Legal services sector forecasts

Transcription

1 Legal services sector forecasts August 2018

2 Legal services sector forecasts The Law Society of England and Wales

3 August 2018 CONTENTS SUMMARY OF FORECASTS 4 DETAILS OF FORECASTS 6 Total turnover of the legal services sector 6 Housing transactions 11 Net exports of legal services 12 Employment in the legal services sector 14 Prices of legal services 18 Effects of alternative Brexit outcomes on our forecasts 19 APPENDIX A: TABLES OF FORECAST FIGURES 24 APPENDIX B: FURTHER DETAILS OF THE LEGAL SERVICES SECTOR MODEL 28 REFERENCES/LINKS 34 CONTACT DETAILS FOR FURTHER INFORMATION

4 Legal services sector forecasts SUMMARY OF FORECASTS UK legal services sector Real turnover ( bn constant 2010 prices) 27.94bn 28.10bn 28.06bn 28.50bn 29.10bn 29.77bn 30.53bn 31.04bn % change -2.2% 0.6% -0.1% 1.6% 2.1% 2.3% 2.6% 1.7% Real net exports 3.47bn 3.86bn 3.42bn 3.72bn 4.14bn 4.37bn 4.64bn 4.82bn ( bn constant 2010 prices) % change 9.8% 11.3% -11.4% 8.6% 11.5% 5.6% 6.2% 3.9% Total employment (number) 326, , , , , , , ,094 % change 3.8% -0.9% 1.9% -2.6% -1.6% -0.4% 0.1% 0.0% Total employment 294, , , , , , , ,103 (full-time equivalents) % change 1.9% -0.5% 0.9% -1.8% -1.3% -0.2% 0.1% 0.0% Housing transactions 944, , , , , , , ,232 (E&W) % change 18.6% -0.6% -0.4% -4.5% -3.5% -2.6% -1.6% -4.8% Source: Law Society Research Unit (16 May 2018) The Law Society s estimates of the growth in real turnover (the measure of the volume of work done by the legal sector) for 2017 to 2020 remain relatively buoyant. This is due to increasing amounts of work relating to regulatory changes arising from Brexit, the relative buoyancy of work for law firms from UK businesses in 2016/17, and increased work for non-uk clients following the depreciation of the pound s exchange rate. However, in the medium-term we expect real turnover growth to slow down, due to weaker performance of the UK economy, slower growth in exports of legal services, and also the slowdown in the housing market affecting conveyancing work. Real turnover growth in the sector will still be higher than growth in the economy as a whole, with continuing work relating to regulatory changes after Brexit being a significant factor, but overall growth in the sector will be significantly lower than rates seen in the past. Housing transactions have been slowing down significantly since the beginning of 2018, as there has been little or no increase in people s real incomes, and while the rate of increase in house 4 The Law Society of England and Wales

5 August 2018 prices has fallen in most parts of the UK, prices are still high relative to average incomes. With slower growth in the UK economy and still little sign of significant pay increases, we therefore expect housing transactions to slow down in the shortterm and remain depressed over the medium-term. Net exports of legal services (mainly work undertaken in the UK by UK-based law firms for non-uk clients) have increased significantly in the short-term. However, the benefits of the pound exchange rate s depreciation have now largely come through, and with only modest further falls in the exchange rate expected we do not anticipate further significant boosts to UK exports of legal services from this source. Exports of legal services have also benefited from the pick up in World economic growth. This will continue to some extent in the short-term, but in the medium-tolong term the IMF expects World economic growth to moderate. short-term. In our headline forecasts that assume a soft Brexit, we expect real turnover growth to be 2.2% per year on average over the period But if the final outcome is a harder Brexit such as a Canada-type free trade agreement, then growth over this period could average 1.5% per year. A hard Brexit could have significant effects on employment in the sector, due to lower growth and also due to less investment in UK firms leading to lower productivity growth in the sector. Our headline forecasts assume that there will eventually be a relatively soft Brexit. However, lower overall economic growth, even in the soft Brexit scenario, means that employment in the legal services sector is unlikely to show any significant increases (despite some additional work for the sector due to Brexit). We expect total employment in the sector to fall from an estimated 323,000 jobs (293,000 full-time equivalent jobs) in 2015, to 311,000 jobs (283,000 full-time equivalent jobs) by Also, over the longer term we continue to expect growth in total employment in the sector to be affected by the increasing adoption of new technology and new working methods. This means that by 2038, employment in the sector could be 20% less than it would otherwise have been. Brexit will have a significant negative effect on the sector in the longer term, even though the sector is benefiting from extra legal work in the 5

