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How bad will Brexit get? Here's what top economists are saying.

In the months leading up to Britain’s referendum on whether to leave the European Union, many economists warned over and over again that a "Brexit" could have awful ripple effects: Britain could lose its favorable access to European markets if it left; uncertainty could dry up business investment; the country could tumble into recession.

On June 23, British voters decided to vote "Leave" anyway. And now they’re left to grapple with the consequences — including any economic turmoil that may follow.

So how bad would severing ties with the EU be? On the day after the vote, markets plunged sharply around the world, suggesting serious economic risks were on the horizon. But economists have differing views on just what Brexit would mean — and exactly how dire it could get. Here’s a running roundup from around the web.

John Van Reenen: "There will be an immediate slowdown of growth"

At the moment, there's still a ton of confusion as Britain's government decides whether and how to actually exit the European Union. And that uncertainty alone could lead to economic turmoil.

Here's John Van Reenen, director of the Centre for Economic Performance at the London School of Economics: "You get a rabbit-in-the-headlights phenomenon where businesses don't want to make new decisions, or new investments, because they are uncertain about the future. The immediate effect will be a lowering of investment activity, a lowering of hiring. There will an immediate slowdown of growth."

Prior to the referendum, the center put out a research brief explaining why the British economy would suffer if it actually did leave the EU. Among other things, 48 percent of all UK exports go to the rest of Europe, and the country has long benefited from the lower tariffs and favorable market access that comes with EU membership.

If Britain left, those trade flows could shrivel considerably — though there would be a two-year window in which the country will maintain unfettered market access as it negotiated an exit. The report notes that UK incomes could fall between 1.1 percent and 3.1 percent as a result. In the longer term, the slowdown in productivity growth and new restrictions on immigration could hurt Britain’s growth prospects even further, though that’s harder to quantify.

Paul Krugman: "Yes, Brexit will make Britain poorer. But..."

Paul Krugman of the New York Times argues that leaving the EU would hurt Britain's economy...

Yes, Brexit will make Britain poorer. It’s hard to put a number on the trade effects of leaving the EU, but it will be substantial. True, normal WTO tariffs (the tariffs members of the World Trade Organization, like Britain, the US, and the EU levy on each others’ exports) are low and other traditional restraints on trade relatively mild. But everything we’ve seen in both Europe and North America suggests that the assurance of market access has a big effect in encouraging long-term investments aimed at selling across borders; revoking that assurance will, over time, erode trade even if there isn’t any kind of trade war. And Britain will become less productive as a result.

But he’s also skeptical that Brexit would lead to a broader financial crisis the way, say, the implosion of Lehman Brothers in 2008 did:

But right now all the talk is about financial repercussions – plunging markets, recession in Britain and maybe around the world, and so on. I still don’t see it.

It’s true that the pound has fallen by a lot compared with normal daily fluctuations. But for those of us who cut our teeth on emerging-market crises, the fall isn’t that big – in fact, it’s not that big compared with British historical episodes. The pound fell by a third during the 70s crisis; it fell by a quarter during Britain’s exit from the Exchange Rate Mechanism in 1992; it’s down about 8 percent as I write this. ....

Furthermore, Britain is a nation that borrows in its own currency, not subject to a classic balance-sheet crisis due to currency devaluation – that is, it’s not like Argentina, where the fall in the peso wreaked havoc with firms and consumers who had borrowed in dollars. If you were worried that fears about Brexit would cause capital flight and drive up interest rates, well, no sign of that – if anything the opposite.

ING Bank: "Quantifying the impact from a possible Brexit is anything but easy."

Before the vote, analysts at the Dutch bank ING tried to run numbers on the consequences of Britain leaving. One thing that makes this so maddeningly difficult is that there's no real historical precedent:

Quantifying the impact from a possible Brexit is anything but easy. As so often in these unprecedented big bang events, headline estimates of a quantified economic impact on the Eurozone and individual countries should be taken with a pinch of salt. ... Nevertheless, such estimates give at least some idea of the possible magnitude. To give an example, a study by the German Bertelsmann Foundation, relying on Ifo estimates, shows that a Brexit could lower Eurozone GDP growth by between 0.01 and 0.03 percentage points each year.

ING also dug into some of the details, noting that European financial firms with offices in London could leave and relocate to the continent. (The financial sector is about 8 percent of Britain's GDP, so that could make a considerable dent.)

It is undisputable that Britain plays an important role in the EU. Whether it is the share in total population, total GDP or FDI, Britain ranks in the top three countries and a Brexit would be a big loss. Obviously, the trade channel is the most direct channel through which a Brexit would hit the rest of the European Union. Looking at bilateral trade, Ireland and the Netherlands, followed by Belgium seem to be the most exposed Eurozone countries to a Brexit ...

