4. Economic context

• In terms of international ranking, the UK economy is: 
  • 6th largest global economy in nominal terms
  • 9th globally in terms of relative purchasing power
  • 28th globally in economic output per capita
  • Higher in income inequality than nearly all other European countries
• 80% of UK economy is devoted to services; 10% is devoted to manufacturing
  • Manufacturing accounts for over 50% of UK exports – so critical for trade (and vice versa)
  • Services sector output has grown faster than manufacturing output since Brexit
• Trade plays a critical role in the economy
• UK economy has recovered to pre-pandemic levels but growth rate was bottom of G7 in 2023 and early 2024
  • Since referendum, £ has weakened against $ and €
  • Brexit trade barriers mean UK’s trade openness has declined
• UK has high employment but low labour productivity (a key drag on nation’s wealth)
  • Real wage levels in 2024 are still below levels before the global financial crisis
  • In 2022 and 2023, real wages fell before rising in 2024
  • Productivity growth slowed after the crisis of 2007/8 and has been patchy
• Brexit has hindered UK economy but views differ on size of impact and timing
  • UK is growing more slowly than its peers with Brexit than without
  • Long-run impact of ~£95 billion lost GDP (based on 4% of 2023 GDP)
  • Central estimate of long-run on GDP is reduction of 3% to 5%, compared to remaining in EU
    • Reduced productivity
    • Exports and imports around 15% lower in the long run 
    • Trade deals with non-EU countries have an immaterial impact
    • Business investment has weakened
    • Reduced EU immigration has caused labour shortages
    • Increased non-EU immigration has had a positive effect
  • Majority of impact may have already happened

Click here for summary of Brexit FactBase.

Global overview

Outlook for 2024 and 2025

The IMF, in its April 2024 Global Outlook, observed:

• Economic activity was surprisingly resilient through the global disinflation of 2022–23.
  • As global inflation descended from its mid-2022 peak, economic activity grew steadily, defying warnings of stagflation and global recession.
• Global growth, estimated at 3.2 percent in 2023, is projected to continue at the same pace in 2024 and 2025.
  • Pace of expansion is low by historical standards, owing to both near-term factors, such as still-high borrowing costs and withdrawal of fiscal support, and longer-term effects from the COVID-19 pandemic and Russia’s invasion of Ukraine; weak growth in productivity; and increasing geo-economic fragmentation.
• Global headline inflation is expected to fall from an annual average of 6.8 per cent in 2023 to 5.9 percent in 2024 and 4.5 percent in 2025.
  • Advanced economies were expected to return to their inflation targets sooner than emerging market and developing economies.

Separately, economic forecasters expect that the UK economy will grow more slowly as a result of Brexit than it would have done without it.  For more detail, scroll down to Brexit impact.

Table 4.1: Annual percentage changes in GDP (source: IMF)

Source: IMF, World Economic Outlook Update, April 2024

GDP rankings

The US (26.1%), EU (17.5%) and China (16.9%) dominate the world economy, accounting for 60.5% of global nominal GDP in 2023 – see Figure 4.1.

Figure 4.1: World nominal GDP in 2023 (source: IMF)

The UK accounted for $3.3 trillion or 3.2% of global nominal GDP in 2023. The UK ranked sixth globally, behind the US, EU, China, Japan and India. Treating the EU member states as separate countries, the UK also ranked sixth globally, behind Germany (ranking third), but ahead of France (ranking seventh).

To compare countries, economists use the Purchasing Power Parity (PPP) method. This tries to overcome two problems:

• the cost of living differs between countries – a dollar in India buys more than a dollar in the US;
• exchange rates do not necessarily fully reflect these differences. 

The PPP method converts GDP to an indicator of comparable purchasing power for a common basket of goods and services. This is a better basis to compare GDP between countries but is an approximation.

Using PPP data, the rank order of countries’ GDP changes greatly (see Figure 4.2).

• China now comes top with 18.7% of world GDP, ahead of the US (15.6%) and the EU27 (14.5%) with the UK ranking 9th.
• Treating the EU as separate countries, the UK ranks 10th (2.2%) below China, US, India (7.6%), Japan (3.7%), Germany (3.2%), Russia (2.9%), Indonesia (2.5%) and Brazil (2.3%). France was 11th with 2.2%.

