MICHAEL KEATING. Brexit – What does it mean?

 

To the evident surprise of most of the pundits the UK has voted decisively to leave the European Union (EU). The question now is what follows next?

So far there has been plenty of speculation, led especially by that most speculative of institutions – global stock markets. And the one thing we can be certain of is that in typical fashion the stock markets, and the finance industry more generally, have over-reacted. Indeed, it seems that major UK banks are writing to their customers to assure them that their deposits are safe. Whoever thought that they weren’t safe? But if you want to frighten people start writing letters like that. The fundamental problem with financial markets is that they claim that they don’t like uncertainty, yet they keep adding to it.

But looking beyond the over-reactions of the pundits in the finance industry, to be frank no-one can be certain about the longer-term implications of the Brexit. In particular, at this stage we do not even know when the process of the UK (or England) leaving the EU will even begin, how the negotiations will be conducted and by whom, let alone the likely end-result of those future arrangements between the EU and the UK.

Furthermore, the Leave Campaign avoided any consideration of these questions, but with David Cameron quite properly resigning, the future is apparently now in their hands. The problem is that these people who embraced Brexit have been looking backwards rather than forwards. Their appeal and their support has come from those who have a nostalgia for a supposedly great and glorious past.

In that context the observations which follow about the implications of the Brexit will be equally speculative, although hopefully more detached. In brief I consider that the Brexit represents a serious set-back for the UK (even if it survives intact), but the rest of the world will hardly notice the difference. 

The Impact on Britain

In any assessment of the impact of the Brexit on Britain it is useful to start by considering why did Britain seek to join the EU in the first place. The fact is that Britain never joined up enthusiastically, but only after a delay of several years, by which time the EU was already clearly a success. Furthermore, the UK never shared the dream of the EU’s founding fathers that the European nations should become so tightly bound together, with a shared sense of identity, so that they would never go to war again among themselves.

By contrast, the UK’s dealings with Europe had for centuries been based on maintaining a distance and a degree of separateness, relying on a strategy of divide and rule to ensure that Europe never became united. For example, a headline in the Times published in the early 1970s, just before Britain actually joined the EU, says it all in terms of Britain’s disdain for Europe:

“Fog in the Channel, Europe cut off”.

So the only reason why the UK decided to shift from a behaviour pattern of centuries and pursue EU membership was to enhance what had been a poor rate of economic growth relative to its nearest neighbours. But now forty years later, I suggest there is no good reason to believe that the UK will do better out of the EU than it did before, when it decided that it had to join.

Most importantly, the UK depends upon the EU much more than the EU depends upon the UK. Thus British exports mainly go to Europe, but no European country sends as much as 10% of its exports to the UK. Consequently, Europe’s economic growth and living standards will not be noticeably affected by the Brexit, but the UK’s will. In addition, I think Europe may well drive a very hard bargain with the UK when they negotiate their future trading agreement. After all, the UK needs this agreement much more than the EU. So for example, Norway which is not a member of the EU, in return for EU access has to pay EU dues, and I expect that the same logic will be applied to the UK in future. Finally, the UK has attracted a lot of foreign investment on the basis that it is a gateway to Europe, but now foreign investors are already starting to bail out. For example, any hope of saving what is left of the British steel industry has probably disappeared as the sole remaining company – TATA steel – has announced that Brexit means it will definitely close the last British steel works.

It seems that perhaps the most critical factor in the UK’s decision to leave has been the lack of control over migration from Europe, and mainly Eastern Europe. In this context, it is interesting to note that since the UK joined the EU, the UK has done its best to hinder attempts at closer European integration. Most importantly, the UK was behind the choice to pursue a broadening of the EU membership over the alternative of closer integration. This broader membership, mainly of Eastern European countries, has created strains within the Union, while ironically Eastern Europe is the main source of the migrants to which the Leave campaign was objecting. If the UK had never pressed for the membership of these countries, then there would never have been a migration problem from them. And now that Britain has decided to leave, it faces the risk that the French may be less cooperative in restraining Syrian and other refugees from crossing the Channel to England, in which case the UK may find that it has merely replace Polish and Romanian migrants with Syrian refugees.

The other main alleged factor in the Brexit decision was the straight jacket imposed by regulations designed and enforced in Brussels by the non-elected EU Commission. To some extent that common regulation is true, and common standards for trade are to be expected, and in fact help to enhance trade. But there are also a lot of Furphys about the extent and economic impact of European regulation.

The two most important forms of regulation that could inhibit economic growth are regulation of land-use and regulation of the labour market. In both cases European regulation is practically irrelevant, with most of the regulations being national. More generally, the UK is already a relatively lightly regulated economy. In sum, therefore leaving the EU is unlikely to boost UK productivity significantly.

