Brexit as Economic Warfare
Writing about web page https://www.thetimes.co.uk/article/no-deal-brexit-planning-assumptions-the-leaked-operation-yellowhammer-document-797qxkrcm
This column is about the short-term costs of a no-deal Brexit. Like many economists, I tend to think any disruption will prove temporary, even in the case of no deal. It’s in the nature of temporary costs that, in the long term, they disappear. It’s the long-term costs that we will be left with, and they will exceed the short-term costs by many orders of magnitude. Nonetheless, the only way to the long run is via the short run. As the short run looms before us, we are all understandably fixated on a single issue: what will happen next?
According to yesterday's leaked disclosures, the Cabinet Office’s Operation Yellowhammer report predicts the short-term consequences of a no-deal Brexit: a three-month paralysis of Britain’s maritime trade, a hard border in Ireland, shortages of fresh food and medicines, and many other things. This is the central estimate, not a worst-case scenario.
One side of what passes for Britain’s Brexit debate has seized on the findings as confirming what was claimed all along: Brexit is an act of national self-harm. The other side derides them as more “Project Fear.” The government itself now claims that the report is already out of date: the government has everything in hand.
Uncertainty over the likely short-term outcome of a no-deal Brexit (or any kind is often blamed on the idea that this has never happened before. Never before has a major trading nation deliberately disengaged from deep integration with its nearest and wealthiest neighbours. But this is not entirely true. There are two precedents: 1939 and 1914. The precedents are not recent, of course. Still, they might offer something to discover.
The outbreak of World War I was preceded by what some today might call an Edwardian version of “Project Fear.” Liberally minded commentators – best known were the banker Ivan Blokh and the journalist Norman Angell – warned that war among the industrial powers would lead inevitably to disaster. They offered two predictions, one, that industrialised war would be horrible; and two, that it would prove economically and socially intolerable.
On the first prediction, Angell and Blokh were correct. Total war was horrible. But their second prediction was wrong – at least in the short term.
The industrial powers, they argued, had become so economically integrated that they could no longer tolerate the interruption of trade by war. Within a few months they would run out food – first Britain, then France and Germany. After that, they would starve and surrender. Russia might survive, based on its food surplus. But this is not what happened.
When Germany went to war in 1914, the direction of their attack was against their main trading partners. Britain alone accounted for more German trade than all Germany's allies. Russia was a major source of German food and fodder. Yet as the war dragged on the German economy did not collapse. Like Britain and France, which were even more exposed to the global economy, Germany mobilized its resources for four years of total war.
In every country the war imposed wrenching adjustments and sacrifices on soldiers and civilians alike. But the results were not intolerable, for the people tolerated them. Two forces were at work that Angell and Blokh had neglected, that prevented collapse or at least staved it off for several years. One was the basic flexibility of market economies, which enabled the industrial powers to adapt much more easily to the loss of trade and the demands of war than anyone predicted. The other was the arousal of national feeling among the peoples now at war, which led them to hate the enemy and to tolerate readily the changes and sacrifices necessary for war mobilisation to proceed.
It is true that after several years of total war the populations of Russia, Germany and Austria-Hungary gave up the struggle. But it was Russia, most self-sufficient in food, with the least industrialised economy, that dropped out of the war first. So Blokh and Angell were wrong about that too.
If the Second World War was different, it was that the great powers entered it knowing what had happened in the First. They prepared accordingly. From September 1939, the British blockaded Germany at sea and German submarines waged war on British shipping. Britain, importing 70 per cent of calories for human consumption, was as vulnerable to blockade in 1939 as in 1914. The volume of food imports into Britain halved between 1939 and 1942. Yet the economy and the people adjusted. Domestic farming expanded and prices and rationing shifted diets from meat to cereals and potatoes. The calories available for human consumption barely changed from year to year through the war.
What should we take from such experiences?
- First, market economies were generally more adaptable than government and public opinion expected. When particular goods were suddenly in short supply, it was natural for those who needed them to find substitutes and work around the shortages. As a result, shortages were usually temporary and rarely, if ever, endangered the economy.
- But second, in some countries, survival was endangered eventually, after years of war. In Germany, for example, this was much more because of war mobilization than because of the loss of trade. Still, trade had been lost, and substitutes and workarounds for missing supplies were never costless. Such costs accumulated and were added to the costs of the war. It took time for the overall costs to become evident to the point where they might drag down the war effort itself. The costs of lost trade were hidden from sight at first, partly, because the processes of market adjustment redistributed them around the economy, so that they were rarely salient and were lost in the general step-by-step erosion of everyone’s standards of living.
- Third, in the process, governments took over more and more responsibility for the basic functions of economic life. The methods of command economies were invented during World War I and were widely used from the outset in World War II. While these were usually effective in directing resources into the war effort, the consequences for ordinary people varied. In Britain, food rationing was limited to luxury foods, and was generally effective, so the nutrition of poorer households was levelled up. But where clean government and non-corrupt administration failed, food was diverted into black markets and inequality grew.
