The future: neither paradise nor perdition
For next 27 months, business more or less as usual
by Meghnad Desai in London
Mon 27 Jun 2016
There were many projections before the UK referendum on the possible economic effects of staying in or leaving the European Union. It was a confused, angry debate. Had we had a royal commission rather than a referendum, the UK would have had a more balanced, nuanced account of the costs and benefits.
Now that the political decision has been made, we may reopen the question of the effects, with no need for exaggeration or endless doom-mongering. We can ignore the miracles promised by the Brexiteers or the dire predictions of the Remainers. What counts is forecasting the next 27 months or so when the UK will stay part of the EU.
In the 1960s and early 1970s, the promise was that joining the Common Market would transform Britain’s stagnant economy. As it happened, Margaret Thatcher’s reforms, not Community membership, changed the UK into a growth machine. Nearly five decades later, the euro area is stagnating, while the UK is managing modest but still higher growth. Clearly, making long-run forecasts of paradise or perdition is a rash act.
Most forecasts are conditional upon the future being like the present and the recent past. But the future will not be like the past. We have to speculate on how the world outside the UK may evolve, and how the UK economy will respond. And we need to ask how the UK economy could change in any case under its own dynamism.
The Treasury calculated that Brexit would cost British families £4,300 each by 2030, under certain conditions. That number has spurious precision. Even if we were to grant the validity of the underlying model and the other assumptions, the outcome should have been framed in broader terms, for example, that the loss could be £3,000 to £7,000.
On the morning of 24 June, Britain’s economic fundamentals had not changed. Sterling weakened and the stock market was lower. But these short-run reactions are usually self-correcting. By the end of next week, we may know better the impact of ‘Brexit' on the financial markets. This will reflect the changes in expectations about prospects, rather than real material changes.
Departure is likely to take two years from the date the UK invokes Article 50 of the European treaty, say sometime after October when a new leader of the Conservative party takes over. Under these assumptions, for the next 27 months the UK economy stays in the EU and no changes need to take place in trade flows. Economic agents may bring forward their adjustment to the exit. There could be big decisions on relocating manufacturing from the UK to elsewhere within the EU, and cancelling plans to invest in the UK. Whether the planned Deutsche Börse-London Stock Exchange deal goes through will be an important indicator.
The UK economy (within the EU) has been recovering faster than the euro area, but recovery has been fragile. Employment is high, but wage growth has been slow. Private and public sector investment has been sluggish. Productivity growth is low, as in other developed economies.
If we add a lower pound and continuing low interest rates (with even the possibility of a cut in Bank of England rates), then a recession is unlikely. George Osborne, chancellor of the exchequer, should stay with the estimates and projections of the March budget.
Osborne tried to influence the vote by saying he would present a tough emergency budget to take account of a likely post-Brexit recession. The gesture had a perverse negative effect on the vote, and it was wrong economics. With a small amount of fiscal and monetary easing, the economy should manage to stay on course, unless there is a massive outflow of capital, which is unlikely.
The crucial short-run factor is growth in euro area economies. Euro depreciation would help the region’s trade with the rest of the world. The European Central Bank will continue to be aggressively expansionary. If sterling and euro both fall relative to the dollar, the bilateral rate will be much the same as before. In that case, there would be a greater reason to predict business more or less as usual.
Lord (Meghnad) Desai is Emeritus Professor of Economics at the London School of Economics and Political Science and Chairman of the OMFIF Advisory Board.
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