The economic consequences of Brexit?

The Brexit referendum provided conclusive evidence that economics is inherently political. There was nothing scientific about any of the campaign promises or economic forecasts. Instead, in the run-up to the referendum Brexiters stressed the importance of the domestic labour market and blamed immigrants for the post-crisis slump. They ignored the costs of exiting a huge EU market in goods and services, and of cutting off the long supply chains of British firms. Remainers focused on Britain’s role in the globalised economy.  “Britain is a global nation with a global role and a global reach” opined the Prime Minister. Voters scratched their heads over what it meant to be a “global nation.” Many preferred the Brexiters’ commitment to the national flag or “sovereignty’”

The Treasury argued that the UK would be better off staying in the EU than leaving, and then used an opaque model to estimate the precise cost of leaving for every household in Britain: £4,300 by 2030.  The overwhelming weight of independent economic opinion – from the IMF to the OECD, from the LSE to the IFS backed up the threat that Britain would suffer an immediate economic shock, and then be permanently poorer for the long-term. George Osborne attempted intimidation of voters with a “punishment budget” if citizens voted Leave. With the backing of Alastair Darling, he announced confidently in June, 2016 that if Britain vote to Leave, the Treasury would have to fill a £30 billion black hole in the public finances. This would take the form of increased taxes and even deeper cuts in public spending. 

All these forecasts made basic, but biased political assumptions. They concentrated overwhelmingly on issues of ‘free trade’ as if trade was and is the only important aspect of economic activity and well-being. But in 2017, goods exports were equal to just 17% of GDP, and service exports peaked at 14% of GDP in 2017. (HoC Library, July 2018). It is aggregate demand withinthe economy that drives trade and could help balance our trade deficit. 

Remainers preferred defeatism: the public finances would collapse after Brexit, and government could only fill the ‘black hole’ by cutting spending and increasing taxes. 

Not so. We know that with the help of the government’s Debt Management Office and the Bank of England, government can raise finance to expand investment in the UK, and create higher-paid, skilled jobs. We know because only recently it raised £1,000 billion to finance private bank bailouts, and later added more for HS2. We also know from experience that by investing in, and creating well-paid employment after Brexit, the government could stabilise the economy, ensure the repayment of its financing and balance the books. Keynes’s theory of the ‘multiplier’ would kick in, and job creation would pay for itself. After all, the employed pay taxes, many as PAYE. These revenues return to HMRC in the immediate, medium and long-term as income for the Treasury. Higher incomes would allow employees to shop for fuel, insurance, solar panels and food, for example. The VAT on these items ‘multiplies’ the income returned to HMRC’s coffers. And the makers and sellers of goods and services in turn pay corporation taxes on their gains, multiplying even further the revenues needed to balance the government’s books. Not just in year one, but over the many years that skilled workers remain in employment. 

But fixing the public finances would only happen if politicians abandon the economic orthodoxy that assume markets determine our fates, and take active responsibility for the state of the economy. If they roll up their sleeves after Brexit and choose to invest in skilled, well-paid work to meet society’s, the ecosystem’s and the economy’s urgent needs. If they don’t, then expect the economy to weaken, and public debt to rise, as it has these last ten years. 

The post-referendum economy

After the referendum, a big drop in business confidence occurred but this recovered quickly. The pound fell sharply as many had predicted, but has also since recovered. Employment remains high, and manufacturing and exports are doing well, boosted by sterling weakness. The fall in sterling led to a rise in inflation which in turn cut real incomes, that in any case had been weakened by the Global Financial Crisis. As Geoff Tily at the TUCshows, real wages today are still worth £24 a week less than they were in 2008. But the decline in real wages, and the decline in labour’s share of national income, began well before the EU referendum. Britain’s workers are victims of low levels of public and private investment. The UK ranks below the OECD averagein every single investment category. Policies for the promotion of self-regulating financial markets that periodically crash; for the contraction of the public sector after the GFC – helped exacerbate the shock of the Referendum outcome. Together they caused the economy to shrink by about 1% of GDP. 

Despite this weakness, we can rightly conclude that forecasts of the consequences of voting to Leave were far too pessimistic, and that ‘Project Fear’ was misguided and self-defeating. 

What happens next? 

But and it's a big but, Britain has still to Leave the European Union. 

It is my view that there can be no ‘soft’ Brexit, given divisions within the governing party; given the rules of the Single Market; given the threat to the future of the Union if exceptions are negotiated for Britain; and given the political and logistic complexity of the Northern Ireland border. We are therefore headed either to Remain, or for a ‘hard’ Brexit. If it is to be the latter, we will automatically leave the EU on 29 March, 2019. 

The big concern about the imminence of this date is that the UK government has a record of unpreparedness. Britain was unprepared for the Second World War. We embarked on the Iraq war quite unprepared for the ongoing consequences and fallout. We were catastrophically unprepared for the Great Financial Crisis. Our government, and its under-staffed, stretched civil service is clearly not fully prepared for a ‘hard’ Brexit. And yet that is where we are heading. 

Then there is the global context in which we will undertake this reckless experiment. The US Federal Reserve is determined to continue ratcheting up interest rates and to strengthen the dollar – a policy which impacts the entire global economy. The governor Jerome Powell, cannot reverse this trend, even as a stronger dollar causes turmoil in global capital markets. 

 More financial volatility, including sovereign debt crises will be the global context in which the UK exits from its largest trading market, and begins trading anew - under WTO rules. 

The biggest cost would come from a partial or complete breakdown of the arrangements that make trade possible at all, and the impact this breakdown has on British jobs. This failure is more likely because of the long supply lines of British firms, which locate different stages of production in different countries. 

Firms importing from abroad would be hit by rising prices as sterling will invariably fall. Firms exporting abroad would be hit by rising input prices caused by the need to replace EU imports with costlier products sourced outside the EU. Consumers on low incomes will be faced once again by higher prices, on top of the costs of ongoing ‘austerity’ with its decimation of the ‘social wage’ of public and local government services. 

 Who or what will come to the rescue? The Bank of England bailed out the whole financial system in 2008-9. Regrettably, there is no comparable institution that could bail out Britain’s trading system. So, with a ‘hard’ Brexit, we are likely headed for a severe recession in the near-term. The longer-term? Who knows? Much depends on whether our politicians (and Treasury officials) are willing to abandon the delusion of self-regulating markets and to begin to “roll up their sleeves” and consciously subordinate both domestic and international markets (in money, trade and labour) to the interests of British society as a whole and not just to the vested interests of the ‘global’ 1%. 

End. 

This article was written for, and published in the Church Times on 20th September, 2018.