Download The UK Legal Services Sector and the UK: An analysis by Oxford

THE UK
LEGAL SERVICES
SECTOR AND
THE EU
An analysis by Oxford Economics, commissioned by
the Law Society of England and Wales
SEPTEMBER 2015
The UK legal services sector and the EU
The three scenarios modelled for this report were
chosen by the Law Society in order to test the
sensitivity of the results to the possible effects of
complete UK withdrawal from the EU across four
core modelling dimensions (migration, foreign
direct investment, trading relationships and fiscal).
These represent four areas which could be impacted
significantly by how the UK government would opt to
use its newly achieved policy autonomy as a result of
a BREXIT.
It should be recognised that whilst best efforts were made to ensure that
the modelling was as comprehensive as possible, certain limitations made it
impossible to fully take into account all relevant economic factors. The scenarios
were developed based on a set of assumptions by the Law Society Research Unit,
guided by research and expertise from Oxford Economics, to reflect the impact
of a UK withdrawal on the resulting trade, fiscal and regulatory settlement.
Oxford Economics provided guidance on how these scenarios could be formed
(based on relevant empirical data) and the type of variations that could be
adopted to implement sensitivity testing around a scenario where Most Favoured
Nation tariff rates applied in the absence of fresh trade agreements (which were
assumed in the central and upside cases).
The modelling process was carried out by an independent third party, Oxford
Economics, with acknowledged expertise in macroeconomic modelling and
scenario analysis.
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An analysis by Oxford Economics, commissioned by the Law Society of England and Wales
INTRODUCTION
This report discusses how the UK’s withdrawal from
the EU could affect the legal sector, relative to the rest
of the UK in economic terms.
To date, no analysis has been available to demonstrate the range of possible
economic effects of a UK withdrawal on the legal services sector specifically,
compared with potential impacts on the UK as a whole.
Effects on output and employment
are negative under all three scenarios.
The scenarios will provoke discussion
and, read with our Executive
Briefing document, will provide an
unprecedented picture of the possible
futures for the UK legal sector postEU referendum.
Our headline findings are that:
• Legal services would be disadvantaged disproportionately
compared with the UK economy as a whole.
• The stronger negative effects on the legal services sector are
due to the sector’s reliance on intermediate demand from
sectors which are likely to be adversely affected by a UK
withdrawal from the EU, particularly the financial services sector
and other professional services, and from the subsequent lower
levels of business investment.
• The scale of the impact would depend on economic drivers
shaped by the UK’s withdrawal negotiations and subsequent
UK government policy actions.
Analysis providing an independent view under three economic scenarios –
downside, central and upside – produced forecasts to 2030 for economic output
and employment in terms of total numbers of jobs.1 The effects are compared
against baseline forecasts for output and employment (what is expected
to happen in the status quo situation with the UK’s membership of the EU
unchanged).
1
Economic output of legal services is the
sector’s contribution to the economy as
measured by Gross Value Added (GVA).
This measure is used in national statistics
to indicate the value of goods and services
produced in a sector or geographic area. For
the purposes of our analysis legal services
GVA is compared with GVA for the UK as
a whole (equating to standard, published
GDP less taxes plus subsidies on products).
The total number of jobs corresponds to
the workforce jobs measure from national
statistics.
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The UK legal services sector and the EU
Background
The government has committed to hold a referendum on the UK’s membership
of the EU by the end of 2017. The decision will have profound effects on the UK
including, critically, economic implications.
The Law Society commissioned consultants Oxford Economics to extend their
industry-leading Oxford Global Economic Model to provide an independent
assessment of the potential effects of a UK withdrawal on the legal sector
relative to the wider UK economy. This is, to our knowledge, the first attempt to
date to estimate the economic effects of a UK withdrawal on the legal sector
against those for the UK.
Figure 1: Possible outcomes
following UK referendum on
membership of the EU
EU MEMBERSHIP
RETAINED
The outcomes of a withdrawal are uncertain and depend on any arrangements
that the UK government could negotiate with the EU upon exit, to safeguard
the UK’s interests. Withdrawal is, however, likely to result in one of the range of
possible outcomes summarised in Figure 1.
“THE NORWAY OPTION” –
LEAVE EU BUT BECOME
MEMBER OF THE EEA
Under the three alternative scenarios used in the analysis (downside, central
and upside) the path of economic drivers are affected to different degrees in
recognition of the uncertainty over:
• The UK’s negotiated arrangements if it were to withdraw from
the EU.
