Published in the Nikkei Asian Review 19/7/2016
The immediate shock of Britain’s decision to exit the European Union has faded now that a new administration under Prime Minister Theresa May has taken office.
Many uncertainties remain. British access to the European single market for goods and the regulatory regime for UK-based financial services are up for negotiation. Both sides will be playing their cards close to their chests for months, if not years to come.
Already, though, it is possible to discern the broad outlines of the most important changes ahead. Over the coming decades Britain’s political and economic involvement with the countries of the European Union is set to decline. Its involvement with the rest of the world is set to increase correspondingly.
From being a semi-detached member of the EU – and thus the obvious entry point for non-EU investors – Britain will become an independent middle-weight player managing a portfolio of different relationships.
In a sense Brexit will simply accelerate trends that are already underway. Witness the deal reported on July 18 – the latest and largest in a string of foreign-sourced deals targeting U.K. companies – via which Japanese tech giant Softbank will buy U.K. chip designer Arm Holdings for £23.4 billion.
In the 1980s Japanese foreign direct investment into the U.K. was mostly in the form of manufacturing facilities built by auto and electronics companies seeking to access the EU market. In recent years the emphasis has shifted to acquisitions of globally-strategic assets in the service sector, such as the Nikkei’s purchase of the Financial Times and the Softbank-Arm deal. In such cases EU membership is an irrelevance.
TRADE, INVESTMENT AND TPP
Without doubt the U.K.’s trading and investment linkages with large economies such as the United States, Japan, China and India will become much more significant. Britain will probably make bilateral deals with most or all of these countries. If the Trans-Pacific Partnership (TPP), a US-sponsored free trade agreement, finally clears Congress after the US presidential elections, Britain could even become an associate member.
The TPP covers twelve countries in Australasia, Asia and the Americas which together generate 40% of global GDP. For an open trading nation like Britain, membership would be an attractive prospect. True, Britain is a long way from the Pacific Ocean, but geographically it is a lot closer to the United States than New Zealand and culturally it is a lot closer than Vietnam. Distance is no object in the service economy and with shipping rates at rock bottom levels, transportation has never been cheaper.
The crucial point is that Britain is now in a position to make such deals, whether bilateral or multi-lateral, which would have been illegal under EU rules. Meanwhile, the North Atlantic version of the TPP, the Transatlantic Trade and Investment Partnership, is effectively a dead duck, stymied by entrenched opposition in key countries such as Germany.
Without the UK’s influence in the EU, protectionist impulses will only get stronger. The UK itself will need to beef up its capability in trade negotiations since it has not negotiated on its own behalf in 40 years. Given the legions of lawyers and investment bankers the country produces every year, this is unlikely to be a major problem for long.
In the shorter term the road ahead may be bumpy, but the doom-mongering by economists at the IMF and the OECD and the British Treasury, Bank of England Governor Mark Carney and assorted others should be taken with a huge pinch of salt. Economists do much useful work, but that does not include predicting the future.
Research by Prakash Loungani, an adviser in the IMF’s research department, concludes that for both public and private sector economists the “record of failure to predict recessions is practically unblemished.” Ashoka Mody, formerly of the IMF and now at Princeton University, describes the pessimistic official consensus on Brexit as “a numerical illusion which is masquerading as ‘a fact’.” Lord King, Carney’s predecessor at the Bank of England, observes that the impact on growth is likely to be much less than the figures thrown about in the heated pre-referendum debates.
A GIANT SINGAPORE?
In times of disruption, the possession of a floating currency can be a powerful stabilizing force. Any damage to the competitiveness of British exports caused by the imposition of EU tariffs is likely to be “discounted” by a weaker pound. Indeed over the past twelve months the pound has already fallen by some 15% against the dollar and 18% against the Euro – more than enough to offset the impact of any new tariffs.
In real-trade weighted terms, the pound is now well below its average for the last 35 years. British manufactured products, food and drink, real estate prices, stock prices, school and university fees, hotel charges and workers’ wages have become unusually cheap in the eyes of the world.
Policy can also make a difference. Outgoing Chancellor George Osborne’s cut in corporation tax was designed to reassure foreign companies investing in the UK. There could be more where that came from. Outside the EU regulatory net, the UK would be free to set its own preferential tax rates. If so inclined, it could become a gigantic version of Singapore, with greyer skies but better theatre and museums.
BACK TO THE NATION-STATE
Brexit does not mean that Britain is turning its back on the world. It will continue to welcome large numbers of immigrants. Indeed an end to the commitment to open borders mandated by EU membership could well mean a more liberal regime for non-EU immigrants, especially professionals and skilled workers.
Likewise, it will continue to welcome foreign direct investment. Companies considering relocating operations from the UK to an EU member should consider the risks carefully. The travails of the Eurozone are far from over and a disorderly break-up is a non-negligible probability.
The industrial structure will change only gradually. Finance will remain one of the UK’s most important industries and the City will remain a key national asset, as it has been for centuries. Outside the EU, regulation is likely to be more supportive of competitive principles that foster the industry as a whole, rather than favouring “national champion” mega-banks.
In the referendum the British public voted for the nation-state and against the supranational ambitions of the EU. Asian countries – many of which have fought for their independence within living memory – understand that nation-states, for all their flaws, have hard-won strengths that should not be discarded lightly.
ASEAN has succeeded because it knows its own limitations – and that moving to open borders and a single currency would be a recipe for disaster. Indeed if the EU had displayed one tenth of the pragmatism and flexibility of ASEAN, Britain would still be a member.