On June 1, the Organization for Economic Cooperation and Development issued its latest economic forecasts. In 2016, it predicted that the world economy would grow 3 percent, the United Kingdom 1.7 percent and the euro area (the 19 E.U. countries using the euro) 1.6 percent. We don’t know how these figures will now be revised, but we do know the direction: down.
Whatever the long-term consequences of Brexit — Britain’s decision to leave the European Union — the immediate effects are adverse. So are the channels by which they operate.
Lower stock markets in Europe and elsewhere will hurt consumer spending, as wealthier shoppers feel poorer and less certain about the future. Multinational companies will delay or cancel new investment projects as they reevaluate whether the United Kingdom remains a viable export platform for the E.U. market. Multinational banks will reconsider their operations in London, now Europe’s financial center. Capital flight from emerging-market nations may accelerate, reducing economic growth in these countries.
To these mainly economic effects must also be added the political fallout. Donald Trump is correct in comparing his campaign for the U.S. presidency to Brexit. Both are acts of political defiance: repudiations of conventional wisdom by masses of voters. The more this happens, the more “normal” it becomes. Volatile politics also cloud the economic future.
Economists at Morgan Stanley are pessimistic about the immediate outlook. Brexit will “likely trigger a downturn, if not a recession, in Europe,” they write. “Depending on how Europe responds politically, concerns about euro breakup could start to creep back into markets, causing financial conditions to tighten” — interest rates and lending standards would increase.
The United States could not entirely escape adverse spillovers, the economists argue. The most likely channel, they say, is through weaker exports. There would be a double whammy. Slower growth or an outright recession in Europe would reduce demand for U.S. goods and services. In addition, the expected appreciation of the dollar on foreign exchange markets would lower the competitiveness of U.S. exports.
Writing on his blog, economist and former U.S. treasury secretary Lawrence Summers rates the possibility of a U.S. recession starting within the next year at 30 percent. “There is the real risk of ‘populist exit contagion’ in a number of countries,” he says. “The world economy is far more brittle than usual because of the inability almost everywhere [of central banks] to lower interest rates substantially.”
Not everyone is so pessimistic. In a note to clients, economist Neil Shearing of Capital Economics, a consulting firm, observed that there were no signs of panicky capital outflows from emerging-market countries. “Following the initial shock of the Brexit vote, financial markets in [emerging markets] are starting to stabilize,” he writes.
Some comfort is taken in the apparent readiness of the Bank of England and the European Central Bank to act — providing more funds to financial markets — to prevent a panic or freezing up of credit markets. After the Brexit vote, BOE Governor Mark Carney issued a statement saying that the BOE and the British Treasury had “engaged in extensive contingency planning” and would “not hesitate to take additional measures as required.”
It is too early to make definitive judgments. Brexit’s boosters believe that being liberated from E.U. regulations will revitalize the U.K.’s economy. They could be right. Brexit’s economic consequences may also depend on its politics. Because no country has ever left the European Union, there are no precedents. Will the negotiation between the U.K. and the E.U.’s 27 other members — which could take from two years to five or more — be cordial or contentious? Probably no one knows, but the answer is the crux of the matter.
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