The Economic Consequences of Mr Johnson
When David Cameron finalised his EU deal on the 20th February it seemed that everything was falling into place for the Remain campaign; contrary to his critics’ predictions Cameron achieved a deal which effectively means the UK has a ‘special status’ in the European Union. The emergency migrant benefit brake exceeds the five-year ban that Nigel Farage had been calling for. The protection for countries outside of the Eurozone that Mark Carney, the Governor of the Bank of England, advocated was achieved. And, perhaps most significantly, the UK will no longer be bound to ‘ever closer union’, foiling a potentially lucrative line of attack for the Leave campaign. In addition to this, the most well-known politicians backing leaving were Nigel Farage, George Galloway and Michael Gove, all divisive public figures at best. This was opposed to a Remain campaign headed by a respected Prime Minister, and all four of the main parliamentary parties backing a vote to remain in the EU.
However, at around 5:30pm the next day, this all changed. Boris Johnson, regarded by many as the most popular politician in Britain, announced his support for the Leave campaign. His popularity is undoubted, his ability to retain the Mayor office in London in 2012, when his party were far behind Labour nationally in opinion polls due to unpopular austerity cuts, is a testament to this. Johnson has been reported telling colleagues that he is ‘not an outer’ just a few months ago, pointing towards this being a tactical decision on his part. It is likely to be a ‘win-win’ scenario for his leadership ambitions, as if Britain votes to leave it is likely Cameron will be forced to resign, leaving Johnson as the natural successor after leading his side to victory in the referendum. And even if Britain votes to stay in the EU, it is likely Johnson will have a greater backing of Conservative members, who tend to be Eurosceptic, in a Tory leadership contest when Cameron steps down due to his newly forged Eurosceptic credentials.
Whatever his reasoning, his stance is likely to have a profound effect on the campaign. For example, the chances of leaving the EU shot up from 20-30 per cent to 30-40 per cent after Johnson backed Brexit, according to US bank Citi. In addition, up to 9% of voters were willing to change their minds on the strength of Johnson's arguments to leave the EU, according to BMG Research; in what will be a tightly fought referendum this could make all the difference.
Despite this, it is still likely that Britain will vote to remain in the EU on the 23rd June. However, it just may be that the Leave campaign, headed by the charismatic Boris Johnson, makes a strong enough case to achieve a victory in the referendum. Therefore, it is worth exploring what the consequences to the UK economy would be in this scenario.
The uncertainty fostered by the referendum has hit the pound in recent weeks. For example, sterling slumped by nearly 2% to its lowest point since March 2009, following the London mayor’s decision to back the campaign to leave the EU. This is because Johnson’s backing has halted the momentum that seemed to be going the way of Cameron and the remain camp due to Johnson’s immense popularity.
However, this is nothing compared to the depreciation that would take place if Britain were to vote to leave; HSBC have indicated the Pound could fall as much as 20% if the UK were to leave the EU. This would mean an unprecedented parity between Sterling and the Euro. This may be fear mongering as it would be beneficial for HSBC if the UK were to remain in the EU. Despite this, there is no doubt however Sterling would take a severe hit.
Breaking away from the EU would create deep uncertainty in the UK economy until new relationships with EU countries were established, creating an unstable period of low investment. This increased uncertainty could be enough to tip the UK economy back into recession as the recovery seems to be slowing down already. However, short term effects such as these will depend upon how quickly a new relationship with Brussels is forged. If a new relationship is agreed upon quickly, the adverse short term effects on the UK economy could be negligible.
Of greater concern in financial markets is the possibility of a sudden outflow of money from the UK, which could make the country’s current account deficit of 5 per cent of national income difficult to finance. “Given the clear economic risks [in the event of a vote to leave the EU], markets would likely demand a considerably higher risk premium on the huge capital inflows required to finance that deficit,” says Neville Hill of Credit Suisse. “That would mean a sharp fall in sterling and the price of UK assets.”
Many economists reject the idea that Brexit would create purely transitional problems. Instead, they argue that as investment would likely fall in the wake of Brexit, leading to persistently lower growth. Productivity could be affected too. Raoul Ruparel of Open Europe says that, “with less foreign direct investment, we would lose some potential and technical benefits”.
The main argument put forward by Johnson as to why Britain would benefit economically from Brexit in the long run is that it would be free to strike free trade deals with countries such as India and China instead of having to negotiate as part of the EU. For example, Patrick Minford of Cardiff Business School argues that: “In the long term, Brexit will herald a major growth-boosting period, as the UK breaks free of the over-mighty EU with its protectionist mind-set and establishes free trade and intelligent regulation aimed at UK economic interests.” If this were to be achieved it could set the UK upon a path of higher growth, with greater trade and more incoming investment.
However, it is contentious whether this could be achieved as, for example, the US would prefer to concentrate their efforts of negotiation towards a trade deal with the EU as a whole, rather than the UK individually. For example, the EU is currently negotiating the Transatlantic Trade and Investment Partnership (TTIP) with the United States, and it is unlikely that the US would put this on hold to prioritise a free trade deal with the UK.
Also important is how Britain’s future relationship with the EU is after Brexit. If Britain were to remain a full part of the single market, it would have to accept EU regulations, including the free movement of people, without any influence in setting them. It would still have to pay for access to that market, as does Norway. It could not deregulate more than it can already today.
Seeing as though one of the main line of attacks on the Leave camp is that harmful Brussels regulation could be cut and the free movement of people curtailed if Britain left the EU, it is unlikely this would be politically achievable in the event of Brexit. Therefore, it is likely the UK would adopt a looser trading arrangement. The Leave campaigns say that, because of its importance as a destination for EU products, Britain could relatively easily strike a free-trade deal with the bloc. Such agreements typically govern goods rather than service, but 90 per cent of trade with Europe is in goods, this would serve to limit the adverse impact of this looser arrangement on the UK economy. If this looser agreement was agreed it is easily plausible that the adverse effects on the UK’s long run growth of a looser trade deal with EU will be at least offset by better trade deals with non-EU countries. The key determinant behind whether this is so is the political will for free trade. If Brexit occurs and Boris Johnson becomes Prime Minister it is likely free trade deals would be pursued due to his stance, however this could all change with a change of government.
Therefore, I conclude that even if Mr Johnson’s intervention does tip the balance in favour of Brexit it will not be disastrous for the British economy, as the return to the Gold Standard in 1925 was for Britain, prompting John Maynard Keynes’ article: ‘The Economic Consequences of Mr Churchill’. It is clear that leaving the EU is risky, and would give the UK economy a hard shock especially in the face of such global economic uncertainty. However, it is likely that in the long run the negative effects of a more restricted trade arrangement with the EU would be offset by better trade arrangements with non-EU countries. I would argue that membership of the EU is not one of the most important issues in British economic prosperity. As long as the main forces behind economic growth — investment, skills, competition, innovation and entrepreneurship — remain intact, the UK should continue on a path of growth in the long run.