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Recently, Bank of England Governor Mark Carney claimed that if British voters elect to leave the European Union in June 23’s referendum, it will risk recession.
More than 300 economists have lined up in support of staying in the EU, claiming the consequences of “Brexit” would be dire. On the other hand, dozens of economists claim it’s quite the opposite, and that a Brexit would unshackle Britain from Brussels’ labyrinth of regulation and free it to unilaterally pursue better trade opportunities with faster-growing regions.
Politicians have predictably staked out positions on both sides. Even some select American politicians have weighed in, with presumptive Republican presidential nominee Donald Trump suggesting Brexit would be better for Britain, while President Barack Obama says remain is a necessity. Supranational organizations like the IMF have opined frequently.
Friday, some 250 British celebrities joined the fray, penning an open letter published in The Guardian and The Telegraph claiming Britain is not only better off in the EU, it is “more creative and imaginative” in the single market. The evidence they offer: That Brussels funded several major motion pictures like The King’s Speech, Slumdog Millionaire and The Iron Lady. Additionally, the signatories conclude not being in the EU would threaten Britain’s “creative industry” which they claim employs 1 in 17 UK citizens and adds £84 billion to UK GDP (5.2% of the total, if you are scoring at home).[i]
Unlike Trump and Obama, this American will offer you no opinion of which way Brits should vote on June 23. Vote your conscience. That said, I do worry that investors may get caught up in what amounts to a tangled web of misinformation before the vote, potentially causing mistakes. With the purdah period—the pre-referendum 28-day period restricting campaigning by government officials—arriving a week from today, we could see a fever pitch of talk next week, followed by media handwringing galore in the final run-up to the vote. To prepare you, please consider this simple fact: Nothing automatically changes on June 24, whether “Remain” or “Leave” wins. The economic consequences of the vote are being overstated to the point of ridiculousness by both camps.[ii]
There isn’t much of a way to know which way the vote will go. While polls have recently shown “Remain” with a 55% to 37% lead (8% don’t know or won’t vote)—resembling the odds bookmakers’ websites have long shown—polling has a sketchy history lately. Moreover, this recent poll may be an outlier. With that said, the limited history of independence votes like Quebec (1995) and Scotland (2014) suggests voters tend to stick with a known quantity when the stakes are high. Perhaps they do so once again.
Should the polls and bookmakers prove correct and “Remain” wins, the status quo … ummm … remains. This is a known quantity, and has been for decades—a period during which Britain’s economy and markets have done just fine. More to the point, even those who support “Leave” on economic grounds tend to argue Brexit would enhance Britain’s economic prospects by shedding Brussels’ regulations and allowing the country to negotiate its own trade deals. If you presume those are plusses, then a “Remain” win would merely be the absence of a potential positive—not a new negative.
The consequences of a “Leave” win are more controversial, perhaps explaining why Helena Bonham Carter and Benedict Cumberbatch felt the need to weigh in. But here is a key point: After the vote, there is a two-year exit negotiation period in which Britain and the EU would attempt to iron out the terms their relationship. This is the key to understanding what the economic impact might be. It could be zero, if they work out a continued tariff- and trade-barrier free structure. It could be bigger. But it is unlikely to be dire, as Britain has “Most Favoured Nation” status from the World Trade Organization, capping potential tariffs. However, this hasn’t stopped many experts, politicians and pundits from forecasting pain.
Some in the “Remain” camp speculate the EU has more leverage and will drive a hard bargain with the British, perhaps out of a sense of sour grapes. Many note British exports to the EU account for 15% of UK GDP, while EU exports to Britain only account for 5% of EU GDP. But in actuality, the incentives are high on both sides to ink a deal. The UK is in the top three export destinations for Germany, Ireland, Spain, Cyprus, the Netherlands and Poland. Those countries likely don’t want to risk the business. Trade relationships are mutually beneficial and don’t hinge exclusively on exports. Finally, the share of British exports that go to EU countries has been falling for some time, while the share of exports to the US and Emerging Markets are up—Britain’s exports have been increasing in diversity for most of this expansion. (Exhibit 1)
Exhibit 1: EU Share of UK Exports
Source: Eurostat, as of 5/20/2016. 2004 – 2015.
Many in the “Leave” camp argue Brexit would further strengthen non-EU trade by allowing Britain to negotiate bilateral trade treaties with these faster growing areas, specifically India and China. In theory that is possible. But it takes two to tango,[iii] and neither India nor China have a long history of being open to trade. It is speculative to suggest Britain would be able to get deals done with either of these nations. America, perhaps, but on this side of the Atlantic trade deals aren’t hugely popular presently. (Exhibits A & B: Donald Trump and Bernie Sanders.) I’m skeptical these potential benefits would be so easy to reap.