6 Legal services sector forecasts DETAILS OF FORECASTS The 2018 Law Society Research Unit forecasts for the UK legal services are based on May 2018 National Institute of Economic and Social Research (NIESR) macroeconomic forecasts for the UK and April 2018 IMF forecasts for World economic demand. These macroeconomic forecasts have been fed into the Law Society Research Unit s forecasting model to produce our forecasts for turnover, net exports, employment and prices in the sector, and our forecasts for housing transactions. Further details of this model are in Appendix B. The forecasts here are for the UK legal services sector as a whole (ie combined turnover, net exports and employment of solicitor firms, barrister firms, and other legal services providers) and include estimates for recent years (2017 and 2018) where official data for those years is not yet available. The NIESR macroeconomic forecasts are based on a relatively soft Brexit outcome. However, given the uncertainty around the final Brexit outcome, we have also looked at the implications for our forecasts of two harder Brexit outcomes (see pages 19-23). Total turnover of the legal services sector Growth in the volume of work undertaken by the legal services sector is expected to pick up slightly in 2018 to 2.1% in real terms (ie inflation adjusted) and show further modest increases over the next three years (2.3% in 2019 and 2.6% in 2020). However, over the longer term, growth is expected to remain subdued compared to growth rates seen in the past (see Graph 1, page 7). The recent increase in growth and the somewhat higher growth over the next two years is mainly due to an increase in demand for legal services from businesses, and an increase in exports of legal services (ie work done by UK-based offices of law firms for non-uk based clients) as the has depreciated and World economic activity has picked up. Turnover will also continue to be boosted by additional regulatory work (for example work to rewrite contracts arising from the UK leaving the EU). However, growth in demand for legal services from individual consumers is likely to have remained slow over the past year and is unlikely to show substantial pick up over the next three years. Total real (ie inflation adjusted) turnover of the UK services sector (a proxy for consumer demand) is currently expected to increase by 2.1% in 2018, 2.3% in 2019, and 2.6% in 2020, following an estimated 1.6% increase in In the medium-to-longer term, continuing uncertainty about Brexit, and low UK economic growth, mean that demand for legal services from both business and individual consumers is likely to show only moderate growth. Expansion of the legal services sector is likely to continue to be greater than in the economy as a whole but is expected to be below past rates. We currently expect growth in real turnover of the sector to average 2.1% per year over the period , compared to 4.6% per year over the pre-financial crisis period The Law Society of England and Wales

7 August 2018 Graph 1: UK legal services sector real turnover forecasts (% change per year) % Data Forecasts Source: Law Society Research Unit (16 May 2018) Over half of the work undertaken by law firms is for business (B2B work), and most of the rest is work for individual consumers (B2C work), including work paid for by Legal Aid but undertaken for consumers. More details of factors determining the two main elements of demand are contained in Appendix B of this report. 7

8 Legal services sector forecasts Business demand The main factor in our forecasting model measuring the demand for legal services from business (B2B work) is the gross trading profits of non-financial companies in the UK. In real terms these profits are estimated to have increased by 6% in 2017, reflecting the relative buoyancy of the UK economy in 2016 and 2017, and the sharp depreciation of the exchange rate after the EU referendum increasing export earnings. The UK economy grew by an estimated 1.9% in 2016 and 1.8% in 2017, mainly as consumers maintained their spending through increased borrowing and by running down their savings. Also, the effective (trade-weighted) exchange rate fell by 10% in 2016 and 6% in This increased export earnings of UK companies in terms, and has led to an increase in the volume of exports in certain sectors as UK goods became more price competitive in non-uk markets. Demand for legal services from business will also be affected in the short-term by the need for additional regulatory work related to Brexit. Our assumptions on this additional work are shown in Graph 2. We have assumed that additional work from Brexit will steadily increase up to 2019 when the UK formally leaves the EU, and then continue to increase in the transition period that is likely to occur in a soft Brexit scenario. Additional Brexit-related work then steadily declines in the following years from Under these assumptions, the total value of additional Brexit-related work that needs to be undertaken by the legal sector is approximately 270m per year on average over the period However, the expected slowdown in the economy over the next year, and a slower depreciation of the exchange rate, mean that real gross trading profits of non-financial business are expected to increase by 1.5% in 2018, 1.3% in 2019, and by 1.2% per year over the period The financial sector is an important source of demand for legal services. However, the UK financial sector has shown only a modest recovery since the financial crisis and, given the likely effects of Brexit on the sector, it is expected to show only moderate growth at most over the forecast period. We therefore do not expect the sector to be a significant source of growth in the demand for legal services. 8 The Law Society of England and Wales

