UK: Abdicating a Proud Legacy

Britain is a great country. It combines charming quirkiness with flexible markets for labor, services and goods, as well as an admirable openness for skilled migrants.

As a result, Great Britain today has the most dynamic economy of all major European countries as measured by its trend rate of GDP growth. Its superb armed forces, its top-notch intelligence services and its competent bureaucracy allow Britain to punch well above its weight on the global stage.

A self-inflicted wound

Unfortunately, the trend is no longer Britain’s friend. Conservative hardliners are obsessed with the alleged monster of a European “superstate” that, outside of France’s Front National and other equally disreputable forces, nobody else has ever spotted.

Worse, this obsession has unleashed forces inside the UK that threaten to diminish the country’s relative power and wealth over time.

Against the logic of history

Start with politics. For centuries, Britain has abided by one supreme national necessity: It used its influence to prevent the emergence of a continental European hegemon that could threaten its interests.

With the Brexit vote, Britain has now ditched this time-honored approach. By leaving the EU, Britain is forsaking most of its influence on European decisions. However, these decisions will continue to impact the UK. Brexit can’t beat geography.

Brexit strengthens the cohesion of the EU27

Even more importantly, Brexit is achieving the opposite of what many UK observers expected. Rather than strengthen the EU’s centrifugal forces, Brexit is strengthening those on the continent who want to turn the EU and the Eurozone into more coherent and politically relevant entities.

Brexit is not going to destroy the EU27 and the Eurozone. The opposite may be the case: the downfall of David Cameron, the humbling of Theresa May and the glaring contrast between the big savings promised by Boris Johnson and the reality of a Brexit bill have curtailed the electoral appeal of EU-skeptics on the continent.

Economic damage

Now turn to economics. Libertarian Brexiteers have long argued that the UK could thrive outside the EU as a free-market paradise, a “Singapore on Thames.”

That never made much sense. Being a member of the EU has not kept the UK from enjoying among the most open and flexible markets for labor and capital, for services and goods in the developed world.

Moreover, as the June 8 election demonstrated powerfully, the scope for any further deregulation that could be politically feasible even inside a Tory-run UK itself is close to zero.

The Labour party, despite concerns in many quarters about having fallen under the sway of the hard left, has done unexpectedly well. In part, this is due to Jeremy Corbyn opting for a softer Labour stand on Brexit.

Another self-inflicted wound

By making Britain less attractive for skilled migrants and for inward investment, Brexit will likely reduce Britain’s trend rate of growth from 2.1% to a still solid 1.8%.

A hard Brexit (with a loss of preferential access to the EU27 market beyond the inevitable restrictions to be placed on UK-based providers of financial services) could depress UK trend growth to 1.5%. Any significant surge in domestic regulation would compound the damage.

Even 1.5% trend growth would still be a reasonable pace. It is close to the German rate and well above France’s pre-Macron 1.2% trend.

Fiscal house not in order

However, as a lasting legacy of Gordon Brown’s spending spree, Britain’s fiscal position has been very challenging at the recent trend growth rate of 2.1% already.

Any fall in trend growth, let alone a drop from 2.1% to 1.5%, would require major offsetting tax hikes or expenditure cuts in years to come to keep the deficit under control.

And kicking the can down the road, as Britain could do for a quite a while, would only exacerbate the corrective fiscal squeeze that would be required later on.

Hard choices for a weak government

On many counts, the British economy is still in the pole position in Europe. But extrapolating the recent trends, Britain may soon be falling behind a still-dynamic Germany, a mostly reformed Spain and a France that is finally getting its act together.

Of course, it is very early, Britain may still avoid that fate if it goes for a soft Brexit and resists the urge to turn away from the neo-liberal consensus of the post-Thatcher decades. To some extent, last Thursday’s election result can be seen as a return to the common sense that had been missing in the Brexit debate last year.

Nonetheless, the UK is now saddled with an unusually weak and wobbly government that will have to make unusually hard choices before the end of the Brexit deadline in March 2019. And all that with a risk that new elections could bring Corbyn to power at any time.

Time to end British illusions

One clear worry is that there are still a lot of those in the UK debate who believe that the UK will, yet again, get a special deal from the EU. That is a flawed assumption.

The belief that the EU27’s very detailed position is just an opening position that can be changed significantly is misplaced. German chancellor Merkel probably caught the prevailing mood on the continent well when she warned that the UK may still be harboring illusions about the kind of Brexit deal the EU can offer.

Conclusion

Some four years after David Cameron pledged a referendum on EU membership for purely intra-party political reasons in January 2013, Britain’s political situation and its long-term economic outlook have become more precarious than they have been at any time since the late 1970s.

Chances are that common sense will prevail with a soft Brexit and no turn towards Corbyn-type statist economic policies. Unfortunately, the risks to this call loom large.