Quarterly Economics Briefing Special Report July 2016
Potential Impact of Brexit on the US Economy and
Implications for Workers Compensation
By Leonard Herk, PhD, Miguel Henry, PhD, and Tanya Restrepo
The Brexit Vote
On June 23, 2016, United Kingdom (UK) voters participated in a referendum on Brexit: “Should the United Kingdom remain
a member of the European Union or leave the European Union?” About 52% of Britons voted to leave the European Union
(EU), the UK’s major trading partner. The EU accounted for 45% of the UK’s exports and more than three million exportlinked jobs during 2014, according to a recent report by the House of Commons. The unexpected decision to exit the EU
has sparked debate about the economic and political consequences of Brexit for the UK, the EU, the United States (US),
and the rest of the world. This note focuses on potential economic impacts of Brexit on the US and its possible implications
for workers compensation.
Although the Brexit vote is over, the UK must now go through the formal and legal process of leaving the EU. Once the UK
invokes Article 50 of the Treaty on EU, the provision that regulates the process of a member state withdrawing from the
EU—officially giving notice of intent to leave the EU—the UK will have two years to negotiate and conclude a withdrawal
agreement with the EU. As part of the withdrawal process, the UK will need to renegotiate trade agreements with multiple
trading partners, including the US.
The new status quo for the UK is unknown at this time, because Brexit could play out in several different ways. The
Financial Times has suggested that the best option for the UK would be to strike an agreement similar to that of Norway,
which is not an EU member but participates in the EU’s Single Market. While seemingly attractive, a Norway-style
agreement seems unlikely because the Single Market would preclude the UK from limiting immigration from the EU, one of
the main objectives of the Brexit vote to leave. An alternative would be for the UK to renegotiate its trade status as a third
country vis-à-vis the EU, as this would preserve the UK’s autonomy to undertake new bilateral agreements with other third
countries. Although the UK will have more flexibility negotiating alone, it will also have less bargaining power compared to
the EU. In addition, its counterparties to trade agreements will know that the UK needs to strike deals, giving them
negotiating leverage. In short, the Brexit referendum is clear as to the UK leaving the EU, but not as to the international
agreements that will replace EU membership. Whatever the final outcome, it is likely to have significant impact on trade,
immigration, and foreign direct investment in the UK.
Potential Effects of Brexit on the US Economy
Brexit is a watershed event for the UK, but what about the US? While some effects of Brexit on the US economy are
inevitable, their magnitude is uncertain, especially since a lot remains to be resolved in the UK exit process. The
consensus opinion among economists is that Brexit’s eventual consequences for the US are likely to be minor. For
example, Moody’s Analytics expects that Brexit will be a big shock to the UK and EU economies, but that it will have little
impact on the US—reducing the growth rate of US gross domestic product (GDP) by 0.1 percentage points over the next
year. We share this opinion. However, we also note that if other countries should decide to leave the EU, causing
fragmentation of the European trading block or affecting the Euro monetary union, then the effects on the US economy
could be much larger than those that are likely via Brexit alone.
Brexit can impact the US economy via two key channels—trade and financial.
The immediate effect of Brexit requires the UK to renegotiate trade agreements with the EU and other countries, including
the US. Uncertainty about the new international terms of trade will disrupt and depress UK trade flows in the immediate
future as renegotiation continues. It also may reduce long-term trade flows if new trading agreements are more restrictive
© Copyright 2016 National Council on Compensation Insurance, Inc. All Rights Reserved.
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than those that the UK currently enjoys with EU membership. According to the International Monetary Fund, the UK
currently has a trade deficit in goods with the EU and a small surplus with the US and Japan. The expectation of an
increased UK trade deficit, and possibly a recession, following Brexit is causing the pound sterling to depreciate against
other major currencies, especially the Euro and the US dollar. From June 23 to July 6, the pound depreciated 13% against
the US dollar to its weakest level in over three decades.
