Monday, June 27, 2016

Seven Reflections on Brexit

A long-planned family vacation had me visiting in Great Britain last week during the Brexit vote. Here are some reflections on the event, in no particular order.

1) The Brexit vote seemed to me a strangely American moment. Some of the lasting slogans handed down from the American revolution against England are "no taxation without representation" and "don't tread on me." Thus, for an American there was some historical irony in hearing many of the British argue, in effect, that there should be "no regulation without representation," or perhaps "no legislation without representation." There was similar irony in hearing some of the British turn loose their "don't tread on me" spirit while railing against annoying but in some sense small-scale regulatory impositions from the central power, like rules that sought to standardize shapes and sizes for fruit and vegetable produce, or the rules with force of law that sales of loose and packaged good use only metric measurements.  I found myself half-expecting some "Leave" advocates to start quoting the US Declaration of Independence: "When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them ..."

2) There was a widespread feeling, even among the Remain supporters with whom I spoke, that the nature of the European project had mutated over time. My sense was that many of the Leave voters were (mostly) fine with the progress of the greater European project from the founding of the European Economic Community back in 1957 up through the 1980s. But after the effort had transmogrified into the European Union in 1993, the project was no longer focused on facilitating trade between nations. Instead, it had become focused on an agenda of gradually erasing national boundaries, or in the phrase often-used, a push for "ever-closer union," which pushed beyond the comfort level of many of the British. For example, when the European Union describes its own history, it refers to early participants in the European project back in the 1950s as "Founding Fathers," a phrase with a strong resonance for Americans of those who seek to create a single nation.  The EU website also describes how the 1957 treaty aimed at a "common market" between countries, while the 1986 update treaty aimed at a "single market."

I ran across a 1982 European court decision that involved imposing value-added taxes across countries, which included an explicit statement that the European project viewed itself as involving a smooth movement from a common market, to a single market, then to "bringing about conditions as close as possible to those of a genuine internal market." The Court decision said:
The concept of a common market as defined by the Court in a consistent line of decisions involves the elimination of all obstacles to intra-Community trade in order to merge the national markets into a single market bringing about conditions as close as possible to those of a genuine internal market. It is important that not only commerce as such but also private persons who happen to be conducting an economic transaction across national frontiers should be able to enjoy the benefits of that market.
3) A shuttle driver at Heathrow airport surprised me by explaining the Brexit vote by saying: "Well,
you know, we're a nation of shopkeepers." I don't get a casual conversational reference to Adam Smith's The Wealth of Nations every day! Smith uses the phrase in Book IV, Chapter VII, in a discussion "Of Colonies," and in particular, in part of the discussion subtitled "Of the Advantages which Europe has derived from the Discovery of America, and from that of a Passage to the East Indies by the Cape of Good Hope." In a frequently quoted passage, Smith wrote:
"To found a great empire for the sole purpose of raising up a people of customers may at first sight appear a project fit only for a nation of shopkeepers. It is, however, a project altogether unfit for a nation of shopkeepers; but extremely fit for a nation whose government is influenced by shopkeepers."
There are several odd twists and turns in relation to this passage. A first twist is that Smith using "shopkeepers" as a pejorative term. He is arguing that is after England and the colonists had gone to the effort and expense of developing the colonies, then "shopkeepers" in England wanted the British government to guarantee that the colonists would be required to buy what they needed only from English producers, and also to sell only to English producers. Here's some of what Smith writes in the same paragraph as the above quotation:
"England purchased for some of her subjects, who found themselves uneasy at home, a great estate in a distant country. The price, indeed, was very small, and instead of thirty years purchase, the ordinary price of land in the present times, it amounted to little more than the expence of the different equipments which made the first discovery, reconnoitred the coast, and took a fictitious possession of the country. The land was good and of great extent, and the cultivators having plenty of good ground to work upon, and being for some time at liberty to sell their produce where they pleased, became in the course of little more than thirty or forty years (between 1620 and 1660) so numerous and thriving a people that the shopkeepers and other traders of England wished to secure to themselves the monopoly of their custom. Without pretending, therefore, that they had paid any part, either ofthe original purchase-money, or of the subsequent expence of improvement, they petitioned the parliament that the cultivators of America might for the future be confined to their shop; first, for buying all the goods which they wanted from Europe; and, secondly, for selling all such parts of their own produce as those traders might find it convenient to buy. For they did not find it convenient to buy every part of it. Some parts of it imported into England might have interfered with some of the trades which they themselves carried on at home. Those particular parts of it, therefore, they were willing that the colonists should sell where they could; the farther off the better; and upon that account purposed that their market should be confined to the countries south of Cape Finisterre. A clause in the famous act of navigation established this truly shopkeeper proposal into a law.
"The maintenance of this monopoly has hitherto been the principal, or more properly perhaps the sole end and purpose of the dominion which Great Britain assumes over her colonies." 
A second twist is that that Napoleon (who was familiar with Smith's writings) is reputed to have snarked that England was not a worthy opponent in war, because it was merely "a nation of shopkeepers. There doesn't seem to be much evidence that Napoleon ever actually made this comment, but as the legend metamorphosed into what people thought they remembers, some in England began to treat Napoleon's intended insult about "nation of shopkeepers" as mark of pride. Indeed, news stories in recent years point out British government ministers who now argue that the country should become "a nation of shopkeepers,"  by which they mean entrepreneurs, along with poll results suggesting that "shopkeeper" is viewed as a quite desirable job.

