E. J. Ourso Faculty Weigh in on 'Brexit'

Chanda and Mason

Areendam Chanda and Joseph Mason

June 24, 2016

BATON ROUGE – LSU Department of Economics Associate Professor Areendam Chanda and Department of Finance Professor Joseph Mason each contributed their expert insight on today’s vote by Britain to exit the European Union.

Chanda: While the outcome of the vote itself has taken everyone by surprise, the absence of a rulebook on how to exit, adds to the current period of uncertainty. Rather than engage in predictions, it is more important to understand the underlying causes that led to this since there are lessons to be learned for all of those involved in policy making, even in Louisiana.

First, as in the United States, the rapidly changing nature of technology and industry has left a large fraction of the population with unmarketable skills. The United Kingdom has experienced similar increases in income inequality and has the highest value in the EU. These workers are also typically older and understandably found it difficult to adjust to changing conditions. In fact, despite the anti-immigration rhetoric surrounding the “Brexit” debate, the regions that voted to exit are not the areas that experienced the largest immigration from poorer EU nations but instead, were ones where manufacturing had declined.

At the same time, the EU came to increasingly be viewed as an institution that made rules which seemed to undermine national sovereignty. This toxic combination, rightly or wrongly, seems to have driven the results.

Secondly, the vote highlights a city (London) versus hinterland divide. Cities remain centers of dynamism, progress and economic growth. Encouraging urban agglomerations with diversified industries and what economists call “thick” (i.e., vibrant) labor markets remains vital to growth.

Finally, thinking about business relationships between Louisiana and the UK, it’s not clear that there will be any detrimental short-term effects for us. Louisiana’s largest export destinations in Europe are France and the Netherlands and not the UK. However, some of the European companies with the largest employers in Louisiana are based out of Scotland. It will be interesting to see how things develop given that they overwhelmingly voted to remain in the EU.

Mason: While the immediate effects of “Brexit” will be general market disruptions worldwide, social unrest left over from the credit crisis is at its heart.

It is important to remember that despite the “Brexit” leave vote, the next steps are crucially uncertain. Before anything is to occur at all, Britain must either declare to the EU that it is leaving – in which case all treaties, etc., no longer apply to Britain – or wait for a two-year period to elapse at which time such conditions are automatically imposed. It is unclear how the government will choose to proceed and – if the two-year track is taken – when the expected economic impacts (delayed investment, decreased trade and decreased activity in London’s financial sector) will arise.

In the meantime, uncertainty will cloud Britain’s future, as well as the value of investments in British industries. Markets price risk but hate uncertainty. That is why the S&P 500 is already down considerably and the pound is at a 30-year low against the dollar this morning. While some firms may have hedged the currency risk on markets like the Nasdaq PHLX, we can expect big losses on the flip side of those bets to be taken today on margin accounts.

In sum, however, the leave vote is really just a social manifestation of the drawn-out macroeconomic impacts of the credit crisis. Governments failed to enact stimulative fiscal policy over the past seven years, hoping against hope that central banks would come to the rescue. But monetary economists worldwide know that monetary policy cannot stimulate real growth – they can only stimulate nominal growth via inflation, which hasn’t worked well in recent years. Thus, citizens worldwide are right to expect more from their governments. Let’s hope those governments deliver without further need for secession of – and in – other countries.

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Angela McBride
LSU E. J. Ourso College of Business
225-578-7833