What will the British economic model after the Brexit? George Osborne, the Chancellor of the Exchequer (finance minister), has been clear on Monday morning July 4: the same as today. It is, in any case, the meaning of his willingness, in his first interview post-referendum with the Financial Times. The corporate income tax will be reduced to 15% ultimately against 20% today and 17% envisaged for 2020.
What George Osborne seeks
This proposed tenant 11 Downing Street, the seat of the chancery, simply to further accelerate the economic strategy implemented since the return of the Tories to power in 2010. This strategy of allocating tax benefits and reduce the corporate tax to attract foreign investments. Since 2010, the corporate tax has been reduced by 5 points and if George Osborne plans are followed, the decline could be up to 10 points. This strategy is based on what economists call the “kindness of strangers” ( “ kindness of strangers “), or rather the interest of these to come and invest in the UK. This “kindness” is naturally undermined by the uncertainty caused by the Brexit and the expected decline of the pound which reduces the value of investments in the UK, many investors may be tempted to turn away from the United Kingdom . So, George Osborne sought to reassure foreign by new tax breaks to come.
With a tax rate on businesses by 15%, the UK hopes to approach the Irish rate and Cyprus (12.5%) and attract corporate headquarters and factories. Provided that London has access to the European market for most goods and services, that is, even without full access to the single market, the country could have a strong competitiveness. If there is uncertainty about the exact regime of trade relations between the UK and the EU in the future, it is unlikely that the country does not have at least a free trade agreement with EU . The United Kingdom can therefore, in the spirit of George Osborne, continue to attract investors. This flow will slow the fall in the pound and reassure non-industrial investors.
More tax even aggression in the future?
Above all, by sending this message George Osborne sends another, wider: the United Kingdom, released the European minimum standards, is prepared to act on the tax lever and that of the regulation to maintain the strength of its economy, starting with the City of London. If it loses European “passport” that allows it to export its financial services directly in the EU and if it also loses the rooms of euros in compensation, as appears to be desired, for example, François Hollande, the British government seems determined to use all the levers to preserve what can be. A note from the OECD revealed by Reuters, however, put this risk before. “ The Brexit negative impact could lead the UK to be more aggressive in tax matters ,” says the note signed by Pascal Saint-Amans, head of these issues within the OECD. In short: the UK could follow the example of many of its “dependencies” and want to become a “tax haven”. The goal then would be to maintain the “kindness of strangers” and, in the financial field, to offset the losses of the City by a massive return of hedge funds, for example.
Winning strategy?
The problem is that this strategy is already far from winning. Since 2010, what do we see in fact? Lowering taxes on business, to which must be added the strong wage moderation (real average weekly earnings was in March 2016 eight pounds less than in March 2010) should have in theory lead to large industrial investments in the Kingdom. But it has not happened: between 2011 and 2015, the manufacturing turnover fell 1.5%. Foreign investment attracted to this strategy, therefore, is twofold: real estate and financial. These are two of the main drivers of UK growth which, remember, has been since 2012 stronger than in the euro area. But there are also two engines mainly focused in areas of London and the affluent suburbs of West London. Conversely, the industrial regions continued to suffer both wage stagnation, continuing industrialization and reduction of public services entails lower corporate taxes. It is these regions that voted overwhelmingly in favor of Brexit. George Osborne is pursuing a strategy that led the United Kingdom to the current situation.
The record current account deficit, the result of an ineffective model
Even better, if the country is currently very vulnerable to the decline of the pound, it is because of the size of its current account deficit, currently at 5.2% of GDP, the highest since more than two centuries. The weakness of British industry leads in fact to a heavy dependence on foreign imports for manufacturing and thus digging deficits each consumption growth spurt. Added to this are the massive arrivals of investment attracted by low tax rates. Financial Services exports do not compensate these. In other words, British growth is that of his model, it is bought on credit abroad. This is a particularly unstable model when confidence in the UK economy begins to crumble. What George Osborne proposes is nothing less than a tinkering of this house of cards that, somehow, it continues to operate. His logic is that if the Bank of England lowers rates to “save” real estate and domestic demand, fiscal insurance will be sufficient to continue to ensure the flow of capital to the United Kingdom. The Tories are therefore cling to their economic model for the saving effects of Brexit rather than consider another model. Yet this strategy carries risks.
Offsetting tax losses
The first is the certainty of having to resort back to fiscal austerity policies. True, George Osborne looks back on his pre-referendum threatens to cut spending 30% for pro-Brexit vote. But this desire to play on the tax rates to attract growth has a very negative impact on the public accounts. The British government has a strategy that works in Ireland or Luxembourg because the small size of these economies allows them to have significant revenue collected on foreign economies. But as highlighted in the note of the OECD, the UK economy is too large to take advantage of such a strategy: the state loses too much revenue on its own economy. Moreover, competition is fierce. Ireland close will still be a lower tax rate with direct access to the single market. Switzerland has announced its commitment to further reduce its tax rate on corporations. If the UK wants to follow, it may cost him.
To finance these losses, it will be necessary to resort to a reduction in public spending. Which, again, may not be sufficient. The UK experienced a strong wave of austerity from 2010 to 2012 and, despite a stronger recovery in euro area (through real estate and much of the construction), the deficit is still above 4% of GDP. The Cameron government had promised new cuts to offset the decline of three points of taxation on businesses. It is not sure that the “gains” made on the net contribution of the EU countries, of around 7 billion euros, come to cover these losses. Especially in the case of a solution in Switzerland or Norway, it will continue to participate (less, admittedly) to the EU budget and that it will ensure the replacement of structural funds for areas in difficulty. If all this is not enough, the “savings” that were already massive, it will affect the health system, the NHS, already in default. In the end, the people who do not have the engines of real estate and finance – the very ones who rejected the EU – still may suffer severely, still contributing to the political chaos that has complicated Brexit
weakness of position
Second risk: with such a strategy, the UK will continue to be dependent on investors, suppliers and foreign creditors. It will therefore be in a weak position compared to trading partners with which it will have to negotiate free trade agreements. It is not certain that the objective set by supporters of Brexit within the Conservative party to negotiate these agreements to strengthen the British economy is the final winner, as it will offer gold bridges to foreign investors to continue to finance the British growth. London may not be able to protect its own producers and deindustrialization can not then be curbed.
Increase in interest rates as a supplement?
But above all, the main risk is that efforts to attract investors by hopes of “tax breaks” are not enough. The required rate cut by the Bank of England will try to maintain housing demand could still weigh on the pound and scare away non-industrial foreign investors, particularly in real estate. In this case, the only way to maintain flows to the island will pay them more by raising rates. This will be the final blow for the UK domestic demand, particularly for households that then suffer the cost of inflation, austerity and rising interest rates. This will be the price of a dependency of foreign investment policy sudden drop in tax rates. The Brexit has been the trigger for the crisis, but the conservative policy based on a permanent precarious balance has been the real cause. The strategy advocated by George Osborne thus takes on the appearance of a headlong rush to save a permanent precarious balance.
No political renewal, no economic renewal
Brexit was mainly led by right-wing parties which, moreover, are in power in Britain. The Labour has not really been able to propose a project against economic nor in 2015 nor now. Therefore, this development is logical: the Conservatives will rebuild their unity on their model. But it is very dangerous for the United Kingdom which could have used the Brexit to rebuild a new vision for the UK economy less dependent on the housing and financial bubbles. But this view is not politically available in the UK. This strategy Tory is also, perhaps, a warning to Europeans. If they want to “punish” the United Kingdom in the negotiations or if they show too inflexible, they may have to handle a huge tax haven unstable at their doors.
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