Figure 4.2: World PPP GDP in 2023 (source: IMF)

GDP per capita

Taking it a step further, economists adjust for population. To do this, economists use PPP Gross National Income (GNI) per capita. GNI is similar to GDP but differs in that it measures the income generated by the residents of a country, whereas GDP measures all the income produced by a country, including additional items such as overseas corporate income.

PPP GNI per capita is a simple average measure of national wealth (see Table 4.2 for the top 35 countries in 2022). The top countries include several countries with small populations or huge wealth from natural resources (such as Qatar). Note that this measure does not consider how wealth is distributed across a country’s population.

On a PPP GNI per capita basis the UK ranked, in 2022:

• 28th globally;
• Below 14 European countries (in descending order: Norway, Luxembourg, Ireland, Switzerland, Denmark, Netherlands, Austria, Sweden, Belgium, Germany, Iceland, San Marino, Finland, France).

Table 4.2: GDP per capita 2022 (source: IMF)

Income inequality

To show how income is distributed across a population, statisticians use the Gini Coefficient.  A Gini Coefficient of 0 means that income is distributed perfectly evenly. Higher values indicate greater inequality.

The UK had the highest income inequality of all European countries except for Bulgaria, Lithuania and Turkey (based on after tax income) in 2021/22.

For more on income inequality in the UK, please go to this research briefing by the House of Commons Library on Income Inequality in the UK, April 2024.

Figure 4.3: Income inequality (source: OECD)

Sources:

IMF datamapper, accessed May 2024

World Bank, World Development Indicators database, 12 March 2024

OECD, Income inequality – the statistics are the latest available data as at May 2024  and relate to 2021 and 2022

UK economy

Principal industry sectors

The UK’s principal economic sectors in 2023 were in services rather than manufacturing  (see Table 4.3 and Figure 4.4).

Gross Value Added (GVA) measures economic output (see definition below). In 2023, total UK GVA was £2.04 trillion.

• Service industries made up 80.4% of GVA or £1.64 trillion.
• Manufacturing provided 9.8% or £0.2 trillion

However, the manufacturing sector accounts for about half of UK exports and is critical for the health of UK trade (and trade is critical for the sector’s continued success).

Other non-service sectors contribute smaller percentages but are nevertheless important to the running of the country: construction (6.4%, £130 billion); utilities (2.2%, £44 billion; mining and extractives (0.7% £14 billion; and, last but not least, agriculture, forestry and fishing: 0.6% and £12 billion).

Table 4.3: Output by sector 2023 (source: ONS)

Figure 4.4: Percent of total UK output in 2023

Within services:

• Retail estate activities contributed £265 billion (13%).
• Retail and wholesale industries contributed £203 billion (10%).
• Professional, scientific and technical activities industry contributed £168 billion (8%).
• Finance and insurance services industry contributed £170 billion (8%).

Employment by industry was broadly in line with output. In Q4 2023 the UK employed 33.2 million people:

• Service industries employed 27.1 million people, 81.6% of UK workers.
• Manufacturing employed 2.7 million people or 8.1%.
• Construction industry employed 2.1 million people (6.3%).
• Agriculture, forestry and fishing employed 0.3 million (0.9%).

The House of Commons Briefing below includes a link to a useful searchable spreadsheet tool that allows you to analyse sector activity by region and constituency.

Definition of Gross Value Added. The economic output of part of the economy, such as an industry sector or region can be measured and compared using Gross Value Added (GVA), a measure of economic activity. In brief, GVA is the contribution of part of the economy, minus any costs of materials or services used in the production of the output. GVA forms the basis out of which salaries and wages are paid and profits for shareholders are earned.

Sources:
House of Commons Library, Industries in the UK, October 2023
ONS, Employment by industry, May 2024
ONS, Regional gross value added (balanced) by industry: all ITL regions, April 2024

Output trends and business activity

Since the first quarter of 2007, UK GDP has grown 18.6% in real terms by the first quarter of 2024 (see Figure 4.5).

