A Blog by Jonathan Low


Oct 22, 2018

Deglobalization's Costs Are Becoming Visible

By the numbers. And before the actual impositions of tariffs and barriers. JL

Greg Ip reports in the Wall Street Journal:

Without a single tariff going up, Brexit has extracted a price. Comparing Britain to a basket of peer economies whose performance tracked Britain’s until it voted to leave the EU in June 2016, actual British output is now 2.1% below this counterfactual. Household consumption is now 1.7% below, and investment is 4% lower. Adjusted for inflation, British wages are down 1.4% since June 2016. The pound has fallen 10% because of Brexit. A 2%-plus hit to standard of living is not a rounding error. It should remind everyone that turning back globalization comes with a price.
For outsiders, Brexit has the feel of a long-running soap opera: a mash-up of plot twists and tragic characters loaded with entertainment value but not much significance if you’re not British.
That complacency is a mistake. Never in the last 70 years has a major advanced economy left a free-trade area. Brexit is providing the first real-world evidence of the costs that come from undoing the intricate bonds of globalization.
It is of course an extreme case of deglobalization: The European Union’s single market for goods, services, capital and labor is much more integrated than other free trade zones. Yet many of the barriers that are bound to rise between Britain and its partners, such as on regulations, trade penalties and immigration, are similar to those cropping up in the wider world, such as between the U.S. and its partners.
Measuring the effect of Brexit is complicated by the fact it hasn’t happened yet. British and European leaders met Wednesday in an effort to bridge differences on a post-Brexit deal. Without a deal, Britain could see tariff and nontariff barriers snap back to the maximum the World Trade Organization permits.
Yet without a single tariff going up, Brexit has clearly extracted a price. This can be seen by comparing Britain to a basket of peer economies whose performance closely tracked Britain’s until it voted to leave the EU in June 2016. Pierre Lafourcade, Arend Kapteyn and John Wraith of UBS construct such a synthetic Britain from a blend of other members of the Organization for Economic Cooperation and Development.
Actual and synthetic Britain track each other closely from 1995 to mid-2016, then diverge: Actual British output is now 2.1% below this counterfactual. UBS attributes this divergence primarily to household consumption, which is now 1.7% below its counterfactual, and investment, which is 4% lower.
While UBS’s methodology isn’t foolproof, comparable exercises by others have reached similar conclusions, as has the Bank of England.
A key driver of the divergence is the plunge in the British pound after the referendum, which sharply raised inflation. Adjusted for inflation, British wages are down 1.4% since June 2016, undercutting purchasing power. (In the U.S., where unemployment has behaved similarly to Britain, real wages are up 1.2%.)
Why did the pound fall? Because tariffs and nontariff barriers will create new costs that British exporters must absorb, and currencies adjust to compensate for such costs. UBS estimates the pound has fallen about 10% because of Brexit. Coincidentally, that’s about enough to offset the 10% tariff the EU imposes on autos, which may be why no auto manufacturer is yet contemplating leaving Britain. The losers are British consumers whose standard of living has gone down because of inflation.
Britain leaves the EU without some kind of deal, Oxford Economics estimates its output would suffer an additional 2% hit. Nontariff barriers actually account for more than half the costs, it estimates.
Pharmaceuticals illustrate why. Once licensed for sale in the EU, a British-made drug would still require separate testing and certification for each batch. Clinical trials would be disrupted as testing material takes additional weeks to clear customs and reach patients. Slower deliveries may leave some medicines with too little remaining shelf life for wholesalers. These barriers lengthen delivery times and increase inventories throughout the supply chain. GlaxoSmithKline PLC expects added costs of £70 million a year initially, and £50 million a year thereafter.
There are other, unquantifiable costs: Britain won’t enjoy the lower tariffs the EU negotiates in new free trade agreements. Fewer immigrants from the EU may make it harder to fill key jobs and undercut housing demand.
One lesson of Brexit is that smaller countries suffer more from deglobalization than large; the EU has yet to show much effect from Brexit. That’s to be expected since smaller countries gain more from free trade as their firms and consumers access vastly expanded markets. A study by the Bank for International Settlements concluded Mexico and Canada would each suffer a 2% hit to output from an end to Nafta, versus 0.2% for the U.S.
Yet this doesn’t mean deglobalization is costless for big players like the EU. The fact that Britain’s trade deficit has actually narrowed since the referendum shows that in a narrow arithmetic sense it’s contributing less to its trading partners’ output. To be sure, the pain is spread out over a larger economy; but someone still bears it.
Similarly, the BIS study found that in absolute dollars, the U.S. would lose more from the demise of Nafta than Canada or Mexico. Small countries like Vietnam and Malaysia are worse off because the U.S. is not in the Trans Pacific Partnership, but the U.S. also loses without the preferential access to those markets that Canada and Japan will enjoy.
A reversal of globalization is not a catastrophe. Life in Britain was not nasty, brutish or short before it joined the EU, and predictions of panic and recession now look silly. There will also be benefits: Some production will move to the U.K. to avoid British tariffs, and the British will have more control over immigration and their laws. But a 2%-plus hit to their standard of living is not a rounding error. It should remind everyone that turning back globalization comes with a price.


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