9 August 2018 Graph 2: Assumptions on increase in regulatory work, contract work etc. due to Brexit Increase in turnover ( m) 450m 400m 350m 300m 250m 200m 150m 100m 50m 0m Source: Law Society Research Unit (16 May 2018) Consumer demand Growth in demand for legal services from individual consumers (B2C work) is likely to have remained slow over the past year and is unlikely to show substantial improvement over the next two years. The limited rise in B2C work reflects low income growth of households and falling housing transactions. In the medium-tolonger term, only moderate growth in real incomes of households is expected and housing transactions are expected to remain depressed. As a result, we also expect only moderate growth in demand for legal services from individual consumers in the medium-tolonger term. Since our last forecasts (released October 2017), NIESR has revised down its forecasts of growth in real incomes of individuals. Their May 2018 forecasts expect total real household disposable income to increase by 1.5% in 2018 (compared to 2.3% in their August 2017 forecasts) and increase by 1.8% in 2019 (compared to 2.7% in their August 2017 forecasts). Growth in total real household disposable income has also been revised down in NIESR s medium-tolonger term forecasts. Low growth in households real incomes is therefore expected to be a major constraining factor on demand for legal services from individual consumers. Unemployment is expected to increase slightly over the forecast period, from 4.1% in 2018 to 4.9% in 2025, and this would be expected to lead to some increase in legal work related to social welfare issues. But any increase in this work is likely to be small compared to overall turnover of law firms and will only marginally offset the effects of low growth in households real incomes. 9

10 Legal services sector forecasts Technical note on ONS turnover measures underpinning Law Society forecasts The UK Office for National Statistics (ONS) publishes two measures of total turnover in the legal services sector: Annual Business Survey (ABS) figures and Index of Services (IoS) figures. Our forecasts are based on the ABS figures, as they are more robust given that they are derived from a large annual survey, whereas the IoS figures are derived from a smaller monthly survey. However, the IoS figures do have the advantage that they give an early indicator of changes in turnover. The latest IoS figures suggest that real turnover in the legal services sector did pick up in 2017 (see graph below), and particularly towards the end of the year. We suspect that a proportion of this pick up is due to additional regulatory work (contract work etc. arising from Brexit) as the economic fundamentals do not suggest a pick up in real turnover quite this large. ONS Annual Business Survey (ABS) figures vs ONS Index of Services (IoS) figures Legal services sector real turnover (% change per year) % ABS data IoS data Law Society Research Unit forecasts Source: Law Society Research Unit (16 May 2018) 10 The Law Society of England and Wales

11 August 2018 Housing transactions Some growth in households incomes and slower increases in house prices, will lead to some improvement in people s ability to purchase homes, but not enough to prevent the number of housing transactions falling further in the short-term and remaining depressed for at least the medium-term. The total number of housing transactions in England and Wales fell by an estimated 4.5% in 2017, and we expect them to fall by a further 3.5% in 2018 and 2.6% in As a result, the number of transactions in England and Wales is likely to fall to 840,000 in 2019, compared to a recent high of 945,000 in We currently only expect the number of transactions to begin slowly increasing again from 2023 (see Graph 3). Average UK housing prices increased by 4.6% in 2017, compared to 7.0% in 2016, based on the latest ONS figures. Furthermore, the February 2018 NIESR macroeconomic forecasts are for the rate of increase in prices to fall to 2.0% in 2018 and 1.2% in The UK housing market is therefore weakening significantly. This is confirmed by Halifax house price index figures, which shows that the annual percentage change in prices had fallen to 2.2% in April 2018 from 3.8% in April NIESR attributes some of the slowdown in the rate of increase in prices to tax changes, such as additional Stamp Duty Land Tax on second homes and reduced tax allowances for buy-to-let purchases, and in London to uncertainty generated by Brexit. But the main factor behind the slowdown in the rate of increase in prices is undoubtedly lower growth in households real incomes. The relatively low growth in households real incomes continuing will also mean that house prices are unlikely to show much growth in the medium-term. The February 2018 NIESR forecasts are for the rate of increase in prices to be no more than 1% per year over the period However, average UK house prices are not expected to fall significantly in absolute terms (although prices have fallen in certain areas of the UK, notably London), due to the continuing lack of supply of housing in many regions. House prices are only likely to fall substantially if UK economic growth slows significantly more than is currently expected. Nevertheless, as a result of some growth in households incomes, the ratio of house prices to incomes is expected to fall from an estimated 4.54 in 2017 to 4.43 in 2018 and 4.34 in However, given improvement in the affordability of housing is only modest, the house price to income ratio would only then be back to its pre-financial crisis level and still significantly higher than the ratios of between 2.30 and 3.20 seen in the 1990s. Also, interest rates are expected to gradually increase over the mediumterm, and this will at least partially offset any modest improvement in the affordability of housing. We continue to anticipate the Government s Help to Buy Equity Loans scheme will end in 2020, and this is expected to contribute to a further decline in transactions, particularly in We have used the February 2018 NIESR house price forecasts, as we have some concerns about the May 2018 forecasts. 11

