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Saturday, June 25, 2016

Simon Wren-Lewis: Just how bad will Brexit be, and can it be undone? [feedly]

Just how bad will Brexit be, and can it be undone?
http://mainlymacro.blogspot.com/2016/06/just-how-bad-will-brexit-be-and-can-it.html

Mediamacro love their focus on 'the markets', and this leads to talk that makes Brexit sound like a major financial crisis. It almost certainly is not that.

Impact on the UK economy

At the heart of Brexit is an act of self-harm to the UK's trading industry (including, and perhaps especially, trade in services). But this is something that will evolve over the medium term as we gradually lose the benefits of the single market. It essentially means it will become more difficult for UK firms to sell stuff to the EU, which will only be partly compensated for by any additional difficulty for the EU to sell stuff in the UK. Calculating the size of this effect is an exercise in trade economics not macroeconomics (see herefor example). So it is not 'intellectual arrogance' to do this kind of analysis even if youthinkmacro models have been a failure over the last 40 years.

This decline in trade leads to a loss in productivity which makes UK citizens poorer over the medium term. It also means that the real value of sterling has to fall to make up for the fall in netexports. Other things being equal, this fall in sterling will happen immediately, as indeed it already has. This will make people poorer immediately, because imported goods cost more. But here the macroeconomics gets complicated. The hit to trade from leaving the single market will evolve gradually, but the fall in sterling is immediate. (The reason is something economists call UIP.) That means that trading firms might get a short term competitiveness boost, even though this will evaporate in the medium term. This may or may not be enough to compensate for the short term impact of rising prices on consumption spending.

Unfortunately that is not all that happens in the short term. Uncertainty about future arrangements will hold back investment, and it may also add to the depreciation in sterling. For this and other reasons the short term impact on aggregate demand is likely to be negative, although measuring its size is difficult. We then need to think about whether the MPC will raise or cut interest rates. The National Institute's analysisis very readable on all this.

Mediamacro will focus on the short term. But the short term involves complex macroeconomics, so the size of the hit from Brexit is as uncertain as macro always is. I have always thought the medium term hit to UK incomes was both more serious and less uncertain. 

Impact on the global economy

I was surprised at the extent of the negative global response to Brexit. After all, the direct impact of the UK's misfortune on the world economy will be pretty small. I think it reflects something I wroteyesterday: Brexit is perhaps the first major casualty of the political populism that has followed the financial crisis and austerity. The worry is that it may not be the last.

Political impact on UK

That a country can shoot its own economic foot is surprising but, as I explained above, not catastrophic. What worries me far more is the politics of it all. 75% of 18-24 year old voters wanted to remain in the EU. They are justifiably angry that the opportunities that the EU offered them have been taken away by the same generation that has increased their tuition fees and made house ownership an impossible dream. They, like many others, see their identity as being at the centre of Europe, not part of its political periphery. Scotland will not want to be ruled by an even more right wing government and be outside the EU. On the other side a large section of those who voted Leave did so on the basis of simple lies, and promises on which the campaign's leaders cannot deliver, like much reduced immigration and more money for the NHS. This group are going to get more angry when this becomes apparent, and UKIP will only get stronger as a result.

Can it be undone?

Although Boris Johnson might have initially wished that this referendum would secure him the Conservative Party leadership and negotiations leading to a second referendum, I cannot see the rest of the EU playing ball. It is also very difficult to see how the Conservative party and its MPs would allow him to do this without mass defections to UKIP.

But a second referendum would not be necessary if, as a result of Cameron's resignation, the UK fought a general election where the winning side explicitly campaigned not to invoke Article 50. This general election would become the second referendum.

For this to happen three rather difficult but not impossible things have to happen. The first is that the Labour leadership need to stop talking about 'respecting the will of the people' and focus on how the Leave side are already owning up to their lies and false promises. The second, and perhaps most difficult, is that Labour need to form a united front on the basis of a Remain ticket, involving the LibDems, Greens and SNP. This is the only way the Conservatives and most of the tabloid press will be defeated. Third, the new Conservative leader has to be forced to hold a general election before Article 50 is invoked.

Difficult, but not impossible. What is impossible is to try and remove Corbyn on the basis that he helped lose the referendum, for reasons I have explained before. In terms of those who should be blamed for the referendum result (Cameron, Osborne, Johnson, the tabloids, the BBC ….), Corbyn's role is marginal at best.

Could you persuade Corbyn, Farron and Sturgeon to form an anti-Tory, pro-Remain alliance? Right now, as the horror of the Leave vote and a Johnson led Tory government become apparent, I think many party members could be convinced to do so, and that might put enough pressure on their leaders. It is, as far as I can see at the moment, the only way that Brexit, a right wing government led by our own versionof Donald Trump, and perhaps the break up of the UK can be avoided.   

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