• Services sector output drove the UK’s GDP recovery after the 2007/8 financial crisis and after Covid. By Q1 2024, services output had grown by just under 29% since 2007.
• Manufacturing sector output also grew after the financial crisis but was on a lower path that did not recover from its dip 2009 to 2012. After Covid and the introduction of the post-Brexit trade agreement with the EU from 1 January 2021, manufacturing growth has been much lower than that of services and, by Q1 2024, had grown by 8% since 2007.
• Construction sector output experienced more volatile growth after the financial crisis. Its output was then hit the worst by Covid, and, by Q1 2024, its indexed level remained below manufacturing at only 3.9% above its 2007 level.

Figure 4.5: Sectoral output and GDP (indexed)

Source: ONS, First Quarterly Estimate of GDP data tables, May 2024

Sterling exchange rate

The referendum result in June 2016 caused sterling to weaken sharply both against the US dollar and the Euro (see Figure 4.6 for average exchange rate trends).

• Against the US dollar, following a recovery in 2017, sterling weakened in 2018, strengthened in 2021, weakened in 2022, and in 2024 started to strengthen again.
• Against the Euro, sterling has been relatively weak since the referendum, but saw some strengthening in 2021 and, after declining in 2022, sterling strengthened in 2023 and 2024.

Since the referendum, by April 2024, sterling had weakened against the Euro by 11% and the US dollar by 16% (see Table 4.4). This has helped UK exporters and supported the FTSE100 (around 80% of FTSE100 earnings are earned overseas, so, when sterling weakens, the FTSE increases), but also contributed to inflation through higher priced imports.

Some argue that May 2015 is the relevant benchmark because the Conservatives won the General Election with a manifesto committed to hold a referendum on EU membership. The relevant exchange rate falls are 16% against the Euro and 19% against the dollar as shown in Table 4.4.

The Bank of England dropped interest rates in August 2016 (to 0.25%) in response to the referendum. It raised interest rates in November 2017 (to 0.5%) and in August 2018 (to 0.75%), which supported sterling. In response to Covid-19, the Bank dropped interest rates twice – on 11 March 2020 (to 0.25%) and on 19 March (0.10%). From December 2021 to August 2023, reacting to inflationary pressure, the bank rate has risen in 14 steps to 5.25%.

Figure 4.6: EUR/GBP and USD/GBP exchange rates

Table 4.4: Sterling exchange rates

Source: Bank of England spot rates

Inflation

Since the referendum, annual UK inflation (measured using the Consumer Price Index – CPI) initially peaked at 3.1% in December 2017, reduced in 2018 and stabilised in 2019 (see Figure 4.7).  In 2020 the effects of Covid reduced inflation to almost zero but, in 2021, due to supply chain issues and labour shortages, inflation picked up.  The war in Ukraine was a major factor as were global oil and gas prices. CPI inflation peaked in 2022 at 11% and had fallen back to 3.2% by March 2024.

In May 2024, the BoE expected lower oil and gas prices would mean that inflation was likely to drop to around 2% before rising slightly in the second half of 2024.

The BoE also noted the risk that more global shocks could keep inflation high. For example, developments in the Middle East could increase inflation by causing oil prices to rise.

Figure 4.7: Bank of England inflation projection

Source: Bank of England, Monetary Policy Report, May 2024

Employment, productivity and real wages

The UK has high rates of employment but low productivity.

Employment rates

The proportion of people aged from 16 to 64 in work is known as the employment rate. Employment rates had been generally increasing since early 2012 until Covid in 2020 when the rate dipped. It then recovered, but in late 2023 and early 2024 it has fallen slightly.   For the latest period, January to March 2024, the UK employment rate was estimated at 74.5%, still below the pre-pandemic level of 76.1%.

The unemployment rate is close to its lowest since 2006 at 4.4%, but has ticked up slightly in the first quarter of 2024.

Economic inactivity has been increasing since Covid and was at 22.1% in early 2024, but the rate is still below its peak of over 23% for the period from 2020 to 2012.

The OBR noted that the post-pandemic rise in economic inactivity is likely to prove more persistent than previously thought. The number of inactive working-age adults is no longer declining from its post-pandemic peak and has instead rebounded to 9.3 million. This keeps it around its highest level in over a decade and 700,000 more than before the pandemic. Around one third of the working-age inactive population cite long-term illness as their principal reason for not being in the labour force.

