Brexit

I hope Britain knows something that the rest of us don’t

I have to admit I received a dark satisfaction watching the Brexit saga unfold – not out of any malice towards Britain, but rather from the fact that this was yet another major global development that could make this period in time – and my youth – one the most (academically) fascinating economic and political periods in the last century. And while I may be a little late to the party in terms of my own analysis of Brexit, the past 2+ months has allowed cooler heads to start prevailing in their assessment of what this event could really mean for Britain’s economic and financial place in the world, and for the world itself.

Let’s get the obvious out of the way – I still maintain that Britain made a mistake in electing to leave the EU. While the immediate panic following the Brexit announcement appears to have been an overreaction (the British stock market recovered fairly quickly), the long term impacts are, in my opinion, very real and very significant.

London risks losing its global financial centre status to a mainland city such as Brussels (which is already the unofficial capital of the EU), Frankfurt or Paris. London used to be THE major financial centre in the world (after Antwerp in Belgium), and still arguably remains the most significant, but there are many other competitors, including New York, Singapore, Hong Kong, Tokyo and Zurich – and London’s status is not necessarily set in stone. London’s financial centre status does have history on its side, and as it stands, all that financial services activity in London can do business directly with Europe without barrier. For many, London is merely the headquarters for their wider European and global operations. Until now, there was never really a reason to LEAVE London. But now that Britain is leaving the EU, all that activity has a reason to leave and set up somewhere else where they are guaranteed access to Europe.

These losses to Britain could be far larger (albeit harder to quantify) than the losses just from having to renegotiate trade likely onto less favourable terms, which the IMF estimates at around 3% of real GDP, the OECD at 5%, The Economist at 6% and the London School of Economics and Political Science at 8% (quite a spread here and elsewhere, but pretty unanimously in the negative). But I don’t think these estimates account for the longer term impacts of financial services activity (reaching 10% of British GDP in 2009 – more than any other G7 country – though declining in recent years) actually leaving London altogether.

It may take decades, but this could turn Britain back into a traditional manufacturing and agriculture economy – great for these industries (and possibly also tourism on the back of a weaker exchange rate), but by their nature, they are lower wage industries (to compete with developing countries who can do such activities just as well) and therefore, will bring a permanently lower standard of living to Britain than the white collar/ service/ technology/ knowledge based industries to which Britain should be home. And this reality may remain unless/ until there are higher-wage industries to replace them.

Even if Britain somehow stays in the EU (referendums are, after all, not always legally binding – recall Greece’s recent referendum), these higher-wage finance businesses are possibly now sufficiently spooked about Britain’s future hostility that they may start leaving anyway. And I don’t think the EU will let Britain back in for a long time. Or if they do, it will be with big punishments to deter other countries from trying the same – just like Greece had a referendum to reject one of the EU’s bailout packages (they deemed the attached terms and conditions to be too harsh), but ended up accepting it anyway, along with even harsher terms and conditions for playing that defiant card.

I don’t like to bet against Britain, but they are taking a tremendous risk with this decision, in the hope that outside the EU, they will be able to achieve something great – greater than they would be able to within the EU. Within the EU, Britain already had the best of both worlds – an independent currency, its own central bank and interest rate policy, access to the European common market and the power and influence to encourage the EU to become even better. To be fair, the EU is a big inefficient lumbering beast – but it will get better (surely it can’t get worse). And when it does, Britain had best hope they have re-discovered some serious mojo for themselves – because the EU may not be in a forgiving mood.