First The Telegraph, then The Sun, and today The Spectator all came out on the "Leave" side of the Brexit debate. However, perhaps even more shocking to the establishment is the CIO of a major bank's asset management arm dismissing the apparent carnage that Cameron, Obama, and Osborne have declared imminent, warning that, "many articles on the Brexit vote overstate its risks and consequences." As JPM's Michael Cembalest adds, the reality is "hardly the stuff that economic calamity is made of." As The Spectator concludes, "the history of the last two centuries can be summed up in two words: democracy matters."
As JPMorgan Asset Management CIO Michael Cembalest explains…
My sense is that many articles on the Brexit vote overstate its risks and consequences for the UK, and/or overstate the vote’s impact on political movements and economic malaise in the Eurozone that predate it by months and years. Here are some thoughts on issues I have seen raised over the last few weeks.
“UK growth will suffer a huge hit”. Of all the analyses I’ve read about a possible Brexit scenario, I found Open Europe’s report to be the most clear-headed and balanced. Their realistic case estimates the cumulative impact of Brexit on UK GDP at just -0.8% to 0.6% by the year 2030; hardly the stuff that economic calamity is made of.
“UK-EU trade will collapse”. Not necessarily. Norway, Iceland and Switzerland have entered into agreements with the EU on trade and labor mobility (European Economic Area, European Free Trade Area). As shown below, these three non-EU countries export as much to the EU as its members do. Such agreements could serve as a template for post-Brexit trade between Britain and the EU, if both sides see it in their mutual self-interest.
“The British pound could weaken”. UK core inflation and retail prices are rising at around 1%; inflation risks seem manageable even if the British pound weakened from here.
“Brexit would encourage support for nationalist movements in the Eurozone”. Podemos (Spain), the 5-star Movement (Italy) and the National Front (France) experienced electoral gains well before the Brexit referendum took shape. Rising support for these parties reflects voter concerns about the growth and employment consequences of being a Eurozone member and using the Euro (e.g., 0.3% Italian annual real GDP growth since 1996, even worse than Japan), while the Brexit vote does not. I find it hard to believe that the future destiny of the Eurozone, however uncertain it may be, will be affected by a decision made in a country that’s not even a member.
“Without the UK, the EU would suffer a loss in geopolitical influence on military and security matters”. That has already happened. Europe’s increasing reliance on the US to finance 75% of NATO has been a long-standing process that began in the early 1990s. Since that time, European military spending has fallen to 1.5% of GDP (below NATO’s 2% target), compared to 3.5%-4.0% in the US, 2.0% in China and 4%-5% in Russia. An illustrative quote from Camille Grand at the Fondation pour la Recherche Strategique: “We are moving toward a Europe that is a combination of the unable and the unwilling”. These dynamics appear structural, and are unlikely to be materially changed by the Brexit outcome.
“What about all the things we don’t know?” There are unknowns in financial markets, some of which can be mitigated by Fed extension of swap lines to central banks dealing with adverse capital flows. However, consider the counterfactual: what are risks for the UK of remaining in the EU? As shown below, while some EU countries are in the same economic, political and judicial “orbit” as the UK, the ones that are further away (France, Spain, Italy) arguably exhibit just as strong an influence on EU policy, and by extension, on members like the UK.
Our cluster chart is based on data from the World Economic Forum’s Competitiveness Rankings. The closer countries are to each other, the more similar they are with respect to WEF factors. While some EU countries are in the UK’s immediate orbit (GER, NETH, SWE, IRL), other EU countries are not (FRA, ITA, ESP, PRT). From a purely theoretical UK perspective, a political union based on commonly shared practices & principles might include CAN, NOR, SWI and the USA instead.
Examples of factors included in World Economic Forum Competitiveness Rankings:
- Legal frameworks and property rights
- Judicial independence and corruption
- Investor protections
- Infrastructure, electricity and energy
- Secondary and tertiary education
- Labor flexibility and productivity
- Capital markets access and depth
- Supply chain development
- Procedures required to start a new business
- Innovation, IT development and patents
One last point. The Lisbon Treaty includes Article 50 which does contemplate the departure of an EU member. As messy as it might be, a Brexit would be managed by the parties involved, and be a far cry from dissolving a monetary and fiscal union to which member states had “pledged their lives, their fortunes and their sacred honor”.
So having said all that, we leave it to The Spectator to sum it all up…
No one — economist, politician or mystic — knows what tumult we can expect in the next 15 years. But we do know that whatever happens, Britain will be better able to respond and adapt as a sovereign country living under its own laws.
The history of the last two centuries can be summed up in two words: democracy matters.
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