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Analysis
Democracy the winner after nasty campaign

Democracy the winner after nasty campaign

Brexit should be good news for economy

by Brian Reading in London

Mon 27 Jun 2016

I was elated by the referendum but less so by its result. I reluctantly voted for Leave. It was a nasty campaign. Remain said leaving would be nasty with respect to the economy. Leave said remaining would be nasty when it came to immigration. Nobody said either option would be nice.

Most voters were motivated by self-interest, what is best for individuals, without being able to see what is best for all, which nobody can. That is democracy. My generation voted 40 years ago, in the 1975 referendum, to stay in a customs union. We were denied a say on the Maastricht and Nice treaties which fundamentally changed the EU’s nature.

The referendum exposed the EU’s democratic deficit but also the UK’s, with MPs overwhelmingly for Remain and the people marginally for Leave. Politics may be chaotic; that will be inevitable if representatives in the UK and in the EU learn better to represent the people. So democracy is the winner.

I fundamentally disagree with the economic consensus. In or out, prospects for the UK economy are already dire, with quantitative easing and negative interest rates spawning the next and worse global financial crisis. It is difficult to prevent this; the priority is to reduce the impact on the UK.

The flaws in the economic analysis and forecasts were egregious. The Treasury and most others used a Newtonian gravity model to forecast the cost of Brexit in 15 years, taking insufficient account of many other policies and factors beyond EU membership.

The short-term forecasts of recession were no better. The Treasury postulates that uncertainty causes recession, not recessions cause uncertainty that makes them worse. The examples were cherry-picked. The Treasury seemed to maintain that the early 1990s recession had nothing to do with Britain’s membership of the exchange rate mechanism, but was caused by uncertainty; similarly, that the 2009 recession had nothing to do with the sub-prime crisis.

The burst dotcom bubble in the early 2000s was followed by record uncertainty and vigorous growth. The Treasury’s claims of a causal link between heightened uncertainty and lower growth are deeply flawed. The same applies to market volatility. For everyone who sells short somebody buys long: a zero sum game between winners and losers with little importance to the real economy.

Another fallacy is to suppose that inward investment is an unmitigated blessing. It can be benign or malign. What finances the UK record current account deficit is not the ‘kindness of strangers’ but the avarice of strangers, seeking enhanced returns from a prosperous economy. This leads to an overvalued pound: one of the causes of the deficit.

Many mainstream economists believe Brexit will bring adverse consequences. This is similar to the belief that ERM ejection in 1992 would lead to disaster. These suppositions reflect undue allegiance to an econometric model-bound mentality by the academic profession and forecasting industry. Such an approach forgets basic economics.

The British economy’s future depends on eliminating the current account deficit. As long as we borrow from kind foreigners we run up debt. This has to be passed round between the government, households and companies, none of which can run up debt forever. There are two ways of reducing the current account deficit: depreciation to sell more exports or stagnation to buy fewer imports.

The unbalanced British economy and others will meet a rude awakening. Germany for example faces a savings gluttons’ Japanese fate. Brexit offers a weaker pound, reducing inward investment, blowing some froth off the asset price bubble and reducing the adverse externalities of the City of London. That should be good news, and should allow us to avoid a recession.

Brian Reading was an Economic Adviser to Prime Minister Edward Heath and is a Member of the OMFIF Advisory Board.

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