28 January 2016

Financial Times: Chinese turmoil teaches three basic truths about Brexit

China’s economic troubles can teach Britain three basic truths about holding a referendum on EU membership in 2016.

The first and most obvious is that no one should underestimate the difficulty of economic transitions. China needs to shift its economic focus from industry to services, from investment to consumption and from exports to domestic sales. The world wants Beijing to succeed but no one is certain it will. Compounded by poor policy communication, consumption has barely risen as a share of gross domestic product, from 49 per cent to 52.5 per cent over the past five years.

A vote for Brexit would likewise unleash powerful transitions in Britain’s economy. The UK would need to secure access to the single European market, renegotiate EU trade deals with 60 other countries, rewrite thousands of EU regulations into UK law and come to a deal on EU citizens living in Britain and Brits abroad. None of these transitions would be easy; all have uncertain outcomes.

The second lesson from China and the current turmoil is that when uncertainty over the outcome is high, money is but a fair-weather friend. About $700bn escaped from China in 2015, putting downward pressure on the renminbi and threatening to undermine Beijing’s efforts to shift demand from exports to domestic consumption. The exodus has overcome China’s capital controls and a current account surplus, guaranteeing an underlying flow of cash in the opposite direction.

In contrast, as Mark Carney, Bank of England governor, put it this week, Britain already relies on “the kindness of strangers” to finance its current account deficit, equivalent to 4 per cent of GDP. No one should assume that large quantities of foreign money in London, Manchester or Glasgow would stay in a transition to Brexit. British citizens holding liquid domestic assets would also be wise to consider greater foreign diversification as an insurance policy.

For a nation with a need to finance a large overseas deficit and without capital controls, a run on sterling is a serious risk. I am not talking about a welcome depreciation, such as the 6 per cent decline in sterling since November. Instead, the danger is a currency plunge on the back of an increase in perceived risk of holding British assets. The result would require government, banks, households and companies to pay more to persuade others to lend to them.

With these two big risks to the health of the UK economy in 2016, the third lesson from China is that sensible policymakers gamble on these economic transitions only if there is little alternative.

China faces such a constraint. Its economy is so large that foreign demand is insufficient for sustained export-led growth; officials know that building ghost cities and roads to nowhere ends in tears; and its peoples’ desire for better health, education and environmental services must be satisfied as the nation grows richer. Transition is essential.

Britain is different. Its economy could usefully avoid big upheavals. At close to full employment, the goals should be stability, higher productivity and greater prosperity for all. Leaving the EU is less an economic necessity and more a peculiarly British indulgence.

© Financial Times