“THE SWISS OPTION” –
FTA PLUS BI-LATERAL
NEGOTIATION
• How the UK chooses to use greater autonomy over policy areas
such as business regulation.
“THE TURKEY OPTION” –
CUSTOMS UNION
GO IT ALONE –
WTO MEMBERSHIP
Source: Oxford Economics
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LESS INTEGRATION
The negotiations are likely to feature trade-offs involving access to the single
market, the UK’s fiscal contributions, and policy autonomy over areas such
as immigration and regulation. These issues represent political and societal
concerns. The approach of this report is to present an analysis of a range of
possible economic impacts on the legal services sector compared with the UK as
a whole.
An analysis by Oxford Economics, commissioned by the Law Society of England and Wales
The Oxford Economics modelling framework
The model captures how the changes in the overall level and
composition of demand, as affected by the economic drivers
cited below, cascade through industry sectors including
legal services.2 Its strength is in being able to capture the
interdependencies between sectors and the wider global
economy in order to gauge the impact of significant external
‘shocks’ such as the UK’s exit from the EU. No sector-specific
drivers are included in the economic modelling, for example,
the effects on volumes of work for City of London law firms
from the financial services sector due to a shift of euro
trading from London to Frankfurt or Paris following a UK
withdrawal, are not explicitly taken into account, neither
are regulations that might change governing particular
industries.
This modelling framework used as a standalone tool is not
designed to estimate the impact of every specific eventuality
(to do so would defy the aim of an economic model). While
the economic modelling and long term forecasting does not
account for particular industry events or regulations that
may affect legal services firms, or indeed a potential positive
short term boost for some areas of legal work due to a UK
withdrawal, the historical patterns of supply and demand
between sectors are reflected in the model. More information
on the modelling framework is available on request.
London
Frankfurt
The Oxford Economic model itself consists
of thousands of interlinked equations based
on historical correlations and economic
theory.
2
Paris
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The UK legal services sector and the EU
HEADLINE FINDINGS
Following a UK withdrawal from the EU, moderate
negative economic effects for the legal services sector
would nevertheless be stronger relative to those for
the UK as a whole.
The effects of a UK withdrawal on key economic drivers are assumed to start in
2020, allowing for a period after the referendum for the UK’s negotiation and
effective withdrawal. Details of the drivers and approach to assumptions that
underpin downside, central and upside scenarios are described on pages 8-11.
The full effects on output and employment will be felt by 2030, with results for
that year shown in Figure 2 below.
Distinguishing features of the results
shown in Figure 2 are:
• Effects on output and
employment are negative
under all three scenarios.
• The negative effects range
from small to moderate by
2030 relative to baseline
forecasts; effects are smaller
for employment than output
across all scenarios.
• Negative effects on the
legal services sector
are generally greater in
magnitude than those for
the UK economy as a whole
in terms of both output and
employment.
Figure 2: Effects on legal services output and employment, 2030, under downside, central and
upside scenarios (% deviations from baseline forecasts)
Downside
Central
Upside
0%
-0.5%
-1%
-1.5%
-2%
-0.6%
0%
-1.4%
-3%
-4%
-5%
-4%
Economic output
(Gross Value Added)
Employment
Source: Oxford Economics and Law Society calculations
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Comparable UK deviations
An analysis by Oxford Economics, commissioned by the Law Society of England and Wales
Although the negative effects by 2030 are estimated to be relatively small in
percentage terms, the absolute volumes of lost output forecast can be viewed in
the context that:
• In the downside scenario, projected annual output loss for
the legal services industry in 2030 (£1.7 billion in 2011 prices)
equates approximately to the current combined annual UK
revenue of Linklaters, Freshfields Bruckhaus Deringer, Clifford
Chance and Allen & Overy (on a constant price basis).
• The upside scenario implies an annual loss of £225 million legal
services output in 2030 – approximately the current annual
income of the tenth largest law firm ranked by UK revenue.
The losses in 2030 would follow a gradual erosion of legal services output (versus
the baseline forecast) over time, such that the cumulative loss of output and
employment in the legal services sector (and UK economy as a whole) would be
greater than simply the value of lost output in 2030 itself.
Moreover the loss of output compared with the status quo (the UK remaining
a member of the EU) may persist for a relatively long period if the UK fails to
achieve sufficient economic integration with other trading partners to be able to
offset the impacts following withdrawal.
