The harder the Brexit, the worse it is for Ireland

The resilient British economic data in the immediate wake of the Brexit vote may have led to some hope in Ireland that the economic risks might be contained. The collapse in sterling over the past 10 days and talk of a " hard" Brexit have been a big reality check.

For Ireland, the move to Brexit brings two economic threats: clear short-term risks, and huge uncertainty about the future. Above all, the problem in the next year or two could be volatility – in currency markets, in confidence,in trade and in investment. Beyond that, who knows, though the rough rule for Ireland is the harder the Brexit, the worse the outcome.

Government forecasters and private sector economists have crunched the numbers. The official GDP growth forecast for next year has been cut by half a point to 3.5 per cent, though the sums for this were done before sterling’s latest fall. The rough guide is that every 1 per cut in UK growth hits Ireland by 0.3-0.4 per cent. But all sides concede that the many uncertainties of Brexit could lead to more damage.

A landmark study by the Economic and Social Research Institute last year warned that Brexit could reduce bilateral trade flows between Ireland the UK by 20 per cent or more in time. Looking at the island of Ireland, the ESRI pointed out that the Republic was a more important market for the North that vice versa.

Free movement

But lying behind the numbers are the great uncertainties. What will Brexit mean for UK growth, a vital factor for our exporters? Can sterling fall much further? How will Britain’s talks with the EU affect the terms on which we trade with Britain and, perhaps most importantly, the common travel area which allows free movement of people?

“Words like ‘paradigm shift’ sound very hackneyed but in my career in business it is hard to imagine anything so pervasive and critical,” according to Feargal O’Rourke, managing partner of advisory company PwC. “And one of the key issues is that the scale of the uncertainty makes planning very difficult. And it does. Though that is not a reason for us to bury our collective heads in the sand.”

Standard economic models suggest a loss to Irish GDP of between one and three percentage points after a decade, depending on the new trading arrangements, according to Alan Ahearne, economic professor at NUI Galway. However, he warned that disruptions to trade, particularly from new regulations and any reinstatement of the Border on the island of Ireland, are the kind of factors whose impact is often underestimated by standard forecasts. Like pretty much every other Irish forecaster, he warns of the “ downside risks”.

The immediate focus is sterling. There is no one exchange rate of the pound to the euro which pushes Irish exporters into trouble. But we are already deep into challenging territory. A year ago Irish exporters were benefiting as sterling was around 70p to the euro, its strongest for a decade. The change since then has been a shuddering wake-up call and if sterling heads for parity, then a big challenge will become a crisis.

Irish business have no choice but to get on with it. “Overall it’s a major challenge, but one we can overcome by diversifying exports beyond the UK, although this is not easy to achieve in the short term,” according to Alison Cowzer, co-founder of East Coat Bakehouse, a new large-scale biscuit manufacturer based in Drogheda. She points out that 70 per cent of Irish prepared consumer food exports go to the UK – and that the same companies also typically face UK competitors in the Irish market.

Exposed to sterling

A study published with last week’s budget by the Department of Finance showed that the areas most exposed to sterling’s fall and to disruption to trading links were mostly Irish-owned manufacturing such as food and traditional manufacturing areas such as engineering, with employment concentrated outsider Dublin. They employ close to 100,000 people.

Nor is there an easy or quick answer for the Irish businesses affected . “This represents a fundamental shift,” says O’Rourke of PwC . “ It is not a uni-dimensional problem – it is rather a knotty, difficult, multi-layered and complex issue. It will critical require a complete re-examination of companies’ operating models.”

Economic forecasters in Dublin fear more sterling pressure is to come. “The collapse in sterling is already being felt in the low-margin agri-food sector in particular,” according to Dermot O’Leary, chief economist at Goodbody Stockbrokers.” With further downsides remaining for sterling, the pain is likely to worsen and affected businesses will hold off investing.

And the fall in sterling has other immediate impacts. Shoppers are starting to cross the Border again into the North, particularly for big ticket items. Online sterling purchases by Irish shoppers are soaring. And looking the other way there are impacts, too. One Belfast woman who booked her wedding reception in Donegal has seen the sterling cost rise from £20,000 to £23,000 in a couple of weeks. It is symptomatic.