Figure 4.8: Employment, unemployment and inactivity rates

Sources:
ONS, Labour Market Overview, May 2024
Office for Budget Responsibility, Economic and fiscal outlook, March 2024

Employment numbers

Figure 4.9 shows the trends in quarterly employment numbers from the first quarter 2015 to 2024. Headline observations:

• Employment of UK nationals has been fairly steady at just under 29 million since 2017 (pandemic excepted).
• Non-UK employment has steadily increased from 3.4 million in mid-2016 (11% of total) to 4.4 million (13% of total) in the first quarter of 2024.
• Non-EU employment exceeded EU employment for the first time (plotted on the right-hand axis) in the fourth quarter of 2023.

In the period January to March 2024, total employment of 33.0 million was made up of:

• 28.5 million (86.4%) UK nationals working in the UK, 432,000 fewer than for a year earlier.
• 4.4 million (13.3%) non-UK nationals, 200,000 more than a year earlier:
  • 2.4 million (7.3%) non-EU nationals working in the UK, 279,000 more than for a year earlier.
  • 2.1 million (6.4%) EU nationals working in the UK, 78,000 fewer than for a year earlier.

The corresponding changes in UK employment since the Brexit vote (comparing Q1 2024 with Q1 2017) have been :

• An overall increase of 1,099,000 million employed, consisting of:
  • 180,000 more UK nationals
  • 921,000 more non-UK nationals, made up of:
    • 1,135,000 more non-EU nationals
    • 214,000 fewer EU nationals

Figure 4.9: Employment trends for UK

Source: ONS, Summary of Labour Market Statistics, May 2024

Productivity

UK productivity growth has slowed since the 2007/8 financial crisis: growth since 2011 has been inconsistent, intermittent and markedly below pre-2008 levels (see Figure 4.10).

Labour productivity is measured, in real terms, as GVA produced per hour worked. Although it has demonstrated weak growth since the 2008 economic downturn, in the previous 10 years it was close to historical long-term average growth rates of 2.0% per year. As Figure 4.10 shows, the long-term trend has been for the growth rate in productivity to decline steadily to near zero.

Output per hour (Figure 4.11) has shown little growth since the pandemic and is out of kilter with the long-term trend.

This is a critical issue because productivity is the main cause of economic growth and largely determines the long-term economic health of a nation. It helps define both the scope for raising living standards and the competitiveness of an economy, and informs government policy. International comparisons show the UK has lower productivity than similar nations.

The new trade barriers and increased bureaucracy associated with Brexit have reduced productivity and competitiveness in the businesses affected.

This sustained period of minimal labour productivity growth has been labelled the UK’s “productivity puzzle”. In December 2019, the Royal Statistical Society named the average annual increase in UK productivity in the decade or so since the financial crisis the “Statistic of the Decade”, reflecting the unusual weakness observed since 2008.

PwC analysis in November 2019 found:

• Labour productivity in the UK has consistently lagged other advanced economies such as France, Germany, Sweden and the US.
• Comparative international evidence suggests that the main reasons for lower UK productivity relative to other advanced economies are:
  • Relatively low UK levels of investment and R&D spending;
  • High number of companies and workers with relatively low productivity and skills.
• UK’s flexible labour markets, supported by migrant workers and longer working lives, may encourage relatively labour-intensive business models

PwC concluded that more upskilling, investment and regionally-balanced growth could help the UK reduce its productivity gap with other advanced economies.

Figure 4.10: Growth in UK output per hour worked 1990 – 2024

Figure 4.11: Output per hour 1997 – 2024

Sources:
ONS, Labour Productivity, May 2024
ONS, Labour productivity, UK: October to December 2019, April 2020
ONS, Productivity flash estimate and overview, UK: January to March 2024 and October to December 2023, May 2024

Real wage growth

Real wages started to grow in the UK from the beginning of 2018, dipped during first stages of the pandemic, and started to rise again from mid-2020 (Figure 4.12). In early 2024 real wages had increased compared to their nadir in March 2014 but were still below their pre-crisis zenith in February 2008.