Although the scale of potential losses are compared with the income of large
legal firms named above, the data and modelling framework utilised is not
designed to allow analysis of how the effects of EU withdrawal would be
distributed across functional or spatial areas of the legal services market, or
by size of firm. The box on page 5 contains further detail of the modelling
framework.
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The UK legal services sector and the EU
DRIVERS UNDERPINNING CHANGES IN LEGAL SERVICES
AND UK OUTPUT AND EMPLOYMENT
The UK accesses a single market which promotes
free movement of goods, services, capital and people
within the EU while contributing significantly to the
EU budget (annual net contributions ranged between
£8 billion and £10 billion in recent years).
The selection of economic drivers to analyse potential changes in output and
employment was in the context of macroeconomic factors that stand to be
affected by the UK’s departure from the single market, and the fiscal and other
policy commitments that the UK currently makes in order to access the market.3
Four key economic drivers are responsible for changes in output and employment
within the Oxford Economics modelling framework under BREXIT scenarios:
• Trade tariffs on goods. The decision to move to a WTO trade
model in the event of EU withdrawal is likely to result, at least
initially, in an overall increase in effective external tariffs.
• Foreign Direct Investment (FDI). Lack of free access to the
single market would affect the UK’s attractiveness as a host
location, leading to a likely reduction in FDI.
The forecast paths of the four
economic drivers determine, along
with other economic factors, the
baseline output and employment
forecasts against which our headline
results are compared. The original,
baseline forecasts for three of the
four key drivers are shown in Figure 3
(FDI, net UK contributions to the EU
budget, and net migration). Trade
tariffs on goods are not shown,
because effective tariffs are assumed
to stay as they are under the
baseline.
To analyse the economic impacts,
Oxford Economics considered how
the four drivers could deviate from
baseline projections under the three
alternative economic scenarios, to
provide bounds for inclusion in the
model. The assumptions for how the
four drivers could deviate are outlined
in the next section.
• Net migration. A decrease in inward migration (both skilled and
unskilled) into the UK would follow from the UK government
being able to restrict inflows of EU migrants.
• Fiscal contributions to the EU budget. A direct fiscal impact
would result, to the extent that the UK’s net contribution to
the EU budget is affected (the UK’s gross contributions minus
receipts).
All other economic and demographic changes to baseline forecasts within the
Oxford model stem from changes in the four drivers above (for example net
migration affects population projections within the model, and FDI influences
capital stock). The selection of trade tariffs on goods as a driver, rather than on
all goods and services, reflects not only data availability, but also that there is
currently only a nascent free market in services within the EU. Country-specific
regulations restrict cross-border transactions in tradable services, and these
would still apply.4
The available modelling framework also involves some restrictions in terms of the specific economic indicators that can be considered.
Further detail is provided in the Review of the Balance of Competences between the United Kingdom and the European Union, The Single
Market: Free Movement of Services, HM Government, Summer 2014.
3
4
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An analysis by Oxford Economics, commissioned by the Law Society of England and Wales
Figure 3: Forecasts for foreign direct investment, net migration, and UK fiscal contributions to 2030 under the status quo where
the UK remains a member of the EU
Forecast net UK contributions to the EU budget (£ billions)
Forecast total UK inward FDI flows (£ billions)
16
100
90
14
80
12
70
10
60
50
8
40
6
30
4
20
2
10
2030
2028
2026
2024
2022
2020
2018
2016
2030
2028
2026
2024
2022
2020
2018
2016
2014
Source: Oxford Economics
2014
0
0
Source: Oxford Economics
Forecast net migration to the UK (thousands)
Non-EU net
migration
Total EU net
migration
Skilled EU net
migration
Unskilled EU net
migration
120
110
100
90
80
70
60
50
40
30
20
10
0
2014
2015
2016
2017
2018
2019
2020
2021
Source: Oxford Economics
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The UK legal services sector and the EU
SCENARIOS AND THE APPROACH TO ASSUMPTIONS
Alternative assumptions for economic drivers used the
most appropriate available data, academic studies,
and judgement of best and worst case scenarios.
Three scenarios involving alternative changes to the economic drivers reflect the
uncertainty surrounding the nature of the UK’s exit from the EU should this occur.
The extent of deviation in the economic drivers from baseline forecasts under the
three scenarios was modelled using the best available current evidence (including
academic studies) and, in some cases, judgement to inform:
• The likely maximum and minimum deviations that could be
expected for each economic driver should the UK leave the EU
and, where necessary.
• Subsequent changes to UK economic and trade policy that
would follow the UK’s exit.
