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4 July 2016

The short-term consequences of Brexit are severe – but financial disaster is not inevitable

In the long term – even in the medium term – everything, of course, will depend on the details.

By Felix Martin

England have just been ejected from Euro 2016 by Iceland. Is this an early example of the hapless future that lies ahead for Britain now that we have opted for exile from the richest economic zone on Earth? Or is it a demonstration of the mighty feats that even the tiniest of nations can achieve once freed from the EU yoke?

The debate on the economic implications of Brexit before last week’s vote was fuelled by fantastic claims of epochal economic disaster and transformative economic opportunity made by both sides. What does a more sober assessment of our prospects look like, the morning after?

In the long term – even in the medium term – everything, of course, will depend on the details. Only a fool would try to predict today what Brexit will actually look like, or how the EU itself will function, in five or ten years’ time. Indeed, Mervyn King, the former governor of the Bank of England, claimed on Monday that economically speaking Brexit was a giant red herring, because its impact on Britain’s long-term growth prospects was neither knowable nor likely to be large.

That is not as daft a diagnosis as it may sound. The economic history of most advanced nations shows a remarkable consistency in the pace at which they grow – a consistency that even depressions and world wars have found it difficult to disrupt. The logical inference is that geographic, cultural and demographic factors far outweigh policy levers in the determination of long-term prosperity.

Yet, as Keynes famously said, in the long run we are all dead. Lord King’s Olympian perspective is all very well – but in the short term, Brexit is already having serious economic consequences. Stock markets around the world have stuttered: European bourses, and especially Europe’s banks, have suffered most. Government bonds – savers’ favourite safe havens in a financial storm – have rallied, sending interest rates in the advanced nations to fresh lows (the Remain campaign’s warnings that interest rates would rise following a vote for exit always sounded strange – and sure enough, the yield of the benchmark UK government bond hit an all-time low this week).

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The most visible, and probably the most important, immediate economic casualty of Brexit, however, has been the value of sterling. The pound sank to a three-decade low against the US dollar on Monday, having lost 11 per cent of its value in the space of two trading days. We all know what this means for us individually: we’ve become poorer almost overnight. Foreign holidays have suddenly become more expensive. The price of booze and fuel – we import far more than we export of both – will go up. Remittances to families abroad will be worth considerably less.

What it means for the economy as a whole is less easy to say. Much has been made – correctly – of the negative impact of leaving the EU’s single market on foreign direct investment into the UK. Manufacturing cars in a country from where they can be exported freely to the rest of the EU is clearly a more attractive prospect than making them in one to which import tariffs apply.

Yet sterling’s exchange rate against the euro is at least as important. Between Thursday and Monday, the cost base of manufacturers exporting from the UK to the eurozone got some 8 per cent cheaper as a result of the pound’s fall against the euro. It would take a hefty hike in tariffs to offset a profit margin windfall on that scale.

The weaker pound brings other benefits. Most voters will not have been thinking about how to solve Britain’s addiction to foreign borrowing last Thursday. Yet the pound’s fall will help simultaneously recondition Britain’s gigantic balance sheet and balance our trade. Because of its large financial industry, the UK both lends and borrows a vast amount abroad. Its tends to borrow from the world in pounds, however – while it lends abroad in euros, US dollars and other foreign currencies. A sharp fall in the pound therefore has the effect of suddenly boosting Britain’s net worth, by making its assets more valuable relative to its liabilities.

As for trade: British politicians of all parties have for years talked of the much-needed rebalancing of the UK economy towards manufacturing, exports and saving. Sterling’s decline following Brexit – if sustained – might achieve that. Unlike the politicians, however, the currency markets don’t pretend there is a free lunch. The bill for a rebalanced economy has been presented in black and white: we are all 10 per cent poorer when measured in dollars or euros.

So the economic consequences of Brexit are not clear-cut. I was never convinced that the referendum would be decided by economics, in any case. It was fashionable to say during the campaign that the British would live up to their reputation as a nation of shopkeepers and vote with their wallets. In fact, the electorate apparently grasped quite well that attempting to calculate the economic impact of Brexit is pointless, and cast their votes based on matters of principle instead. The long-term historical record vindicates their approach, because it is those principles that will decide the future shape of our economy, in the UK and in Europe as a whole.

I believe the European Union is one of the greatest monuments to human political co-operation the world has ever seen, even as I deplore the EU’s remote bureaucracy and undemocratic machinery as keenly as anyone. So I voted to remain. The UK is leaving instead. But in the end, economically and in every other respect, it is the principle with which Jean Monnet motivated the project in the first place that matters to me, and – who knows? – maybe that principle will prosper better out than in: “We are not bringing together states, we are uniting people.” 

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This article appears in the 29 Jun 2016 issue of the New Statesman, The Brexit lies