A reckless economic experiment

20 September 2018

The Government is unprepared for a hard Brexit, says Ann Pettifor. The financial impact could be devastating

PA

THE Brexit referendum provided conclusive evidence that economics is inherently political. There was nothing scientific about any of the campaign promises or economic forecasts.

Instead, in the run-up to the referendum, Brexiteers emphasised the importance of the domestic labour market, and blamed immigrants for the post-crisis slump. They ignored the costs of exiting a huge EU market in goods and services, and of cutting off the long supply chains of British firms.

Remainers focused on the part Britain played in the globalised economy. “Britain is a global nation with a global role and a global reach,” the Prime Minister opined. Voters scratched their heads over what it meant to be a “global nation.” Many preferred the Brexiters’ commitment to the national flag or “sovereignty”.

The Treasury argued that the UK would be better off staying in the EU, and then used an opaque model to estimate the precise cost of leaving for every household in Britain: £4300 by 2030.

The overwhelming weight of independent economic opinion — from the IMF to the OECD, from the LSE to the IFS — backed up the threat that Britain would suffer an immediate economic shock, and then be permanently poorer for the long term.

George Osborne attempted to intimidate voters with a “punishment budget” if citizens voted Leave. With the backing of Alistair Darling, he announced confidently, in June 2016, that, if Britain voted to Leave, the Treasury would have to fill a £30-billion black hole in the public finances. This would take the form of increased taxes and even deeper cuts in public spending.

All of these forecasts made basic but biased political assumptions. They concentrated overwhelmingly on issues of “free trade”, as if trade was and is the only important aspect of economic activity and well-being. But, in 2017, goods exports were equal to just 17 per cent of GDP, and, the same year, service exports peaked at 14 per cent of GDP. (House of Commons Library, July 2018). It is aggregate demand within the economy that drives trade and could help balance our trade deficit.

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REMAINERS preferred defeatism: the public finances would collapse after Brexit, and the Government could fill the “black hole” only by cutting spending and increasing taxes.

Not so. We know that, with the help of the Government’s Debt Management Office, and the Bank of England, the Government can raise finance to expand investment in the UK, and create higher-paid, skilled jobs. We know because only recently it raised £1000 billion to finance private-bank bailouts, and later added more for HS2.

We also know from experience that by investing in and creating well-paid employment after Brexit, the Government could stabilise the economy, ensure the repayment of its financing, and balance the books. Keynes’s theory of the “multiplier” would kick in, and job creation would pay for itself. After all, the employed pay taxes, many as PAYE. These revenues return to HMRC in the immediate, medium, and long term as income for the Treasury.

Higher incomes would allow employees to shop for fuel, insurance, solar panels, and food, for example. The VAT on these items “multiplies” the income returned to HMRC’s coffers. And the makers and sellers of goods and services, in turn, pay corporation taxes on their gains, multiplying even further the revenues needed to balance the Government’s books — not just in year one, but over the many years that skilled workers remain in employment.

But fixing the public finances would only happen if politicians abandoned the economic orthodoxy that assumes that markets determine our fates, and took active responsibility for the state of the economy — if they roll up their sleeves after Brexit and choose to invest in skilled, well-paid work to meet the urgent needs of society, the ecosystem, and the economy. If they don’t, then expect the economy to weaken, and public debt to rise, as it has these past ten years.

After the referendum, a big drop in business confidence occurred, but this recovered quickly. The pound fell sharply, as many had predicted, but has also since recovered. Employment remains high, and manufacturing and exports are doing well, boosted by sterling weakness. The fall in sterling led to a rise in inflation, which, in turn, cut real incomes that, in any case, had been weakened by the global financial crisis.

As Geoff Tily, at the TUC, shows, real wages today are still worth £24 a week less than they were in 2008. But the decline in real wages, and the decline in labour’s share of national income, began well before the EU referendum.

Britain’s workers are victims of low levels of public and private investment. The UK ranks below the OECD average in every single investment category. Policies that promoted self-regulating financial markets, which periodically crash, and that contracted the public sector after the financial crisis, helped to exacerbate the shock of the referendum outcome. Together, they caused the economy to shrink by about one per cent of GDP.

Despite this weakness, we can rightly conclude that forecasts of the consequences of voting to Leave were far too pessimistic, and that “Project Fear” was misguided and self-defeating.

 

BUT — and it is a big but — Britain has still to leave the European Union.

It is my view that there can be no “soft” Brexit, given divisions within the governing party; given the rules of the Single Market; given the threat to the future of the Union if exceptions are negotiated for Britain; and given the political and logistic complexity of the Northern Ireland border. We are, therefore, headed either towards remaining in the EU, or for a “hard” Brexit. If it is to be the latter, we will automatically leave the EU on 29 March 2019.

The big concern about the imminence of this date is that the UK Government has a record of unpreparedness. Britain was unprepared for the Second World War. We embarked on the Iraq war unprepared for the ongoing consequences and fallout. We were catastrophically unprepared for the great financial crisis. Our Government and its understaffed, stretched Civil Service are clearly not fully prepared for a “hard” Brexit. And yet that is where we are heading.

Then there is the global context in which we will undertake this reckless experiment. The US Federal Reserve is determined to continue ratcheting up interest rates and to strengthen the dollar — a policy that has an impact on the entire global economy. The governor, Jerome Powell, cannot reverse this trend, even as a stronger dollar causes turmoil in global capital markets.

More financial volatility, including sovereign debt crises, will be the global context in which the UK exits from its largest trading market, and begins trading anew — under WTO rules.

The biggest cost would come from a partial or complete breakdown of the arrangements that make trade possible at all, and the impact that this breakdown had on British jobs. This failure is more likely because of the long supply lines of British firms, which locate different stages of production in different countries.

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Firms importing from abroad would be hit by rising prices, as sterling will invariably fall. Firms exporting abroad would be hit by rising input prices caused by the need to replace EU imports with costlier products sourced outside the EU. Consumers on low incomes will be faced, once again, by higher prices, on top of the costs of ongoing “austerity” with its decimation of the “social wage” of public and local government services.

Who or what will come to the rescue? The Bank of England bailed out the whole financial system in 2008-09. Regrettably, there is no comparable institution that could bail out Britain’s trading system.

So, with a “hard” Brexit, we are probably headeing for a severe recession in the short term. In the longer term — who knows? Much depends on whether our politicians (and Treasury officials) are willing to abandon the delusion of self-regulating markets, roll up their sleeves, and consciously subordinate both domestic and international markets (in money, trade, and labour) to the interests of British society as a whole, and not just to the vested interests of the “global” one per cent.

 

Ann Pettifor is the director of Policy Research in Macroeconomics, a council member of the Progressive Economy Forum, and winner of the Hannah Arendt Prize 2018.

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