Benefit in short term

Jobs in similar sectors are at risk in the North’s economy – but the problems are obviously different. Food and traditional manufacturing exporters are the main companies in the North exporting to EU markets – of which the Republic’s economy is the largest market. They may be benefiting in the short term from the fall in the value of sterling, but they also face considerable uncertainty, with a slowdown in their key British markets and the prospect of tariffs and other barriers to trade with the EU in the years ahead.

Growth predictions for the North have been cut. Danske Bank, for example, has cut its growth forecast for this year from 1.6 per cent to 1 per cent and, more significantly, for next year form 1.9 per cent to just 0.5 per cent. The other big threat to the economy in the North is the potential loss of EU subsidies, particularly to the farming sector but also to support investment.

For the island of Ireland, there are three key economic factors here. The first is the exchange rate. The second is the trading arrangements after Brexit – will there be tariffs applied on trade between Britain and Ireland? But the third factor is the most emotive. If a Border is re-erected on the island of Ireland it will be seen as a step back in time to the days of the Troubles – and a massive blow to the economic and social relationship which has built in the meantime.

There are an estimated 14 million crossings of the Border each year, a vital cog for business,tourism and daily life – and for business supply chains.The potential disruption and complications are enormous.

For the Republic there is also the wider issue of the free travel area with all of the UK. With the UK tightening immigration controls there are real questions about the future of this arrangement. The UK labour market has traditionally acted as a destination for Irish emigrants, particularly at time of high unemployment. Already an estimated 400,000 people who were born in the Republic are resident in the UK.

As these longer-term issues are worked through, the sterling factor highlights the potential short-term costs of the move to Brexit, for the Republic anyway. There may be some upsides, too, particularly the potential relocation of financial services companies from the City of London.

Magnitude

But, as John McHale, economics professor at NUI Galway and the head of Ireland’s independent budgetary watchdog, the Irish Fiscal Advisory Council, puts it: “When weighed against the magnitude of the potential negative consequences, any opportunities for Ireland from Brexit appear to offer only marginal consolation. And even this potential upside would bring its own challenges given the severe shortage of dwellings in Dublin city and the further pressure this could put on house prices and already high rents.”

How can the Republic prepare for this potential influx of new business? Office supply is on the up. The commercial property market has shown itself to be quite responsive to increased demand in the past, according to Dr John McCartney, director of research at Savills, a Dublin estate agency. A greater concern, he feels, is the tight supply of residential housing. Vacancy rates in the residential market are now below 2 per cent, he says and this is rapidly inflating rents.

There are other opportunities. Ireland might also gain from FDI in other sector which would otherwise have located in Britain, coming to Ireland instead. O’Rourke of PwC also says EU companies could buy inputs in Ireland rather than the UK, to avoid tariff barriers, he says. Also companies could choose to manage more of their supply chains from the Republic, given the potential complications and costs of moving goods through the UK.

Niamh Bushnell, the Dublin Start-up Commissioner, sees the pluses and believed there is an “FDI 2.0” opportunity to attract operations of UK-based companies who want to “passport” into the EU to access research grants, investments and customers. “We have a superb track record of setting up small offices for companies here that become large offices in time.” She also believes Ireland can create an environment to attract entrepreneurs now feeling unwelcome in the UK, though she believes the changes in the recent budget were too timid on this score.

And then there is the transition of the next few years. Initially senior Irish officials had hoped Britain would move for a softer Brexit, retaining membership of the single market and the customs union. But with immigration control appearing a key factor in London, this does not seem possible. Now two years of tough talking will take place on exit terms. And then there will be future years of working out a new trade deal, and a decision to be made about what happens after Britain leaves Europe but before new trade arrangements are reached.

It is impossible to run this through any economic model. There are simply way too may variables. The simple rule of thumb is that for Ireland, the harder the Brexit, the bigger the risks – to sterling, to future trade arrangements and to the Border and freedom of movement.

Former Irish government minister Ruairí Quinn said last week that this was the biggest crisis faced by Ireland since the outbreak of the second World War in 1939.This time the battlegrounds will be trade, commerce and migration, but the scale of what is happening is indeed slowly becoming apparent.