Nonetheless, the effect of Brexit on the US is likely to be small. This assessment takes into account that the UK is not one
of the US’s largest trading partners. In 2015, exports to the UK made up only 3.7% of all US exports. Moody’s forecast that
Brexit might shave 0.1% from US GDP growth in the coming year is based on the assumption that US exports to the UK
will drop to half of their current level.
US export sectors most likely to be impacted by Brexit are predominantly manufacturing and technology. In addition, the
investment banking and financial services sector merits specific mention. London’s status as Europe’s financial center has
depended on EU “passports” held by London banks and financial services firms, which allow them to sell services
throughout the EU. It is unclear how London’s financial industry will operate under new agreements to be negotiated as a
result of Brexit. For example, financial firms currently located in London may need to establish subsidiaries in other EU
countries—an expensive and time-consuming process. A diminished role for London as a financial center would impact
US-based investment banks and financial services companies that have operations in London.
Apart from the trade channel discussed above, the financial channel refers to international flows of investment capital as a
consequence of Brexit. Perhaps the most obvious immediate effect of the Brexit vote has been its impact on the US stock
market. The Standard & Poor’s 500 (S&P 500) stock index dropped 5.3% in the two days after the Brexit vote was
announced, but has since rebounded. In our opinion, the eventual impact of Brexit on US stock prices will mirror its
eventual impact on the US economy. Because we expect a minor impact on the US economy, we anticipate a minor and
transitory impact on US equity markets as well.
A separate but related question is Brexit’s potential effect on US interest rates, especially nominal rates of return to
benchmark US Treasury securities. Momentarily at least, a “flight to safety” of international investment capital has tended
both to lower and flatten the US Treasury yield curve. The yield to the 10-year US Treasury bond closed below 1.4%
shortly after the Brexit vote for the first time on record. Whether international investment flows into US assets, particularly
U.S. Treasury securities, are a transitory or longer-term effect of economic uncertainty relating to Brexit remains an open
question for now, and one whose resolution—like trade effects—will depend on how Brexit plays out in the future.
Meanwhile, a couple of observations are pertinent.
First, Brexit appears to have stayed the Federal Reserve’s inclination to raise the Federal Funds rate, at least at its July
meeting. Second, flows of financial capital into the US increase the demand for US dollars, thus strengthening the dollar’s
exchange rate against most other foreign currencies—not only the British pound—and impacting US exports more broadly
with other trading partners besides the UK. Overall, we regard the potential effects of Brexit through the financial channel
as secondary consequences of its impact through the trade channel, and likely to be minor.
Brexit and Workers Compensation
Our preceding discussion suggests three possible impacts of Brexit that are relevant to workers compensation. The first
and most significant impact involves the reduction of US exports to the UK. This is likely to most directly affect companies
involved in manufacturing and technology, and also in financial services. However, the overall impact should be modest
because the UK accounts for a modest share of US exports. A secondary impact to exports will come from the appreciation
of the US dollar in relation to international currencies besides the pound sterling. Because the dollar’s appreciation against
other currencies is largely a result of financial flows into the US, its persistence will depend on the persistence of global
economic uncertainty, to which Brexit itself is a relatively minor contributor. A third effect relates to Brexit’s impact on the
term structure of interest rates. As we have observed, investment inflows to the US in the aftermath of Brexit have tended
to lower and flatten the US Treasury yield curve.
Lower exports, due either to reduced trade with the UK or to appreciation of the dollar exchange rate with other trading
partners, can negatively impact payroll in affected industries. Constrained investment returns, particularly at longer bond
maturities, can reduce investment income and may incentivize insurers to shift their portfolios into riskier or less liquid
asset categories in search of higher yields. As an offset, a continuation of low interest rates would be positive for mortgage
financing in the construction sector, which is already recovering in most regions of the US. (See our discussion of the
construction sector in the Quarterly Economics Briefing of March 2016 at ncci.com.)
We expect the overall impact of Brexit on the US economy, and therefore on workers compensation, is likely to be
minor. Notwithstanding the minor impact to workers compensation as a whole, individual risks could be impacted to varying
degrees.
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