What will be the economic effects of Britain leaving the European Union?
By Martin Cohen
The British Pound is the Canary in the Brexit Coal-mine. And on the night of the referendum it fell off its perch and it’s been twitching horribly ever since.
June 23 2016, just after polling stations closed, the pound fell to its lowest level since 1985. Five months later, in November 2016, Credit Suisse was calculating that the vote had cost the UK $1.5 trillion. Consider what that sum of money could have done to the NHS! Since then, the Pound has fallen even further, heading to a new thirty year low against the US. As I write this, one British Pound now trades for 1.25 US Dollars, and 1.18 Euros.
The US economist, Robert Shiller, put his finger on it all when he said that the result of the Brexit vote was a triumph of narrative over facts, and indubitably the referendum was a fact-free zone, with Brexiters variously claiming as ‘official information’ that Turkey was joining the EU and that a vote for Remain would mean that the National Health Service would be privatised, the British Army disbanded, and that we would abolish the Queen.
But then, at the time hardly anyone thought the consequences merited serious attention. Facts, like experts, didn’t matter. Now they do. On Credit Suisse’s figures, each ‘Leave vote’ has already cost £88,235.29. Don’t forget the twenty nine pence – these are people, as Mrs. May has said, who are only just managing to get by!
Back in June last year, it seemed for many people just like the European elections and an opportunity to record a protest vote against everything. The Leave campaign’s economic analysis fitted on the side of a bus; the official HM Treasury advisory paper looked cobbled together and was widely booed out of serious consideration as mere politicking.
Even those who did try to read it would have been confused as the report (like the vote itself) alternated between three possible scenarios: the softest of soft Brexits with the UK continuing to be part of the single market and European Economic Area; or exiting without any agreement and reverting to Word Trade Organization rules, like Russia and Brazil – or some sort of negotiated deal somewhere imbetween.
The media still talk as though a grand negotiation is still where we are, even though now, six months on it is acknowledged that the UK will leave the single market, and the European Economic Area and even the common customs area. To stay in the EU’s single market would have meant the UK staying under the auspices of the European Court of Justice and having to allow unlimited EU immigration, under freedom of movement rules, but the official Leave campaign wasn’t for any of that back then.
Now though, the Prime Minister and fellow Brexiters talk glibly of being perfectly prepared to leave with no deal at all. They say that it has to be that way because (and the ‘opposition’ agrees) the British people are no longer prepared to live under the EU rules.
To imagine that Britain can continue to trade with its former European partners in more or less that same way after exiting the single market, the common customs area and the European Economic Area is to assume that Britain can both have its cake and eat it to use Boris Johnson’s immortal phrase about the government’s policy.
It’s a fine story, but it’s fiction, not fact. But then those are so dull… First, the HM Treasury analysis, in line with academic research, showed that EU membership increased the UK’s trade with the rest of Europe by around 75%, and made the UK an attractive place to invest for countries and corporations worldwide. Almost three quarters of foreign investors cite access to the European market as a key factor for deciding to invest in the UK. As a member of the European Union, the UK basked in its status as the top location for inward investment.
But Brexit reality Number One is that that both trade with Europe and inward investment will rapidly dry up. I’ll give practical examples of how and why this will happen in a moment. But before that, a nod to the “Leavers’” economics analysis.
This is that the Treasury report contained a peculiar mistake which has led to the rest of its warnings being dismissed. The report predicted a drop in total UK production, or GDP, if people voted to leave, whereas in fact (as Brexiters never tire of saying) it has actually gone up!
Instead, the report’s authors should have known that under an expansionary monetary policy, which is what the Bank of England has, as the currency depreciates the headline figure for Gross Domestic Product, (the total value of all goods and services) increases – along with inflation. The country earns more in pounds, so tax receipts may indeed rise, entirely contra Mr. Osborne’s warnings, but the pounds are worth less and less. This is what has happened – but the Treasury misstatement has allowed supporters of Brexit to claim if not a political victory, certainly more time before their errors and misstatements are exposed.
