Posted by Professor Michael Waterson · January 12, 2017 4:39 PM
Historians don’t all study WW2; Lawyers don’t all study English contract law; Physicists don’t all study the solar system; Accountants don’t all study double-entry bookkeeping; and Economists don’t all do economic forecasting. In fact in each case, albeit important, these are the interests of a minority. In each case, there are many important questions for society apart from these. It is easy but facile to make the elision between “Economic forecasters failed to predict the immediate consequences of Brexit” and “Economists are rubbish”. It is also wrong.
Brexit is something new. Predicting the outcome of something than has never been tried before is the ultimate challenge, not just in Economics. The electrical engineers in Britain who connected the various local electricity grids together in 1937 to create the country’s national electricity grid did so secretly, because there was significant concern that a disaster would occur. If it had, electrical engineers would definitely have got a bad press, once the presses were running again! So why are economists as a group so convinced that the impact of Brexit will be bad for GDP in the medium term? Essentially, and actually rather like the engineers, because they see the benefits of trade. For engineers, the benefits were those of connecting up local grids to enable movements of electricity across space within the UK. They had the advantage of seeing previously the benefits accruing to the North East of England of the local NESCO grid, Europe’s largest integrated system at the time.
Are there analogies on which economists can draw? The benefits for Mexico of the free trade agreement with the USA are obvious. However, this also reminds us of something extremely important, a point made frequently by Joseph Stiglitz, a Nobel Laureate in Economics and one of the world’s most prominent economists. There are benefits to free trade, but the benefits are not evenly spread. As Stiglitz says, in principle, the gainers can compensate the losers. The challenge is to encourage, or even force, them to do that. The City of London is a clear gainer from trade in services. But do those in the City compensate the losers? Almost certainly not.
There is another analogy, less direct but extremely powerful. The break-up of the Soviet bloc meant that a comprehensive system of trade between the former countries of that bloc collapsed. They were freed from the yoke of Russian control, free to trade outside the bloc, but the medium term consequence was a significant collapse in GDP in all those countries.
Free trade is not easy to achieve. It is not so much about tariffs as about non-tariff barriers to trade. In fact paradoxically, as regards trade in services within the EU, Britain was pushing for the Services Directive to be implemented against the wishes of many in Germany. The reason is instructive. The directive meant that qualified Belgian hairdressers and Polish butchers, for example, would be able to operate in Germany. What made this difficult was the German crafts guilds, who tried to block what was price undercutting competition, undermining their comfortable existence. They did this by imposing various restrictions on who could operate in individual cities. Consumers were not foremost in their minds!
So economists generally view Brexit as having negative medium term consequences for trade and GDP. We do not agree on when exactly this will happen, nor how large the impact will be. And of course the impact will be uneven. The only shorter-term impact has been a collapse in the value of the pound, prompted by market expectations of the future. This potentially makes the UK a more favourable location from which to export, provided non-tariff barriers can be surmounted; a substantial proviso. But it will also inevitably filter through into higher prices for imported goods, the first signs of which are being seen, hence making us all worse off. This will not be immediate- most companies engaged in significant trade hedge currencies over a few months, even up to a year, meaning that currency movements do not affect them immediately.
The significant challenge, then, is to achieve the benefits of maintaining trading relationships whilst compensating the losers. This is the point to which economists have failed to devote significant attention.