12 Legal services sector forecasts Graph 3: Housing transactions number of transactions (England & Wales) 1,400,000 Affordability 6 1,200, ,000, , , , , Data Forecasts Affordability (house prices relative to incomes) Source: Law Society Research Unit (16 May 2018) Net exports of legal services Net exports of legal services is work undertaken by the UK offices of law firms for clients based outside of the UK, minus the small amount of work undertaken by non-uk offices of law firms for clients based in the UK. The majority of legal services exports (over 95%) is undertaken by firms of solicitors, and mainly larger City firms for business clients. The volume of net exports of legal services is estimated to have increased significantly in 2017 and is expected to show further significant growth in 2018, due to the depreciation of the exchange rate and the pick up in World economic activity. Our current estimate is that the volume of net exports of legal services by UK-based law firms increased by 9% in 2017 and will rise by a further 12% in The UK legal services sector has performed very well over the longer run in terms of exports, but the recent large increases in exports are not expected to continue as the effects of the depreciation of the diminish and World economic growth begins to slow down. In the medium-to-longer term, export volumes are expected to increase by 5-6% per year below the long-term trend but still making a significant contribution to the UK balance of payments. 12 The Law Society of England and Wales

13 August 2018 Graph 4: UK legal services sector real net exports (exports minus imports) forecasts (% change per year) % Data Forecasts Source: Law Society Research Unit (16 May 2018) The depreciated sharply following the UK s referendum on EU membership, falling against the euro from 1.38/ in 2015 to 1.14/ in 2017, and against the US dollar from US$1.53/ in 2015 to US$1.29/ in This is likely to have had a significant short-term effect on where law firms choose to undertake internationally mobile work, as it means that UK-based offices have cost advantages in international markets (ie a depreciation of the means that costs of undertaking work in the UK is cheaper in terms of US$ or euros). Also, because legal services work is relatively labour intensive, work can more easily be transferred from non-uk offices to UK offices, and firms can often transfer work within a few months. This is in contrast to sectors such as manufacturing which use a substantial amount of plant and machinery, and may well need up to a few years to move production. A caveat concerning the amount of work that law firms may have transferred to UK offices is, however, that the recent depreciation of the is due to fears that the UK will lose access to important EU markets following Brexit. As a result, we have not incorporated in our forecasts as large an increase in UK exports as we might have normally seen with such a sharp depreciation of the. 13

14 Legal services sector forecasts Although the depreciation of the is the main factor behind the recent increase in volume of net exports of legal services (even bearing in mind the circumstances of the depreciation), World economic activity has also picked up and, in the short-to-medium term, is likely to benefit law firms undertaking work for non-uk clients. The latest IMF figures estimate that GDP growth in the advanced economies increased from 1.7% in 2016 to 2.3% in 2017, and is expected to rise to 2.5% in We estimate that almost all the increase in UK legal services exports in 2017 was attributable to the depreciation of the but, conversely, in 2018, approximately three-quarters of the expected increase in exports is likely to be due to the pick up in World economic activity 2. However, the IMF does not expect growth in the advanced economies to be sustained at the 2018 rate, slowing gradually to 1.5% by Economic activity in the advanced economies is more important for UK legal services exports than activity in emerging economies, but growth in the emerging economies will still have some positive effects on those exports. The latest IMF figures estimate that GDP growth in emerging economies increased from 4.4% in 2016 to 4.8% in 2017 and is expected to reach 5.1% by Employment in the legal services sector Total employment in the UK legal services sector fell in 2015, and we expect further falls in the short-term due to below average real turnover growth in the sector. However, total employment could increase in due to the continuing need for additional regulatory work arising from Brexit. We currently expect total employment in the sector to fall from 323,000 jobs in 2015 (equal to 293,000 full-time equivalent jobs), to 314,000 jobs in 2019 (286,000 full-time equivalent jobs), but then to increase marginally over the period to 315,000 jobs (287,000 full-time equivalent jobs see Graphs 4 and 6). However, in the longer term, modest growth in the UK economy and the increasing use of laboursaving technology and new working methods in the sector, mean that total employment in the sector is unlikely to grow at the rates we have seen in the past. Furthermore, over a 20-year time horizon the number of jobs in the sector is likely to gradually decline. Total employment in the sector could fall to 311,000 jobs in 2025 (283,000 full-time equivalent jobs) and 294,000 by 2038 (268,000 full-time equivalent jobs). Our expectation for the increasing adoption of new technology and new working methods in the sector to result in jobs being replaced is reflected in productivity forecasts. We have assumed that in the long run, productivity growth in the sector increases to approximately 2.7% per year, from a rate of approximately 1.3% per year seen in the past (see Graph 7). On this basis we have estimated that by 2038, the total number of jobs in the UK legal services sector will be approximately 20% less than it would otherwise have been, as a result of the adoption of new technology. This corresponds to between 70,000-80,000 fewer jobs in total (or between 60,000-70,000 full-time equivalent jobs) than there would otherwise have been (see Graph 8 and also our October 2017 forecasts report We estimate that if the had remained at its 2015 value against the US$ and the euro, then UK exports of legal services would have only increased by 1% in 2017 (compared to 9% with the actual depreciation that occurred). However, for 2018, our forecast for the increase in exports would have still been for 9% growth (compared to 12% with the actual depreciation that occurred), even if the had remained at its 2015 value. 14 The Law Society of England and Wales