While not every sector is as vulnerable to a British demand shock, manufacturing in general and air transport would definitely take a hit.

Moreover, a Brexit could actually reroute investments to continental Europe, either through repatriations or new investments from non-EU countries which took the UK as an entrance point to the European Single Market.

Last summer, it was reported that Deutsche Bank had set up a working group, investigating whether London business should be returned to Frankfurt in case of a Brexit. Other international banks also mentioned contemplating moving a part of their business from London to the continent (with Luxemburg often cited) in the case of Brexit. These considerations are unlikely to remain limited to the financial sector, especially if post-Brexit free trade negotiations would announce themselves rather difficult.

Larry Summers: "The effects on the rest of the world will depend heavily on psychology"

Larry Summers, former director of the US National Economic Council, argues that it may take awhile to understand the full economic impacts; the biggest question is what happens if other countries in the European Union also decide to leave:

For Britain, the economic effects are two sided. On the one hand, a major jolt has been delivered to confidence, to future unity and down the road to trade. On the other, the currency has become more competitive, and liquidity will be in very ample supply. I would expect that a significant deterioration in growth and a recession beginning in the next 12 months has to be a substantial risk though short of an odds on bet.

As suggested by the fact that stock markets in Italy and Spain are down almost twice as much as in the UK, the prospects for Europe may in some ways be worse than for the UK. There is the real risk of "populist exit contagion" in a number of countries. A credit crunch is a serious risk. Unlike in Britain, the trade weighted exchange rate is unlikely to decline very much. The central bank has less room for incremental policy measures. ... The effects on the rest of the world will depend heavily on psychology.

Brexit will rightly be taken as a signal that the political support for global integration is at best waning and at worst collapsing. Dramatic exchange rate fluctuations tend to portend upswings in protectionist pressure. And problems in European banks could as in 2009 lead to a drying up of trade finance. Already global trade has lagged global growth in recent years. A clear sense of commitment to avoid backsliding towards protection from the G20 will be essential going forward. Specific efforts with respect to trade finance may be appropriate.

Scott Sumner: "The ultimate effect depends ENTIRELY on how the central banks react"

Scott Sumner, the director of the Program on Monetary Policy at the Mercatus Center at George Mason University, points to monetary policy as the key question:

At this point (midnight) the global economy has been hit by a negative monetary shock, one of the biggest in years. ....

I’d emphasize that this is an almost purely a monetary shock—in real terms it makes little difference whether the UK is in or out of the EU (especially in places like the US and Japan). It’s monetary. That means the ultimate effect depends ENTIRELY on how the central banks react. Do they show imagination and leadership, or . . . do they keep acting the way they’ve been acting since 2007. We won’t have to wait long for an answer. (Obviously the markets believe that the central banks will not rise to the occasion.)

The odds of a global recession in 2017 just increased, by at least a few percentage points (albeit still less than 50-50). I think this also makes it slightly more likely that Trump will win, although he’s clearly still the underdog.

Capital Economics: "Brexit is not a disaster for the world economy"

It's worth adding that some analysts are more sanguine. On Friday, the British research consultancy Capital Economics circulated a note with this headline: "'Brexit’ is not a disaster for the world economy."

Before the vote, Capital Economics produced a paper that was somewhat less dire than other economic analyses out there. Their broad takeaway is that there would be a lot of turmoil for Britain in an exit, but the country would ultimately adjust. Some highlights:

It is highly probable that a favourable trade agreement would be reached after Brexit as there are advantages for both sides in continuing a close commercial arrangement. But the worst-case scenario, in which Britain faces tariffs under ‘most-favoured nation’ rules, is certainly no disaster. Exporters would face some additional costs, such as complying with the European Union’s rules of origin, if they were outside the single market. However, these factors would be an inconvenience rather than a major barrier to trade. ...

Financial services have more to lose immediately after a European Union exit than most other sectors of the economy. Even in the best case, in which passporting rights were preserved, the United Kingdom would still lose influence over the single market’s rules. The City would probably be hurt in the short term, but it would not spell disaster. The City’s competitive advantage is founded on more than just unfettered access to the single market. A European Union exit would enable the United Kingdom to broker trade deals with emerging markets that could pay dividends for the financial services sector in the long run.

Concerns about a drying up of foreign direct investment if Britain votes to leave the European Union are somewhat overblown. Access to the single market is not the only reason that firms invest in Britain. Other advantages to investing here should ensure that foreign firms continue to want a foothold in the country. It is likely Britain would remain a haven for foreign direct investment flows even if it was outside of the European Union. Of course, we could see a period of weak foreign direct investment inflows as the United Kingdom’s new relationship is renegotiated. However, if Britain is able to obtain favourable terms, then foreign direct investment would probably recoup this lost ground.

There are a whole lot of "if"s in that paper, but that's one of the more optimistic assessments around.

Further reading:

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