While on the other hand, the Brexit is likely to result in the UK losing influence both within but also outside of Europe. Clearly the UK will lose influence in Europe now that it no longer has a vote in their major deliberations. Equally, special relations with the US and other English-speaking nations are a pipe-dream. The US will want to engage with Europe as a whole much more than with one ex-member. To the extent that the UK was ‘special’ in the past, it was because it represented a channel of US influence on Europe. That is no longer possible, and the US will have to engage directly with other key nations, such as France and Germany. In reality that should not present any problems for the US. Similarly, the idea of reconstructing an English-speaking union based on ties of kith and kin, is another pipe dream. For example, the majority of Australians no longer have any close ties with England, and almost all of us understand that our future lies in engaging with Asia, not England. 

Impact on Europe and the rest of the World

As I have already intimated, the economic impact on Europe and the rest of the world is likely to be very small.

Europe’s principal economic problem stems from the loss of competitiveness of various members of the Euro, a loss that cannot be remedied in the usual way be these members depreciating their currencies. Instead they have been forced to adopt a policy of austerity, in the hope that eventually their competitiveness will be restored. But the UK had nothing to do with these fundamental problems, as it had the good sense to never join the Euro. Nor has the UK been a driver of economic growth for a very long time; not in Europe, let alone globally.

The UK is a major financial centre, but that involves the intermediation of other peoples’ savings, and the UK is not a major source of global savings itself. That intermediation role is important, and the UK may lose some of it, but that would make it easier for other centres such as Paris and Frankfurt to step in and take-over.

More generally, the EU may well find it easier to gain a consensus in future without the presence of the UK, as the UK has frequently been a disruptive force bent on slowing the pace of integration. Some of the smaller EU member countries may be concerned about the risk of domination from a Franco-German partnership without the UK. On the other hand, the EU desperately needs leadership in these troubled times, and it is hard to imagine how that can occur without Germany and France providing it, as they have in the past.

Lessons to be learnt from the Brexit vote

Perhaps the most important question to ask, is why did a majority of English people vote to leave the EU when the major political parties and most of the policy elite were urging a vote to remain. The answer would seem to lie in the extent to which a large number of English people feel that they have been cheated by the economic and social system. In particular, the decline in manufacturing has resulted in much of the previous industrial heartland of the UK, north of the Trent, becoming more like an industrial waste land. Not surprisingly the people, and particularly the older people, who live in these regions are now suspicious of an economic, social and political system which, as they see it, is not delivering them what they believe they deserve and which they expect. The temptation is then to blame someone else, and particularly foreigners.

Furthermore, this internal divide of Britain into “two nations” is not unique. What has been forcibly brought home to us in recent times, and especially since the Global Financial Crisis, is the substantial increase in inequality over the last few decades in many countries. In addition, in the US in particular, male incomes for the lower six deciles of the population have fallen over the last forty years. In effect, many American men are earning less than they used to, and less than their fathers and even their grandfathers. The implicit social contract between these men and their government has been broken; despite their hard work and good citizenship, they can no longer aspire to an increasing living standard over time.

While the experience of the US, and to a lesser extent the UK, may be outliers, many blue collar workers in other countries similarly feeling that the promise of a good life is evading them. Not surprisingly they too are questioning the established political and economic order. It is these people, who typically have no tertiary qualifications, who over-whelmingly supported the “Leave” campaign in the UK and who support Donald Trump in the US, and who similarly support a host of nationalistic populist parties in other countries.

The big question for the future of our system of governance is how will this sort of emerging divide, which is essentially between the well-educated and the less well educated citizens work itself out. Democratic government typically needs a basic concensus where people agree on the fundamentals, and dispute the choices at the margin. Where compromise between contending groups or parties is not possible, many nations have succumbed to revolutions and/or dictatorships, where the views of minorities are ignored at best, and forcibly suppressed at worst.

The risk now is that the sort of open society and global economy that has been the driver of economic growth over the last 70 years, may give way to much more autarchic policies. In my view that would represent a grim future.

However, the good news is that so far Australia is less prone to these tendencies than other countries. The most obvious reason is that while inequality has also risen in Australia, this increase has been less than in some other countries. Most importantly, very few Australians have actually experienced a decline in income over the last twenty or thirty years or so. The experience of almost all Australians has been that we have been able to expect an increase in our living standards in future. But in the last three years, since the cessation of the mining boom, that has not been true. Thus, unless we can further lift the rate of productivity growth and/or employment participation, we too may be on the verge of experiencing some of the stresses and strains that other advanced countries have been enveloped in.

Michael Keating AC is former Secretary of the Department of Finance and Secretary of Prime Minister and Cabinet.

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