Brexit!

Brexit could harm the UK if the new government seriously tries to apply public policies that reduce productivity and protect great swathes of the country from competition. But whatever the new Prime Minister may have said on the first day on the steps of 10 Downing Street, the need to survive on its own in a difficult world will hopefully keep the UK from committing the worst mistakes. The pride of newly gained independence will sweeten the initial sacrifices. Drake has singed the beard of the King of Spain.1 The resulting prosperity may in the end reconcile a generally anti-capitalist popular opinion with the advantages of the free market.

Many see Brexit as another example of the spread of populism in our democracies. They present the result as the reaction of a boorish majority of foreign-haters against globalisation, who should have listened to the good advice of the metropolitan experts who were telling them to remain. There is no doubt a measure of disillusionment with our political and economic arrangements, but it is crucial that we should diagnose it properly. Liberal democracies have promised too much. We have failed the people because the welfare state that the liberal intelligentsia have built in the countries of the West in the 20th century is just not sustainable.

Along the same lines, the European community that the experts have been putting together since the Treaty of Rome in 1953 is perpetually in danger of breaking up. The remedy proposed by the elites is always the same: higher taxes to finance what is broken, more centralisation to glue together what is falling apart. No wonder ordinary people are suspicious and rebellious. Of course populist solutions will not work, but we, the so-called liberals, should have had the courage to explain that a democracy cannot rest on the illusion that people can be free and irresponsible at the same time—schooled, cared for, and governed from afar by a bunch of all-knowing administrators. An independent UK could show the ‘populists’ that a social system based on individual self-reliance can give a prosperity and freedom that paternalism and centralisation cannot.

Politically correct in Rome

Is it conceivable that the EU, at the sight of a British economic success after their divorce, would move away from ever growing centralisation towards variety and competition among its members? A meeting of the Italian Aspen Institute in Rome in which I took part a few days after the referendum disillusioned me. A more disappointing gathering could hardly be imagined. There was much wailing about the British trying to scupper the EU project again and some hope that in the end a way would be found to bring the UK back into the fold.

Hearing the sixty or so participants gathered round the table I clearly saw how different the conception of democracy is in Italy from the UK: in Britain it is just unthinkable that a decision like the Brexit referendum be quickly reversed or slyly changed through back-door manoeuvres.2 When my turn came to speak, I pointed out that the continental authorities had been very ungenerous to Mr. Cameron. He was serious enough to put his job on the line. He needed effective concessions to bolster up his bid to keep the UK in the Union. The concessions were not forthcoming because, I added, demands for more variety and competition in the EU are simply impossible to grant, as they go against the grain of what the EU has become—an inchoate state. However, what really struck me is that what I said about the good reasons for Brexit and the hopeful future for the British on their own, fell on deaf ears: there was not a single comment in response. In essence, the discussion never came round to economics. It was all about power. The assembled experts saw Brexit as a disaster all round because it made Europe weaker and the UK puny, in a world where what counts is not individual freedom and prosperity but gaining weight to elbow a place at the High Table of world geopolitics. The possibility that economic competition between the UK and the EU could be positive for both sides and for the world did not seem to cross anybody’s mind.

Cross Currents

This referendum and the reactions to it evidence the clash of two different conceptions of society: one is the grassroots view that the nation must regain a measure of its sovereignty and return to a more direct way of governing itself; the other is the cosmopolitan view that the world should be better off if rationally administered by transnational organisations, properly designed by enlightened minorities. This divide, observable in the UK, in Europe, and in the United States, is sowing discord in the foundations of liberal democracy. One of the seismic waves has been the popular discontent that surfaced in the UK with the Brexit referendum. Another is the backing garnered by Donald Trump in his race towards the American Presidency. In the EU we also have numerous instances of revolts against the ‘Establishment’, to use a word launched by the ‘angry young men’ of England in the sixties: Spain and its large Leninist Party; Italy, with a comedian on the brink of heading the government; Hungary using barbed wire to stop the refugees from Syria; nationalist parties in Austria, in the Low Countries, in France especially. Condemning these movements as ‘populist’ and hoping they will go away will be of little help. They may be undefined and contradictory but they well up from a general disillusionment with our political and social arrangements in the West. The conflicting troops are badly arraigned: nationalist underdogs against metropolitan left-liberals, when it should be self-governing individuals versus both the communitarians and the paternalists. The effective antidote would be to re-examine the aims of our liberal democracies and purge them of make-believe.

