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August 19, 2019

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 The government itself now claims that the report is already out of date: the government has everything in hand.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.


August 06, 2018

Brexit and the Rights and Wrongs of Austerity

Writing about web page https://warwick.ac.uk/fac/soc/economics/research/centres/cage/manage/publications/381-2018_fetzer.pdf

A great new paper by my CAGE colleague Thiemo Fetzer was in the news last week. It asks: Did Austerity Cause Brexit? Thiemo is one of those that know how to write a good abstract so, rather than try to summarize the paper in my own words, I’ll use his:

Did austerity cause Brexit? This paper shows that the rise of popular support for the UK Independence Party (UKIP), as the single most important correlate of the subsequent Leave vote in the 2016 European Union (EU) referendum, along with broader measures of political dissatisfaction, are strongly and causally associated with an individual’s or an area’s exposure to austerity since 2010. In addition to exploiting data from the population of all electoral contests in the UK since 2000, I leverage detailed individual level panel data allowing me to exploit within-individual variation in exposure to specific rules-based welfare reforms as well as broader measures of political preferences. The results suggest that the EU referendum could have resulted in a Remain victory had it not been for a range of austerity-induced welfare reforms. These reforms activated existing economic grievances. Further, auxiliary results suggest that the underlying economic grievances have broader origins than what the current literature on Brexit suggests. Up until 2010, the UK’s welfare state evened out growing income differences across the skill divide through transfer payments. This pattern markedly stops from 2010 onwards as austerity started to bite.

Thiemo’s paper has already been widely reported (e.g. hereand here). The reports have tended to sustain a simple political narrative: In 2010, as Chancellor of the new coalition government, George Osborne set the course towards austerity. Austerity provoked the rise of UKIP and anti-EU sentiment. By implication, austerity was a mistake for which we are paying now with Brexit.

Not so fast.

Thiemo’s findings should be considered in the context of another story in last week’s news. In the Financial Times on 2 August, Chris Giles reported on the latest fiscal sustainability report of the Office of Budget Responsibility The report showed that, if the economy grows and if we continue to tax and spend on pensions, long-term care, health, education, and welfare at current rates, by 2050 there will be no funding for anything else. The government will be unable to pay anything towards defence, police, transport, arts and museums, business, and local authority services such as bins, libraries, and parks.

Driving this conclusion is two problems. One, the British population is ageing. Two, the economy is growing more slowly than in the past. Spending on old age will necessarily encroach more and more on a pool of resources that is finite and will fail to keep up.

In an era of low-interest rates it is tempting to suppose that the government can simply borrow more to pay for these things. Certainly, it can do this for a while. But that can only kick the fiscal can down the road. As deficits rise and once more accelerate the growth of the public debt, the burden of debt interest payments will also grow more rapidly, tightening the screws ever more harshly.

What does this have to do with Thiemo’s paper? It affects the implications that may be drawn.

First, when slow growth makes deficits unsustainable, austerity is inevitable at some point. Certainly, this does not deprive us of all choice. For example, we can choose to have austerity now or later. But for every unit of austerity that we postpone now, we will have more than one unit down the road; that's in the nature of the accumulation of debt. As Chris Giles points out, the government’s relaxation of fiscal targets in 2016, and its more recent boost to health spending, have brought forward the point at which the government will run out of money for “other” spending by six years. We can also choose who will bear austerity’s burdens. Are welfare benefits too generous? Should graduates pay higher contributions? Should companies pay higher taxes, or their shareholders, who include both relatively wealthy households and the pension funds responsible for the retirement incomes of the middle and lower classes?

These are all choices that could have been made differently, and that we can still make. But, as growth prospects diminish, what we cannot do is choose not to have austerity at all, ever.

Second, if you’re thinking that the government should not have imposed austerity in 2010 because that policy induced people to turn to UKIP and Brexit, think again. Rightly or wrongly, George Osborne was trying to return the UK economy to fiscal sustainability by following transparent targets and rules. The purpose of such rules has been to try to bind governments, so that they do not exploit their discretionary powers to time taxing and spending decisions in order to reward supporters, win their votes, and so manipulate elections.

Which is a good thing—right?

If your present thinking is that Thiemo’s paper shows that austerity was a bad policy, ask yourself what you thought of austerity before you knew his findings. If you already had reasons to believe that austerity was a bad policy, then stick to them, whatever they were. Thiemo’s findings have not added to them.

If, perhaps, Thiemo has changed your mind—previously, you thought austerity was necessary, and now you have turned against it—then be careful. The risk you face is that you may soon get what you now wish for: a government that systematically manipulates its electoral base with fiscal generosity that must be paid for later.


