Re­venge of the ex­perts

Financial Nigeria Magazine - - Contents - By Barry Eichen­green

The Brexit de­bate is an end­less source of mirth for any­one with a dark sense of hu­mor. My own favourite quote is from Michael Gove, cur­rently Bri­tain's en­vi­ron­ment sec­re­tary.

Just prior to the June 2016 Brexit ref­er­en­dum, Gove, who was jus­tice sec­re­tary in David Cameron's gov­ern­ment at the time, dis­missed the all-bu­tu­nan­i­mous view of econ­o­mists and oth­ers that a de­ci­sion to leave the Euro­pean Union would deeply dam­age the Bri­tish econ­omy. “Peo­ple in this coun­try have had enough of ex­perts,” Gove testily ex­plained, re­fer­ring to “ex­perts from or­ga­ni­za­tions with acronyms, say­ing they know what is best and get­ting it con­sis­tently wrong.”

The early post-ref­er­en­dum ev­i­dence sug­gested, to the sur­prise of many – or at least to many of the ex­perts – that Gove was right and they were wrong. There was in fact no im­me­di­ate re­ces­sion in the United King­dom fol­low­ing the Brexit vote; in­deed, there was not even a slow­down in growth.

To ex­plain this, ob­servers pointed to the nim­ble re­sponse of the Bank of Eng­land (BoE), which cut in­ter­est rates to pre­vent any soft­en­ing of de­mand. They pointed to the big post-ref­er­en­dum de­pre­ci­a­tion of the pound, which promised to make Bri­tish ex­ports more com­pet­i­tive and off­set any prob­lems with the tran­si­tion to a new trade regime. They sug­gested that a UK freed of bur­den­some EU reg­u­la­tions could of­fer a more busi­ness-friendly en­vi­ron­ment and lower cor­po­rate tax rates, and thus be­come a mag­net for for­eign in­vest­ment.

Most provoca­tively, they ques­tioned pre­dic­tions that the un­cer­tainty sur­round­ing Brexit would have a pro­foundly ad­verse im­pact on eco­nomic per­for­mance. Econ­o­mists can't mea­sure un­cer­tainty di­rectly, they re­minded us, while prox­ies, like the fre­quency with which the term ap­pears in the fi­nan­cial press, do a poor job of cap­tur­ing its ef­fects.

In­deed, we econ­o­mists have had lit­tle suc­cess at re­li­ably pre­dict­ing when and why un­cer­tainty spikes. And there is lit­tle agree­ment on the sever­ity of its im­pact. Maybe we would be bet­ter off plac­ing less weight on the ef­fects of un­cer­tainty when mak­ing fore­casts in gen­eral, and in the case of Brexit in par­tic­u­lar.

But this view looks rather less com­pelling with the pas­sage of a cou­ple of ad­di­tional quar­ters. Bri­tish con­sumer con­fi­dence is down, with spend­ing in the sec­ond quar­ter of this year fall­ing to its low­est level in four years. New car sales have been down for four con­sec­u­tive months. The BoE fore­casts a whop­ping 20% de­cline in busi­ness in­vest­ment in the com­ing years, whereas Brexit's cham­pi­ons pre­dicted the op­po­site.

The drop in con­fi­dence, some might ob­ject, re­flects an in­con­clu­sive gen­eral elec­tion and a hung par­lia­ment, not the Brexit vote. Or wors­en­ing con­di­tions can be blamed on the gov­ern­ment's less-thanstel­lar ne­go­ti­at­ing strat­egy and the ap­pear­ance that it is en­ter­ing dis­cus­sions with its EU part­ners un­pre­pared.

But the in­con­clu­sive elec­tion re­flects the schizophre­nia of both the Con­ser­va­tive and Labour par­ties on the Brexit is­sue. Prime Min­is­ter Theresa May op­posed Brexit prior to the ref­er­en­dum, but now em­braces it as the oc­cu­pant of 10 Down­ing Street. The Labour op­po­si­tion un­der Jeremy Cor­byn of­fi­cially op­poses Brexit but seems to de­rive pe­cu­liar sat­is­fac­tion from the fact that it is pro­ceed­ing.

Some ar­gue that if the gov­ern­ment adopted a more co­her­ent ne­go­ti­at­ing strat­egy the dam­age would be less. But the fact is that there is no co­her­ent ne­go­ti­at­ing strat­egy. May's ob­jec­tives – re­stric­tion of im­mi­gra­tion from the EU while main­tain­ing full ac­cess to the Euro­pean sin­gle mar­ket – are fun­da­men­tally in­com­pat­i­ble.

The only sur­prise is that it took so long for the con­se­quences to ma­te­ri­al­ize. It ev­i­dently took more time than ex­pected for the im­pli­ca­tions to sink in – to un­der­stand that “Brexit means Brexit,” as May's pithy tau­tol­ogy put it. It took time to re­al­ize that there would be no smooth break with the EU and that ne­go­ti­a­tions would not be wrapped up in two years. There might be no free-trade agree­ment, no pass­port­ing rights for Bri­tish banks seek­ing to do busi­ness in the EU, and not even an agree­ment on land­ing rights for Bri­tish air­craft on the Euro­pean con­ti­nent.

And now the chick­ens are com­ing home to roost with a vengeance (if chick­ens could be venge­ful). Con­sumers, see­ing the pound de­pre­ci­ate, front-loaded their spend­ing in the sec­ond half of last year, be­cause they un­der­stood that im­port prices would rise. Hav­ing in­curred ad­di­tional debt, they are now in no po­si­tion to con­tinue spend­ing at that ear­lier pace.

Sterling's sub­stan­tial de­pre­ci­a­tion, more­over, au­gurs a sig­nif­i­cant rise in in­fla­tion, which means that the BoE will have to start rais­ing in­ter­est rates sooner rather than later. The con­se­quences for growth will not be pretty. The Bank will no longer be the Brex­i­teers' friend.

What the late, great MIT economist Rudi Dorn­busch – that most ex­pert of ex­perts – said about Mex­ico's peso cri­sis in the 1990s ap­plies to the dam­age from Brexit as well. A cri­sis, Dorn­busch noted, “takes a much longer time com­ing than you think, and then it hap­pens much faster than you would have thought.”

Barry Eichen­green is Pro­fes­sor of Eco­nomics at the Uni­ver­sity of Cal­i­for­nia, Berke­ley, and a for­mer se­nior pol­icy ad­viser at the In­ter­na­tional Mone­tary Fund. His lat­est book is Hall of Mir­rors:The Great De­pres­sion, the Great Re­ces­sion, and the Uses – and Mis­uses – of His­tory. Copy­right: Project Syn­di­cate

Barry Eichen­green

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