An alternative perspective

25 November 2016

Brexit and a Poorer Britain

Dieter Helm, Professor of Energy Policy, University of Oxford & Fellow in Economics, New College, Oxford

It has gradually dawned on Britain’s political leaders that a central claim of the Leave campaign in the 2016 UK referendum on EU membership was wrong. It was asserted repeatedly that Britain could have access to, and even participation in, the Single Market and limit the free movement of people. Britain could, as Boris Johnson put it, have its cake and eat it too.

Boris Johnson has form: he endorsed the idea that there would be an additional £350 million per week to spend on the National Health Service and, along with Michael Gove, dismissed the overwhelming body of expert opinion that opposed Brexit as ‘Project Fear’. They took the view that ‘experts’ were no better than anyone else.

Devaluation is a Sign of Weakness

What they sowed, they now reap. Whilst it is true that there has been no sudden collapse, the markets have spoken. Britain has resumed its path of the last century. It has been a long process of devaluation: from the abandonment of the Gold Standard in the 1930s, the devaluations in 1948 and 1967, the exit from the Exchange Rate Mechanism in 1992 and now to this big Brexit devaluation.

The Leavers would have us believe this is a ‘good thing’. Whilst it does make exports relatively cheap, it lowers the standard of living through higher import prices and inflation. It is one way of reflecting the poorer performance of Britain, and that in turn reflects poor productivity. Devaluation is the concrete manifestation of relative economic failure. To pretend otherwise is to fall into Harold Wilson’s delusion back in 1967 when he notoriously claimed that devaluation did not mean the value of ‘the pound in your pocket’ had changed.

It is not only the currency that has taken an immediate hit. The bond markets are responding too. Longer-term rates have doubled. The UK government has had to abandon its fiscal targets and go in for yet another bout of quantitative easing. None of this looks like the sunny uplands that the Brexiters promised us.

Yet this is probably only a taste of things to come. The Prime Minister, Theresa May, has signalled a hard Brexit, for the very good reason that she, at least, realises that she can’t have her cake and eat it too. If the small majority (four per cent) of the electorate are to mandate complete control of the UK’s borders, then access to the Single Market is not an option. Johnson was wrong. 

Whether or not there really is a mandate for hard Brexit, and one which Parliament is to be excluded from much say in, the full implications are slowly sinking in. Hard Brexit is a fast track road to a limbo-land with no trade agreements with almost anyone. Fast Brexit means that Britain has 24 months from the triggering of Article 50 of the Lisbon Treaty in March 2017 to negotiate its exit with the EU.

Hard Means Hard

After March 2019, Britain can start negotiating new trade deals, not before. Only then can it can apply for full membership of the World Trade Organization in its own right, and it will need considerable support from existing members. In March 2019, there will be all the bureaucracy of import tariffs, export licences and customs controls at the borders, not seen in Britain since the 1960s.

There will be some offsetting gains. It will be the end of the UK’s participation in the Common Agricultural Policy for example. But it does not offer any immediate relief from what has been claimed to be the ‘greatest regulatory burden’ that has been imposed by the EU. This is because the proposed Great Repeal Act will in fact incorporate all the existing European regulations into British law at the exit date in March 2019. Only after that can the British government start repealing, and then it will need to know what it wants to replace it with.

It is yet to be explained how the great cash cow of the City will survive this hard exit. Passporting of financial services matters. Special subsidies and state support for the car industry buys time, but it is not a long-term solution. The key business question will be why global banks and companies should be located outside the EU and the Eurozone. Hard Brexit gives little reassurance, as compared with New York, Paris and Frankfurt. Existing staff and offices may stay, but future business development may well go elsewhere.

Back to the Past

In March 2019, Britain may be back where it was in 1972. That was a time when Britain’s decline looked permanent, and it was before the terrible mid years of the 1970s which saw 25 per cent inflation and trades unions out of control. By 1979, when Margaret Thatcher came to power, there had been three further years of 10 per cent inflation, and even the dead were having difficulty getting buried in the Winter of Discontent. This level of inflation wiped out much of the debt.

Much has changed since then. But there are some worrying underlying similarities. The 1970s were the last time – until now – that Britain had to rely on importing its oil and gas. Since 1980, the balance of payments has not mattered, because North Sea oil and gas have helped to pay for its underlying trade deficits. Then the City emerged to pay our taxes. Now the oil bonanza is all over and the City’s future is in doubt. No wonder the currency markets have taken fright.

The 1970s are also the last time government lost control of the nation’s finances and the International Monetary Fund had to be called in. Brexit’s first casualty was the target to eliminate the fiscal deficit. Since the economic crash in 2007-2008, the British economy has been on a life support system of large-scale public borrowing and printing money through quantitative easing. The Coalition government had a clear plan to eliminate the fiscal deficit.  That has had to be abandoned since the result of the UK referendum.

Things may get better in due course. Thatcher’s economic reforms pulled Britain back from the brink in 1979. Something may materialise again, but probably not before March 2019, when hard Brexit will hit and financial markets will no doubt react. What is missing this time is any serious plan to turn things around, so that when normal interest rates return and the budget is under control, the economy can grow.

Europeans Cannot Afford a Brexit Success

As the nature of hard Brexit in 2019 dawns, it will become imperative for the British government to reach some sort of deal so that there is no cliff edge. It will have little option. Yet the deal will be harder and harder to achieve as the 24 months tick away. No European leader wants Brexit to be seen as a ‘success’, for fear that their electorates will take the same path and the EU collapses. This time the existential threat is all the greater since the EU is back where it was in the Cold War, and its rationale of providing political solidarity in the face of the Russian occupation of much of Eastern Europe – and half of Germany – again has a powerful resonance.  It is not hard to see why many Europeans think that now is not the time to dismantle Europe. If this means that the EU pays a price too for Brexit, many will conclude ‘so be it’.

A deal to get over the cliff edge is therefore unlikely to be one that the Brexiters will like. Access to the Single Market will require fees to be paid to Brussels and probably quite a lot of free movement of people as well. Yet again, the UK government will not be able to have its cake and eat it. How exactly will the Prime Minister explain this to Parliament in 2019 and to the electorate in 2020? Whether the UK government sees it this way or not, the 2020 general election will probably be a de facto second referendum, and there is no majority in either the House of Commons or the House of Lords for hard Brexit. There was after all only a four per cent majority for any sort of Brexit. A parliamentary defeat before then could also trigger a new general election.

The Judgement of History

When historians look back on our times, 2016 will stand out as one of those rare and very decisive moments in British history. They will see the credit crunch in 2007-2008, the subsequent great recession, the end of North Sea oil and gas, Brexit and the devaluation of the British pound as a structural break with the great late twentieth century boom.

Theresa May has the chance to try to ameliorate the shocks and steer a moderate path though the Article 50 process. But she is not the master of these deep structural changes. Her strength lies in her ability to read the script that the British public has charted – and would probably have charted whether or not the referendum happened in 2016 or later. It is hard to see how Brexit can be the unbridled success some of her more ideological ministers and backbenchers anticipate. What she can do is make sure it is not a cliff-hanging crisis. To do this she will have to persuade the British public that contrary to what Johnson promised, they can’t have their cake and eat it too.

Dieter Helm is an economist, specialising in utilities, infrastructure, regulation and the environment, and concentrates on the energy, water and transport sectors in Britain and Europe.

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