October 20, 2017

The Past and Future of Free Trade, or How Partisan Preferences Spread Foolishness

Writing about web page https://twitter.com/nickdearden75/status/919871698236829697

I woke up on October 16 to a learned debate on Twitter about economic history. Daniel Hannan, who is a Conservative Member of the European Parliament, had posted this:

What made us the world's richest nation? We removed trade barriers and so put money into ordinary people's pockets.

In response, Nick Dearden, who is the director of Global Justice Now, a campaigning organization, replied:

No. We plundered & pillaged. We sold people by the millions. We forced China into opium addiction. We decimated Bengal's textile industry.

(At the time of writing, both of these tweets were well liked, with Dearden well ahead: Hannan 982, Dearden 1.9K.)

Maybe you've guessed: this dispute was not really about economic history. It's about Brexit. Hannan urges Britain to go it alone as a free-wheeling, free-trading nation state, as in the past; that, he maintains, is what made us rich then, and it will work for us again. Dearden maintains that we owe Britain's wealth to the world, from which we once stole it. I'm not sure what that implies for Brexit, but for sure he doesn't seem to like free trade.

Considered as economic history, which version is more plausible? Neither account would pass even a low bar, say, that of an undergraduate multiple choice test. But, of the two, I prefer Hannan's. Here's how that works:

Why Hannan would not pass: he is wrong to imply that free trade was the key factor. Britain's relative advantages can be dated at least back to the fourteenth century, long before free trade; in fact, long before foreign trade represented a substantial share of Britain's economic activities.

Why Hannan deserves some credit: he is right to suggest that in the nineteenth century free trade further promoted British productivity and prosperity. He is also correct to remind us, as many forget, that trade is primarily about wages and prices, and that the gains from trade stem from higher productivity in the jobs we have, not from more jobs.

Why Dearden would fail -- on every count. Plunder, pillage, and the slave trade have little or nothing to do with Britain's modern competitive advantages. These advantages stemmed from factors that came into play long before the eighteenth century. Even in the eighteenth century, Britain's foreign predations were not on a sufficient scale to explain the continued growth of the economy at home, for at that time the total of foreign transactions was not large enough relative to the size of the economy, and all profits on trade did not represent a significant share of British investment.

At home, the revenues from British colonies and plantation enriched a few, but they did not generate economic growth. Britain's industrial revolution was made by mill owners and ironmasters, who were not especially enriched by their entrepreneurship because competition continually drove down their prices and profits. Those enriched by the cotton trade were the many who gained from falling textile prices and cheap imported food.

That's at home; what about the rest of the world? The cotton trade did not only enrich Britain. It also enriched others. It did not, as Dearden claims, "decimate Bengal's textile industry." That was done by Indian mill owners. In India as in England, some lost but many gained. This is shown by the fact that, throughout India's so-called deindustrialization, both production and consumption of textiles rose decade by decade.

So . . . if Hannan had the better case for Britain to have embarked on free trade in the nineteenth century, does he have the stronger case for Britain to leave the EU in the twentiy-first? Absolutely not.

The gains from free trade in the nineteenth century arose from exchanging basic staple commodities: food and raw materials, textiles, and simple machinery. These goods could be described by simple standards, and contracting for them was largely free of regulation. Trade in the twenty-first century is radically different.

Today, trade in complex machinery and electronic devices relies on common standards for quality, safety, and networking. Trade in services, where there are the greatest unrealized gains, relies even more on common regulatory standards for consumer protection and contract enforcement. These things are not provided by the WTO, or by free trade, or by free trade agreements. They are provided by international regulatory harmonization, such as by the EU's Single Market.

If you want to import, you have to export. By leaving the Single Market, we throw up a trade barrier between ourselves and our largest, most competitive market.

So, to the extent that Hannan is correct on free trade, his is a powerful argument against Brexit.

More generally, the exchange between Hannan and Dearden illustrates how the desire to defend or attack prompts the opposing sides to oversimplify history and to spread half-truths and "alternative facts." Partisanship makes idiots of us all.


I am a professor in the Department of Economics at the University of Warwick. I am also a research associate of Warwick’s Centre on Competitive Advantage in the Global Economy, and of the Centre for Russian, European, and Eurasian Studies at the University of Birmingham. My research is on Russian and international economic history; I am interested in economic aspects of bureaucracy, dictatorship, defence, and warfare. My most recent book is One Day We Will Live Without Fear: Everyday Lives Under the Soviet Police State (Hoover Institution Press, 2016).



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  • Prof. Harrison: Thank you so much for your very kind, complete and prompt response (and on a bank ho… by Froghole on this entry
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