Brexit: from Project Fear to Project Hysteria
The economic doom-mongers really need to calm down.
In the realm of economics, Project Fear has become Project Hysteria. Post-EU referendum, economists are portraying this moment as the worst economic crisis since the 1930s slump. The day after the referendum, Philippe Legrain claimed: ‘This is just the start of the Brexit’s economic disaster.’ He anticipated the harmful effects as both ‘immediate and lasting’. Martin Wolf similarly predicted ‘the decision to leave Europe will be costly’. He suggested bluntly: ‘This is probably the most disastrous single event in British history since the Second World War.’
And when chancellor George Osborne finally broke his silence in order to ‘reassure’ the bruised markets, he reiterated his pre-vote threats of spending cuts and tax rises as ‘absolutely’ necessary. The difference this time was that he said he wouldn’t implement the budget immediately, and will pass that buck on to his successor. With just about every economic institution parroting his earlier warnings about a Brexit hit to the economy, Osborne gave the economy another whack with the threat of another fiscal squeeze. Very reassuring.
People should calm down. This brilliant democratic decision to leave the European Union should bring huge change. And with major change comes the possibility of setting the new radical, disruptive course that we need to revive our long-depressed economy.
But all the hyperbole about impending economic disaster is injurious to a sensible, reasoned discussion about how to take good economic advantage of the opportunities opened up. More immediately, these warnings of economic crisis threaten to bring an economic crisis on. An already fragile economy was on its way to recession. Scaring businesses and everybody else away from spending could accelerate that process.
The Institute of Directors conducted a survey of business leaders in the three days after the vote. A typical media headline was: ‘Anxious businesses freeze jobs and cut plans from investment.’ Yet only one fifth of respondents thought their investment would ‘significantly’ decrease. Over a half said investment levels would probably stay the same, or increase. After seeing such gloomy coverage of the survey, and all the other economic pessimism, the results from the next business survey will likely look much worse.
The key point is that there is no determinate relationship between Brexit and the economy. How the economy performs depends on another relationship, and how it could shift. That is, the relationship between the state of the fundamentals – levels of productive investment, the pace and scope of innovation, productivity and growth – and the policies adopted to promote economic growth. Today, the fundamentals are dismal, and the policies are mostly making things worse.
That is good cause for a bit of gloom. It is also why Brexit provides us with a wonderful opportunity to shake the economy up, and develop genuinely pro-growth policies through democratic debate. In particular, stagnating productivity needs to be cracked. This should be an energising discussion. Here, let’s first dispel some of the delusions that are getting in the way.
1) In his resignation statement, David Cameron claimed the British economy was ‘fundamentally strong’. This is rubbish. It is the sort of evasion of economic reality that exemplifies how detached members of the political class are from their constituents. Such economic make-believe alone justifies the people’s disillusionment with the political elite. The British economy was in a parlous condition before the referendum result. It was stuck in depression well before the prospect of a referendum was raised in Cameron’s Bloomberg speech in January 2013.
The business investment that is essential for growing productivity and prosperity has been in structural decline since 1973. The amount of capital stock available to each British worker actually declined in 2013 and 2014, the first time this has happened since the Second World War. Labour productivity has barely grown since before the financial crash.
At the start of the referendum campaign, Bank of England governor Mark Carney set the scary tone when warning about Britain testing the ‘kindness of strangers’. He was referring to reliance on foreign institutions for financing Britain’s current-account external deficit. But the relevant point is that Britain’s dependence on foreign capital long preceded the referendum campaign. Indicative of its fading economic performance, Britain has been running a persistent current-account deficit since 1984. It rose to a record of over five per cent of GDP last year.
Blaming economic weakness on the ‘shock’ of the referendum result, or the future possible loss of access to the Single Market, is misleading in the extreme. Starting from this false premise distorts and debases the hard thinking we need to do about Britain’s real economic challenges and options.
2) President Barack Obama and others have warned that the UK vote raises ‘longer-term concerns about global growth’. Some perspective is needed, particularly on the claim that Brexit is a major threat to global prospects. While we are always being reminded that the UK is the ‘fifth-largest economy in the world’, on a purchasing-power basis it accounts for less than 2.5 per cent of world GDP.
More pertinently, without Brexit the world economy has already been slowing down for six years, never having recovered properly from the effects of the 2007/09 financial crisis. In March, an editorial in Foreign Affairs magazine, with the cover title ‘The world is flat’, summarised the pre-Brexit situation: ‘Growth has ground to a halt almost everywhere… a grim new reality: the world is stuck in the slow lane and nobody seems to know what to do about it.’
Annual global growth fell from 5.4 per cent in 2010 – buoyed by China’s final year of double-digit growth – to 4.2 per cent in 2011, and then 3.5 per cent, 3.3 per cent, 3.4 per cent, and finally 3.1 per cent in 2015. No wonder the International Monetary Fund this April titled its half-yearly world economic outlook report: ‘Global Economy Faltering from Too Slow Growth for Too Long.’ The IMF prominently joined in on the Remain campaign’s pre-referendum doom-mongering. However, it could hardly attribute that fair economic assessment of the past to what might happen in Britain in the future.
3) Fears about uncertainty focus most on Britain’s future trading relationship with the EU Single Market. This arrangement is uncertain, because it will follow only from the negotiations between the EU and Britain. If the future trade relationship were knowable, it wouldn’t be subject to negotiation. But whatever is agreed, the salient point is that the economic significance of trade and trading arrangements is being overblown.
Trade does not set economic growth rates. Exporting success does not make businesses or economies stronger. It is the other way around. Strong high-productivity businesses and economies are successful sellers and exporters of their goods and services. Trade determinism is obscuring what is needed for getting out of the Long Depression. This requires restructuring and renewing the engine of domestic production, not focusing on negotiating trade deals around the world.
