significant negative long-term effects of leaving (deconstructed by professor David Blake on these pages) was based on assumptions of restricting free trade and not changing any regulation – things no known Leave campaigner wanted.
A new Conservative leadership can help overcome this by outlining a “grand bargain” package of measures to enhance the long-run growth potential of the economy. This could entail: embracing unilateral free trade, a liberal migration policy, abolishing the Common Agricultural Policy, resetting our currently damaging energy policy, cutting business taxes, and other domestic measures such as substantial planning reform and airport expansion.