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The Brexit Effect

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Message Seymour Patterson

If you live in the US your interest in Brexit might be nil or perhaps made of a fleeting thought. This indifference is understandable against the backdrop of the upcoming US presidential election and its outcome; i.e., President Donald J. Trump, the businessman become politician, or President Hillary R. Clinton, the onetime lawyer, Senator, Secretary of State and longtime public servant. That said, on June 23, 2016, Britain voted (Scotland voted not to leave) to leave the European Union (EU) with much jubilation. Prime Minister (PM) David Cameron stepped down as a direct result of this Brexit vote. The Prime Minister Theresa May set March 2017 as the date for triggering Article 50 (the December 13, 2007, Treaty of Lisbon), which contains the provisions for the countries to withdraw from the EU. There is a hitch in the PM's timetable; parliament might have to weigh in on the legitimacy of the Brexit vote, although the PM has stated that she plans to stick to her timetable for withdrawal from the EU.

There are at least three mutually alternative exit strategies that have been discussed: hard Brexit, soft Brexit, or goldilocks Brexit. Turkey's relationship with the EU is an example of what a hard Brexit would mean for the UK, as opposed to a soft Brexit as exemplified by Norway. Turkey's ties to the EU are loose. The country seeks accession to the EU but it seems to be moving in the direction of a customs union where there is free movement of goods in the union, but a common external tariff against non-EU members. There are ongoing talks between the EU and Turkey that have devolved into Turkey assuming the role of a buffer state against the hordes of Syrians headed for Europe. On the other hand, Norway is not a member of the European Union. It is linked to it via the European Economic Area (EEA) Agreement whereby the country enjoys the four freedoms as the Economic Community, namely, the free movement of goods, persons, services, and capital. The EEA countries are not in the EU, but have free trade with the EU. In other words, Norway (and Iceland) is like other EU members, but for agriculture and fisheries agreements.

From PM May's announcement, one can infer a hard Brexit approach. The pound Sterling did not respond well to this and fell against the US dollar by 6 percent from a little over $2.26 to a 31-year low of $1.18 in 30 minutes on October 6, 2016. Uncertainty about Brexit could propel the exchange rate to par with the dollar.

The pound is an international currency and its precipitous fall against the dollar generated concerns, and maybe some buyer's remorse about Brexit. However, there are silver linings: British companies like BP and Shell who hold their product earnings in dollars, suddenly saw their wealth spike upward. In addition, a cheaper pound means British goods are more competitive in world markets and Britain will see her exports rise and imports fall. Put differently, the Brits would live above its means and save more by consuming less of its own GDP. Britain could be considered whole again since having monetary policy at its behest; it will also be able to deploy fiscal policy to regulate to the economy. The country will regain control of her borders, which will have implications for employment and wages (and income) in Britain. This will be offset by the loss of the huge tariff-free EU market.

A hard Brexit would mean walking away from the European Union without looking back. New trade arrangements would have to be WTO-compliant, based on tariffs, which create distortions. Tariffs could incentivize UK manufacturers of importables to increase production; UK consumers would reduce consumption and pay a higher price (domestic price plus the tariff) and the volume of British/EU trade would likely decline.

Does Brexit have any US concern? Maybe. It likely matters in small measure who the next president of the United States is. In general, Hillary Clinton is for free trade although recently she has expressed concerns about TPP, which she erstwhile labeled the gold standard. Mr. Trump denounces TPP, NAFTA and attacks US companies for setting up operations in Mexico and China. His campaign rhetoric appears to favor a closer relationship with Putin's Russia. PM Putin and Mr. Trump share a mutual admiration for each other and Mr. Trump states that Putin is a more effective leader than both President Obama and Secretary Clinton. On the other hand, Ms. Clinton's relationship with Putin is frosty at best and she thinks Mr. Trump is Mr. Putin's puppet. This is tantamount to crass political posturing and what either candidate manages to accomplish after the presidential election will depend in part on forces beyond their control, and, not least, which party controls Congress.

Certainly the center of trade gravity between Britain and the EU is greater than the center of trade gravity with Britain and the US. Post Brexit, the US will have to enter separate bilateral trade agreements with Britain and it is not clear what the net results of the agreements would be. However, American importers will be happy with the relative decline of the pound, since US dollars will buy more British goods. And more American tourists would travel to Britain. Overall, US imports from Britain would increase and her exports will decrease, perhaps resulting altogether in a US trade deficit with Britain.

Mr. Trump believes that, like the Brexit vote, he will prove the polls wrong when he wins the presidential election. It is not clear what his more inward-looking foreign inclinations mean for US/British trade agreements. It might be safe to say that Hillary Clinton has an outward-looking trade orientation and she will continue President Obama's with the exception of TPP, which she once supported. Her public change of heart might have been inspired by the reception of Mr. Trump and Bernie Sanders' opposition to TPP during the presidential campaign.


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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
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