The new government in the UK has apparently decided to take the difficult road out of the EU. What will actually be gained or lost by this remains for now a completely open question. The conditions of the Brexit still need to be negotiated. However, macroeconomically speaking, Great Britain faces the same dilemma as the EMU.
It is clear and we have pointed this out on several occasions (for example here), that the EU will not accept unlimited access to the single market and restrictions to intra-European migration. This is simply out of the question. It raises the question whether the exit of the United Kingdom will create macroeconomic positive or negative effects. Will the Brexit allow the UK to formulate better economic policies?
To answer this question, we must realise that the UK has been far less affected by the oftentimes irrational and increasingly dogmatic Eurogroup policy, because the UK has never been a member of the monetary union. Great Britain had the freedom to follow a completely different set of policies. Whether this happened, and to what extent, is another question altogether. Former Prime Minister Cameron’s government was just as dogmatic neoclassical-conservative as the EU Commission and the Eurogroup.
The most important macroeconomic indicators show that in reality the situation in the UK has indeed been the same as for the rest of Europe for many years. Figure 1 shows the short-term interest rates in real terms from 1980 onwards compared to Germany and France.
The figure shows that in recent decades British monetary policy has been moving between that of Germany and France within a very narrow range. This is also true for the most recent period, the one since the start of the European Monetary Union. In the years following the financial crisis, however, British monetary policy vigorously followed another strategy: its short-term interest rates were already clearly negative in 2010. Surprisingly, no major changes occurred of this, despite the current account deficit in Great Britain up to the year 2007 and, again, after the outbreak of the financial crisis.
Figure 2 shows the evolution of the Pound against the euro (since 1999, before that against the D-Mark and the Franc). Until the depreciation of 2007 (an upward movement means a depreciation), no great changes took place. It was not until 2016, after the Brexit decision, that there was a clear depreciation which surpasses the one from 2007 (not shown here).
It is not to be expected that this depreciation will decisively change Great Britain’s economic outlook in the short term. This is due to the low level of industrial reactivity. The increase in imports, on the other hand, is likely to have a significant impact on the current account balance. In the medium to long term, all of this can work out quite differently. Then an increased concentration on tradable products is again possible. It is an open question to which extent such developments will collide with the EU negotiations. A deterioration of English exports to the EU would undoubtedly affect the ability to balance the current account, even with a low Pound.
Does British economic policy have other options? The answer to this question is clearly shown by the financial balances of the sectors which are often used in this type of analysis.
In Great Britain a very untypical constellation developed over the years. I have already said in the second part that private households through their negative savings in the United Kingdom have stabilised the economy in two recent phases. While companies did become net savers since 2003, there has been a program aimed at stimulating demand from the side of the private households, both before the financial crisis and in the last two years. This means, in other words, that Cameron’s attempt to consolidate the government budget at any cost would have failed miserably in view of the current account deficit and the companies that were saving, if the households had not spent a lot of money, despite a poor income development.
In the case of a constellation with regard to the households’ low-income economy, as in Germany and France (see figures 4 and 5), the British current account deficit has, under the given circumstances, shown itself to be a significant disruption.
However, today the UK budget deficit is still above four percent, which would result in sanctioning threats from the part of the EU Commission if the UK would be a member of the EMU.
Active fiscal policy is indispensable
The new British government seems to have realized, much to the horror of the German conservative media, that the bells are tolling. Perhaps May’s government feels the pressure of Jeremy Corbyn’s alternative proposals stronger than it admits. Pressuring private households into consumption, however pleasant it may be for a while, is a two-edged sword, because it is not clear how quickly and under which circumstances the households will be able to return to their normal economic behaviour, i.e. to positive saving territory. If governments want to stave off a deep recession or even a depression by stimulating demand, as it did in 2008 and 2009 on a very short term, the injection has to be massive. In 2008 and 2009, the UK government accepted deficits of more than ten percent of GDP.
An enlightened British government – and this of course also applies to a possible Labour government – must recognize the fact that, today, Great Britain is far removed from a functioning market economy. On the one hand, and this it is absolutely crucial, any government must ensure that wages continuously rise in sync with productivity growth, rather than to bet on unsustainable consumptive excess. Doing so, would have the direct effect that the private savings ratio will normalize, i.e. that it will rise into the positive range. If this happens, regardless of which government is in power, it will have no choice than to accept much higher government deficits than today until the current account deficit is has been eliminated. Any honest politician today should tell this to the citizens without any further political ado.
The tragedy is that the conservatives will never act in this way. They could only do it, if they abandon their microeconomic views and even their identity which they derive from (their conception of proper) entrepreneurship. In their view, there is no positive macroeconomic role for the state. Other parties, which are willing to implement the correct economic policies, cannot do so without the conservatives. There is also the problem of the media, which relentlessly stigmatises these politicians as trouble makers and their programs as recipes for anarchy. They are even being called traitors of future generations and they are constantly being pushed into the corner. There is a chance that the voters will see through this in these crucial times. If not, democracy is being progressively more endangered, because the majority of countries can no longer implement successful economic policies.