Well the news of the day is the UK is leaving the EU. Yesterday the citizens of the United Kingdom voted in a historic referendum to leave the European Union. The immediate response has been profound. Prime Minister Cameron resigned. The international stock markets have plummeted, with the FTSE declining 8% in early trading. The NYSE dropped 400 points in its first hour of trading. The pound sterling has dropped in early trading to its lowest rate against the dollar since 1985 ($1.3236). The divorce from the EU will take two years and the negotiations will be a huge challenge. Perhaps the greatest challenge the EU has faced since its formation. We do not know the economic outcome of Brexit, but I believe this event will be studied for years to come. Debates will ensue on how individual governments should respond, and how their responses affect the long-range economic outcomes. Below are several economics lessons.
1. Will the EU countries retaliate with stricter trading agreements? The EU needs favorable trade with the UK, but may fear other countries leaving if the deal is too good. What will the economic consequences be? President Obama suggested that leaving the EU would place the UK on a lower trading level than the EU in campaigning for remaining in the EU before the election. The Leave advocates believe the two year divorce will allow the markets to settle and enable the UK to negotiate favorable deals – perhaps more favorable than exist today.
2. How will Brexit impact employment? Economic growth fuels employment. It will be very interesting to see how the economy responds. Will strained trading relationships slow the economy? If so, then unemployment should increase. Can savings from money paid to the EU (supporters of Leave use the figure of 350 million pounds a week) be sufficient to bolster the economy as the Leave supporters say?
3. Another lesson relates to currency values. The pound has been falling in anticipation of Brexit and was down considerably this morning when the markets opened. The Greeks fear the loss of tourist revenues as it becomes increasingly expensive for the British to visit Greece because of the value of the pound vs the euro. Spain is also a popular destination for British pensioners and tourists. Brexit should also boost the value to the dollar. How will the US economy be affected? The strength of the dollar and weakening demand will hurt exports.
4. What will happen to the UK's balance of trade? Many international companies may be more likely to invest in an EU country if it wants access to the EU. Yet the UK must attract investment to help balance its trade. How much will the pound sterling need to drop to attract those investors?
5. How will Brexit affect interest rates? The Bank of England may lower its rate to zero in fear of a recession. However, doing so may dissuade investors from buying the pound sterling, which will hurt the UK's balance of trade.
6. Then there are the microeconomics lessons. How will Brexit impact specific industries? Experts believe the financial industry will be one of the hardest hit. Arguably, London has been the cornerstone of European finance. Banks may lose significant business following Brexit. This concern is reflected in early trading of the financial stocks. Barclays and RBS dropped approximately 30%.
7. Real estate values may drop because the demand for high-end real estate may fall. Wealthy foreign investors have been active in the London real estate market. They have contributed to bidding up real estate values. Will the uncertainty of the UK's economy and the pound sterling depress real estate values? If so, how wide-spread will the lower prices be? Will a drop in real estate values be felt in rural areas outside of London? How long will real estate prices remain low?
The UK's future economy is tied to the strength of its negotiations. The Leave contingent believe trade deals will be negotiated that strengthen the UK's position, thereby minimizing the economic consequences. I certainly hope they are right because it will diminish the fallout from leaving the European Union. Eventually, the most valuable lesson of all will be that the markets balance each other out, and in the end the UK will again thrive. The question is how long will that take?