15 August 2018 Graph 5: UK legal services sector forecasts of total employment (% change per year) % Data Forecasts Source: Law Society Research Unit (16 May 2018) 15

16 Legal services sector forecasts Graph 6: UK legal services sector employment forecasts (000s) 000s Total employment (number) Total employment (full-time equivalents) Full-time employees employed Part-time employees employed Other employment (partners, directors, owners, and self-employed) Source: Law Society Research Unit (16 May 2018) This does not mean that the actual number of jobs will fall by this amount, as a significant proportion of the jobs lost as a result of the adoption of new technology will be offset by continuing growth in the demand for legal services (albeit that the growth in demand will be lower than it has been in the past). Also, the increases in productivity from the adoption of new technology and resulting reductions in unit labour costs of providing services (lowering prices of services to consumers), will also have an offsetting effect. These offsetting factors will help to mitigate job losses from new technology and new working methods to an extent. 16 The Law Society of England and Wales

17 August 2018 Graph 7: Underlying trend productivity (Index 1990=1) Transition period Forecasts without increase in underlying trend productivity growth Forecasts with increase in underlying trend productivity growth Source: Law Society Research Unit (31 May 2018) Graph 8: Total legal services sector employment (000s full-time equivalents) Forecasts without increase in underlying trend productivity growth Forecasts with increase in underlying trend productivity growth Amount employment lower than it would otherwise have been Source: Law Society Research Unit (31 May 2018) 17

18 Legal services sector forecasts Prices of legal services The forecasts also incorporate the effects of changes in the prices of legal services. Firms supplying legal services appear to mostly set prices as a mark-up on costs (mainly unit labour costs 3 ) and relative to the general level of inflation in the economy as a whole. Prices are also adjusted slightly upwards or downwards according to whether demand was previously above or below average, although these pressure of demand effects on firms do seem to be relatively small in the legal services sector. Generally, price effects on the demand for legal services are relatively small, as the demand for legal services is mainly a derived demand (ie legal services are purchased as part of another process, be it for example, a business merger or a consumer issue such as divorce or buying a house). The rate of increase in prices of legal services is expected to remain relatively low over the forecast period, and remain at or below the general rate of inflation in the economy. The limited price growth reflects more moderate growth in the demand for legal services, and in the longer term is due to reductions in the cost of providing services from the adoption of new technology. Price increases could rise slightly in 2020/2021 due to increasing unit labour costs as firms have to take on more staff to meet additional demand for legal services arising from Brexit. But our central forecasts do not show any sharp increase in prices (see Graph 9). Our medium-to-longer term forecasts for legal services prices continue to assume price increases will be moderated by increasing competition and de-regulation in the market. Increasing competition in the market is also likely to raise the importance of prices to consumers of legal services. There is evidence that consumers have become more Graph 9: UK legal services sector prices relative to unit labour costs (% change per year) Prices (data) Prices (forecasts) ULC (data) ULC (forecasts) Source: Law Society Research Unit (16 May 2018) 3 Unit labour costs are defined as total employment costs divided by the total volume of turnover. They can therefore be thought of as total staff costs per hour of work undertaken. 18 The Law Society of England and Wales

