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Since 2005 / Desde 2005
Friday, June 24, 2016
WHAT'S NEXT FOR BRITAIN?
The votes are in. And the result is a political earthquake. But what does it mean for the economy? What does Britain leaving the European Union mean for our prosperity, our standard of living, the opportunities for our children? The answer is that it is impossible to say with any uncertainty.
Why? Because so much depends on the skill and nerve of our policymakers in the hours ahead, the actions of our political leaders in the months and years to come, the decisions of political leaders in Europe, and the behaviour of myriad foreign investors and companies. In the short-term there is a danger of financial panic. Sterling is falling through the floor. We have a current account deficit (the difference between aggregate national spending and income) of around 7 per cent of GDP. That’s something that implies the pound could fall a very long way indeed. If the currency does not stabilise, domestic inflation could explode, forcing the Bank of England to raise interest rates and pushing us into a recession, which will cost jobs, reduce incomes and damage millions of Britons' living standards.
A rout of the pound could also conceivably set off a run on UK financial institutions, which have trillions of pounds of sterling liabilities. The Bank of England’s primary responsibility over the next few hours is to stabilise the currency and financial markets. Expect a statement very soon from Threadneedle Street promising to provide financial institutions with all the short-term sterling “liquidity” they need. The European Central Bank, the US Federal Reserve and other major central banks around the world are also likely to make similar pledges to provide banks and other large financial institutions around the world with all the short-term lending they may require. Brexit is a global financial threat.
But even if financial panic is averted, the peril of recession for Britain itself still looms very large.Companies had been holding back investment until the referendum result was known. Will they spend now? Or will those projects simply be cancelled? If company share prices are crushed in the coming days, as many expect in the wake of this Brexit vote, firms may well cancel them. If so, our national output will suffer immediately. There is a danger that consumers – who have been driving the recovery since 2013 – retrench too in the wake of this vote, pushing us into recession again.
The Bank of England could cut interest rates to support demand and encourage borrowing and restart its printing presses. But if the pound drops excessively the Bank’s Monetary Policy Committee may feel it has no choice but to raise rates to support sterling. That would push up the mortgage costs of millions of homeowners.
During the campaign George Osborne held out the prospect of a tax-raising, spending cutting emergency budget in the wake of a leave vote in order to keep to his target of returning the government’s budget to balance by 2020.
Such austerity would pile on the recessionary pressure too. But Osborne might not be Chancellor for very much longer. And his successor might decide to adopt a traditional Keynesian response to a recessionary threat by allowing state borrowing to rise, or even increasing spending with a deliberate stimulus. But then again he or she might not.
Then there is the medium/long-term. The fate of large swaths of our economy – our banks, our car manufacturers, our farmers to name but three – hang in the balance. Their fate will hinge on the nature of the trade deal that our political leaders (very probably new leaders) reach with the rest of the European Union in the coming years as the terms of the Brexit divorce are negotiated.
Will the rest of the European Union be willing to strike a quick and favourable deal with Britain after this repudiation? Their own economic interest may push them down this route – they export a great deal to the UK. But their political interest – dissuading other states from leaving the EU – may push them in a different, less amenable, direction.The medium and long-term outlook also depends on the nature of any trade arrangements our leaders forge with the rest of the world. Was Barack Obama really bluffing when he said the UK would be “at the back of the queue” when negotiating a trade deal with the US, the world’s largest economy?
Be in no doubt about how much this matters. In the absence of such trade deals our companies could face damaging tariffs when exporting their goods and services. That would hurt their profits, forcing them to hold down wages paid here in Britain and also cutting jobs.The consensus of independent economic experts on the long-term impact of Brexit prior to the vote was clear: it was going to hurt. The only question was how much. Now we are going to find out the answer to that question.