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How Brexit will constrain a future Labour government

Summary:
Those who suggestthat Brexit is of second order importance to getting a Labour government need to think about what that government will be able to do and how long it will survive if we leave the Single Market and customs union. The OBR did a rough and ready estimate of the near term impactof Brexit [1], and concluded that productivity growth would fall (which means lower GDP and real wage growth) and the government deficit would deteriorate by around £15 billion by 2020. That sum is about a third of the current defence budget, or a tenth of the entire health care budget. It is simply wrong to imply that this can be ignored, because Labour is anti-austerity. That large deterioration in the deficit due to Brexit is mainly the result of low productivity and less immigration, not the

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Those who suggestthat Brexit is of second order importance to getting a Labour government need to think about what that government will be able to do and how long it will survive if we leave the Single Market and customs union. The OBR did a rough and ready estimate of the near term impactof Brexit [1], and concluded that productivity growth would fall (which means lower GDP and real wage growth) and the government deficit would deteriorate by around £15 billion by 2020. That sum is about a third of the current defence budget, or a tenth of the entire health care budget.

It is simply wrong to imply that this can be ignored, because Labour is anti-austerity. That large deterioration in the deficit due to Brexit is mainly the result of low productivity and less immigration, not the consequence of an economic downturn. It cannot be undone by the government spending more on infrastructure: public investment is not some magic instrument that can get you any GDP you want.

No economic theory that I know of suggests you can safely ignore the public finances outside of a recession. In a world where monetary policy regulates demand (absent the lower bound) then a build up in government debt risks crowding out private capital, discouraging labour supply (because higher debt has to be serviced through higher taxes) and redistributing income between generations. This is why Labour’s fiscal credibility rule aims to balance current public spending outside of a recession. Every £billion lost to Brexit is a £billion that cannot be spent on public services, or has to be raised in taxes.

The same logic meant that Labour’s election manifesto in 2017 had a large increase in current public spending entirely financed by higher taxes. Their programme is anti-austerity because their fiscal credibility rule would do the opposite of what Osborne did in 2010 if interest rates were at their lower bound. It also sensibly allows public investment to rise when borrowing costs are so low.  But once interest rates begin to rise, the Labour government would have a current deficit it needed to finance, and its difficulty in doing this would be made much worse by Brexit. [2]

In all this it is vital to not be distracted by some of those who see Brexit as an opportunity for Corbyn-bashing. Those that do so seem to forget two key points. First, the attitude of a large number of Labour MPs in Leave voting areas is just as much of a problem as the views of the leadership. Second, there is a purely political argumentfor Labour being just a bit less supportive of Brexit than the government right now. My own view is similar to this discussionby Mike Galsworthy.

However I feel I have to end by responding to a second postfrom Owen Jones. Let me do so by imagining the following scenario. Suppose the Conservative leadership changed, and the new leader said this on being elected: “we tried as hard as we could to respect the result of the referendum, but we found there was no way of doing so without causing the economy great harm. As a result, I have regrettably decided to revoke Article 50, and remain in the EU.” What should Labour’s response to that be? The logic of Owen’s position is that Labour should oppose this, and side with the Hard Brexit faction of the Tories and defeat the new Tory leader.

A highly unlikely scenario I agree, but it helps establish this point. Owen, unlike many Corbyn supporters, is not arguing that Labour should remain pro-Brexit while in opposition as simply a strategic move to gain votes. He is saying that Labour has to support leaving the EU because of the referendum demands it. Indeed he says anyone arguing otherwise because the referendum was advisory is “beyond delusional”: It seems I have become a beyond delusional ‘Hard Remainer’.

Does democracy mean being bound by a referendum that was called only to appease the hard right, decided by lies using a rigged electorate, and apparently made mandatory as a result of the words of a now departed Prime Minister? Is it a democracy when we are unable to change course because new facts clearly deviate from promises made, resulting in a decision that imposes costs on the young largely as the result of votes by the old? These are difficult questions, but not delusional questions.

I doubt it will happen, but would ignoring the referendum destabilise democracy? Let me turn the question around. If the final Brexit deal involves staying in the Single Market and therefore accepting free movement, will that destabilise democracy? The number of people who voted Brexit but wanted to stay in the Single Market may be more than 2% of the population, but it is bound to be small. There will therefore be plenty of people who will say that accepting free movement ignores the referendum, and plenty of aggrieved voters to back them up. Is that going to produce a reaction which is very different from the reaction to actually ignoring the referendum?

The hard truth is that any deal which avoids serious economic costs for the UK is going to make most of the 52% pissed off. And they will remain pissed off until either we reduce immigration, with the economic costs that will bring (less schools, less hospitals, higher taxes), or senior politicians start being honest about the benefits of immigration.


[1] Stupidly, the OBR were not asked to estimate the impact of Brexit before the referendum, and their mandate prevented them from doing so themselves.

[2] And please no MMT inspired comments about how taxes are not needed to finance spending. The MMT world is very different from our current world: fiscal policy rather than monetary policy regulates demand. In that case you never worry about the deficit, but spending is constrained by inflation.  
Simon Wren-lewis
Professor of Economic Policy at the Blavatnik School of Government, Oxford University, and a fellow of Merton College. This blog is written for both economists and non-economists.

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