A similar popular misperception concerns the rise in the FTSE stock market. This too is taken, particularly by Leavers, as an optimistic indicator for the post-Brexit economy – yet the rise is simply a mathematical effect of the fall in the pound. Why? Because many of the large companies listed on the London exchange, like the oil and gas majors BP and Shell; mining companies like Anglo-Australian BHP Billiton and Anglo American; and banks such as HSBC, make their profits in dollars, which are then converted to pounds for the purpose of listing on the exchange. Of course, with the pound falling against the dollar, these ‘profits’ go up – and so too does the stock market.
How many politicians and commentators respect the logic of that? Not many. Britons at all levels, from car workers in Sunderland to Brexiting Ministers in Chequers, remain blissfully unaware at all levels of what ‘really is going on’ in the modern economy, and thus grossly underestimate the economic importance of common regulation and free movement of goods and people. As Tom Whyman has noted, the post-Brexit trade strategy of Andrea Leadsom, the minister for the environment, food and rural affairs, is primarily based around the export of jam, biscuits and cheese. Under the Tories, ‘Britain, it seems, is in danger of becoming the world’s largest church fete.’
But consider the case of the car manufacturer, Nissan, the company that received a special ‘letter of comfort’ from the Vicar, sorry, the Prime Minister, concerning its business prospects post-Brexit. When Nissan took the original decision to invest in a huge car plant in the UK despite having to more or less train the workforce from scratch, it factored in four things:
* the skills of the British workforce,
* special tax breaks offered by the UK government,
* prevailing wage rates,
* and the UK’s membership of the EU.
What is the situation today? The first three factors have actually shifted in Nissan’s favour.
But I wouldn’t put much weight on that. That the skills of British workers is not decisive is shown by recalling the fact that UK workers were originally considerably less skilful than elsewhere – which helps explain why, in the first year of production, Nissan UK built only one hundred cars a week. Today, the factory churns out more than 10,000 in the same time. The point is, transnational corporations do not come to Britain because of some special quality of the workforce.
How about wages? The government is keen to offer the UK as a low-wage economy with special tax breaks as some kind of sweetener – especially as the costs of that have to be borne by British workers. But British wages are hardly going to be able to undercut those in Poland – or Mexico for that matter, our soon to be new World Trade Organisation (WTO) competitor, so factors two and three won’t be very high on the checklists of foreign investors either.
No, the elephant in the car factory is that the Nisan investment hinged on assumptions about the borderless exchange of components and finished products. That all changes with Brexit.
In the real economy, in the post-Fordism world, countries depend on complex supply chains and can’t cope with delays or disruption. The car manufacturing industry is the paradigm example of this where ‘Just-In-Time’ production has been is fundamental for many years, along with a myriad of regulatory and procedural agreements that have transformed the way all sectors of the British economy work. Forget tariffs – which for many industries are a minor and possibly negotiable factor. Brexit reverses decades of progress for its industries towards smooth and efficient trade throughout Europe.
Cars and other engineered products today products are made of thousands upon thousands of foreign sourced components that in turn rely on more supply chains. Recent much-trumpeted celebrations of Chinese investment in Jaguar Land Rover illustrates the delusional basis of economic debate just as a Reuters investigation underlines the realities. The report, by Tom Bergin that highlighted the fact that a £3billion ‘export’ deal by Jaguar Land Rover with China was, in practice, worth only a tiny fraction of that – as China intends the vehicles to be made in China, using Chinese components.
Likewise, a dramatically unveiled £6 billion deal between Oxford University and China Construction Bank to help fund research into regenerative medicine shrinks a thousand fold because in reality Oxford’s role is largely to provide advice on the creation of new research facilities in China. Reality check: far from the Chinese investing in the UK, the trade gap between Britain and China has widened sharply in the past decade, with the flow of money from the UK and towards China in 2015 equivalent to more than one percent of Britain’s GDP! So forget the headlines about British triumphs, the vigorously exporting Post-Brexit Britain of tabloid newspapers is a myth; the reality is rather of an elderly and rather sclerotic economy with a dangerous taste for borrowing money to buy imported goods.