19 August 2018 sensitive to price changes over the past three to four years (approximately the period since LASPO), and we continue to assume that consumers will become more sensitive to prices over the forecast period. Effects of alternative Brexit outcomes on our forecasts Our main forecasts for the UK legal services sector are based on NIESR macroeconomic forecasts for the UK economy, which assume that the eventual outcome of the UK s negotiations to leave the EU will be a relatively soft Brexit. There is however (as NIESR also acknowledges) significant uncertainty around this assumption about Brexit. The Law Society Research Unit has therefore looked at the effects of two alternative hard Brexit outcomes on our forecasts for the UK legal services sector. The NIESR Brexit assumptions are based on the Phase 1 draft legal agreement published by the EU and UK negotiators in March On this basis, NIESR assumes that a soft Brexit will entail: a) the UK maintains a close but not frictionless trading relationship with the EU b) a transition period of 21 months after the UK leaves the EU in March 2019 c) no significant decrease in productivity growth in the UK as a result of Brexit (although NIESR acknowledges that in the longer term productivity growth could be affected) d) (in line with the Office for Budget Responsibility s assumptions) that the UK continues to make contributions to the EU budget as if it were a full member of the EU. The two alternative hard Brexit macroeconomic scenarios we have looked at are those recently produced by Oxford Economics for Thomson Reuters 4 : a scenario in which the UK adopts a Canada-type free-trade agreement (FTA) with the EU a scenario in which the UK fails to reach a final deal with the EU (a no deal scenario) and falls back on World Trade Organisation (WTO) rules for international trade. These macroeconomic scenarios have been fed into the Law Society Research Unit s model for the UK legal services sector to produce alternative forecasts for the sector. Graph 10 shows our forecasts for real turnover in the UK legal services sector under the: 1) NIESR soft Brexit macroeconomic scenario (our main forecasts for the sector) 2) Oxford Economics FTA scenario 3) Oxford Economics WTO scenario 4 More details of the Oxford Economics FTA and WTO macroeconomic scenarios are contained in their forthcoming report for Thomson Reuters The Outlook for the UK s Legal Services Sector Helping to understand the implications of Brexit. This report includes an assessment by Oxford Economics of the effects of their Brexit scenarios on the sector, results from an online survey on the potential effects of Brexit, and results from face-to-face interviews with a number of firms on the potential effects. The Law Society Research Unit and the Law Society Relationship Management Team have provided advice and assistance in producing the Thomson Reuters report, although Thomson Reuters and Oxford Economics are responsible for the final report. We have used the FTA and WTO macroeconomic scenarios from the report with permission of Thomson Reuters/Oxford Economics. 19

20 Legal services sector forecasts Graph 10: UK legal services sector effects of different Brexit scenarios Forecasts of real turnover (% change per year) % Law Society Research Unit model used Macroeconomic forecasts fed into model: NIESR soft Brexit scenario Oxford Economics FTA scenario Oxford Economics WTO scenario ONS data Source: Law Society Research Unit (20 June 2018) Under the WTO scenario, growth is particularly affected by the likelihood of shock downward reduction in the UK s exports from 2019 and, in this scenario, on average, real turnover in the legal services sector increases by only 1.1% per year over the period Growth under the FTA and WTO scenarios is lower than in the soft Brexit scenario despite those hard scenarios assuming more regulatory and contract related work arising from Brexit. This additional work is also responsible for the marginally higher growth rate in 2018 under the FTA and WTO scenarios. 20 The Law Society of England and Wales

21 August 2018 The forecasts for employment in the sector in the two hard Brexit scenarios are somewhat more uncertain, as the effects on employment are dependent on how a hard Brexit affects (underlying) productivity growth in the UK legal services sector 5. The Oxford Economics FTA and WTO scenarios assume that a hard Brexit has no effect on productivity growth in the sector. Graph 11 shows how much total employment in the sector would be lower in the two hard Brexit scenarios compared to what it would be in the soft Brexit scenario assuming that the hard Brexit scenarios have no effect on productivity growth. Under these assumptions, total employment is substantially lower in the two hard Brexit scenarios compared to the NIESR soft Brexit scenario. Graph 11: UK legal services sector effects of different Brexit scenarios no decrease in productivity growth in FTA and WTO scenarios Decrease in total employment (number of full-time equivalent jobs) compared to NIESR soft Brexit scenario 4, ,000-8,000-12,000-16,000-20,000-24,000 Law Society Research Unit model used Macroeconomic forecasts fed into model: Oxford Economics FTA scenario Oxford Economics WTO scenario Source: Law Society Research Unit (20 June 2018) 5 Productivity growth does also have an effect on demand for legal services (real turnover) in our model, through its effects on unit costs and prices. However, price effects in the legal services market are relatively weak, and therefore demand for legal services is not affected significantly. 21