- Fourth, while the war continued, most people were motivated to accept the resulting sacrifices by leadership that provided the sense of a shared national struggle, that focused their anger at the enemy who imposed these losses on them. War leaders created an atmosphere of national unity and solidarity in which the overwhelming majority became willing to “keep calm and carry on” through years of hardship.
Since 1945 the nature of economic life and the structure of international trade have changed nearly beyond measure. Despite this, all four lessons are deeply relevant as we contemplate what will happen on 1 November, the day after Brexit.
- First, don’t underestimate the flexibility of the market economy. Any real disruption is likely to be short lived. (Unless the government makes shortages worse by adopting price controls, say.) Whatever is suddenly missing from our lives, we will adapt, find substitutes, or work around what is missing. Our lives will certainly change, but we will probably get by. If Russia and Iran can survive trade sanctions, we will survive Brexit.
- Second, adaptation and substitution will incur many minor costs, and the costs will cumulate and may well grow over time as Britain decouples from the European economy. The sharper the shock, the more trust will be broken. Since trust underpins all long-term relationships, the more our long-term relationship with Europe will be damaged.
- Third, demands for the government to “do something” about disruption and shortages will push the government to intervene more and more in our economic life. For a time at least, scarcity pricing will be regulated by public pressure if not by law. Supplies will be prioritised. Failing firms will be bailed out. Once in place, these controls will take on a life of their own. Don’t forget that food rationing, which began in Britain in 1939, did not end in 1945; the last controls were not relaxed until 1954.
- Fourth, our willingness to “keep calm and carry on” will be much less than was the case in 1939 or 1914. We are not at war. We are divided among ourselves. Our government is representative of an extreme, not of a broad national coalition. Half the country expects Brexit to be painless or quickly beneficial. The other half sees it as a self-inflicted wound. Neither of these constituencies seems likely to put up with much pain for the good of the cause.
This can change, only if the government is successful in persuading the majority that we are in fact at war, that Europe is the enemy, that pro-Europeans are the “enemy within,” and that departure from the European Union is worth any sacrifice.
Mark Harrison
19 Aug 2019 13:43
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Tags: Brexit Economics Politics War
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Rick Berino
Great paper, and well written for a general audience. I agree that trust underpins all long-term relationships, social and economic just as the romantic variety.
But hasn’t the United Kingdom (not only Britain) lost its internal and cohesive trust? If so, have you failed to factor in the risk of the UK fragmenting, even in the short to medium term? This could have two significance and more enduring costs: One, either a permanent hard Irish border, or Irish conflict prior to dissolution of the UK and the union of Ireland; and two, Scotland to Europe, with either the Euro or the Scottish pound, and potentially another hard border.
I’m an Australian of Irish, Scottish, English, German and Greek origins. I don’t mind if that’s the outcome (other than more Irish conflict), but I’m guessing most in the UK would not be so sanguine.
21 Aug 2019, 03:54
Mark Harrison
I agree. In the longer term, Brexit will raise the prospects of both Scottish independence and a united Ireland, breaking up the United Kingdom. (I tried to focus on the shorter term, however.)
21 Aug 2019, 11:26
Froghole
Many thanks for this excellent piece. I don’t deny that Brexit will have a corrosive effect. However, what perplexes me is the apparent unwillingness of the political nation to engage with this question: if current account deficit = capital account surplus, and if the UK has been running perpetual deficits since accession (with a couple of brief pauses), how can continued membership fail to be dynamically unstable?
Thanks to the 1967 devaluation, Jenkins’ retrenchment between 1967-70 and the SET, increasing import penetration slowed prior to 1973. In the run up to accession the UK was running a respectable balance of payments surplus: indeed, Wilson and Heath saw it as being necessary in order to demonstrate to Pompidou that the UK had some economic vitality left in it (unfortunately, this need for the UK to prove itself may also have led Heath and Barber to derail the economy by engineering a hazardous boom).
The Jenkins/Wilson/Kaldor model changed utterly with accession: (i) VAT replaced the more restrictive purchase tax; and (ii) the UK switched from a progressive cheap food with deficiency payments to the farm sector, to a regressive dear food policy under the CAP. Whilst most of the 1970s inflation is blamed on the oil shock, a good deal of it must be attributable to the economic impact of accession. Unions had to bid up wages in response to this inflation, making manufactures uncompetitive on world markets, but they took the political blame. As Kaldor, Harry Johnson, Bob Nield and others predicted, import penetration (largely from Germany) accelerated. Perpetual deficits resulted, and the much vaunted positive dynamic effects to industry were nowhere to be seen. After 1980, it might be argued, there had to be an aggressive turn to financial services, with all that has entailed, to offset the remorseless decline of manufacturing. It seems to me that there is a pretty straight line from 1973 to 2016, for all that 2016 might be blamed on a resurgent nationalism, imperial nostalgia, the ‘politics of pain’, ‘fake news’, etc., etc. I suspect that, for many people, the perceived loss of control is not so much about a relative abstraction, like parliamentary sovereignty, as the progressive and seemingly unremitting divestment of domestic assets to overseas interests as a function of having to run a capital account surplus. This has tended to engender a profound loss of confidence, alienation and no little bitterness.
