The British Economy and the Brexit Vote Explained in Two Charts

In the course of doing my day job, which involves writing about the US economy and international trade, I came across two stunning charts on the British economy which I would like to share with my British readers and anyone else who is interested. These two charts put a sharp spotlight on the performance of the British economy in recent years and go a long way towards explaining the Brexit vote of 2016. 

The first chart (Figure 1 below) comes from a Century Foundation report entitled 11 Ways American Workers Are Falling Behind the Rest of the World by Amanda Novello and Jeff Madrick of Century, a Washington think tank. The report does an excellent job of documenting the sluggish average wage growth that has afflicted the US economy since 1990.

But the shocking thing about this graph is the position of Britain (grey line). The UK is the only nation in this sample of nine that has seen average real wage decline since 2007, the peak year before the Great Recession. Every other nation managed to produce some sort of recovery, however weak and anemic. Only Great Britain was unable to raise its real average wage over ten years! It's down by 3%, and median wages would of course be down by even more. This is economic failure of the first order. 

Figure 1: UK is the only nation in this sample to see a fall in real average wages in the ten years since 2007. Source: OECD via The Century Foundation

And Britain's economic failure is confirmed by a look at Figure 2 below. This chart, courtesy of the National Institute of Economic and Social Research, a London think tank, shows that Britain's recovery from the 2008 recession has been weaker and slower than in every other significant recession Britain has faced since 1930. Nor is it close. After 4 1/2 years from the bottom, all the other recoveries had regained and surpassed their pre-recession output levels. Only the 2008 recession saw output still below (by 4%!) the pre-recession level.

Figure 2: UK 2008-2012 was most disappointing economic recovery of modern times, worse even than post-1930 recovery from the Great Depression (which used devaluation & protection to boost domestic demand). 

Why has British economy recovery been so poor? The most common explanation in the British media is that the country was overly dependent on its financial sector, which suffered badly from the finance-led recession of 2008. But finance is not large enough (in employment and output terms) to explain such a deep and pervasive economic decline. Britain has continued to lose market share in global manufacturing industry. The overvalued pound sterling is undoubtedly part of the reason for the decline. The century-old cultural problem of undervaluing business success continues to be a fundamental issue for Britain. I write this from London, where this week Meghan Markle is in the news, as she has been for months. She is said to be "exhausted" from the difficult life she has embarked upon of wearing different outfits each day, riding in limos, and being photographed constantly. Meanwhile, David and Victoria Beckham are also in the news, because she is on the cover of British Vogue and is showing her collection at London Fashion Week. The British media poked fun at David for being left conspicuously out of the Vogue picture of the Beckham family. He gave an interview attributing his and his wife's success to“hard work.”

For two decades, British elite opinion has mercilessly mocked and lampooned the Beckhams, he as a once-great, now fading football player past his prime (true), and she as a gold-digger with no talent from the most tasteless, arriviste part of Britain. Now that she runs one of the country's most successful fashion companies, comment on her is grudgingly changing. But Meghan Markle, who has just joined the world's most celebrated family of layabouts, is lauded, while Beckham, with his simple, charmingly humble attitude, is mercilessly derided. The old British aristocratic ideal of “effortless superiority" maintains too strong a hold on the British public. One suspects that modern university education puts more emphasis on the first half of that phrase than the second. Beau Brummell radiated effortless superiority. Today's university graduates in Corbyn's Labour Party exude effortless mediocrity.

But all those cultural forces have been with Britain for 100 years. What has changed since 2008? I suspect it is the combination of recession with the increased competition from eastern Europe and Asia. Countries like Slovakia and Poland joined the EU in the 1990s and by the mid-2000s were becoming economically integrated with western Europe. In the east, wages are some 50%-75% lower than in the west. This has put downward pressure on British wages. That competition will continue, even if Britain leaves the European Union next March. 

Modern free trade is all about regression to the mean. Poor countries see their wage levels rise and rich countries see their wage levels fall. As I have said before, it's not a hard concept to grasp. Anyone can understand it, unless they are an economist, in which case they have devoted their lives to building complicated models that enable them to ignore the reality in front of their faces. The situation is made much worse if there are countries that dedicate themselves to twisting and abusing the rules of free trade in their favor, as Germany has done with the euro and China has done with virtually every rule in the book. Furthermore, as Joe Stiglitz and others have pointed out, in poor countries, oligarchs have shown ruthless skill in allocating most of the gains from free trade to themselves, leaving the poor masses little better off. In rich countries, what efficiency gains there have been from free trade have gone to the top 10% of the population, leaving the rest of the population in many nations with only the efficiency losses from trade, and so creating nations more divided than at any time since the Industrial Revolution. 

