Open Nav

Brexit: A critical juncture?

Are we making the right assumptions about the economic impact of a no deal Brexit? Critical junctures analysis challenges conventional wisdom and provides 10 reasons why we may be making the wrong assumptions about Brexit.

One of the biggest reasons for economic forecasting error is assumptions. Assumptions are made and become rigidly established, but all too often they are either incorrect in the first place or the situation changes over time. So, here’s an iconoclastic take on Brexit amidst all the fears of ‘crashing out’. The conventional assumption is that no deal will be bad, very bad. This message is repeated over and over by politicians and the media. But what if that’s wrong, what if that’s lazy thinking? Here’s a different narrative, for the sake of completeness, as a contribution to the debate.

In their international bestseller, Why Nations Fail: The Origins of Power, Prosperity & Poverty, Daron Acomeglu and James Robinson argue that ‘critical junctures’ lie at the heart of ultimate economic success or failure. Critical junctures are seen as those pivotal moments in history which have a permanent impact on the nature of the institutions which govern the economy. In economics, institutions are the rules of the game, such as economic freedom, the role of states versus markets, taxation, regulation and competition. Examples of critical junctures in history are the collapse of the Berlin Wall and communism, or the contrasting economic developments between North and South Korea in the wake of the division along the 38thParallel.

Brexit could be a critical juncture because it is a fundamental break with the economic history of the past 50 years. It is also a potentially huge culture shift with a change in attitudes towards markets, competition and genuine free-trade with the whole world, outside of the EU’s protectionist Customs Union. Post Brexit Britain will need to go global in a big way. This will place far greater emphasis on maximising global competitiveness. Recognition of this fact will be a culture shift in and of itself. This could be a once in a generation or once in a century opportunity to transform the economy and make it fit for purpose in the 21stcentury.

So, let’s examine 10 reasons for optimism about the ultimate impact of Brexit on the economy. This is not say that this will come to pass, merely that the real possibility is there:

  • Pessimistic views of the economic impact of Brexit are largely based on gravity models of trade, and the knock-on effect on productivity and FDI. Gravity models relate trade flows to the size and proximity of economies. But there is another approach in economics, the classical school, which models trade on the basis of so-called static and dynamic effects. Static effects are the gain to consumers (and intermediate producers) from leaving the EU Customs Union and its protectionist wall, and trading at lower world prices. The dynamic effect is the long-term supply-side boost to productivity and competitiveness from having to compete at lower world prices.
  • Faced with a need to make a big statement about global competitiveness, the UK could put in place the lowest Corporation Tax regime in the world, outside of tax havens. The Government should pre-announce a progressive reduction in the rate of Corporation Tax to 10 percent by 2025, thereby helping the UK to become an even greater magnet for FDI.
  • Wider Income Tax reductions could reduce the higher rate of Income Tax (40 percent) and the additional rate (45 percent) to 39 percent. HMRC estimates suggest the removal of the additional rate would cost peanuts and might even be revenue positive. Reducing both rates to 39 percent would be a potent symbol of a commitment to lower marginal tax rates at the top end, to attract the best global talent.
  • There will be a supply-side boost to competitiveness and productivity growth from tax reductions and improved incentives to work, save and invest. The most recent research in the economics literature shows a marked trade-off between the size of the state and economic growth. The UK could aim to raise potential output growth to 3 percent – double the current rate.
  • It’s argued that the EU can achieve far better free trade agreements (FTA) because of the political clout of 28 countries in any negotiation. But there is an alternative perspective that 28 countries is a hinderance not a help. This relates to the need to get unanimity across all those countries, thereby diluting FTA gains. The UK may be able to conclude more FTAs, more rapidly, than any country in economic history. The Anglosphere economies (US, UK, Canada, Australia & New Zealand) alone account for 33 percent of global GDP and are an obvious initial port of call for FTAs. Outside of the EU Single Market the UK would be able to put ‘skin in the game’ in service sector trade negotiations, a critical factor in 21stcentury service orientated trade agreements.
  • Product market deregulation opportunities abound. EU directives have been transposed onto the UK statute book, but we now have the opportunity to systematically work through them and remove those which reflect a triumph of producer over consumer interests. With regard to the City, freed from Mifid2, and 10s of 1000s of pages of prescriptive regulation, the world’s biggest financial centre could become even bigger.
  • EU labour market regulation and employment law has impacted the entire economy (100 percent), even though EU trade is a relatively small proportion (12 percent) of total GDP. As with product market regulation we now have the opportunity to be the rule maker not taker.
  • Infrastructure improvements, particularly with regard to the transport system, can be turbo boosted by Brexit, with a greater emphasis on competitiveness and the national interest, over vocal local nimbyism. Building on his experience as Mayor of London, the new Prime Minister seems intent on a big push for strategic national infrastructure projects. But this push might also include the myriad of smaller schemes – identified a decade ago in the Eddington Transport Study – which also contribute to competitiveness. It’s even possible to envisage a post-Brexit world which liberalises the residential planning system in order to boost competitiveness. Disgruntled farmers, losing their EU protectionism, might be appeased by being granted permission to sell-off some of their Green Belt land for residential construction.
  • There are deep concerns in many quarters regarding the impact of Brexit on the union of the United Kingdom. But the political threat to the Union could be assuaged, and also transformed into an economic opportunity, with constitutional reform entailing a more federalist structure. The cross-party Constitutional Reform Group has proposed a new Act of Union Bill which reverses the current constitutional arrangement whereby all powers are centralised unless they are devolved. The CRG propose greater devolution of power across the UK and this would entail the creation of an English Parliament and the abolition of the House of Lords. Thinking through the implications of this a little further, if it were to occur, an unintended but positive consequence for the economy could quickly emerge. This new constitutional arrangement would force the Scottish Parliament and the Welsh and Northern Ireland Assemblies to make greater efforts to bring the size of the state under control, because the current situation of large fiscal transfers haemorrhaging from South to North would be dramatically curtailed.
  • John Gillingham, America’s pre-eminent historian of the EU, argues in his book, The EU: An Obituary, that the EU’s institutions are dramatically ill suited to the flexibility and agility required for success in the 21stcentury digital economy. His thesis is that the EU faces an existential threat. Many economists would agree, adding the tensions and imbalances stemming from the operation of the euro which will surely lead to a day of reckoning. Throw in the demographic time bomb which will hit the EU economy over the coming decade, and it looks like we’re leaving the club just before the club-house roof falls in.

Even if Brexit occurs pro-competitiveness policy choices might not be made. What we do the morning after Brexit matters. Of course, all these reasons for optimism don’t negate the possibility of some negative consequences from Brexit. Economic transitions always entail costs and benefits. But just as the collapse of communism brought negatives and positives, it has been unequivocally net positive on a long-term view. Might that be the case for Brexit also? Only time will tell who is right or wrong.