Brexit and The Global Economy Now and Later

Cover Story By Professor Huw D. Dixon

There are clearly strong political forces rising in EU member states that are opposed to the free movement of labour

Brexit means Brexit! Which means...? It would be a brave person to try to predict what will happen after the referendum vote for Britain to leave the EU. One prime minister has fallen, another arisen: the opposition is in turmoil. The new government has yet to say what its vision of Brexit actually means. Things will become clearer in the following months we hope. However, it is worth thinking what the key issues are likely to be and how they will affect the UK and the world.

Well, for me a key feature will be the change of status of Britain: it will probably cease to be the ‘Gateway to Europe’ as Indian Prime Minister Modi recently stated. Currently, many non-EU companies want to locate their EU headquarters in Britain. Of course, there are linguistic and cultural factors that will remain unaffected by Brexit, but if you want access to the single market it will almost certainly mean you need to be based in the EU and not in Britain. We have already heard of several large US investment banks planning to move part of their operations to Dublin, Frankurt or Paris. Even British firms that do most of their business on the continent may be forced to relocate: low cost airline Easyjet is another example.

Post-Brexit World: What it Means for Business?

Many industries could be affected. For example, media companies: in the EU at least half of TV broadcasting time should be allocated to European films and television programmes. If British films and TV no longer count as ‘European’, film and television companies may choose to relocate so that they are still broadcast in the EU. Japanese, American and Korean car companies may well need to relocate part or all of their production to the continent. The result of this will be a reduction in foreign direct investment (FDI) into the UK post Brexit. This is not something that will happen overnight, it will take years as companies review their long term investment plans. Now, this matters because the UK has had a large trade deficit for many years – currently the gap between imports and exports is over 5 percent of GDP. Pre-Brexit, this trade deficit was balanced by a large surplus on the capital account – inflows of investment from overseas. Post Brexit, Britain will need to ‘live within its means’, to find a way to cut imports or increase exports. Clearly, the devaluation to a thirty-year low against the US Dollar should help – assuming domestic inflation is not generated.

How Brexit itself will affect trade depends on several factors that are hard to call now. Most importantly, how much access to the single market will the UK manage to keep? Both sides have a lot to lose here: Britain is the EU’s main trading partner and vice versa. Negotiations will be tough and conducted on a sector by sector basis. The EU has strong protection in agriculture and cars, but the UK is currently an important market for continental exporters in both of these sectors, so maybe something can be worked out here. However, there may be more opposition on the continent to allowing access of the ‘anglo-saxon’ financial services sector, which is so important for the British (or at least the city of London).

At the end of the day, the British public seem to want to restrict the mobility of EU nationals into the UK labour market, or at least their access to the welfare state (the NHS, social housing, benefits). How far will the Europeans be willing to sacrifice their key principle of the free mobility of labour in order to maintain trade with the UK? German car manufacturers want to keep selling cars to the British: it remains to be seen how far such domestic pressures will sway politicians in Germany and France (after all, the continent has a big trade surplus with Britain). However, it seems clear that since remaining in the single market is politically unacceptable in Britain at the moment, post Brexit there will certainly be a reduction in trade between Britain and the EU, which will harm both parties (although the UK rather more, simply due to its smaller size).

In the medium term, Britain will build up its trade with other non-EU countries. This will take time: the main barriers to trade nowadays are not tariffs (except in agriculture and cars) but regulations. To trade freely, countries need to agree to some degree of common regulation for products and services. Since countries have different concerns and histories, their regulations are often inconsistent. The US is currently the UK’s second-largest trading party after the European continent. In the US genetically modified crops are widespread and consumed both by animals and humans. In the UK, they are largely absent from human consumption and genetic crops are highly restricted. In any trade deal with the US, the UK would almost certainly have to adopt the US standards (the dog wags the tail). However, this will not be at all popular with the UK public, who have until now shown a distaste for ‘Frankenstein foods’. In any Anglo-American trade deal, the UK will be a subordinate partner and have to accept US standards pretty much wholesale. Worse than that, current US trade policy is to include ‘investor protection’ (IP), which again would prove to be very unpopular (it is even unpopular in the US). IP means that companies can sue governments in specially constituted courts for regulations and actions that harm their profits. It effectively makes corporations equal to governments and marks a shift in international law.