Even that pro-“Remain” celebrity letter is citing trumped-up statistics (I know, shocker!). “Creative Industries” is a very liberal term encompassing not only film, music and entertainment, but advertising and marketing, software, video games, publishing and translation, architecture, arts and crafts and more. In fact, the music and film industries combined—the most likely to generate celebrity—amount to only 1% of UK GDP and 19.3% of creative industries output.[iv] As Exhibit 2 shows, Britain’s creativity is mostly focused on software, advertising and marketing.
Exhibit 2: UK Creative Industries Breakdown
Source: Office for National Statistics, as of 5/20/2016. Share of value added by industry group, 2014.
It is hard to see how Brussels’ film office would benefit all these groups. Now, I’m sure they do benefit from EU membership in some ways, but regulation and such could easily harm them too. The argument can go both ways. Whether we’d have a more or less creative and imaginative Britain outside the EU is anybody’s guess, but my inner skeptic feels compelled to note Charles Dickens, William Shakespeare, Emily and Charlotte Bronte, Lord Byron, Aldous Huxley, George Orwell, William Blake and John Keats—among scads of other phenomenal British artists, writers, poets and actors—did their work pre-EU. Creativity isn’t a British import.
Other “Remain” supporters—most notably BoE Governor Mark Carney—have argued exiting the EU risks more than just trade, but financial stability, as Brexit could send interest rates skyrocketing as EU buyers are unlikely to buy gilts and finance the British current account as a result. Last week, he even went so far as to suggest “Leave” risks recession. Balderdash. Gilts aren’t attractive because Britain is in the EU. They are attractive because Britain has a stable government, sound property laws, a vibrant, capitalist economy and is open to foreign capital flows. This is evident in recent gilt auctions and low interest rates—after all, markets won’t wait for the vote to react. If Brexit really threatens Britain’s ability to finance itself, we should be seeing it in bond markets. We’re not. The things that make Britain attractive to investors won’t change with a “Leave” win.
As for BoE head Carney’s recession claim, its defining characteristic was the absolute lack of any identifiable data. Carney’s claim hinged on Brexit dinging “confidence.” Which, fine, sure, confidence could impact economic growth. But we’re not aware of any purely confidence-driven recessions, and statistical attempts to quantify it usually amount to less-than-predictive tallies of how people felt at one isolated moment. For example, market-research firm GfK’s April 2016 UK Consumer Confidence Index fell to -3, its lowest level in 15 months, which most media types connected to Brexit. Upon concluding the survey, it appears Brits turned around and went shopping: The same month, the Office for National Statistics reported retail sales spiked 1.3% m/m, doubling estimates. This isn’t an isolated data point—confidence surveys have shown a downtrend since last August but retail sales are in a choppy uptrend. (Exhibit 3)
Exhibit 3: UK Consumer Behavior Doesn’t Suggest a Confidence Issue
Source: FactSet, as of 5/20/2016. April 2014 – April 2016.
Now, the “Leave” camp has been fairly liberal in citing the benefits of reducing regulation. To the extent it exists in the way described, deregulation may be a plus. But the thing is, most of the regulation campaigners point to isn’t what it seems. Many of them, like restrictions on shrimp-flavored chips, tea bag recycling and kids inflating balloons aren’t real. Some others, like regulations on the size of olive oil containers are miscast. There are some real ones, like Sir James Dyson’s fight over energy efficiency labeling for vacuum cleaners. The trouble is, campaigners too often lump the real in with the false or miscast, muddying the water.
For investors, the key to all of this is to stay cool and see through the fog. Brexit isn’t inherently negative and defies handicapping, which means making a major portfolio shift based on the possibility Brexit may be bad is sheer speculation. What’s more, as the vote draws near and eventually passes, uncertainty should fall. Now, if “Leave” wins, it’s true we won’t know what the post-Brexit relationship exactly looks like. But just knowing the vote is out of the way allows businesses to begin preparations, and the debate will be widely watched and publicized. Markets will gain clarity as June 23 approaches and, if “Leave” wins, they should continue to thereafter.
[i] Source: Office for National Statistics, as of 5/20/2016. Creative Industries and GDP by value added, 2014.
[ii] Americans are guilty of this in the recent past, too. See “the Fiscal Cliff” for more.
[iii] This is a technical term for, “Ink trade deals.”
[iv] Source: Office for National Statistics, as of 5/20/2016. Creative Industries and GDP by value added, 2014.