Real wages fell in 2022 and 2023 as inflation increased (see Figure 4.13). With inflation falling in late 2023 and early 2024, real wages have started to increase again.

Figure 4.12: Real average weekly earnings using CPI (total pay)

Figure 4.13: Real average weekly earnings single-month annual growth rates in Great Britain

Source: Average weekly earnings in Great Britain: May 2024

Why trade matters

Role of trade

Trade plays a critical role in the economy.  Trade allows a country to specialise in producing and exporting goods and services where it has a comparative advantage, which enables it to import other goods and services that it produces less efficiently.  International goods and services exports accounted for 31% of UK gross domestic product (‘GDP’) in 2018.

The government estimated that exports supported 6.5 million jobs in the UK in 2016.  Around 58% (3.8 million) of these jobs were in exporting industries and 42% (2.7 million) were in the UK supply chain of exporting industries. Specialisation raises productivity, which leads to higher real incomes. The government found that roles linked to exports were 21% more productive and 7% higher paying than other equivalent roles.

Imports are also critical: they serve the needs of UK consumers such as for food, electronics, technology, and medicines. More important, most imports are destined for producers, not consumers. Imports and exports, and goods and services are interlinked. Manufacturers use services in the production of goods, and goods traders often trade services. For example, about 30% of firms that export goods also export services.

Before Brexit, more than half of the UK’s imports from the EU – such as raw materials, auto components, chemicals, and business services – were intermediate goods and services or inputs to the production of finished goods and services, many for export. In the other direction, 70% of UK exports to the EU were intermediate goods and services for use by companies rather than consumers. For UK trade with non-EU countries, around 60% of both imports and exports were intermediate goods and services.

See the second section on trade for detailed analysis of UK trade statistics.

Components of GDP

The other main components of GDP expenditure are household spending, government spending and investment. Figure 4.14 shows the breakdown for 2018 (from ONS), the last stable year of trade patterns before preparations for the UK’s EU exit, and, then, Covid disrupted them. Please see the section on investment for trends in business investment and foreign direct investment.

Economists typically use Q4 2019 as a pre-pandemic reference point, but we prefer to use 2018 as our pre-Brexit reference point because ONS regards it as the last year before Brexit began to disrupt trade patterns significantly.

Household spending was 65% of GDP followed by government spending (18% of GDP) and investment, shorthand for ‘Gross Fixed Capital Formation’, (18% of GDP) and a key driver of future prosperity. Trade expenditure is measured as exports minus imports, which results in the trade balance – a small net figure (-1% of GDP). Note that GDP statistics usually exclude inflation because it does not create value: the preferred measure is ‘real GDP’. (Figures below are in 2019 prices and as reported by ONS in February 2022, so there may have been some subsequent revisions.)

Figure 4.14: Components of GDP expenditure

‘Trade openness’ is an important complementary indicator which measures all trade (exports plus imports of goods and services) as a proportion of GDP. It indicates the openness of an economy and its depth of integration with the global economy. The UK’s trade openness was 62% in 2018, above the global average of 57%.

‘Trade intensity’ is another important trade indicator. It expresses exports of goods and services as a percentage of GDP – a measure of the success of ‘global Britain’.  In 2018, UK trade intensity was 31%, just above the OECD average of 30%.

Sources:
Department for International Trade, Estimating the relationship between exports and the labour market in the UK, 10th March 2021
Institute for Fiscal Studies, Firms’ supply chains form an important part of UK-EU trade: what does this mean for future trade policy?, 8 January 2018
UK Trade Policy Observatory, Links between services and manufacturing trade in the UK: Mode 5 and Beyond, January 2022, Ingo Borchert, Michael Gasiorek, Guillermo Larbalestier and Nicolo Tamberi
World Bank, Trade as % GDP
GDP first quarterly estimate, UK: October to December 2021, Office of National Statistics, 11 February 2022
OECD, Trade statistics

Brexit impact

Brexit has hindered rather than helped the UK economy, but views differ on the extent of the impact and its timing.