22 Legal services sector forecasts However, there is a significant risk over the longer term that less investment, less competition with non- UK firms, and less access to skilled staff from other EU countries, could lead to lower productivity growth. This would mean that, although real turnover growth would be lower in the two hard Brexit scenarios, firms would no longer be benefiting as much from productivity increases. The difference in employment between the two hard Brexit scenarios and the soft Brexit scenario would be smaller as a result. Graph 12 shows, compared with the soft Brexit scenario, how much lower total employment in the sector would be in the two hard Brexit scenarios, assuming reduced productivity growth. It is assumed that in the WTO scenario, productivity growth reduces more than in the FTA scenario 6. Under these assumptions, total employment is still significantly lower in the two hard Brexit scenarios compared to the NIESR soft Brexit scenario, but by somewhat less than in the no effects on productivity growth situation. If a hard Brexit has a significant effect on productivity growth, by 2025 total employment in the sector (in terms of number of full-time equivalent jobs) is 4,000 (1.5%) less than in the soft Brexit scenario (based on the FTA case). But if there is a no-deal Brexit followed by WTO rules, the total employment is 10,000 (3.5%) less than in the soft Brexit scenario in However, this does not mean that lower productivity growth is beneficial for the sector, as it will have other significant negative repercussions on firms. Lower productivity growth will mean that unit costs will rise faster and, although some of these higher costs will be passed on in terms of higher charges, profit margins and amounts available for salary increases are likely to be significantly lower. Also, in the longer term, higher costs are likely to affect the international competitiveness of UK-based law firms. 6 In our central soft Brexit scenario we assume that in the long run, productivity growth in the sector increases to approximately 2.7% per year as a result of new investment, from its previous rate of approximately 1.3% per year. In the simulations where a hard Brexit has a significant effect on productivity growth, in the FTA scenario we assume it increases to only 2.0% per year in the long run, and in the WTO scenario we assume it increases to only 1.7% per year in long run. 22 The Law Society of England and Wales

23 August 2018 Graph 12: UK legal services sector effects of different Brexit scenarios with decrease in productivity growth in FTA and WTO scenarios Decrease in total employment (number of full-time equivalent jobs) compared to NIESR soft Brexit scenario 4, ,000-8,000-12,000-16,000-20,000-24,000 Law Society Research Unit model used Macroeconomic forecasts fed into model: Oxford Economics FTA scenario Oxford Economics WTO scenario Source: Law Society Research Unit (20 June 2018) 23

24 Legal services sector forecasts APPENDIX A: TABLES OF FORECAST FIGURES UK legal services sector real turnover forecasts Years m constant % change 2010 prices per year UK legal services sector housing transactions forecasts Years Number % change per year year periods Average Average % per year over change per year period over period year periods Average Average % per year over change per year period over period Source: Law Society Research Unit (16 May 2018) 24 The Law Society of England and Wales

25 August 2018 UK legal services sector real net exports (exports minus imports) forecasts Years m constant % change 2010 prices per year UK legal services sector full-time employees in employment Years 000s % change per year year periods Average Average % per year over change per year period over period year periods Average Average % per year over change per year period over period #N/A #N/A Source: Law Society Research Unit (16 May 2018) 25

26 Legal services sector forecasts UK legal services sector part-time employees in employment Years 000s % change per year UK legal services sector other employment (partners, directors, owners and self-employed) Years 000s % change per year year periods Average Average % per year over change per year period over period #N/A #N/A year periods Average Average % per year over change per year period over period #N/A #N/A Source: Law Society Research Unit (16 May 2018) 26 The Law Society of England and Wales

27 August 2018 UK legal services sector total employment (number) Years 000s % change per year UK legal services sector total employment (full-time equivalents) Years 000s % change per year year periods Average Average % per year over change per year period over period #N/A #N/A year periods Average Average % per year over change per year period over period #N/A #N/A Source: Law Society Research Unit (16 May 2018) 27

