Many observers bemoan the Brexit vote yesterday, as does this writer. But we don’t hear adequate analyses of just what the explicit risks are. Let me summarize most of them.
- Trade with the European Union, which is Britain’s major trading partner, will be reduced, perhaps sharply. Existing trade agreements will be ended or significantly renegotiated. You don’t have to be a fundamentalist free trader (like many a mainstream economist) to realize that this in itself will cause recession. It will also affect Britain’s trade with the United States, whose trade agreements are with the entire EU, not Britain alone. This is the most discussed of the Brexit risks, but there are others of considerable danger.
- A falling pound could have many consequences. It fell sharply on the results of the vote. Will Britain be able to import the financing necessary to compensate for its current large international deficit? The falling pound adds dangerous uncertainty to such foreign investment decisions—at what level, to put it simply, will the pound stabilize? If financing is not forthcoming, and it will surely be mitigated, interest rates will have to rise, which is also recessionary, despite the best efforts of the Bank of England to make funds available. The uncertainty over the pound could also result in capital flight that could endanger an already over-valued housing market.
- Falling equity markets, due to a recession that deflates corporate profits, may undermine consumer and capital spending. Again, this is recessionary.
- If a recession ensues, tax revenues will decline and the government budget deficit will rise. Given the myopic austerian attitude of the Conservative chancellor of the exchequer, George Osborne, it is possible he will disastrously cut government spending or even raise taxes, making a recession worse.
- A round-the-world recession will hurt Britain further as nations buy fewer of their goods and services. One cause of such a global recession could be a contagion of equity-market collapses, which will, as noted, undermine consumer and capital spending. Another is a dollar that rises against the pound and the euro, suppressing American exports and resulting in recession here in the United States.
- Britain’s valuable financial services surplus—it is of course one of the world’s leading financial centers—will likely be significantly diminished, as rules for capital flows with the rest of Europe are scotched or rewritten to Britain’s detriment. The finance community is a major source of Britain’s economic strength.
- And maybe most dangerous, Britain’s exit may lead to other EU nations’ contemplating an exit or to continued growing electoral strength of populist, anti-EU, anti-labor parties.
It’s by no means impossible to mitigate these risks. The only reason the EU should sharply punish Britain is if it helps it frighten other nations into “remaining.” Moreover, if Britain does not want to abide by the open immigration regulations of the EU, it should not be rewarded. On the other hand, the EU should begin the process as soon as possible of rewriting trade and services agreements that are, if not as liberal as they were under the EU, then at least favorable enough to avoid sharp recession. A harsh British recession would also spread to the EU, its ministers should realize.
The Bank of England and the European Central Bank should open the spigots now to be sure there is enough liquidity to avoid a financial meltdown.
The United States should also begin to discuss new trade agreements with Britain, although again, they should probably not be as liberal as the current trade agreements involving the EU. The United States cannot disrupt its relationship with the EU, which it should wholeheartedly support.
This should mark the end of the age of fiscal and monetary austerity. But it probably will not. Austerity economics is the root cause of slow growth in the EU, high unemployment, and growing discontent in Europe with the great idea the EU once was. Britain is growing again, but that growth has been delayed by the irrational and punishing policies of the Cameron government. The working class across Europe has taken it on the chin. These policies have to be rethought.
The one medicine that can relieve all pressures is significant, job-creating economic growth. This too applies to the United States. I saw Alan Greenspan interviewed on television this morning, again claiming US debt is the nation’s major problem, caused by entitlements. He is relentlessly supply-side, and allows no constructive influence of faster growth on sluggish productivity. The head-in-the-sand austerity advocates like Greenspan still get credibility, however wrong they have been. The CNBC analysts praised him lavishly, despite his abysmal record. In fact, growth is the best antidote to the current anti-EU austerity poison.