Devil’s advocate

July 9, 2016

I am going to be the devil’s advocate here. The Brexit vote has produced a paroxysm of horror amongst Remainers and has resulted in a tidal wave of news stories about how the sky is falling and we are all doomed. It is however possible to look at the immediate consequences of the pro Brexit vote in another light. It is possible to actually welcome some of what the Leave win has already wrought.

One could, for example, argue that seeing lots of speculative capital fleeing the London property market is actually a good thing. It also possible to welcome as a good thing the fall in the value of the pound, especially given the very large trade deficit the UK is currently running. A large sustained deficit is a sign of an unbalanced economy, and the usual way to adjust an external trading imbalance is via currency exchange rate adjustment. Being able to devalue ones currency is precisely the main advantage of staying out of the euro.

The worst performers in the stock market falls since the Brexit vote were: construction, property investment, life insurance, property trusts, retailers, financial services, and tourism. But almost all of this is explained by a combination of exchange-rate depreciation (tourism, retail) and a deflating property bubble. Britain’s property sector has blown into a massive bubble, a bubble deliberately engineered so as to generate growth under Osborne’s ‘austerity lite’ program, and Brexit had the effect of deflating that bubble. Deflating a property bubble is a good thing, especially if it is a deflation and not a sudden stop collapse.

Another effect of Brexit, and perhaps the most important, has been to kill off Osborne’s aim of a budget surplus by 2020: Both he and (more relevantly) Theresa May, have abandoned that target. And there is substantial space for this relaxation of fiscal policy. Yet another impact of the Brexit vote was to push down yields on UK government debt, and this was from a starting position where government borrowing costs were already at historical lows. Twenty year index-linked gilts now yield minus 1.4 per cent, which means that, left to itself, government debt will fall over the long run. To put this another way, it implies that the government could run a significant budget deficit and still stabilise the debt-GDP ratio.

Simple maths shows that, if we assume a trend real GDP growth rate of 1.5 per cent and real yields of minus 1.4 per cent, the UK could stabilise the debt-GDP ratio at its current 88 per cent with a primary budget deficit of 2.5 per cent of GDP. This contrasts to a surplus of over two per cent of GDP in 2020 foreseen by the OBR in March. That allows a fiscal easing of 4.5 percentage points of GDP. A fiscal easing of 4.5 percent is a significant stimulus package. It means an additional £80 billion plus in public spending per year.

That fiscal relaxation could, for example, allow the government to increase spending on the NHS by around one per cent of GDP – roughly £350 million per week – and still stabilise public debt.

Time for some caveats. Some of the fiscal space created by the abandonment of Osbornomics will be eaten up in the near-term by a counter-cyclical rise in borrowing as the economy slows. In the very long run, the fact that GDP will be lower means we have less to spend on anything than we otherwise would. If bond yields rise then the maths because less nice. And if our big current account deficit causes a “sudden stop” then all bets are off.

Nevertheless the abandonment of austerity will allow the government to increase spending, and that would mean it would be possible, within government spending limits, to increase spending on the NHS. If I was a calculating Tory politician I would do just that leading up to the 2020 election just to wrong foot the Labour Party. Although frankly the Labour Party seems perfectly capable of wrong footing itself.

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