The UK can make trade deals with other countries on a more equal footing: India, China, Australia, New Zealand and Canada have all been mentioned. Whilst this is possible, these markets are smaller than the EU (which even without the UK will be one-fifth of the world economy) and the UK will need to develop new economic activities so that it can export to these markets. Currently, it is oriented to the nearby EU markets. How this reorientation will happen is uncertain. For example, let us suppose that the UK loses access to the continental agriculture markets for beef and sheep. It would need to sell lamb and beef to these other non-EU countries, or sell something else. Maybe British beef can become a luxury good for export to China? Maybe not. The lamb and beef farmers will go out of business or shift onto something else. What would countries such as India or Canada want to import from the UK? It will probably be different things from the French and Italians.

So, how will Brexit affect the rest of the world? Common sense might say that in terms of world GDP, Britain is pretty small (less than 5%), so even if Britain will be 5-10 percent smaller due to Brexit in the long run, this will not affect other countries much unless they trade a lot with the UK. I will agree: it will affect Germany and France quite a lot, but not India or Brazil. But, there are possible butterfly wings. London is currently the centre of global finance and Sterling is an important global currency. Brexit may well affect London and this can have a knock-on effect around the world, which is far in excess of the real effects of Brexit. Indeed, in the immediate aftermath of Brexit there has been much market ‘turbulence’. Once it becomes clear exactly what Brexit means, this will die down. However, the Brexit turbulence could revive other problems – the Eurozone sovereign debt problem – Bank stability in many countries is linked to London. The fall in commercial property prices in London and the UK may hit banks in the balance sheets that could revive the banking crisis. However, this would probably mainly affect the UK.

Geopolitical Effects and the Rise of Nationalism

Then, there are the political effects. Brexit may inspire people in other EU countries: there is already a polarisation and growing discontent in many European countries that is making them less governable. The ‘refugee crisis’ is gnawing at the heart of the European ideal and the spectacle of Brexit may lead to the weakening of the European project and even its break up as we know it. The UK could even come apart: Scotland may well leave the UK in order to remain part of the EU.

However, Brexit is one among a heady cocktail of geopolitical events going on at the moment. Syria, Turkey, the Ukraine, the refugee crisis, terrorism just to mention a few current news items (as seen from the Western media). Whilst it may start a new trend (Texas and Alaska to exit the US?), I doubt it because Brexit is something unique because of the nature of the EU. However, it does indicate that nationalism (regionalism) is alive and kicking and that the assumption that there will be a drift towards larger and larger entities such as the EU has been knocked on the head. Indeed, you might argue that Brexit is part of a longer term trend that has been going on since the collapse of the Soviet Union into its various successor nations. Other examples include the effective break up of nation states such as we see in Belgium and Iraq and may well see in Spain. The nations of Syria and Libya are unlikely to re-emerge as unified states in the future. And remember Yugoslavia? The EU expansion appeared to be going in the opposite direction, but this will almost certainly cease post Brexit. There are clearly strong political forces rising in EU member states that are opposed to the free movement of labour. Ukraine and Turkey are unlikely to ever become EU members.

We still do not know what Brexit is. However, whatever precise form it takes, its main impact will be on lower growth in the UK and a smaller British economy. The main drivers of this will be a fall in foreign investment and a reduction in trade as the UK economy adjusts to the new situation. The trade effect will dominate in the short run, the investment in the longer run. The effect on the global economy will be minimal, except for those countries that trade a lot with the UK. Some countries will benefit through increased trade with Britain – India, Australia, New Zealand, Canada and some others. The effect on global financial markets will be minimal in the long run, but may lead to short term turbulence, particularly if existing problems such as with sovereign debt in the EU flare up again. The world economy is unlikely to be much affected in the long-run, whatever turbulence there may be. So, perhaps Brexit is “Much ado about nothing”? Well, not for the actors on the stage in Britain, but more so for the audience abroad – at least those not sitting in the front row.

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