Four Economic Questions on Brexit
Could a Britain outside the EU survive economically and politically?
The possibility that Britain could leave the European Union is preoccupying those with a political and an economic focus. In her testimony to Congress this week, Federal Reserve Chair Janet Yellen spoke of the uncertainty of Brexit as a cause for market volatility, and warned that a vote to leave could harm both the British and American economies.
There have been attempts to quantify the costs of Brexit (such as one by by HM Treasury) and economists generally warn about adverse effects, ranging from the mildly negative to serious. But economic models are generally better suited for analyzing small tweaks (a cut in the corporate tax rate) than massive shifts (partial dissolution of the EU). So, rather than tossing out another number, here are some qualitative questions that may help determine how big a deal this could be economically.
What kind of deals could an independent Britain strike?
One negative reaction to British departure is that we live in an integrated world and a successful modern economy must have access to other modern economies to flourish. This is certainly true, but the implicit presumption is that if Britain departs the EU it will have significantly diminished access to world markets. That is less clear.
There are certainly examples of actual islands (New Zealand) or political “islands” (Switzerland) that have managed to build extensive free trade ties with the rest of the world. Both are members of the World Trade Organization, and thereby gain access to its provisions such as “Most Favored Nation” status, whereby other members must offer market access on par with the best going rate. True, there is no requirement to match the special deals cut under free trade areas like the EU, but prevailing tariff rates among developed countries are quite low.
At the moment, Britain is part of the WTO through its EU membership. The question, then, is what new arrangements would look like. There are at least two scenarios one might think of — the easy way and the hard way. Under the easy way, a departing Britain would quickly strike deals with the United States, the EU, and the WTO that largely codify existing practice. Under the hard way, the United States tells Britain to get in the back of the line, the EU seeks to make an example of Britain to deter other potential defectors, and WTO accession is long and arduous. In an effort to defeat the Leave campaign, President Obama and others have been threatening the hard way, though it is not clear whether that threat is credible. The Financial Times does make good points about how the model of striking trade deals from outside the EU (as Switzerland does) is harder than it seems.
Are we worried about the transition or the new steady state?
There is also the question of whether we’re focused on the day after a Leave vote or where Britain ends up a few years out. There is no doubt that a decision to depart would be a shock (note that the actual departure would occur sometime later). Any breakup of a long marriage is going to have transition costs. Lawyers are kept busy, bank accounts are separated. But ultimately these things get worked out.
This is not to argue that Britain is necessarily better off separate in the long run, only that a short-run analysis is always going to look scary and the longer-run questions should be considered separately.
Is the rest of the EU stable?
One of the reasons to look at the longer run is the uncertain fate of the euro zone. Most analyses of Brexit employ comparative statics — they compare a world with Britain as part of a well-functioning EU against an alternative in which Britain is excluded from a well-functioning EU. But what if there is no well-functioning EU?
Europe’s leaders have done a remarkable job navigating past seemingly mortal perils — sovereign debt crises, a shaky banking system, slow growth and dangerously high unemployment, and a migration crisis. But few, if any, of these crises have actually been solved. More often, a makeshift solution was employed which effectively borrowed time, often at high interest rates. Those crises all still loom. And they are joined by rising nationalism through political groups such as Cinco Estrella, Alternativ für Deutschland, and the Front National. Should German Chancellor Angela Merkel ever falter, the EU could come apart at the seams.
Were it to do so, then the comparative statics Britain would be quite different.
Are there financial bubbles out there susceptible to being pricked?
Finally, some of the alarm at the prospect of Brexit deals with the threat to the world economy. This threat is real, but the question is how much it is Britain’s responsibility. There are reasons to fear that we are in a financial bubble. Central banks have been pursuing extreme monetary policy, pushing many interest rates negative. That is meant to spur investment and growth, but does not seem to have done so. Instead, we have seen stock markets and real estate prices at fairly high valuations, as investors take that cheap money and put it elsewhere.
Hence, worries about contagion. In a financial bubble, a small prick can have disproportionate consequences. That prospect raises two further questions: Do we hold the catalyst responsible for the downfall waiting to happen? And is popping a bubble a bad thing? Sure, popping a bubble causes pain. But waiting to pop a bubble can cause more pain, just deferred.
All that said, were I British, I would vote Remain. But I am less confident than many that a Remain vote will lead to smooth sailing or that a Leave vote will plunge us into readily avoidable turbulence.
Photo Credit: Christopher Furlong / Staff