Formal trading arrangements are not that important, either. If Single Market access is so decisive for Britain’s economic performance, how come British productivity grew faster in the 22 years before the EU Single Market was established in 1993, than in its 22 years of existence since? From 1971 to 1993, labour productivity grew by an average of 2.3 per cent each year. This was getting on for double the 1.4 per cent a year from 1993 to 2015.
People have traded overseas for millennia. The Ancient Greeks exported wine, bronze goods and olive oil, and imported wheat from Egypt and wood from Macedonia and Thrace. They didn’t need trading agreements or World Trade Organisations to export and import.
Nor do countries today need to be inside customs unions or Single Markets to sell their goods and services. Scores of countries export successfully to the EU: more than 70 countries export in excess of one billion euros a year into the Single Market. China is at the No1 spot with €350billion, and the US is No2 at about €250billion; neither of these nations even has a free trade agreement with the EU. Honduras completes the list at position No73, just exceeding €1bn a year, mainly coffee and knitted sweatshirts and t-shirts.
Britain should get on quickly with resetting its trade arrangements with the EU. But this should not be all-consuming in time and effort. The outcome is going to be much less important for Britain’s future economic state than resetting its power of productivity.
Finally, in the interests of a less anxious economic dialogue, people should desist from telling us that ‘markets hate uncertainty’. It’s a meaningless phrase. Markets neither hate nor love anything; markets don’t have feelings. Financial market traders, though, love uncertainty – even if they don’t often admit it. Volatile markets are good news for City traders, because that’s how they make money. They earn more fees from buying and selling when markets in shares, bonds and currencies are moving sharply.
Financial investors also depend a lot on ‘uncertainty’, or prices would never move upwards. Financial speculators are like anyone else who bets on outcomes — of horse races, football matches, or elections and referendums. Gamblers win or lose money because the outcomes are uncertain. They tend to hate it when they lose, and love it when they win. And, unlike gambling, with financial speculation there is always a direct counter-party. For every disappointed losing seller of a financial asset there is a willing buyer, who presumably hopes to go on to be a happy winner.
There is more financial volatility today, but this is a symptom not of heightened uncertainty, but primarily of financialisation. This is when economies are increasingly dominated by financial rather than productive activities. Businesses and others use their surpluses of money not mainly for enhancing their productive capabilities, but to make money out of money. This includes buying financial assets, or property, or works of art, in the hope of selling them later at higher prices. Businesses also seek financial gains, with a few more intermediate steps, when they buy back their own shares, or engage in mergers and acquisitions with other firms.
The golden rule of a depressed financialised economy is that when ‘value production stagnates, market prices fluctuate’. States have supported the financialisation of the economy, not least through promoting debt by their easy-money policies, since the 1980s. The result is that stock markets, bond markets and other assets bought for speculation have often become ‘fully priced’, or overvalued. When shocks happen, like the Brexit vote, there is therefore plenty of scope for big percentage falls, and subsequent debt-supported price recoveries.
Financialisation, by the way, underpins that topsy-turvy outcome when the rating agencies, joining in the post-referendum gloom, moved to downgrade the economy, or rather downgrade British gilts – that is, government-issued bonds. By the textbook of ratings downgrades, gilt prices should have fallen and market interest rates risen. The opposite happened. Bond prices rose and the yield on 10-year UK government bonds fell below one per cent for the first time. Financialised, debt-fuelled markets do odd things. In this instance, lots of surplus cash moved into the safest assets around — central bank-supported sovereign bonds — pushing prices up and interest rates down.
The Brexit vote does bring extra uncertainty, and therefore extra opportunity. It is trite, though, to blame greater post-Brexit uncertainty for weak business investment, which has been in long-term decline for over 40 years. The future is always uncertain, so businesses are always investing, or not, in the context of uncertainty. Economic drivers for investment change. Perceptions of uncertainty change. The two things are not determinedly connected.
It is easy now to find domestic and foreign businesses saying they are more reluctant to invest and hire in Britain until post-Brexit uncertainty passes. But, first, they weren’t doing much of either before the referendum. Second, if the vote had gone the other way, businesses would be attributing their failure to invest and create decent new jobs to other sources of uncertainty instead: the US presidential elections, the Eurozone crisis, or the global effects of China’s economic slowdown.
What is more important for economic prospects is that, judging from their reactions to the vote, the political class and its sympathetic media commentators are unable to handle uncertainty. Their instinct is to resist change and seek to preserve the status quo. That’s been the big problem with economic policy in Britain, and in other Western countries, since about the 1980s. From this base, they will not be seizing any opportunities from Brexit. A continuation of these conservative political efforts is therefore the biggest medium-term peril to the economy. Confronting this policy resistance to change will be vital in the weeks and months ahead.
A more immediate hazard is of an earlier than necessary, and unprepared for, recession. It is likely that the higher the post-vote fear levels are cranked up, the less businesses and others will spend. There is a real danger that the scaremongering about post-Brexit catastrophe will be self-fulfilling. If every piece of forthcoming economic data continues to be overanalysed to find the dark clouds within, then the economic clouds will darken faster. All this panic talk needs to stop. Given the fragility of the British economy to start with, it could be enough on its own to trigger an earlier and more out-of-control recession.
Phil Mullan is author of The Imaginary Time Bomb: Why an Ageing Population Is Not a Social Problem (IB Tauris, 2000: (buy this book from Amazon (UK) or Amazon (USA)), and Re-Mojo: Putting an End to the Long Economic Depression (forthcoming).
Picture by: Getty Images.