If remainers can present a credible case for the progressive elimination of the current account deficit without wrenching levels of austerity, then they may well find a willing audience even amongst many committed leavers. Some remainers are for remain-and-reform, but it has been painfully evident since Wilson’s attempted re-negotiation, that whilst the UK might be offered the occasional scrap (as well as opt-outs) there can be no re-constitution of the EU along lines that would enable the UK to rebalance its economy. What then do remainers have to offer? All they are really saying is that the UK must be content for the deficit to continue, for it to widen still further, and for such economic growth as occurs to be based upon rent-seeking, especially in the housing sector. The currency can therefore take the hit.
Whilst the prospect of revoking the Article 50 notification is very tempting, I have come to the painful conclusion that all the UK can now do is to leave, make a serious attempt to rebalance its economy and reduce its deficit and then, after a polite interval, seek a renewal of its membership in the hope that, in that interval, something will be done to reconfigure the single currency along more rational lines. The WA makes Brexit pointless, its main objection not being the Irish backstop, as that it would entrench the current account deficit for all time, and that there will be no means in international law for the UK to denounce any such settlement.
24 Aug 2019, 18:04
Mark Harrison
@Froghole I understand your perspective, but I don’t agree. You suggest two things (1) EU membership condemns the UK to a trade deficit, which forces us to borrow, and the result is that we are being sold off to overseas interests (2) a persistent trade deficit of 2% of GDP means that eventually foreigners will own everything. That may not be how it works.
(1) Start with foreigners, who have a view of the value of our assets. Suppose the assets look cheap; they’ll want to buy them. To buy them, they have to buy our currency. They will buy our currency until its price rises to the point where our assets are no longer cheap. That also means it will reduce our exports; our trade will move into deficit.
As you point out, our trade deficit is also our capital surplus. The two are determined simultaneously, but the capital market is so much larger and quicker to adjust that it is more the capital surplus that determines the trade deficit through the exchange rate than the other way round. So, if you want to us to run a trade surplus, stop foreign investment coming to Britain. Do that and the trade deficit will go away.
All this doesn’t seem to have much to do with EU membership—especially when we don’t even use the Euro. Should we have joined the Euro? No. The Brexit tragedy is that we had the best of all worlds, in the Single Market and not in the Euro. But the voters threw that away.
(2) Does a persistent trade deficit of 2% of GDP mean that we’ll end up with foreigners owning everything? No. Britain’s national wealth is around six times GDP. So, if 2% of GDP slips into foreigners’ hands each year, that amount is only 2×1/6 per cent of national wealth—just one third of a per cent. As long as the national wealth is growing faster than that, then British owned wealth is increasing too. I can’t tell you the stability condition because I don’t know the proportion that foreigners own in the first place.
Introspection tells you that “for many people, the perceived loss of control is not so much about a relative abstraction, like parliamentary sovereignty, as the progressive and seemingly unremitting divestment of domestic assets to overseas interests as a function of having to run a capital account surplus. This has tended to engender a profound loss of confidence, alienation and no little bitterness.” But you don’t need to introspect. There is plenty of research on why people voted for Brexit. The quality is uneven, but this contribution https://voxeu.org/article/austerity-caused-brexit by my colleague Thiemo Fetzer seems pretty sound.
25 Aug 2019, 18:07
Froghole
Prof. Harrison: Thank you so much for your very kind, complete and prompt response (and on a bank holiday!). I have, perhaps, been reading rather too much Kaldor, Godley and Cripps in order to understand why it was that things went to sour so soon after accession. Also, I have struggled to find much useful recent literature about the impact of deficits (whereas they were seen as vitally important thirty or forty years ago); perhaps there is a view that, as Dick Cheney reasoned, they “don’t matter”...
Yes, I have read a good deal of the literature about the causation of 2016, but thank you very much for that reference. The other cause that seems especially compelling to me is that advanced by Jim Tomlinson: the replacement of good jobs with poor ones (https://voxeu.org/article/brexit-globalisation-and-de-industrialisation, elaborating on elements of https://global.oup.com/academic/product/managing-the-economy-managing-the-people-9780198786092?cc=gb&lang=enx%x%# which, I appreciate, is in part a collection and amplification of some of his more recent articles).
The other key issue for me is the impact of the housing market, and especially the long-term consequences of the tax preference to owner occupation (since the abolition of Schedule A in 1963, the exemption of the primary place of residence from CGT in 1965 and the liberalisation of credit from 1971). This, of course, has nothing to do with Europe, and everything to do with the need for both parties to woo the middle class vote; however, it has left a significant section of the public feeling helpless and might have informed some of the voting in 2016. I have struggled to find any serious discussion of this topic, even in the secondary literature (there was nothing on it in Martin Daunton’s second volume, and nothing in Richard Whiting’s “The Labour Party and Taxation”, which otherwise included useful remarks on the development of CGT). In view of the importance of this issue, the seeming lack of materials is rather disconcerting.
25 Aug 2019, 23:38
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