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Professor Michelle Baddeley comments on Brexit, Construction and Infrastructure

5 July 2016

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As the immediate shock of the EU Referendum starts to dissipate, sterling is stabilising and share markets are recovering. But what are the wider impacts - medium-term to long-term? Impacts on the construction sector are likely to be negative and far-reaching. Construction is a key contributor to the UK’s output and employment. The construction industry employs around 2 million people - 6-7% of the UK workforce, and contributes around 6-7% of the UK’s output. The Office of National Statistics (ONS) estimates that, before the EU Referendum, output in the construction industry had already decreased by 3.7% between April 2015 and April 2016. Construction is traditionally a volatile sector, driven by cyclical fluctuations in sentiment. Uncertainty, magnified spectacularly by the Brexit vote, will affect any business investment and construction projects are particularly vulnerable. Expectations of profits versus loss unfold over long time horizons, and construction activity is more complex and unpredictable than, for example, manufacturing activity. 

So, post-Brexit, it is no surprise that the headline news for the UK construction sector is not good. Pessimism in the construction sector had been building-up with growing expectations of a vote to leave the EU. Some fears were realized with yesterday’s release of Markit’s Purchasing Managers’ Index – showing a fall of around 10% from 51.2 in May to 46.0 in June, crossing the 50% line separating expansion to contraction, and the lowest figure since June 2009. Whilst house-builder Persimmon gave some reassurance today with their release of an upbeat trading update, UK construction share prices have crashed: for example, between 23 June and 5 July, share prices for British Land, Barratt Developments, Kier Group and Balfour Beatty have fallen by around 29%, 35%, 23% and 19% respectively.

But share markets can be quick to recover. What are the real, long-term implications for the UK construction sector? The most obvious casualty is housing. News about potential falls in property prices have featured heavily in the headlines. But with an over-valued property market in London, some correction in property values is no bad thing, especially if it gives younger buyers a foothold in the market and/or corrects the inequality in house prices and housing wealth in London and South East versus the rest of the country. In any case, some commentators have argued that cheaper sterling might in fact be a boost, with UK property investments looking relatively cheap to foreign investors.

What are some of the other implications? Shortages of skilled labour are a key constraint for the construction sector, and immigrant workers are strongly represented in construction labour markets, not only those working in the key construction trades but also project managers and architects. The irony for Brexiteers is that immigration flows are unlikely to change that much if the UK leaves the EU. Any sort of favourable deal for the UK with the EU will probably depend on an agreement to retain the principle of free movement of labour. Many “Leave” voters did not object to free movement anyway. They were more concerned about Euro-bureaucracy. More subtle questions revolve around the impacts on the psychology of immigrant workers. Do they feel accepted in the UK post-Brexit? Would our talented and entrepreneurial European workers prefer to be in another country, where they feel more welcome, safe and secure?

Another key implication for construction links to infrastructure, specifically the construction of new infrastructure. The Brexit vote has raised concerns, for example, about potential delays to airport expansion in the South East, withdrawal of project funding for HS2 and EDF re-thinking its commitment to Hinkley Point (which could meet up to 7% of the UK’s future energy needs). UK productivity is relatively low by OECD standards and partly this reflects our insufficient and ageing infrastructure. Good infrastructure can be a significant boost to an economy’s productivity in the long-term, and a boost to faltering private sector activity in the short-term. If the Brexit vote leads to a contraction in UK output, as was almost unanimously predicted by economic experts in the run-up to the Referendum vote, then infrastructure projects are likely to suffer - even though, ironically, a boost to infrastructure spending might help ameliorate current uncertainties. The question of how we finance infrastructure will become more pressing if fears about the drying-up of foreign investments in UK infrastructure are realised. Whilst government borrowing is cheap, public sector investments in infrastructure could fill the gap.

What next for government? One of the destructive impacts of the Brexit vote has been the subsequent political infighting. Politicians from all major parties have been pre-occupied with the political consequences for their careers and their parties, and there has been little evidence of the strong and united leadership that we need to calm fears. One beacon of hope has been the Bank of England’s quick response to build confidence and to reassure markets that the Bank was standing by lower interest rates and inject liquidity into the economy if necessary. On the fiscal policy side, the news is less reassuring. In the early days following the Brexit vote, George Osborne was arguing for an invigorated austerity push – with more spending cuts and tax rises – in other words, additional negative shocks to aggregate spending. With the Brexit vote generating a large negative, recessionary shock to the economy, it would probably be wiser to consider increasing public spending to boost the economy and expectations, especially if this spending could be diverted to the types of productivity-enhancing infrastructure projects that are most likely to suffer in the collapse of confidence that has followed the Brexit vote.

Whether or not the Brexit vote holds, the UK economy is in urgent need of a confidence boost to build positive expectations, reduce uncertainty and get construction and infrastructure projects back on track. But as all the political infighting rumbles on, and with no sign of a coherent post-Brexit recovery plan from any of the major political parties, the future prospects for construction and infrastructure do not look good. 

Professor Michelle Baddeley

5 July 2016