Clearly, applying Smith's argument to the Brexit phenomenon in any direct way is a stretch! But it is true that in Smith's usage, Britain was a nation of "shopkeepers" who expected their government to cut them a profitable deal in world markets--and the seeming inability of the British government to cut such deals was part of the fuel for the "Leave" forces.

4) A comment I heard several times from "Leave" proponents is that the United Kingdom has fifth-largest economy in the world, and even outside the EU, it will remain an important player in the global economy. This argument strikes me as whistling in the dark. Yes, if GDP across countries is compared at market exchange rates, the United Kingdom ranks fifth (after the US, China, Japan, and Germany). But world GDP isn't a race, where finishing 5th of the 195 economies where the World Bank estimates a GDP level gives you a prize. Absolute size matters, and the UK is only about 3.8% of the global economy by size. In other words, if countries don't want to deal with the UK for whatever reason, there are lots of other options out there. If one compares GDP across countries using "purchasing power parity" exchange rates, then the UK ranks only 10th in the world, and is 2.4% of the total world economy. One of the main economic justifications for the EU is that with an internal market of more than 500 million people, and with a total GDP exceeding either the US or China (at market exchange rates), members will be better-positioned both to trade within the group and to be part of better deals negotiated outside the group.

5) Along with issues of democratic representation and the possibility of negotiating alternative international agreements, the other big issue in the Brexit vote concerned immigration. Here are a couple of graphs from the "Migration Statistics Quarterly Report: May 2016" published by the UK government. From 1970 up to the early 1990s, immigration and emigration were roughly equal in the UK. But then immigration rises rapidly, and in many year there is overall net in-migration of 200,000 per year or more.

Are Britain's migrants coming from inside the EU or outside? This figure shows "net" migration--that is, immigration minus emigration--for various groups. You can see that in starting around 1997, the main surge in net migration was at first from outside the EU, a change often said to be triggered by pro-immigration policies adopted by the government of then-Prime Minister Tony Blair. However, in since about 2010, net migration from within the EU has stepped up as well. After 2004, a substantial share of this migration from inside the EU was from eastern European countries. In the last few years since 2010, there has been increased immigration to the UK from countries in the so-called EU-15, which are the countries that were members of the EU up to early 2004, as well as from Romania and Bulgaria.

Thus, greater immigration had a fairly modest affect on the UK through the earlier decades of the European project, up through the 1990s. The big change in UK immigration around 1997 was mostly a result of decisions by Britain's government, not imposed by the EU. It was also a decision of Tony Blair's government, not imposed by the EU, to allow workers from the eastern European countries joining the EU after 2004 to work in the United Kingdom.  Although the more recent issues about refugees from Syria and north Africa who are seeking asylum in Europe and the United Kingdom have clearly added heat to the immigration issue, the underlying message here is that immigration--a rising share of it from within poorer countries of the European Union--has been shaking up the UK economy for the last 20 years.