If you fail to plan for a free trade world, you are planning to fail. Germany has planned for this. Their major industries have moved a portion of jobs and production east but, working closely with local and national government, maintained a large volume of production at home, and favored home suppliers, through policy, informal agreements, and a euro that is undervalued for the competitiveness of the German economy.

The British have not planned at all. The British government and many London commentators believe in free trade much as children believe in the Tooth Fairy. Even today, there are pro-Brexit groups claiming more free trade is the answer to Britain’s problems. They seek agreements with the US, with Australia, and—God help them—with China. 

Brexit and The People’s Vote (Again)

The shock Brexit vote in June 2016, in which British voters repudiated the leadership of all three major political parties and the vast majority of respected commentators to vote to leave the EU was the result of two forces: first, the British public’s dissatisfaction with large-scale immigration, especially from eastern Europe, and secondly the dismal economic results I have illustrated above. It is not a fluke. We have seen the same trends in the US election of Donald Trump, the election and reelection of Viktor Orban in Hungary, a populist victory in this year’s Italian election, and increased votes for anti-immigrant parties in Sweden, Denmark, France, and Germany. 

Trade and globalization have been with us for a long time—at least since Marco Polo brought back spaghetti from China. Cultural, artistic and culinary globalization are great things. But the modern version of economic globalization, which is essentially a license for corporations to sell their products in high-wage countries while shifting production to low-wage countries, is a recipe for disaster in the high-wage countries, unless those countries regulate and manage the process.

On Saturday, as many as 700,000 Britons marched in London against Brexit in a so-called “People’s Vote March.” This “people," angry about the other "people" who voted to leave the EU two years ago, could well reverse the Brexit process. After all, in 2005, the French public voted in a referendum to reject the treaty creating the European Union, and the French political elite simply decided that voters had given the wrong answer and ignored the referendum. The British would have a more legalistic, transparent, tortuous process but could arrive at the same conclusion. Union is very much in the interests of the political elite, senior corporate management, and mainstream economists. 

But whichever way Britain goes, the tragedy is that the nation is more divided than at any time perhaps since the 1920s. As an economist, I think Brexit is somewhat irrelevant. Norway has achieved economic success outside the EU. Germany and Denmark have achieved it within the Union. The issue is not the legal structure but the determination to build and execute a strategy for economic success in a world where international competition makes this more challenging than ever before. Britain’s great problem right now is lack of political leadership and the huge uncertainty caused by the interminable debate over Brexit. This uncertainty has depressed British GDP in the short term. Sadly, none of the major political parties are focused on Britain’s fundamental problem of reduced competitiveness and the need for an industrial strategy. 

For example, Britain’s most successful large industry today is automobiles. The country exports 75% of the 1.7 million vehicles it builds each year. Yet it still runs a deficit in the sector, of about 18 billion sterling. According to London think tank Civitas and the UK auto trade association, the British auto industry has the opportunity to produce domestically as much as 80% of the components that are now imported. So Brexit represents a huge opportunity for the British auto industry. Politicians and the media rarely talk about opportunities, only about risks. Defeatism and paralysis can be midwife to the disasters they fixate upon.

Britain needs more industries like its auto industry. It needs to aggressively pursue economic growth with an industrial strategy--I'm not talking about apple-pie plans for education and training, but targeted markets, targeted product sectors, targeted investment, with rewards for success and penalties for failure. This is more easily done outside the EU, although it could be done within the EU if necessary. Since the EU insists that the free movement of peoples is non-negotiable and British voters (at least those north of Watford) have recognized that the free movement of peoples is in large part a wage-reduction strategy and are implacably opposed, it is best done outside the EU. 

In Italy, where conditions in the Mezzogiorno (southern Italy) are being likened to the poverty and hopelessness widespread before World War II and even World War I, it is no longer impossible to imagine that country splitting in two. Britain (like the US) risks being torn apart by anger and increased polarization—political, regional, and income polarization. Smarter leadership and better economic policies are needed today more than ever.