Revenge of the experts
A crisis, Dornbusch noted, “takes a much longer time coming than you think, and then it happens much faster than you would have thought.”
The Brexit debate is an endless source of mirth for anyone with a dark sense of humour. 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-but-unanimous 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-than-stellar 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
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