Martin Ruhs offers an interesting overview of these issues in "Is unrestricted immigration compatible with inclusive welfare states? The (un)sustainability of EU exceptionalism," published in 2015 as Working Paper #125 for the Centre on Migration, Policy and Society at the University of Oxford. As Ruhs points out, a standard argument why high income countries cannot allow mass immigration from lower-income countries was given in a speech by Milton Friedman back in 1978. Friedman said:
"... it is one thing to have free immigration to jobs, it is another thing to have free immigration to welfare, and you cannot have both. If you have a welfare state, if you have a state in which every resident is promised a certain minimum level of income or a minimum level of subsistence regardless of whether he works or not, produces it or not, well then it really is an impossible thing.”
As Ruhs points out, this conventional wisdom doesn't quite summarize the issue accurately. Most intra-EU migrants are workers, not welfare recipients. He writes (citations omitted for readability:
The paper is not concerned with the intra-EU migration and social rights of EU citizens who are not workers, a group that has recently been much discussed in debates about alleged “benefit tourism”. This usually refers to claims that EU citizens move to other EU countries for the primary purpose of accessing benefits rather than working and contributing. Although popular in media and public debates across the EU, there is little evidence to support this claim. In the UK, for example, there is no evidence to support the idea that access to the welfare state is a major driver of EU immigration and EU migrants are significantly less likely than UK workers to access out-of-work benefits. In any case, the great majority of EU migrants across EU member states are labour migrants who qualify as “workers”.
But that said, the United Kingdom has a lightly regulated labor market compared to other high-income countries within the EU, and thus is more likely to attract unskilled workers. In addition, many of the benefits received by British workers are "non-contributory," meaning that they are paid out of general government revenues rather than out of payments from workers (and their employers). Ruhs sums it up this way:
In a free movement area with unrestricted labour migration across countries, the nature of the labour market plays an important role in shaping the scale of immigration in particular countries. More flexible labour markets tend to attract more migrant workers, especially for employment in lower-waged jobs, than more regulated labour markets. At the same time, the nature of the welfare state, especially the extent to which it provides non-contributory benefits, impacts on the net-fiscal contribution that new migrants make. In countries with welfare systems characterized by a high share of non-contributory benefits, low-skilled immigration will, ceteris paribus, create a smaller net-benefit (or greater net-loss) than in countries with welfare states that include a greater share of
contributory benefits.
Most economic studies (although not all) suggest that the native population of a country as a whole benefits from immigration. However, those who find themselves in most direct competition for jobs with the new migrants are more likely to incur costs. And the UK labor market and welfare policies, relative to the other high-income economies in the EU, are set up in a way that will raise the economic tensions from a more-open immigration policy. .

6) After the vote, a number of "Remain" proponent often emphasized that the margin seemed very narrow. I disagree. In big elections with millions of voters, a 51.9% to 48.1% vote is actually pretty decisive. In absolute terms "Leave" won 17.4 million votes and "Remain" had 16.1 million. Thus, it would have taken a swing of something like 700,000 voters to alter the outcome--and that's a lot of voters. As another perspective, President Obama won reelection in 2012 over Mitt Romney with 51.9% of the two-party vote, and that isn't (and shouldn't be) thought of as a narrow marginal victory, either.

7) Finally, consider in broadest terms the many ways in which the relationship between the United Kingdom and European Union, or between the United Kingdom and various subsets of European countries, might be arranged. Such relationships have many possible dimensions, involving trade, competition policy, environmental policy, immigration policy, workplace regulation, welfare policies, spending, taxes,  monetary policy, and others. This very multidimensional set of policy choices can't really be distilled into a binary choice labelled either "Leave" or "Remain." 

The Brexit vote doesn't determine what the eventual outcome of the renegotiated relationships between the countries will be, but it may alter the default negotiating positions of the two sides. In some sense, it's similar to the change that occurred in marital divorce laws. When divorce required that one party be found to be at "fault," the person in the marriage who least wanted to divorce had greater power to block the divorce. When divorce shifted to "no-fault," the party who wanted to get divorce had more power in the negotiation that followed. Similarly, before the Brexit vote, the presumption in Britain's negotiations with the EU, or other countries around the world, was that Britain would more-or-less follow the consensus of the rest of the EU. With that negotiating position, the European Union wasn't willing to concede much at all to Britain's Prime Minister David Cameron in negotiations before the Brexit vote. After the vote, the presumption will be that Britain will not follow the group, so any negotiations either with the EU or with other countries will have a different tone. The default negotiating position will be shifted. The United Kingdom will have less leverage in cutting international deals than the EU as a whole, but it will also gain greater flexibility.