Brexit: Economic Mythmaking

The UK is likely headed for a mild recession. Mild in terms of GDP but sadly not in terms of unemployment and the human tragedy.

There is a myth being developed that this is down to the Brexit vote or even due to the uncertainty caused by there even being a Brexit vote.

Growth Rates (%) 1960-2014

GrowthRates

Source: World Bank

The average length of an economic expansion in the UK since 1960 is 9.8 years, including the current period. Assuming, as seems likely, GDP expands by a marginal amount over 2016 falling into recession from Q3 onwards the current expansion will have lasted for seven years. Hardly an extraordinary departure from the average over the past 50+ years. The average length of a period of economic growth in the US and EU over the same time periods has been 7.8 and 10 years respectively. There is a cycle to economic expansions as with most other things and to pretend that any contraction in the UK is completely out of character is ridiculous.

OK – of course, there could be a connection to the Brexit vote and to the economic cycle right? Yes.

However, PMI Surveys for the services, manufacturing and construction have all been trending down since Q12016 or earlier. The heat has been going out of the UK economy since the early parts of the year. Employment growth has been similarly slowing since the start of the year (though here it can be at least partially attributed to marginal gains being hard to come by when near full employment.

The National Living Wage came into effect from the beginning of April and was predicted to lead to higher unemployment, accepted as a consequence of increasing pay for the lowest paid. So any upticks in unemployment in the coming months can be attributed more to the NLW than to Brexit.

 

The UK was more than likely due a mild recession. It is likely that the severity of the recession will be increased by the uncertainty around what Brexit means. But the idea that any recession is due to our decision to leave the EU is ridiculous.

 

 

The chancellor has suggested a cut in corporation tax by 5% taking the UK down to 15% by 2020 instead of 17% by 2020. Naturally, I’m all in favour of this but can’t help thinking the economy would be better served by taking a penny off employer’s NICs. Corporation tax cuts have been more than self-funding over the last parliament so maybe even better would be to do both.

Brexit – Rules Are Made to be Broken

We have to accept free movement of labour to get access to the single market.

I don’t know how many times I’ve heard that over the past ten days. I’ve heard it so much that there’s no way it can’t be true. Right?

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EU law, isn’t. It’s a series of guidelines that can, and are, discarded when convenient.

Germany exceeded their deficit limits in the early years of the Euro – illegal? Sure. Any action taken? Against Germany, in the Euro? Come on. Be serious.

Bailouts are specifically forbidden under the Lisbon Treaty. But Greece, Portugal, Ireland, and Spain are all in trouble. Well, damn the law. The Euro is more important than the law.

1. The Union shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of any Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. A Member State shall not be liable for or assume the commitments of central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of another Member State, without prejudice to mutual financial guarantees for the joint execution of a specific project. – Article 125, Lisbon Treaty

Politics trumps law every time in the EU. It’s one of the main reasons I voted to leave – because the rule of law, isn’t.

So, will politics – the armed wing of economics – trump the law when it comes to negotiating the UK’s exit from the EU? Most likely.

The EU will need some paper wins to prove they weren’t walked all over. The UK will be made an example of in a very public but very limited way.

The UK is (depending on measure) the country with the highest military spending in the EU. We, along with France, hold a permanent seat on the UN Security Council, we are one of two nuclear powers in the EU. We have one of the two blue water navies in the EU and are (from 2020) able to project power from the Queen Elizabeth Class aircraft carriers. We are Atlanticist in  a way that no other EU country is. The UK anchors the USA in NATO, checking Russian aggression. Is NATO less relevant now than it was 30 years ago? Yes – but Ukraine proves that Russia is still a strategic threat. NATO counters that threat. Poland, Finland, Latvia and Lithuania all share a land border with Russia. Without an economically strong UK, able to fund our NATO commitments, the USA will continue to see Europe as not pulling its weight. Four EU countries, Poland especially, that have a strong incentive to see a deal done for the UK.

The UK has a colossal trade deficit with the EU – primarily with France and Germany. The German CBI went on the record before the referendum saying (correctly) that free trade was in the interest of all parties. The French business lobby is making more noises to the same effect. The EU attempting to punish the City can lead to reciprocal punishments to the French and German car industries. A beggar thy neighbour policy would hurt everyone. So if the EU puts down their gun, the UK puts down its gun.

The EU has a strategic and economic interest in keeping the UK engaged. Keeping the UK engaged on the continent will require a deal that allows both sides to save face but both sides to prosper. The laws… rules… guidelines can, and will, be damned for political expediency.

 

EURef – Calm Down

One week on from the end of the world and the world is still somehow turning.

The FTSE 250 is admittedly down 8% on last week and has been among the, if not the worst performing asset globally over that time period. The pound has fallen to the low 30s against the dollar and the Euro is trading at parity in some places.

The French economy has overtaken us as the fifth largest in the world and the EU seem to be playing hardball on negotiations, which haven’t even started yet. The picture is not rosy.

And yet, and yet – the most likely outcome for the UK remains a Norway style deal – something if, when taking into account the 48% who voted to remain and the 52% who voted to leave, would get a very high level of support. We will likely have to trade some financial passporting and definitely the Euro denominated trading in turn for restrictions on migration. We will also have to contribute to the EU budget. But we will be outside the EU.

We will no longer need to fund the CAP – New Zealand abolished agriculture subsidies and saw the farming sector boom. We will be able to control the fisheries in our waters, we will never join the Euro and will be able to determine our policy in myriad other ways.

We will be able to sign our own free trade agreements. This is the key.

I’m a classic liberal. I believe in the primacy of the markets. So to my mind we should unilaterally abolish all tariffs, decreasing cost to consumers and industry in the UK whilst building goodwill with other countries. This would only reduce costs by around 3% – non-tariff barriers remain the real hindrance to trade but this would be a good signal. Tarrifs on agricultural products remain considerably higher – unilaterally abolishing these would grant the triple benefit of reducing UK food costs, improving economies in Africa and decreasing the need for the UK aid budget through trade.

We should aim to have in place before we leave the EU a free trade deal with as many countries as possible. Australia, New Zealand, Canada and Singapore are all obvious first ports of call where the likelihood of a true free trade agreement is high. We can replace the lost GDP from the services, which we will inevitably lose, with increased trade with the rest of the world. A free trade agreement with the USA will likely take longer to negotiate but would be in place before TTIP was ever ratified.

We remain the third largest contributor to NATO, we remain a P5 member of the UN Security Council, a member of the G8 and G20. A member of the Council of Europe, the IMF, the World Bank. We remain the centre of the Commonwealth which could form a new loose free trade area. English is still the most widely spoken international language in the world. The world still revolves around GMT – the easiest way to trade with Asia if you’re based in the US is to go through London for the strong legal system, the timezone, the language. London remains a vibrant, international city.

The short-term is a blip. The short term is always more volatile than the long-term. Many economists think we’re likely to enter recession over the coming year. However, the markets will settle down over a period of weeks. Over a six-month timeframe our deal with the EU will become clearer, pending elections in Germany, France and the Netherlands. Over a one year view we will be able to see how initial efforts at external trade deals are going. Over a ten-year view the impact of our shaking off the shackles of the EU will be clear as our growth rate continues to outstrip the EU.

We remain a vibrant economy with a huge deal going for us. The end is not nigh.

 

Yet.