First reactions to Brexit in Britain seem to be communitarian rather than individualistic. Much of the Brexit vote seems to have come from a disgruntled part of the population, resentful of the presence of hard working, high saving immigrants from Europe, unhappy with the financial prosperity of London, and disgusted with globalisation and free trade. The new Prime Minister Theresa May, in her first declaration, sounded a tithe more egalitarian and nationalistic than David Cameron, her predecessor in the office. She spoke of restoring social justice, stopping the influx of EU immigrants, and re-industrialising Britain. She even mentioned putting more worker representatives on company boards and limiting the emoluments and perks of corporation bosses. She seemed to echo populist protest against aloof professional politicians, foreign workers, cheap imports, financial wizardry—anything that makes society ‘unfair’. This seems the voice of a ‘Little Englander’ to use Cameron’s expression to define Brexit Leavers, though Cameron there was being unfair to historical ‘Little Englanders’.3

If we attend to the reactions in the EU, the snapshot is also disheartening. The call to a Europe in crisis is ‘More Europe!’ The President of the European Commission, Jean Claude Juncker, on seeing new cracks in his Lego house, immediately declared that it would not be a friendly divorce since it had not been a love marriage: the separation from the UK should be swift and hard, he implied, so that it did not stand in the way of an ever closer union among the peoples of Europe. He has lately softened his tone, perhaps after seeing Germany’s Angela Merkel take a more accommodating stance. However, François Hollande, the President of France, has turned out to be far more intransigent, for good domestic reasons: he does not want the leader and voters of the far right “Front National” to think that leaving the euro and the Union is easy and costless. The reactions in the EU, hostile or not, show that the lessons of the exit of such an important member as the UK may be lost on the rest.

Economics to the rescue

On the Continent, officials are usually off the mark about Brexit because they do not start from good economics. They mostly discuss reversing or watering down the British referendum, changing treaties to make them more encompassing, creating a European Confederation, turning Europe into a great-power, or reforming the Commission, the Council, the European Parliament, the Court of Justice, the Central Bank—whatnot. All are matters legal and political, which indeed can be of some import but which ordinary people do not connect to their personal lives. There are two main ways to bring Europeans together: harmonisation and competition. As the project has proceeded, uniformity has been gaining the upper hand. The possibility that different ways of doing things may unite us better than regulation does not seem to occur to our European regulators. One outstanding example is how the euro was forced on willing and unwilling member countries, only to fail signally. The EU proposals on questions of employment, productivity, wealth creation, trade, the environment, are usually all about the authorities doing something: launching investment funds for public work, keeping a level playing field by controlling ‘harmful competition’, breaking up (private, not public) oligopolies, stopping tax avoidance, protecting the environment, managing globalization, or redeeming the euro from its original sin. It is all about faire faire, make do, rather than laissez faire. They seem not to know that fighting unemployment, increasing social mobility, managing the cycle, and using money to restart the economy are simply unfeasible through direct political action. Their point of view in all is mercantilist and constructivist—how to tame markets and how to help Europe confederate.

It always surprises politicians and bureaucrats to see how economic incentives cut across the best laid out administrative plans. The ‘remain’ camp and expert opinion in Europe made much play of the likelihood of a recession in the UK if it left the EU. How did they know? This prediction was based on the idea that, with the UK out of the Union, a number of negative reactions could be expected: foreign demand for real estate would fall; tariffs would be charged on British exports to the Continent; banks domiciled in Britain would be deprived of their ‘passport’ to operate freely across the EU. More generally, the City of London, would lose large chunks of its insurance and financial business and all its euro business in favour of Frankfurt or Paris. Individuals and companies react in strange ways. After a clean cut with the EU, Britain could become a Norway or Switzerland, or rather a Singapore or a Hong Kong writ large.