Actual changes to domestic economic and trade policy would be a function of
the arrangements that Britain negotiates with the EU and other trading partners,
and the policies that the UK pursues as a non-EU member.
As highlighted above, the assumptions regarding economic drivers have
knock-on effects within the model on other economic and demographic factors
(population, capital stock, productivity and prices). The table included as an
appendix provides a list of all factors within the model that were directly altered
to calibrate the scenarios, full details of the approach and evidence used to form
assumptions, and the resulting scale of deviations in economic drivers from their
baseline forecasts.
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An analysis by Oxford Economics, commissioned by the Law Society of England and Wales
While three scenarios were formulated the bounding scenarios are broadly
characterised as:
Upside
• Trade negotiations proceed swiftly and successfully, meaning
new trading relationships are established relatively quickly
following the UK leaving the common market.
• The UK uses an exit from the EU as an opportunity to liberalise
economic conditions, helping to offset some of the negative
impact that losing access to the single market has in terms of
FDI and migration.
• The fiscal windfall (saving from net contribution to the EU
budget) is used to cut taxes for workers and businesses.
Downside
• Trade negotiations reach an impasse resulting in the UK failing
to reach any subsequent trade agreements with the EU or
outside partners.
• The UK fails to use the opportunity offered to enhance the
economic and business environment.
• The fiscal windfall is used to support an increase in spending on
welfare and frontline services.
The approach to forming assumptions regarding the paths of economic drivers
did not involve predicting changes based explicitly on political choices that
the UK may have to make in any post-withdrawal negotiations with the EU,
for example, between maintaining access to the single market and autonomy
over policy areas that the UK may enjoy as a non-EU member. Rather the
approach was to make assumptions about realistic bounds for economic drivers
by considering each driver in isolation, and based on what the UK may or may
not be able to achieve through its own domestic economic policies and trade
negotiations following a UK withdrawal from the EU.
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The UK legal services sector and the EU
APPENDIX
Detailed approach to scenarios and assumptions
Economic driver
Trade tariffs on goods
Main other modelling
factors affected
• UK export prices
• UK import prices
• Productivity growth
Rationale and evidence
to inform deviations
from baseline forecast
Following BREXIT the UK is initially assumed to become a standalone member of the WTO.
This would result in tariffs being imposed on UK goods exports to all existing EU member
states, and countries which have signed bi-lateral free trade agreements with the EU. It is
assumed that the UK responds to newly imposed tariffs on its exports by imposing tariffs on
imports from these countries.
Bilateral trade and WTO data were used to estimate effective tariff rates of each country
(based on Most Favoured Nation tariffs charged by the EU on products to other non-EU
nations).
Basis for selection of
downside, central and
upside assumptions
Under the three scenarios, new trade agreements are introduced differently, meaning the
increase in tariffs vary:
• Downside scenario: Sees all barriers remain (no new trade agreements to 2030).
• Central scenario: Previous trade agreement with EU countries re-introduced after 5 years,
and with countries that have bi-lateral free trade agreements with the EU after another
5 years.
• Upside scenario: Barriers with EU countries and others with bi-lateral trade agreements
with the EU are removed after 4 years, and further free trade agreements with other
major trading partners introduced another 4 years later.
Other modelling
assumptions
Also factored into scenario tariff rates were changes in UK import taxation. The effect of
import tariff changes on UK manufacturing productivity was separately estimated for entry
into the model using empirical evidence from Bernard, Jensen and Schott (2006), Trade
Costs, Firms and Productivity, Journal of Monetary Economics.
Scale of deviations
from baseline forecast
Maximum increase in effective tariff rates (downside scenario):
• UK exports: 2.12%
• UK imports: 1.95%
Reduced increases in tariffs in the central and upside scenarios were introduced through
2030.
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An analysis by Oxford Economics, commissioned by the Law Society of England and Wales
Economic driver
Foreign Direct Investment (FDI)
Main other modelling
factors affected
• UK capital stock
Rationale and evidence
to inform deviations
from baseline forecast
The negative relationship between BREXIT and net FDI flows into the UK was estimated
using empirical evidence (Pain and Young, 2005) on the importance of EU membership
to UK FDI by sector, from Pain and Young (2004). The macroeconomic impact of UK
withdrawal from the EU, Economic Modelling, Vol. 21.
Basis for selection of
downside, central and
upside assumptions
The negative impact on FDI flows is felt to different degrees under the three scenarios
depending on assumed UK government policy responses:
• Productivity growth
• Downside scenario: Assumes no policy response from UK government to reform
regulation and therefore stimulate FDI.
