Will Davos bow before Brexit?
The crème de la crème of the global elite got their annual meeting underway Monday in Davos, Switzerland. Then on Tuesday, British Prime Minister Theresa May announced her country will be exiting the European Union's "single market" — setting up a dramatic test of one of the Davos crowd's most cherished beliefs.
When Britain shocked the world last June when it voted to leave the EU, it still left open the question of a "soft" or "hard" Brexit. Should the country simply renegotiate Britain's EU status or cut ties completely? The "Davos class" that spent the last few decades championing globalized free trade sided pretty strongly with the former. Waves of prestigious groups and think tanks put out multiple projections that a hard Brexit would leave the United Kingdom's economy permanently poorer — perhaps dramatically so.
Now May's declaration means that Davos' free-trade faith will be put to the test: Britain is leaving the EU — no ifs, ands, or buts about it.
For believers in free trade, the EU's single market is close to an ideal. It allows all member states to trade goods, services, capital, and (to a large extent) people back and forth without tariffs or barriers. But enjoying the benefits of the single market comes with a reciprocal requirement: that member states abide by EU norms on a whole raft of issues, from immigration rules to business regulations to welfare state design and more. That was what the Brexiteers objected to. Hence, May's commitment to a hard Brexit.
Now, Brexit will probably be a two-year process, which should kick off in March. And when all is said and done, Britain will still want to trade with the EU, and vice versa. But it's very unlikely that any trade deals struck in the post-Brexit era will be as frictionless as the single market. Why would the EU give Britain all those goodies back without demanding all those reciprocal obligations? That's why most projections say Britain will be poorer in the long run.
To be clear, Britain's economy won't stop growing. It's just that by, say, 2030, it won't have grown as much as it would have in a world where Brexit never happened.
There's reason to be skeptical of this, though. At bottom, the case for maximizing free trade rests on the idea of "comparative advantage" — that some countries are just better at doing certain things than others, be it banking, wheat farming, electronics manufacturing, or whatever. But Britain is an advanced market economy. It seems unlikely, to put it very mildly, that there's something other EU member countries are doing so much better than Britain that it would make a big difference to the British economy.
The most important factor in long-term growth is productivity, which boils down to know-how. But that won't be a problem for Britain because it has enough heads — over 60 million — to problem solve. The one other thing that the island could lack is natural resources. But again, Britain will still have plenty of access to trade post-Brexit — including trade with resource-rich non-EU countries like America — and it's unlikely that the costs of getting those natural resources will go up that much.
In fact, the computer models used by economists have a very tough time figuring out whether free trade actually helps countries grow at all. Obviously, one should take economic models with a grain of salt. But the ones used in this case actually have a pretty good track record when it comes to mimicking the real world. And when economists run big changes in global trade regimes through these models, the effects on economies are minimal. That faith in free trade persists despite real doubt is one of the economic profession's more embarrassing secrets.
Nonetheless, let's say the low-end projections prove right, and the British economy winds up 2 or 3 percent smaller in 13 years than it would be if it remained in the EU. That's a few hundred billion dollars, which isn't nothing. But most British workers would still be better off if Brexit redistributes incomes within the country.
That's because adding a bit more friction to Britain's imports and exports could reduce its trade deficit, creating more domestic jobs and raising wages. More importantly, the free flow of capital around the EU single market allowed London to become one of the global hubs for financial services. This became such a huge part of Britain's exports that it warped the rest of the country's economy and its exchange rates, driving up inequality and creating a boom in London while the rest of the national economy suffered. A hard Brexit could very well break up the London financial industry and its hold on the rest of the country.
Of course, we won't really have a handle on Brexit's aftermath for at least a decade. But eventually the Davos crowd might have to eat crow.