28 Legal services sector forecasts APPENDIX B: FURTHER DETAILS OF THE LEGAL SERVICES SECTOR MODEL The model and forecasts are for the UK legal services sector as a whole (ie the combined turnover, exports, employment etc. of solicitor firms, barrister firms, and other legal service providers that undertake paid for legal work, such as licensed conveyancers, patent and copyright agents). The model structure (ie the estimation of the relationships in the model) is based on Office for National Statistics (ONS) Annual Business Survey data for the UK legal services sector and ONS data for the UK economy, over the period The relationships (equations) in the model are estimated using econometric techniques. This has enabled us to determine: (a) which factors best explain movements of key variables (real turnover, employment, real net exports, and prices) in the legal services sector; (b) the magnitude of the effects of these factors on the variables; and (c) how quickly the factors affect the variables. The methodology also enables us to assess the degree of confidence in the estimated relationships (ie how closely the estimated relationships accurately reflect how the market actually works). The scope of the model is constrained slightly by the data available, but the model does explain at least 90% of the movements of key variables in the legal services sector. The forecasts for the UK legal services sector are based on the macroeconomic forecasts for the UK economy produced by the National Institute of Economic and Social Research (NIESR) and forecasts for world economic demand produced by the IMF. These macroeconomic forecasts are then fed into our model to produce forecasts for the sector. Projections for the total number of households in the UK from the Department for Communities and Local Government are also used to calculate disposable income per household to use in the affordability term in the housing transactions model. Key assumptions relating specifically to the legal services sector are made with respect to the underlying trend rate of productivity growth, the effects on prices of increasing competition and regulatory changes, and the effects on real turnover of the expected increase in legal work from the process of the UK leaving the EU. Details of the main components of the model are given below. The structure of the model is also shown in the flowchart on pages 32 and 33. Real turnover of the legal services sector Real turnover (variable rturn) of firms in the UK legal services sector (the measure of the volume of legal work done by the sector) is broadly determined by factors relating to the demand for legal work from the business sector (B2B work) and factors relating to the demand for legal services from personal consumers (B2C work). The two main factors relating to business demand are the real profits of (non-financial) businesses in the economy (rprof) and output of the UK financial sector (yfin). Financial sector output is included separately as it is an important source of business for the legal sector. Forecasts of real profits of (non-financial) businesses in the economy (rprof) are not provided in the NIESR macroeconomic forecasts using the same definition as we use in our model. We have therefore included a subsidiary equation which relates real profits to UK GDP at market prices (gdp), and real unit labour costs in the economy as a whole (rulcecon) ie unit labour cost (ulcecon) deflated by consumer prices (cpi). The results from the equation have also been adjusted slightly for the effects of the post-eu referendum depreciation of the on profits of businesses. 28 The Law Society of England and Wales

29 August 2018 The main factors relating to demand from personal consumers are the real (ie inflation-adjusted) disposable (ie after tax) income of households (rhhdi), the number of housing transactions (htrans), and the average unemployment rate (ur). Forecasts for housing transactions are generated by a separate equation in model (see below). Unemployment is included in the real turnover part of the model as, under normal circumstances, an increase in unemployment would be expected to lead to some increase in legal work (eg through increased social welfare work and also possibly increased criminal law work). However, the effects of unemployment are relatively small compared to the effects of other factors. The real turnover equation also includes an adjustment for the expected increase in legal work from the process of the UK leaving the EU. These adjustments are based on external estimates, including results from specific questions on this in our surveys of solicitor firms. Real net exports (inflation adjusted exports minus imports) of legal services (rnetexp) and prices of legal services (pdlegserv) relative to the general level of consumer price inflation (cpi) are also included in the real turnover model. Exports relate to work undertaken in the UK by UK-based law firms for non-uk clients and are therefore included in UK legal services sector turnover. Forecasts for real net exports of legal services are generated by a separate equation in model (see page 30). Legal services prices do not appear to have a major effect on real turnover, reflecting that most legal services are a derived demand (ie are bought as a necessary input into other activities or actions). However, there is some evidence that users of legal services have become more price sensitive over the past three to four years (approximately the post LASPO period) and this change is incorporated in the model using a shift variable (dlaspo) on the real prices of legal services. Forecasts for legal services prices are also generated by a separate equation in model (see page 31). Housing transactions Housing transactions (htrans) are included in the model in more detail as, although residential conveyancing work accounts for a relatively small proportion of the total value of legal work undertaken (approximately 4-6% of solicitor firms total turnover is accounted for by residential conveyancing work), the magnitude of increases and decreases in housing transactions that can occur from year to year mean that they can have a significant effect on the rate of change in total turnover of the legal sector. The main factor determining the number of housing transactions each year is the affordability of housing (afford) (ie average house prices relative to average disposable income per household). Affordability is calculated as average real house prices (rhp) divided by average real disposable income per household, where average real house prices are defined as average house prices (hp) divided by consumer prices (cpi), and average real disposable income per household is defined as total real disposable income of households (rhhdi) divided by the total number of households in the UK (hh). Average mortgage rates (mortrate) are also included in the housing transactions equation. Changes in mortgage rates mainly only have an effect on transactions in the short-to-medium term, as increases in rates mostly lead people to delay house moves rather than abandon them altogether and, similarly, decreases in rates can enable people to bring forward moves. There are also two types of one-off factors included in the transactions equation. Factors are included relating to the Government s Help to Buy Mortgage Guarantee scheme (which ran from 1 April 2013 to 31 Dec 2016) (dummy variable dhtbmgs) and its 29