Brexit could be just the shock the economy needs

UK governments, of whatever party, may finally be compelled to break with the crony corporate capitalism promoted by New Labour
November 13, 2017

In this month’s issue of Prospect, Adam Posen articulates clearly the serious damage he thinks Brexit will do to the UK economy. He may be proved right. But the future has a habit of remaining obstinately unknowable. Keynes wrote in the 1930s of the “dark forces of time and ignorance which envelop our future.” This is a more stylish way of making the same point. Keynes used “ignorance” in its literal sense. We face inherent limits to our knowledge of social and economic systems.

One regrettable aspect of the current Brexit debate is the way in which many Remainers appear to believe that their opinions about the future are scientific: their “evidence base” means they are bound to be correct. They do not appear to have learned anything from Project Fear’s referendum projections. Posen bases his arguments on conventional economic theory, in just the same way that the Treasury’s fear-mongering forecasts claimed to be based on a “widely accepted [my italics] modelling approach.” Yet these turned out to be completely wrong. On a “Leave” vote, for example, unemployment was forecast to rise by half a million by the end of 2016. In fact, it has fallen more or less continuously. It is now at its lowest level since the mid-1970s.

Posen places great weight on the argument, shared by almost all economists, that free trade is in general a Good Thing. Of course, reducing trade barriers can destroy some jobs: US manufacturing employment dropped after 2000, due to a more determinedly liberal trade policy towards Chinese imports. But trade, by increasing the efficiency of production, benefits industries by reducing costs, and benefits consumers by reducing the price they pay for goods and services. Different jobs are created, and eventually more jobs overall. Much economic evidence supports this view.

Yet Posen is unwilling to rely completely on economics. He acknowledges that “In pure economic theory, the UK could do away with all of its tariffs, not only those with the EU, but with the entire world, and leave the UK consumer much better off.” However, in his judgment, the disruption would be too great. He does not appear to recognise that this is simply an opinion. Economic theory is correct, except where it does not help him make his case.

The key question facing the UK economy over the next two decades is not so much whether we are in or out of the EU. Rather it is whether our institutional structures and attitudes evolve to become flexible enough to prosper in a challenging world economy.

The EU faces very serious problems with growth and the take-up of innovations on which it depends. Growth fluctuates from year to year, over the business cycle. But if we average it over a period of, say, 20 years, we smooth these out, and get a good heuristic measure of an economy’s sustainable growth rate. The 20-year average in the main EU economies—Germany, France and Italy—peaked in 1970. Growth in the 1950s and 60s had been rapid. It has fallen ever since, and now is barely 1 per cent a year. In contrast, although the UK lagged behind in 1970, its growth has fallen only marginally since then, and remains above 2 per cent. Underlying Europe’s sclerosis is its failure in emerging industries of the 21st century, such as biotech, where the US and the UK lead the world, while the EU lags far behind.

As Posen points out, Brexit is indeed a supply side shock to the UK economy. But he sees this shock as wholly negative. Essentially, he believes we will retreat into a 1970s-style “comfort zone” of low growth in which a large state hands out subsidies to its clients. But, again, this is a judgment dressed up as scientific evidence. For shocks can sometimes stimulate innovation, as they did—for example—in one case Posen discusses, the boom across many of the old iron curtain countries that followed the fall of the Berlin Wall.

An equally valid opinion is that UK governments, of whatever party, will be compelled to break decisively with the crony corporate capitalism promoted by New Labour. Schemes such as PFI encouraged a culture of “rent seeking,” which diverts creative energy into devising ways to extract a bigger share of existing income and wealth, rather than genuine innovation, slowing technical progress and stunting growth. If Brexit shocks a complacent country into changing course, and concentrating on creating new things the world wants to buy, it could yet prove a spur to revival and renewal.