• Central and upside scenarios: Assumes policy response with FDI forecast adjusted
upwards based on empirical evidence on the relationship between the quality of
regulation and FDI flows – from Daude and Stein, (2007), The Quality of Institutions
and Foreign Direct Investment, Economics & Politics, Vol. 19 – and using the World Bank
Governance Indicators’ Regulation Score series with differing degrees of catch up by the
UK to the top-scoring country (Sweden).
Other modelling
assumptions
Effects are modelled to occur gradually over a 10-year period following withdrawal.
Scale of deviations
from baseline forecast
Cumulative % changes in FDI stock by 2030 compared with baseline:
• Downside: -11.8%
• Central: -4.8%
• Upside: -0.7%
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The UK legal services sector and the EU
Economic driver
Net migration
Main other modelling
factors affected
• Working age population
• Supply of skilled labour
• Supply of unskilled labour
Rationale and evidence
to inform deviations
from baseline forecast
End to freedom of movement between the UK and EU member states is likely to restrict
both inward and outward migration. Given that net migration from the rest of the EU to the
UK has been strongly positive over the past 10 years, the overall impact of withdrawal is
assumed to be to lower net inward migration. The UK Government is assumed to impose a
points system on EU migrants (similar to the current model operational for non-EU citizens)
resulting in reductions in net inward migration of skilled and unskilled workers.
The split between skilled and unskilled migration was estimated using ONS Labour Force
Survey data showing the share of individuals who had moved to the UK from an EU country
in the recent years with at least degree level qualifications.
Basis for selection of
downside, central and
upside assumptions
The system brought in to manage inward migration is assumed to favour skilled migrants
so their inward flows are reduced at lower rates compared with unskilled migrants. Based
on anecdotal evidence of how the points system for non-EU migrants has affected net
migration flows the changes in EU net migration in the three scenarios were set at:
• Downside scenario: 40% reduction in skilled EU net migration and 60% fall in unskilled
by 2030.
• Central scenario: 30% reduction in skilled EU net migration and 50% for unskilled
by 2030.
• Upside scenario: 20% fall in net migration for skilled and 40% for unskilled EU nationals
by 2030.
Other modelling
assumptions
The reductions on baseline net migration forecasts are introduced at a gradual and
constant rate from 2020 to 2030 and working age population and labour supply forecasts
are adjusted accordingly.
Scale of deviations
from baseline forecast
Changes in working age population by 2030 compared with baseline:
• Downside: -371,000
• Central: -141,000
• Upside: -79,000
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An analysis by Oxford Economics, commissioned by the Law Society of England and Wales
Economic driver
Fiscal contributions to the EU budget
Main other modelling
factors affected
• Income taxes
• Employer social security contributions
• Government consumption
• Government investment
Rationale and evidence
to inform deviations
from baseline forecast
Historically, the UK has been a net contributor to the EU budget and there is a very high
probability that this would remain the case over the forecast period if the UK did not leave
the EU. As such, withdrawal should have a positive impact on the fiscal balance, other
things equal. The assumption is that the UK saves its entire net contribution to the EU
budget for use on other fiscal measures. To estimate net EU budget contributions for the
baseline forecasts, for 2015-19 official forecasts from the Office for Budget Responsibility
were used. Post-2020, it was assumed that the net contribution continues to average 0.4%
of Gross National Income.
Basis for selection of
downside, central and
upside assumptions
Under the three scenarios the saving of net EU budget contribution is put towards different
fiscal uses:
• Downside scenario: The financial savings are put towards increased government
expenditure split evenly between higher government consumption (which would be
reflected in higher spending on front line services), higher investment and higher
transfers (this would include benefits, the state pension etc).
• Central scenario: Funds from the EU budget are split between government consumption
and economically efficient measures that involve reductions in income tax and employer
social security contributions.
• Upside scenario: The fiscal benefit of leaving the EU is entirely put towards measures
friendly to businesses and enterprise (i.e. what can be thought of as economically
efficient measures). The windfall is split evenly between reducing income tax and
employer social security contributions.
Other modelling
assumptions
None. The net UK contributions to the EU budget are assumed to be used in full from
2020 on other fiscal measures.
Scale of deviations
from baseline forecast
Total savings from 2020 to 2030 as a result of foregoing the net UK contributions to the
EU budget are £128 billion. These are split between government spending uses in the
downside scenario and to fund tax cuts in the upside scenario.
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