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H2 Econs [Globalization] 3 Lessons of Brexit - A Case Study on Globalization

June 24, 2016

*Note: This article is a commentary based on the report by the Wall Street Journal on the Brexit's impact on the U.S. and can be found here.

 

Brexit - or British-Exit, has been the main source of worry globally for the months leading up to yesterday's referendum in the UK. Now that the dust has settled, and Nigel Farage's "Leave" Campaign has edged out the "Remain" camp by the narrowest of margins, it is worth considering the economic impacts should this referendum translate into Britain actually exiting the EU. 

 

Credit: Techcrunch 

 

1. A massive depreciation of the GBP against a basket of global currencies

 

As the uncertainty of Brexit takes hold among investors, a large capital outflow would cause a massive depreciation of the GBP due to the rise in supply of GBP as investors exit the UK and a fall in demand for the GBP. At the time of writing, it has fallen by almost 10% against the USD and even the SGD. 

 

Assuming the Marshall-Lerner condition holds, the depreciation can benefit the UK economy by making exports more price competitive in foreign currency and making imports more expensive in domestic currency, increasing X and C at the expense of M as domestic consumers "buy Britain" (as Nigel Farage would say). However if we factor in the loss of free trade access to the rest of the EU countries, the overall impact on X could be negative as tariffs would be imposed on British exports to the EU. 

 

In addition, the economy could suffer from a lower purchasing power with a weaker pound and consume less imports, reducing material standard of living. Also the depreciation could result in imported cost push inflation as the cost of imported raw materials rise in terms of domestic currency. Inflation would further hurt standard of living as the cost of living rises. 

 

2. A potentially large outflow of FDI and labour

 

One of the biggest factors driving the Brexit was the issue of immigration. Free movement of labour under the EU agreement has led to widespread disillusionment as the British felt that their jobs were being "stolen" and wages were depressed from this labour inflow. The increasing risk from global terrorism as highlighted by the Charlie Hebdo killings and the Paris attacks made the British fearful of the EU's liberal stance on border control. With Brexit, there is expected to be some deportation of existing foreign workers and naturally a drastic fall in immigration rates. This could lead to a rise in wages as the supply of labor falls and a slow in the rate of growth in productive capacity as there is a fall in the rate of increase in quantity of labor (factor of production). Clearly this will hurt economic growth (both actual & potential) and employment. It could even hurt X competitiveness and worsen the current account. 

 

Additionally, MNCs would be less inclined to invest in Britain and even downsize their existing operations due to the loss of trade, labor and capital access to the rest of the EU. Companies can no longer benefit from a low cost of labor or tariff-free access to other EU countries and hence Britain becomes a relatively less attractive destination for FDI. Clearly this could worsen economic growth due to a fall in I leading to a fall in actual growth and a slowdown in potential growth. Additionally the capital account could worsen from the outflow/lower flow of FDI. 

 

3. A fall in domestic and global economic confidence

 

The official process of leaving the EU would take two years and in that time, there is an enormous amount of policies that has to be unwound and renegotiated, particularly on trade, labor and capital flows. What this means is that the world is set up for two good years of uncertainty, alongside the UK. This would naturally weigh on consumer and firm confidence and put a dampener on Consumption (C) and Investment (I) spending, weighing on AD as well as potential economic growth. What this could mean is that the recent trend of anemic growth in Europe and other developed nations could continue while unemployment rises and output contracts. 

 

Conclusion

 

While these outcomes are by no means certain, as the "Remain" camp would continue to claim, its worth pondering and perhaps anticipating the impact of such a monumental statement by the British public. The two years that it takes for a proper exit would mean the economic impacts would gradually take hold in the real economy. Whatever the outcome, this would truly be a great case study of a massive anti-globalization move by one of the biggest developed nations in the world. 

 

 

 

 

 

 

 

 

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June 24, 2016

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