Well, we were warned. The governor of the Bank of England and the IMF, as well as much of the financial community, were very clear that Brexit would produce a damaging economic shock. It is happening.
Even if we discount George Osborne’s absurd and counterproductive attempts to predict the precise fall in house prices and threaten a deflationary emergency budget, there were sensible and dispassionate warnings of severe trouble ahead. We now need to think through how progressive opponents of this government should respond.
My starting point is a disagreement with my Tory former colleagues in the coalition – from both Remain and Leave – who argue that Britain has a “fundamentally strong economy”. It doesn’t. We have barely recovered from the 2008 crisis, are still on the life-support system of artificially cheap money and have a horribly unbalanced economy. Recovery was happening but fragile.
The first stage in the post-Brexit shock is the predictable turbulence in financial markets as liquid investors jump into safer assets and away from riskier holdings of sterling, UK banks and other shares. This is a very different situation from 2008, which was a financial crisis to which politicians had to respond; this is a political crisis, a huge escalation of political risk, to which markets are responding.
The fall in sterling should not exercise us too much. If devaluation is locked in, it would help rebalancing. The Monetary Policy Committee will surely be sensible and disregard the short-term inflationary consequences, as members did the spike in commodity prices five years ago. If investors move out of UK residential property and precipitate a sustained fall in house prices, that is also to be welcomed. The main casualties of the immediate turbulence are Brexit-voting pensioners whose annuity values crashed with the flight into gilts.
The gravest potential short-term risk was anticipated by the Bank of England when it pumped in £250bn to prevent a drying up of liquidity in the banking system and another credit crunch. The prompt action has clearly reassured markets. However, what may be more serious is the gradual reassessment of risk by bank credit committees leading to restrictions on lending to smaller businesses. That would be disastrous for growth. A pragmatic government should reach for some of the tools created by the coalition, such as the British Business Bank, for sources of business credit.
In the second stage the crisis will migrate from asset markets to the real economy and jobs. The new Tory leader will be praying the time before unemployment kicks in will be long enough to have a general election. By autumn, we shall have a clearer picture of the scale of any slowdown, but I find it difficult to see how we can avert a Brexit recession.
The issue is how to deal with a recession. Monetary stimuli are losing effectiveness. With interest rates close to zero, there isn’t much scope for further cuts and quantitative easing is becoming increasingly problematic. Some in the City will be urging more cuts, worried about Osborne’s plan to eliminate government borrowing by 2019.
There was never a better time for public investment to fill the gap in demand left by private investors. There is a long pipeline of coalition infrastructure projects, including Network Rail’s stalled investment plan, to get on with. But then we encounter the Treasury’s pathological aversion to borrowing to invest. Its deep conservative instincts will be reinforced by our deteriorating credit rating.
Yet the need to confront the structure and balance of the economy transcends the issues of short-term crisis and medium-term macroeconomic management. The financial sector may well take a bad hit with banks migrating to European centres. We should not minimise the costs to individuals and the Exchequer, but it may be no bad thing if the result is some rebalancing. The industrial strategy put in place under the coalition is an ideal vehicle for building confidence in long-term investment in manufacturing and creative industry. Of course, none of this will happen without a speedy confirmation of the UK’s continued role within the single market.
How the economics of this political crisis will be dealt with depends on the parliament that is returned when a new Tory leader calls an election. If the Tory right emerges triumphant, the consequences will be ghastly. If the parties of the centre and left – including disaffected Tory Remainers – can get themselves organised, however, we could see an altogether happier outcome.
This article appears in the 29 Jun 2016 issue of the New Statesman, The Brexit lies