The overall Brexit context for the UK is that the country imports goods like a shopoholic on steroids. In the fourth quarter of 2015, its trading deficit reached a record of 7.2% of GDP. Eurozone rules, the so-called Stability and Growth Pact, by contrast limit such deficits to 3%. Quelle horreur.
Ahead of the referendum on EU membership, the Bank of England had highlighted Britain’s record current account gap and noted that the UK relies on foreign investors to fund the shortfall. The governor, Mark Carney, expressed concern that in the event of a vote to leave the EU, foreign investors would become more nervous about buying, or holding, UK assets.
The problem that seems to have escaped leading Brexiteers is that size of the UK current account deficit shows the UK has an imbalance between imports and exports. And the 7.2% figure was the largest deficit since records began in 1955. So what’s the UK government doing about it? Perversely, in economic terms, but all too predictably in political ones, at the moment, the Bank of England is indicating a willingness to cut interest rates to 0% to protect economy against decline in spending and to increase the scope of ‘quantitative easing’. This last is ‘helicopter money’ – but for banks and financial institutions. Nonetheless, this monetary easing can only further erode the value of the UK pound, and worse the trade deficit.
Against all this is the popular story that a weak pound will boost exports. But this also is based on wishful thinking not evidence. Instead, a fairly detailed analysis by Maurizio Michael Habib, Elitza Mileva and Livio Stracca in a research paper for the European Central Bank (yes, the enemy!) shows that amongst developed economies, such benefits simply do not exist. Or, as they phrase it:
“…our results suggest that using the exchange rate as a policy lever could be beneficial only in the early stages of economic development, while it becomes irrelevant in the long term as countries become richer.”
This finding can only make sense when you consider the complex nature of developed economies.
Yet other economics ‘experts’ continue to ignore the evidence and pursue such theories about currencies, in just the same dogmatic way that humbler folk continue to insist their communities are being drowned by mainland Europeans – despite the inverse relationship between how many immigrants there actually are in certain areas and how much of a political issue it is.
But let’s look at some more practical examples, and first of all, the curious case of Irish milk, which illustrates in a very practical way how European trade really works and how open borders bring considerable economic gains.
Every year, 600 million litres of milk produced by cows in Northern Ireland are carried by tanker across the border to be processed in the Republic – a trade equivalent to one quarter of not only the Republic’s own dairy requirements but a key contribution to products like highly regulation sensitive infant nutritionals exported further on.
Alas, once the UK leaves the EU, quite apart from the external tariff that are obligatory under World Trade Organization rules, the safety and quality of the milk will no longer be possible to legally assure. The only way to do that would be for the UK to both accept EU laws again and the supervision of EU authorities – the rejection of both of which was supposed to be the point of leaving. Instead, newly liberated British products will have to go through customs checks at the EU border, applying for relevant import licences, and travel with certificates to show that the product meets EU public health standards, and so on.
Another farming example again illustrates the unsquarable circle of rejecting rules and wanting trade. Consider that if the UK wishes to sign a deal with the US, the US will insist on the inclusion of its farm products. So unless the UK lowers its environmental, safety and animal welfare standards to the American level it can’t access the US market. But if it does accept the US rulebook – then it will not be able to export UK farm products any longer into the EU. That will be a death blow for UK farmers many of whom, it seems, voted for Brexit. Because another hard Brexit reality is that the main export markets for the sector are (in order of importance) Ireland, France, the USA, the Netherlands and Germany. Did rural farmers not realise that markets 1, 2, 4 and 5 were all European countries?
Cut farms off from the EU and they lose access to an existing £10 billion export market, the market at present that is double in size for them to that of the whole of the rest of the world combined.
Only that posh boy’s strategy of having his cake and eating it seems to offer a way around the problem – and with milk, that’s the approach the Irish government too, after much reflection, seems to have arrived at. Its only suggestion to solve the cross-border milk problem is that all milk in Ireland be called ‘Irish milk’ thus obscuring its origins. Please everyone in Europe agree…! But it’s not legal and the European Union, however it may be presented in the media, is at root not a large slab of political fudge but rather a set of very carefully drafted legal regulations.