I am arguing against friendly negotiation to ‘contain the damage’ caused by Brexit. Imagine sitting down to play games with the movement of people between the EU and the UK; the permanence of the UK in the Single Market, especially for financial operators; fisheries and agricultural policy; climate control; defence and diplomacy; not to speak of the unwinding of forty years of legislation. All this could only mean the postponement of Brexit, much to the anger of all parties. There is danger for both the UK and the EU in lengthy negotiations over complicated demands for mutual concessions. This kind of diplomatic disposition has caused endless delays to the signing of the Transpacific Partnership and equally is now making the discussion of the Transatlantic Trade and Investment Partnership between Europe and the US interminable. With either Donald Trump or Hillary Clinton in the White House both agreements seem to be dead in the water. British freedom to build and to sell could end constrained and shackled.

Furthermore, a clean cut might be best for harmony across the Channel and prosperity all round. The British economy could surprise if the new government allowed it to spread its wings. Brexit can be for the good for both the UK and Europe as a whole if Brexit is not watered down or taken hostage by socialists and if the shock of separation wakes up the rest of Europe to the benefits of legal, monetary, and commercial competition. We may then all come out better from the June referendum.

The UK on its own

The question is, why are people disenchanted with liberal democracy? After World War II we in the West built an ever more encroaching state, with the assurance that it will deliver the goods people want. Individuals are told that they are free to lead the lives they prefer but their most important decisions are taken in their name by the powers that be. Health, education, old age pensions, unemployment insurance, and working conditions are all out of their hands. Also, their expectation of living an ever more prosperous life without much effort are disappointed by competition from faraway lands, by the arrival of immigrants, and by unforeseen crises in the economy. Will these widespread feelings be used by the Theresa May government as an excuse to turn Britain inwards after Brexit?

Two forces are pulling the UK Government, one toward an accommodation with Europe, the other away from the EU. It would be best in my view if the call to accommodate European conditions was downright ignored. A clean cut would allow the British and the Continentals to find spontaneous solutions to problems that crop up. As an economist I will add that the best policy should be to forget about reciprocity and choose unilateral free trade as was done in the 19th century. Of course there will be protests from people having to adapt to domestic and foreign competition, but trade protection in the end harms the country imposing it. So much the worse for the people on the Continent if they make British goods more expensive there,4 and so much the worse for them if they cut themselves off from one of the three world financial markets.

The danger is that a combination of communitarian nationalism and ‘one nation conservatism’5 will condemn the UK to becoming a backwater of the world economy. The temptation will be to keep existing regulations of working hours, health and safety, genetically modified foods, fracking, and such likes at the pre-Brexit level. It is all very well to try and heed old hat community feelings but there comes a point when imitating German co-determination or Mitbestimmung will undermine what a middle size country like the UK with lots of talent and energy can do in the world.

The composition of Theresa May’s cabinet indicates that she does not intend to let things linger. She has organised a strong team of eurosceptics to deal with Brexit.6 The UK should not feel forced to pay a high price for staying in the Single Market. Luckily, Theresa May could find it close to impossible to attain. Catastrophe is not round the corner. Brexit need not bring another recession to the UK. Out of the Single Market, the British will have to sell their goods and services to the whole world. The trade weighted tariff of the EU which Britain would have to face is variously calculated at 4 to 5 per cent, a mark-up British industry can easily digest. Europeans may try to close their doors to financial services originating in London but the City will gain attraction if it escapes the regulating mania of the Continent.7 It would not be the first time. In the 1960s and ’70s the US government put a cap on interest paid on domestic checking accounts as a means to decouple interest rates and inflation; this led to American companies depositing their dollars in London to side-step the regulation: thus was born the ‘Eurodollar’ Market (no relation of the present day euro) which grew into a trillion dollar net size. Frankfurt and Paris will not displace as experienced a market as that of the City. There is nothing more convenient than a large “black market” when regulators lose their bearings.

Soon the British Government will be led by foreign competition to lower company, value added, and personal income taxes. Elementary budgetary responsibility will then lead to review public expenditure and avoid Keynesian public works .The welfare state will have to be reformed, at least along the lines of the Swedish voucher system. It may even happen that the British will set up a sensible immigration policy to better their productivity. All this is not wishful thinking: it is simply my belief that reality will force Britain to be a success.