Has Brexit affected the supply capacity of the economy?

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Published on 06 March 2020

Growth in the potential supply capacity of the economy has slowed, driven by weaker productivity growth. We believe that Brexit-related factors have contributed to some of the recent weakness.

The Bank of England’s Monetary Policy Committee (MPC) conducts a regular assessment of supply-side conditions. It assesses how quickly the supply capacity of the UK economy can grow, which puts a ‘speed limit’ on the pace of sustainable demand growth.

Supply capacity is mainly determined by structural factors, such as technological progress, the size and skills of the labour force, the quantity and quality of capital, and the degree of openness of the economy.

Potential supply growth has been subdued since the financial crisis, driven by weaker productivity growth, which has averaged around 0.5% per year since the crisis, compared with around 2.25% beforehand (Chart A).

Chart A Potential supply growth has slowed and is expected to remain subdued

Decomposition of estimated potential supply growth (a)

Sources: ONS and Bank calculations.

(a) Average percentage point contributions to annual growth. For more information see Table 4.A of the January 2020 Monetary Policy Report. Potential productivity growth is based on a growth-accounting framework using a constant returns to scale Cobb-Douglas production function, with total output to capital elasticity of ⅓.

Some of the recent weakness in productivity growth is likely to reflect a continuation of persistently weak productivity growth since the crisis. Some is also likely to reflect Brexit-related factors, such as heightened uncertainty and contingency planning.

Heightened Brexit-related uncertainty is likely to have weighed on underlying productivity growth. Business investment has slowed as firms have been incentivised to delay spending until they have more clarity around the future trading relationship between the UK and the EU. That has caused capital per worker to grow more slowly, lowering labour productivity growth.

Our Decision Maker Panel (DMP) Survey also suggests that companies are spending money and senior management time on Brexit planning. That could have diverted resources away from other activities.

Planning for Brexit has been correlated with weaker productivity growth across sectors. Since the EU referendum, productivity growth in the manufacturing and finance sectors has remained weak, and these sectors have also spent the most time on Brexit planning (Chart B).

Chart B The manufacturing and finance sectors have spent the most time planning for Brexit

Time spent by chief financial officer (CFO) on Brexit planning by sector (a)

Sources: DMP Survey and Bank calculations.

(a) Question: ‘On average, how many hours a week is the CFO of your business spending on preparing for Brexit at the moment?’. Respondents are asked to choose between ‘None’, ‘Up to 1 hour’, ‘1 to 5 hours’, ‘6 to 10 hours’, ‘More than 10 hours’ and ‘Don’t know’. Responses collected between August and October 2019. Point estimates are constructed by using values of 0, 0.5, 3, 8 and 15 for the respective categories.

This post has been prepared with the help of Louise Johnston.

This analysis was presented to the MPC as part of its January 2020 round.

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