From London, Northern Ireland can seem a long way away, of course. So take the very successful British pharmaceuticals industry based in the South-East of England instead. In recent years, British pharma has been a huge success and is sometimes offered as another example of British ingenuity beating the world again. But not so fast. Surely someone in government has noticed that regulations are at the heart of modern pharmaceuticals? Anyone can mix up a medicine but it costs a lot to get it approved for treatment. No, the industry’s revival seems to have more to be a consequence of the EU kindly placing its regulatory body in London. Certainly, the Pharma companies seem to think so, as they are now arguing desperately against plans for a new UK regulator as they prefer to stick with the European Medicines Agency following Brexit. But then they know how the world works. At present, pharmaceutical companies often head to London to get the green light from the EMA in tandem with approval by the US Food and Drug Administration, and in some cases go through the European process first. The proposed new 100% British regulator will seem to these global brands as merely an irritating distraction. It seems that for the drugs industry, the British just threw away control – and along with it half its $36 billion pharmaceutical export market and who knows how many jobs.
Okay, drugs are complicated and taste nasty. So let’s take chocolate. It’s the UK’s biggest food export and the case also reveals something about the role of the UK in European decision making. Because, for many years, Belgium, France, Italy, Spain, Luxembourg, Germany, Greece and the Netherlands – refused to allow British chocolate to be sold in their shops as they complained it was not made of cocoa solids but rather of vegetable fat.
Flourishing the single-market rules, the UK wanted to be able to sell American-style sugary, fatty mixes with only a low proportion of cocoa solids in them all round Europe instead – and in 2000 the European Court of Justice in Luxembourg gave them the right to do so. This victory underlined how within the EU the UK did retain a degree of control, whereas outside it, in practice, it will have none. And secondly, that much of the coverage of the ‘chocolate wars’ was inaccurate: there never was, for example, a European Commission proposal to oblige Britons to eat ‘vegelate’ and none of the British confectionary companies had any objection to its real proposal that the amount of vegetable fat used need to be cited in ingredients lists.
Chocolate again illustrates how British political debates, and particularly the Brexit ones, are based not on the facts but on ‘narratives’ – or what might be less flatteringly call ‘Fairy Tales’. Thus, apparently responding to newspaper reports, John Redwood, former UK trade minister, and voluble Eurosceptic polemicist behind books entitled things like ‘The Death of Britain’, complained that the had UK was losing chocolate production to (enemy EU member) Poland, so that classic ‘British’ brands like Flake, Double Deckers and even Curly Wurlies for goodness sake! were made in a small village about an hour from Wroclaw. Shame! Cadburys should never have left its legendary chocolate factory in Bournville, Birmingham…
For Brexiteers the disgrace was that the Polish workers were being paid just over the local minimum wage of 13 Zlotys an hour (£2.35), which is barely one third of the UK rate. But then, which country was really sucking the UK’s chocolate wealth? Although all the chocolates are still festooned with the familiar Cadbury’s brand, Cadburys itself was bought out by the US transitional Kraft foods in 2010 for £11.5 billion. These days, Cadburys is barely a British company at all, with many of its activities from ingredients, packaging and marketing services outsourced. When Cadburys helped block EU chocolate standardisation they fought not for the interests of UK consumers but for those of their US masters.
Only one British-based business seems to be truly laying golden eggs at home – and this is the City of London. At the moment, the City of London dwarfs other industries in the UK accounting on its own for 12 percent of the British economy, and generating about £66 billion in tax revenue a year.
Part of this wealth comes from London’s dominant place in the trillion dollar trading of euros in derivatives. 2 trillion euros (1.60 trillion pounds) of short-term funding for banks is also based in London and then there is foreign exchange trading in the currency itself.
