May 2017 Editor's Note: This post was originally published in November 2016 and has been updated for accuracy and comprehensiveness.
Guest Blogger: Dr. Danny Soques, Assistant Professor of Economics, Cameron School of Business
In June of 2016, the United Kingdom (UK) voted to leave the European Union (EU), move that gave rise to the term, “Brexit.” This successful referendum vote gave rise to fears about the future of the British economy and what it means for the US.
Both the Bank of England and the British Chambers of Commerce cut their projections of economic growth next year and further into the future. Investor confidence fell dramatically due to rising uncertainty regarding the relationship between the U.K. and the EU. In the global economic environment, American business leaders naturally wonder if these negative economic effects will spill over to the U.S.
Early signs from data and policymakers suggest only a modest effect from Brexit on the U.S. economy, at least in the short run. The U.S. unemployment rate is relatively low at 4.9 percent and economic growth shows no substantial signs of weakening.
In their July meeting, monetary policymakers at the Federal Reserve expressed concern about the domestic effects of a “slowdown in [foreign] economic growth” due to Brexit. However, this concern was alleviated by “expectations of greater policy accommodation” from the Bank of England, along with “positive US economic data releases.” It appears that the U.S. economy dodged the Brexit bullet in the near-term.
However, the long-run effects of Brexit are more uncertain. Most economists agree that increasing trade barriers and limiting international capital flows can decrease the long-run growth outlook of an economy by limiting its access to cheaper goods and more foreign investors. This reasoning is reflected by the downward revisions of expected growth from U.K. economists and policymakers.
The UK’s participation in the EU allowed their economy to benefit from the free movement of goods and services, as well as labor, across borders. Brexit could potentially remove this benefit, depending on the resolution reached by U.K. and EU policymakers in the coming years.
From a traditional economics perspective, the true danger to both the U.S. and the global economies comes from more countries following the path of nationalism paved by the U.K. The implementation of isolationist policies could undo the global trade network, which has made the world better off as a whole over the past 30 years and led to a sustained period of lackluster global growth.
One country pulling back from globalization will only have minor effects on the world economy, whereas a number of countries choosing to isolate themselves will multiply the downward effect on growth.
Of course, global economic integration comes with costs, including reduced economic sovereignty and, often times, concentrated transition costs. But countries can work to overcome these difficulties through effective regulatory policies and the frameworks set up in international trade agreements. In the academic community there is little argument that trade on the whole is good. The debate centers on how to smooth the transitions.
UPDATE: Since the initial publication of this post, significant strides have been made towards the UK’s exit from the EU. In March, the UK formally invoked Article 50, which outlines the plans for a country which wants to leave the currency union. Per the agreement, the UK has two years to negotiate and finalize its exit from the EU, implying a deadline of March 2019. In preparation for these negotiations with the EU, Theresa May – the UK’s new prime minister after David Cameron’s resignation– called for a snap election to signal the country’s solidarity towards Brexit.
The U.S. economy remains relatively insulated from the effects of Brexit and lagging growth in the EU. Proposed fiscal expansion, both in the form of tax cuts and increased infrastructure spending, has helped to lift growth expectations from businesses and consumers despite the prospect of heightened foreign trade barriers.
However, as the Brexit agreement is negotiated and becomes enacted, the US economy should see more disruptions from abroad and a potential fall in output growth. In the coming months, market participants should pay close attention to the negotiations and outcomes from the Brexit talks.