How to Reboot Britain's Economy After Brexit
The U.K. decision to quit the European Union appears to be slowing the global recovery. But the government's policy response put the domestic economy on a stronger footing than before, limiting Brexit's negative impact on the rest of the world. Britain, previously Europe's poster child for austerity, has an opportunity to augment the Bank of England's monetary-policy efforts with some much needed fiscal firepower.
The International Monetary Fund cited Brexit for smothering a modest upgrade in this year's outlook, saying on Tuesday that the world will grow by 3.1 percent, unchanged from last year. "The real effects of Brexit will play out gradually over time, adding elements of economic and political uncertainty that could be resolved only after many months," said IMF chief economist Maurice Obstfeld.
The impact on the U.K., though, is worse; the IMF sees the U.K. decelerating to 1.3 percent growth in 2017 from 1.7 percent this year -- slower than the euro zone's projection for 1.4 percent.
Even before she became prime minister, Theresa May announced that efforts to generate a budget surplus by 2020 would be abandoned. It's a very different tone than former Chancellor of the Exchequer George Osborne's June 15 threat to introduce more spending cuts and higher taxes if the nation voted in favor of Brexit on June 23.
The task facing Britain's government is to avoid letting the political drama develop into an economic crisis. Britons are more pessimistic about the financial outlook than at any time in the past two-and-a-half years, according to the Markit July survey of U.K. households.
Business uncertainty has climbed after the vote, according to the Bank of England's regular survey of business conditions, with one-third of firms seeing a negative impact on hiring and investment in the coming year. And a U.K. Treasury survey published on Wednesday showed that independent forecasters now see growth of just 0.8 percent next year, down from a consensus for 2.1 percent just a month ago.
Trying to untangle the complex web of reasons why Britons voted in favor of exiting the bloc is a fruitless exercise. Immigration concerns, exaggerated claims about "taking back sovereignty" and the perennial desire to give an incumbent government a kicking all played a part. But a sense that the alleged trade benefits of EU membership weren't translating into an improved sense of economic well-being -- especially under the stewardship of Osborne-- undoubtedly played a role.
The Institute for Fiscal Studies published a report this week on U.K. living standards. Here's a chart the research group produced showing what's happened to household incomes in the past decade, divided by age groups and calculated both before housing costs (BHC) and after (AHC). In short, working Brits haven't had a pay rise in the past 10 years:
The government’s foremost priority must be to begin to turn this picture around. That will take a much different fiscal policy – more investment driven – than anything the previous administration tried.
Some 44 percent of global investors regard global fiscal policy as currently too restrictive, according to a survey published this week by Bank of America. That's a record for the monthly poll, according to the bank's chief investment strategist Michael Hartnett. It suggests that money managers are losing faith in the world's reliance on monetary policy and quantitative easing to avert a renewed slump.
Philip Hammond, Britain’s new Chancellor, said this week he won't rush to change course and will wait until his Autumn statement to set out his stall. But his comment on Tuesday that the central bank should deliver "the initial response" to the Brexit shock suggests scope for a secondary response on the fiscal front, and might also help explain why the central bank didn't immediately reduce borrowing costs when it met last week.
The futures market (which was completely wrong-footed by the last non-cut) suggests traders see about an 87 percent chance of a Bank of England rate cut to 0.25 percent from 0.5 percent when it next meets on Aug. 4. But the experience of the European Central Bank and the Bank of Japan suggests even borrowing costs below zero don't have the power to restore business and consumer confidence.
So let's hope the new administration has the intellectual courage to change direction and loosen the fiscal purse strings -- funding more high-speed railways and improved road links between cities in the north, for example, or a commitment to developing tidal power in the nation's lagoons and bays. A break from the "austerity is good for you" message that's dominated government policy in recent years is just what the country needs.
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