A Brexit from economic wisdom

The ‘leave EU’ vote goes against basic economic judgment and was mounted on a campaign stirring up xenophobic hysteria. As its economy takes a hit, the U.K. can expect no favours from the EU.

Updated - September 20, 2016 05:20 pm IST

Published - July 05, 2016 02:35 am IST

Illustration: Deepak Harichandan

Illustration: Deepak Harichandan

Not so long ago, virtually everyone seemed confident that a sizeable majority of British voters would reaffirm their faith and confidence in a united Europe. Unfortunately, what was considered to be a remote possibility has actually become a very grim reality. A small majority of voters have opted to take Britain out of the European Union (EU) in the referendum held on June 23. Brexit — the term coined to denote the exit of Britain from the EU — has won the day.

The buck stops here

No one has or will come out of this with any credit. First, >British Prime Minister David Cameron showed extraordinarily poor political acumen by agreeing to the referendum without additional safeguards favouring the status quo. For instance, he could have attached riders, stipulating that Britain would go out of the EU only if a majority of eligible voters or a supermajority — say 60 per cent — of actual voters, opted for this. As it is, the electoral turnout was about 70 per cent and so roughly 35 per cent of Britain’s voting public took one of its most momentous decisions. Second, Jeremy Corbyn, the leader of the Labour Party, hemmed and hawed his way through the pre-referendum campaign, and has to bear a sizeable share of the blame for not being able to inspire Labour voters to vote against Brexit.

Bhaskar Dutta

Finally, >the pro-Brexit leaders ran a most scurrilous campaign . They often made statements which had only a remote connection to ground realities, and made promises they had either no wish or power to implement. Perhaps the saddest aspect has been the blatantly xenophobic hysteria stirred up during the campaign. The pro-Leave camp claimed that Britain needed to quit the EU to close its borders to more EU migrants since the country had reached a “breaking point”. Pre- and post-election polling suggests that this was the pro-Leave argument that most resonated with British citizens, and was in large part responsible for Leave’s victory. Not surprisingly, several instances of racism have been reported after June 23.

Instead of crowing over their stunning victory, the leaders in the Eurosceptic faction of the Conservative Party have almost disappeared from the media. Perhaps, they have now realised the enormity of their blunder. What is surprising is that it took them so long to come to their senses. After all, virtually every well-known economist, including 10 Nobel laureates in Economics, opposed Brexit and issued several statements pointing out that the British economy would go into a tailspin if the Leave campaign won the day. But the leaders of the Leave movement brushed aside these dire warnings. In a statement that will probably hound and haunt him for the rest of his political life, the Justice Secretary Michael Gove, who, along with the flamboyant ex-mayor of London Boris Johnson, was the public face of the Conservative Eurosceptic camp, contemptuously brushed aside all these warnings remarking that “People in this country have had enough of experts”.

>Also read: Brexit’s winners and losers

Economy in a tailspin Economists often make mistakes, perhaps the most famous being the failure to predict the U.S. housing boom bust and its effects on the global economy. But, this time round, they seem to have got it right. As I write this, the economic scenario in Britain is, if anything, gloomier than that painted by the economists who advised against the divorce from the EU. The pound has sunk to its lowest value in 31 years against the U.S. dollar. The devaluation of the pound will mean that imported goods and services will be costlier for the British public. Trillions of dollars have been wiped off the global stock exchanges, with U.K. shares naturally taking most of the beating. Major agencies have downgraded Britain’s credit rating.

>There are also fears of thousands of job losses particularly in the financial sector . Over time, London has become the hub of the financial network in Europe. An important reason explaining the growth of the U.K. financial sector has been the “European passport scheme” under which financial services firms located in one member state can carry out business activities in another member state without having to incur the additional costs that are normally associated with being a “foreign” entity. That huge advantage will be lost once Brexit is formalised. More generally, Britain will become a significantly less attractive destination for all foreign investors that have favoured the country because it is such a convenient gateway (partly because of the English language) to Europe. Now, negotiations with the U.K. and the EU will have to be separate. Since the EU market is so much larger than the U.K. market, major manufacturers may well move to Ireland since that is still a part of the EU. So, Dublin could replace London as the gateway to Europe for these foreign firms. All this suggests that the U.K. economy will take several years to get back to “business as usual” mode.

The British government seems in no hurry to initiate the divorce process. This must surely be a mistake as far as the economy is concerned. Entrepreneurs hate uncertainty, and must have put all their major investment decisions on hold to await the outcome of the referendum. Statements coming out of Brussels suggest that Britain will not be able to retain the advantages of a single market. The details about the level of tariffs that will be imposed on British goods and services will be known only after all trade negotiations are completed. Perhaps the only issue which is certain is that Britain will not get any favours from the EU since the EU will want to send out a message that it is costly to leave the Union!

The impact on India What will be the impact of Brexit on the Indian economy? The immediate, short-term effect must be negative, with its severity depending on the extent to which the major economies in Europe are affected. If Brexit results in a sharp contraction in these economies, then their demand for Indian exports will shrink. These effects will smoothen out over time once the European economies recover. This process will be faster for those Indian companies which compete with British manufacturers in European markets since the British companies can no longer treat continental Europe as a “home market” in so far as import taxes are concerned.

Of course, the devaluation of the pound implies that imports will be costlier in Britain and this will be another source of decrease in imports over and above that caused by a shrinking economy. Since Britain is an important destination for Indian exporters, this will also have a non-negligible impact on Indian exports. Indian firms which use Britain as a base for their European operations will now experience an increase in trading costs since they will face increased tariff barriers once Britain formally leaves the EU.

Some commentators have interpreted the results of the referendum as a vote against globalisation, pointing out that an integrated Europe has failed to raise living standards in much of Europe. The Italian economy is apparently not much bigger than it was when the Euro was created, while the Greek economy has shrunk appreciably. In Britain itself, the austerity drive of the Tory government has slashed welfare budgets. But is this all due to globalisation itself or the wrong set of policies followed by member states in Europe?

One can argue this till the cows come home. But the post-referendum surveys show clearly that xenophobia was the dominant reason explaining the vote in favour of Brexit. This is surely reason enough to desist from giving any positive spin on the referendum.

Bhaskar Dutta is a Professor at the Department of Economics, University of Warwick, U.K.

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