Yet here, again, the brilliance of Britons and Britain is over-estimated. Rather, the reasons are both more cosmopolitan and more temporary. For a start, London is a major centre because much of the world’s money is American, and American’s speak English. Up to now, the big US banks — JP Morgan Chase, Goldman Sachs, Bank of America, Citigroup and Morgan Stanley — have had large operations employing tens of thousands of people in the UK. The rest of the world’s banks want to work with them. But now, London-based financial institutions that rely on ‘passporting’ rights to sell services and investments into the rest of Europe are realising they will lose these once Britain leaves the single market. Okay, the government says this is still to be seen, to be part of the ‘negotiation’ – but the bankers are already planning their next homes. Key US players have already announced that they are preparing for the contingency that the right to sell financial products and services from Britain to EU clients could be limited or entirely abolished.
Since the UK is not even a member of the Euro zone, and since any problems with the trade à la 2008 Lehman Bothers bank collapse ultimately fall to the European Central Bank and Euro zone members, London’s role even before the referendum was much resented by euro zone central bank officials. No other central bank allows a third country, outside of its control, to take charge of its currency like this.
According to the Bank for International Settlements, interest rate swaps accounted for $435 trillion of the world’s $550 trillion derivatives market in 2015, and London clears about half of them with $1.76 trillion in dollar-denominated contracts and €736.3 billion in Euro-denominated ones. Such swaps have been called the ‘nuclear power plants’ of financial markets not because they are quietly humming away but rather because of the threat they pose to whole banking system if they go wrong.
The ECB has already tried to insist that clearing houses that process euro derivative trades should be based in the Eurozone and under its rules. But the UK (butter evidently not melting in its mouth) mounted a legal challenge to defend its financial sector claiming the policy was discriminatory under single market rules – and won at the General Court, the EU’s second-highest court last year.
So banks and other UK-based institutions expect to lose their rights to use ‘passporting’ rules to provide such financial services to clients elsewhere in the EU.
“We’ll get on with it,” a senior executive at one large US bank told the Financial Times. “We’ve started to think about how we put people in our existing offices and entities in Europe. We are already rebalancing our footprint.”
As to all this, Nigel Farage, of the United Kingdom Independence Party, and like most of the Leave campaigners in everyday life a city financier, remains sanguine. On the particular case of the disruption to the City, he has simply offered the glib assessment that: ‘By leaving the EU and doing a deal after we left, we might get a better deal for financial services than we have today.’
Mr. Farage, despite his beery public image, is a commodities trader who’s worked in both London and New York: other prominent Brexiteers with City jobs are :
* Richard Tice, co-chair of Leave.EU the official campaign for ‘Brexit’, is CEO and a partner at Quidnet Capital.
* Crispin Odey, prominent Leave backer, is founding partner of Odey Asset Management.
* Peter Cruddas, another key backer for the Brexit campaign, is a spread-betting millionaire and founder of online trading company CMC Markets.
Mr. Tice still insists that leaving the EU can be pulled off without upending the economy. More to the point, Mr. Odey boasted to the Daily Mail that he had made £220 million by ‘shorting’ sterling over the Brexit vote.
Perhaps the analyst at JP Morgan put it most perceptively when, with a nod at classical reports of the French revolution, they wrote:
“In our view, leaving the EU’s single markets like smashing a crystal flower vase, and then trying to glue the pieces back together again. You may be able to do it, but the result may not hold water, will not be pretty and the flowers will wilt in the meantime”
I started this article by saying that the fall in the pound was the canary in the Brexit coal mine, which is another way of saying that financial markets are the ultimate judge of economic policy today – referendum or no referendum. And in recent months, even as the UK government seems to grow in confidence about its Brexit plan, the canary continues to twitch feebly, the pound continues to plumb new lows. The implication is that the smart money is still not voting for Brexit – although some of the sneakiest has already made lovely profits speculating on the likely fallout from it.
Martin is an author, philosopher and social scientist with a particular interest in social justice issues. He was an early commentator on the significance and consequences of the Greek Crisis and his recent book Paradigm Shift: How expert opinions keep changing (Imprint Academic 2015) includes a discussion of the lessons of the financial crisis, 2007–9.