GDP growth rate

Before the Brexit vote in 2016, the UK economy was growing faster than most G7 economies (see Figure 4.15). With the arrival of Covid in 2020, UK GDP growth dropped to the lowest of the G7 and plunged the deepest.  The UK economy then responded by growing the strongest of the G7 in 2022. However, by 2023 and early 2024, the UK had slipped back to the bottom of the G7 growth table.

Figure 4.15: UK GDP growth vs G7 (2015-2024)

The recent weakness of the UK economy is shown by comparing it with the pre-pandemic position. As of Q1 2024, the UK economy was only 1.7% ahead of Q4 2019 in real terms. This is the worst performance in the G7, apart from Germany (see Table 4.16 from a House of Commons Briefing in May 2024).

Figure 4.16:  Comparisons of G7 GDP change Q1 2024 compared to pre-pandemic

Views on economic impact

Economists face three challenges: estimating the long-term impact of Brexit, how much has already happened and, by implication, how much is likely to come. In making their assessments, they also need to disentangle the effects of other major disruptions such as the pandemic and Russia’s invasion of Ukraine.

Recent estimates of the long-term harms to GDP range from 1% (IEA) to 4% (OBR), 5.7% (NIESR) and 8% (Goldman Sachs).

Estimates of the economic impact that has already happened range from 1% to 5.5%:

• IEA estimates the impact to date at 1%;
• OBR estimates that GDP is 1.6% lower than it would have been;
• Professor Jonathan Portes of Kings College London argues for 2-3% (mainly because of higher immigration than expected);
• NIESR put the impact to the end of 2023 at 2.5%;
• Goldman Sachs puts it at 5%;
• The Centre for European Reform found the GDP impact to be 5.5% by the end of Q2 2022.

NIESR estimates that the impacts of Brexit will escalate to reach 5.7% by 2035. The IEA (the outlier) argues that unspecified long-term economic benefits will emerge.

Economists agree that the main factors driving weaker economic performance are:

• reduced productivity;
• trade effects:
  • non-tariff barriers on UK-EU trade which disadvantage the UK;
  • lower trade volumes (both imports and exports);
  • immaterial benefits from new UK trade deals.
• weaker business investment;
• reduced immigration from the EU leading to labour shortages offset in part by increased non-EU immigration.

Sources:
Goldman Sachs, The Structural and Cyclical Costs of Brexit, February 2024
House of Commons Library, GDP – International Comparisons: Key Economic Indicators, May 2024
OBR, Brexit analysis, May 2024
OECD database
Professor Jonathan Portes, How much has Brexit cost the UK economy? June 2023
Jonathan Springford, Centre for European Reform, Are the costs of Brexit big or small?, May 2023
IEA, Has Brexit really harmed UK trade?, November 2023
NIESR, NiGEM Topical Feature,Revisiting the effect of Brexit, Autumn 2023

Impact on trade openness

Trade openness is the ratio of goods and services trade to GDP and indicates how much an economy benefits from trade. The ratio depends on structural, historic and cultural factors which means that the relative position of one country to another should not normally change dramatically.

The G7 has a wide range of trade openness, bounded by the US with the low ratio of less than 30% and Germany with the high ratio of over 90%  (see Table 4.5). Figure 4.17 shows trends in indexed ratios to highlight the relative changes between countries (with Q4 2018 being 100).

The figure shows that the UK has experienced the largest fall trade openness in the G7 since 2018. This is consistent with the UK putting up trade barriers with the EU’s single market and the relative reduction in trade growth that results.

Figure 4.17: Trade openness

Table 4.5: Trade openness

	2015 Q1	2018 Q4	2024 Q1	2024Q1 - 2018Q4
Canada	65.7%	65.7%	65.7%	0.0%
France	60.9%	65.4%	65.1%	-0.3%
Germany	85.8%	91.5%	93.9%	2.4%
Italy	56.4%	61.6%	64.9%	3.3%
Japan	35.8%	38.2%	38.7%	0.5%
United Kingdom	57.5%	61.1%	58.5%	-2.7%
United States	27.8%	28.2%	27.5%	-0.8%
G7 weighted average	43.1%	45.1%	44.2%	-0.9%

Last updated on 27th August 2024 by Richard Barfield