The early line on Brexit's economic impact
Britain's vote last week to exit the EU continues to leave its mark far and wide. It has produced volatile movements in financial markets from Tokyo to Wall Street, slammed the value of the British pound and generally created a massive amount of confusion about what comes next -- for the U.K., Europe, the U.S. and the world.
Of course, the real answer to "what comes next?" is "who knows?" But that doesn't mean we can't make some educated guesses. So here's a summary of several likely economic consequences:
Investment and productivity: It's clear that the rules of trade between the U.K. and the EU will have to be renegotiated, but how those negotiations may turn out is far from clear. This uncertainty and loss of confidence in the future will translate into less investment in the U.K., fewer new businesses and less willingness to engage in long-term contracts and relationships.
That will result in lower output, lower employment and lower productivity. It's not clear how long this uncertainty will last; at some point the new trading relationships and other details associated with Brexit will be clarified. But it does appear that the uncertainty will persist for a considerable amount of time.
Will other countries leave the EU -- and the U.K.? One big question is whether Brexit will induce additional countries to exit the EU and whether countries within the U.K., i.e. Scotland, will attempt to sever the relationship with the U.K. and perhaps rejoin the EU.
The biggest danger is that one of the countries within the EU, Greece for example, is emboldened to leave and abandon the euro. If that were to happen, fears of Greece defaulting on the debt it has incurred would skyrocket, provoking the potential for bank runs and other financial disturbances.
As former Fed Chair Ben Bernanke noted: "The challenge for European leaders will be to keep the overall integration process on track, while finding ways to meet the concerns of potential leavers. One issue that could be revisited is the EU's commitment to the absolutely free movement of people across borders, which seems more a political than an economic principle; the perception that the U.K. had lost control of its borders was one of the most effective arguments for 'leave,' and secessionist movements elsewhere have also seized on the issue."
Economic impact on the U.S.: The main impact for the U.S. comes from financial linkages such as investors fleeing the risks associated with Brexit and seeking a safe haven though the purchase of U.S. Treasury securities or other dollar-denominated financial assets. This could cause the dollar to appreciate. Still, the effects on the U.S. economy are likely to be minor unless substantial disturbances hit the financial markets, induced by events such as the exit of more countries from the EU and the euro.
However, the Federal Reserve's plans for future interest rate hikes may have to change as members of the rate-setting committee wait for the Brexit waves to ease.
Financial sector and asset prices: London's financial institutions rely, in part, on free access to European markets and financial institutions. As these relationships become more difficult, British-based financial services are likely to shift to other countries in Europe. That will reduce economic activity in London and in Britain more generally.
In addition, the fall in the price of British assets such as housing and stocks will reduce wealth and make U.K. households less willing to consume goods and services, exacerbating the other negative effects from the Brexit vote.
Currency values, imports and exports: It seems unlikely that Britain will be able to negotiate the same degree of access to European markets it enjoyed as a member of the EU. If not, exports from Britain to EU countries will fall. The drop in the pound's value will make British exports cheaper and offset the fall in trade with Europe to some extent, but Britain will likely face ongoing losses.
Paul Krugman calculated a "sustained 2 percent of GDP loss; this is in the same range as other calculations. The number isn't at all a hard fact -- it could be smaller, but it could also be bigger -- but the direction is completely clear."
Regulation: One of the motivations for "Leave" proponents was the ability to get out from under regulations that come with EU membership. However, as Britain renegotiates trading relationships with the EU, it will be forced to agree to re-impose many of these regulations because the EU will have a strong hand in the negotiations. Thus, the ability to escape these regulations may not be as great as proponents have implied.
In addition, to the extent that Britain is able to deregulate, the economic benefits may not be very large. For example, there's certainly room for doubt about the economic benefits from deregulation in the U.S., and whatever benefits there were must be balanced against the financial crisis that grew out of the deregulatory effort. There's little reason to expect Britain will be any different.
It' difficult to predict how large the negative economic consequences will be for the U.K. given all the uncertainties at this point in time, including the distant chance that Brexit won't happen at all. But it does seem clear that Britain will experience lower output and employment growth, lower productivity and reduced influence in global financial markets as a result of the Brexit vote.