By William Tarr
Against the predictions of many of the world’s leading central banks and economic thinkers, inflation has gripped the world economy and shows little indication of easing. In Britain, however, the inflationary problem seems dramatically more pronounced. The U.K.’s year-on-year inflation rate reached a 40-year high of 9.0 percent in April and is predicted to reach 13 percent by the end of 2022. Compare this with the economic state of some of Britain’s neighbors across the channel, such as France and Germany, whose inflation rates to May were 7.4 percent and 4.8 percent respectively, and the extent of Britain’s inflationary crisis is quite apparent. The Bank of England’s governor, Andrew Bailey, has been quick to point to the impact of the pandemic, blaming inflation on both a tight labor market and a growing propensity for more militant union action in wage demands. Aside from this, while many argue that a U.K. inflationary problem may be both a response to the weak pound on the currency markets and heightened pressures added by an energy crisis to which Britain is particularly susceptible, others point towards supply chain shocks rooted in the disruption caused by Russia’s invasion of Ukraine. Together, each of these theses are accurate to some extent, but none solely can explain the extent of the U.K. excess inflation over that of its G7 peers given the inherent international impact of these events. This article discusses the underlying causes of inflation in the United Kingdom and gauges the extent to which Brexit has weakened the foundations of Britain’s economy and exposed it to economically destabilizing international events.
The initial consideration regarding the cause of inflation—and perhaps the most pellucid illustration of Brexit’s impact—is Britain’s increasingly tight labor market. The Office for National Statistics has estimated a 110,000-person drop in the number of EU nationals employed in the U.K. between the end of 2019 and March 2021. With the unemployment rate in Britain reaching a 40-year record low of 3.9 percent and the number of job vacancies reaching an unprecedented 1.3 million positions, it is hard to disprove the notion that Brexit has tightened the already fragile labor market. Similarly, Britain’s reliance on seasonal work by, often eastern-European, EU workers will compound this problem further in the months to come. While businesses in the U.K. could once rely on cheap European labor for much of their labor demands, uncertainties around temporary visas have left many of these positions unfilled, with some areas of the U.K. reporting farm produce rotting in fields. In this way, Britain’s woes—caused by a combination of an unprecedented dearth of workers, a largely stagnant economy, and a growing appetite for a reversion to Keynesian-era unionization—have been deepened by institutionalized labor shortages cemented by Boris Johnson’s Brexit deal.
In other ways too, Brexit has forced the hand of policymakers and arguably laid the groundwork for a pandemic-triggered inflationary crisis. Adam Posen, an ex-Bank of England rate-setter and now president of the Pearson Institute for International Economics, attributes 80 percent of Britain’s excess inflation to the Brexit decision. He argues that the “substantial drop in the value of the pound,” occurring as a result of the referendum, and measures set forth by the Bank of England to calm financial markets laid the groundwork for long-term inflationary problems. As a result of post-referendum Britain’s weak currency, import costs dramatically increased, leading to a rise in the per-unit cost of imported goods, in turn weakening profit margins and exposing Britain’s febrile economy to international price shocks. This has been further accentuated given the complexity of supply lines established in the European free-market. The fall of the pound’s value relative to the Euro from a peak of €1.42 in 2015 to €1.10 after the referendum in 2016, a fall of 23 percent, was largely absorbed in the profit margins of businesses reliant on imports at the time of the referendum. Now, however, with the pound falling relative to the dollar once again, and imports costs increasing as a result of new border controls, the dramatic exchange rate movement that has been lying dormant in the U.K. economy is beginning to rear its head. Profit margins that have been whittled away are being reestablished to the market’s, and wider economy’s, disadvantage.
Despite these points, however, there is a growing school of economists who reject this thesis and instead point towards Britain’s susceptibility to the supply chain difficulties caused by Putin’s invasion of Ukraine. One of these economists, Peter Levell, associate director at the Institute for Fiscal Studies, argues that the impact of Brexit on inflation cannot be accurately gauged due to the sheer extent of price increases. Instead, he proffers the argument that Britain’s reliance on gas for energy, in conjunction with its reliance on ‘just-in-time’ manufacturing methods that often incorporate much of eastern Europe in its complex supply chain, have meant that the U.K. would inevitably see greater inflationary impact than its EU peers. The Organization for Economic Cooperation and Development (OECD) cut Britain’s growth forecast in response to the invasion to 0 percent in 2023, the lowest of the G7 nations. It further commented on Britain’s susceptibility to the fall in commodity exports such as food and energy, with U.K.-Ukraine trade amounting to £800 million in 2021. Additionally, increases in other food import costs, as other more Ukraine-reliant nations raise demand for a smaller market of suppliers, are driving up food costs in a nation that is disproportionately dependent on cheap imports due to its chronically declining domestic agricultural industry.
Similarly, Levell argues that the universal rise of energy prices, caused by a combination of a reduction in Russian oil imports and pandemic supply chain issues in the middle east, would have had a disproportionately negative effect on the U.K. economy. Britain’s position as a net importer of energy, a fact undoubtedly exacerbated by the opening of the North Sea Link that connects Norwegian gas supply to the U.K., means the island is more exposed to global price shocks than most of continental Europe. He uses this to argue that rising oil and gas prices would drive inflation in the U.K. much as the 1973 crisis did in the late 1970s.
Yet, it is important to note some shortcomings in Levell’s explanations of the cause of Britain’s excess inflation. Despite his initial argument, inefficiencies in Britain’s supply chains can instead be traced back to Brexit and Britain’s withdrawal from both the EU’s Customs Union and Single Market, established governmental systems through which importing and exporting of goods within the EU is streamlined. The impact of this can be seen unambiguously in the delays at the Dover-Calais border crossing. To blame this on Putin’s invasion then, is specious. Further, Levell’s arguments surrounding Britain’s reliance on energy imports are also superficial. Germany, a country that imported over 98 percent of its oil in 2021, 34.1 percent of which is from Russia, is seeing inflation rates much lower than that of the U.K. France, too, has capped all energy price rises at 4 percent.
Brexit, then, can be seen as the guilty culprit in Britain’s inflationary crisis. A conspiracy of international events stemming from the geopolitical environment combined to constitute the perfect storm for the U.K. and the rocky foundations entrenched by its Brexit decision. Through tightening Britain’s labor market and damaging her ability to trade with her closest trading partners across the channel, Brexit has embedded structural failings into the U.K. economy. Through slashing confidence in the pound and failing to protect the just-in-time manufacturing process, it ensured that Britain was not only unable to respond to geopolitical crises but that it would buckle under trade pressures, its economy plunging into stagflation not seen since the 1978 winter of discontent. Inflation reignited by a rapidly shifting geopolitical context has been fanned by the failings of the Brexit withdrawal agreement, damaging Britain’s economic stability for years to come.
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