When the Brexit vote was still months away, veteran Conservative Party politician Kenneth Clarke predicted that, should David Cameron lose the campaign for Britain to stay within the European Union, '[he] wouldn’t last 30 seconds.'
Clarke was slightly off; Cameron lasted a few hours. But what came next could hardly have been more spot on: Afterward, 'we’d be plunged into a Conservative leadership crisis,' he said, 'which is never a very edifying sight.'
The Brexit vote has opened a Pandora’s box of instability, and the United Kingdom is descending into political chaos. The jockeying for Cameron’s job is, in some ways, the least of it: the Scottish nationalists have made clear their intention to call a second referendum on Scottish independence; nearly four million people have signed a petition for a second referendum on EU membership; and the Labour Party is facing a spectacular internal rebellion against party leader Jeremy Corbyn.
How Britain’s economic future will look outside the EU is difficult to predict. It depends largely on what sort of deal the British government can extract from the union. But the current upheaval means that a deal is very far off indeed. Debates are still ongoing about whether Scotland will attempt to block a Brexit, and there are questions about when, or even whether, divorce proceedings will actually start and who will oversee them. Until the official notice of Britain’s intent to withdraw from the EU has been served, Germany and other EU member states say they will not start negotiations.
In other words, the political turmoil currently engulfing Britain might, in the short term, hurt the economy at least as much as the outcome of the referendum itself.
So, what should we expect? In the months ahead, economic activity is likely to slow sharply. Concerned individuals and nervous investors will freeze consumption and investment. Firms have already put on hold some decisions — for example, opening new branches or upgrading existing equipment. Business confidence and manufacturing export orders have been on the decline since mid-2015, when it became clear that the EU referendum would be held before 2017. And quarterly fixed capital formation, which measures investment in physical assets — for instance, new machinery and office equipment — has grown at its slowest rate since 2013. The pound sterling declined from $1.49 to a low of $1.32 in the aftermath of the referendum (it has since recovered slightly).
People have begun to fear for their jobs and their futures. According to a survey of its members by the Institute of Directors, a pro-business advocacy group, nearly two-thirds of respondents thought the outcome of the referendum was bad for their business, a quarter said they were freezing hiring plans, and five per cent were planning to make employees redundant. Approximately 20 per cent of respondents were considering moving their operations elsewhere. Financial services are particularly vulnerable: non-EU banks that are currently based in London are planning to move to financial centers based in the EU, costing as many as 70,000 to 100,000 jobs in the UK.
Keeping up confidence is critical. Britain has a large current account deficit — about seven per cent of GDP — and inflows of foreign money are necessary to finance this deficit. London, the world’s leading international financial center (for now, at least), requires foreign investors’ confidence to thrive; liquidity is essential to maintaining this confidence, and any hint that flows might be constrained would create turmoil.
One of the lessons from the global financial crisis is that confidence tends to hold when individuals and businesses have the sense that there is somebody in the driver’s seat. Perhaps sensing that the present mess in Westminster isn’t reassuring, both the governor of the Bank of England, Mark Carney, and the chancellor of the Exchequer, George Osborne, have made it clear that they are prepared to do whatever is necessary to avoid a rerun of the financial crisis: The Bank of England has promised to supply more than 250 billion pounds to support economic activity, among other measures. But will this kind of support be enough?
Market reaction so far has been brutal. Rating agencies Standard & Poor’s and Fitch have downgraded Britain’s credit rating to AA (from AAA and AA+ respectively) due to what the former called a 'less predictable, stable, and effective policy framework in the UK'. The bumpy ride looks likely to continue. Political uncertainty looks unlikely to be resolved soon, and regulatory and institutional uncertainty will be a feature of doing business in the UK for years to come. As a result, financial markets will become more volatile, and professional investors will have to shift gears and adapt to a bumpier landscape. Volatility, however, does not always signal intrinsic vulnerability; the British financial system is more resilient and more able to absorb shocks than it was in the 2008 crisis. There is a well-knitted safety net in place: swap agreements have been arranged to provide liquidity in foreign currencies, and the banking sector has more capital.
It is the real economy where vulnerabilities are more pronounced. As things stand, Britain has many years of adjustments ahead of it, which will be spent, first, disentangling its laws and institutions from the EU and, second, engineering an entirely new regime. Investment will be reduced, jobs will be lost, and businesses will be shuttered or relocated. News of Brexit has finally sunk in, and there seems to be only one certainty: Britain will be poorer for some years to come.
This article was originally published in Foreign Policy.
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