Date: 15-08-2016
Source: The Wall Street Journal By SIMON NIXON
The ultimate cost of leaving the EU may be largely out of the U.K.’s hands, Simon Nixon writes
It is too soon to count with any certainty the immediate cost of the Brexit vote on the U.K. economy. Some indicators point to a possible recession on the horizon: New manufacturing orders, for instance showed the biggest decline in July for nearly 20 years, while business confidence has taken the steepest dive since 1974.
But other evidence suggests a less severe and shorter-lived shock: stock-market indexes are back above prereferendum levels; sterling has stabilized at around 11% below its prereferendum trade-weighted level; real-estate agents expect housing prices to recover and rise over the next year, while the amount of new commercial real-estate space leased in July was up 24% from the previous year.
Many economists now expect the U.K. will stagnate rather than tip into outright recession in coming quarters. The swift resolution of the post-Brexit political crisis after former Prime Minister David Cameron’s resignation has clearly steadied nerves. The market’s biggest fear was a chaotic or confrontational Brexit process, says Holger Schmeiding, chief economist of Berenberg Bank. “But new Prime Minister Theresa May has so far exuded calm, raising hopes of an orderly exit,” he says. At the same time, the Bank of England’s “kitchen-sink” stimulus package announced this month should also help boost domestic demand to offset some of the impact of uncertainty.
But even if the short-term damage proves more muted than feared, there is nothing that monetary or fiscal policy can do to offset the long-term supply-side hit to the U.K.’s potential growth rate that almost all economists agree is inevitable. How great this shock might be remains impossible to calculate since it hinges on three so far unanswered questions:
First, what will be the U.K.’s new trading arrangements with the rest of the world? Much will depend on what degree of access Britain is able to negotiate to the EU’s single market. This isn’t just a question of tariffs but crucially what nontariff barriers British exporters might face in the form of customs checks, recognition of U.K. standards and so-called rules of origin, which stipulate how much third-country content U.K. exports will be permitted to qualify for any preferential EU tariffs.
These in turn will determine how attractive the U.K. will remain as a hub for international companies to serve the EU market. Failure to secure a free-trade deal would force the U.K. to trade with the EU on World Trade Organization terms. Depending on what agreement is reached, U.K. output is likely to be between 2.5% and 6% lower than it would otherwise be, according to a study published last week by the Institute for Fiscal Studies, a respected London-based think tank.
Second, what will be Mrs. May’s new economic strategy? Economists agree that to make a success of Brexit, the U.K. will need to become more competitive and open to investment—not least because the U.K. needs to attract large foreign capital inflows to fund its record current-account deficit of 6.9% of GDP.
Yet Mrs. May has also acknowledged that the Brexit vote in large part reflected disillusionment with globalization and has promised in response an economy “that works for the many, not just the privileged few.” What this means in practice is unclear, but she has spoken of the need for greater scrutiny of foreign takeovers, worker representation on company boards, curbs to executive pay and a new “industrial strategy.”
At the same time, Mrs. May has stunned the City with an 11th-hour delay to a high-profile nuclear-plant deal backed by the French and Chinese governments. Any perception that a post-Brexit Britain will become less investor-friendly risks worsening the supply shock to the economy, given the well-recognized relationship between investment and long-term productivity growth.
Third, what will be the impact of Brexit on the EU? So far, there has been no evidence of financial or economic contagion: recent surveys show little impact on eurozone activity or confidence. But some analysts remain wary of political contagion, should Brexit boost support for anti-EU parties across the Continent, prompting further exits or frustrating the search for common solutions to common problems such as migration and low growth.
“Our central scenario assumes that the U.K.’s decision to leave the EU was an isolated event,” wrote Fathom Consulting in a report last week. “But in our risk scenario, to which we attach a 20% weight, Brexit is a symptom of growing isolationism. This shift towards greater disintegration threatens both global financial market turmoil and global recession.”
The EU faces a busy political year ahead with referendums on EU migration policy in Hungary and constitutional reform in Italy, and elections looming in the Netherlands, France and Germany. The ultimate cost of Brexit may be largely out of British hands.
