There was one post yesterday, “The Macroeconomics of Brexit: Motivated Reasoning?”:
I’m still on vacation, but had some time to catch up today, and felt an urge to scratch an itch I’ve been feeling. You see, much of the discussion of Brexit and its impacts bothers me. I believe that Brexit is a tragic development, which will do substantial long-run economic harm. But what we’re hearing overwhelmingly from economists is the claim that it will also have severe short-run adverse impacts. And that claim seems dubious.
Or maybe more to the point, it’s a claim that doesn’t follow in any clear way from standard macroeconomics – but it’s being presented as if it does. And I worry that what we’re seeing is a case of motivated reasoning, which could end up damaging economists’ credibility.
OK, let’s start at the beginning. Brexit will almost certainly have an adverse effect on British trade; even if the UK ends up with a Norway-type agreement with the EU, the loss of guaranteed access to the EU market will affect firms’ decisions about investments, and inhibit trade flows.
This reduction in trade relative to what would otherwise happen will, in turn, make the British economy less productive and poorer than it would otherwise have been. It takes fairly heroic assumptions to make this into a specific number, but 2-3 percent lower income in perpetuity seems plausible.
So far, so good, or rather so bad: this is standard economics, basically Ricardo with a dash of new trade theory.
But what about warnings that Brexit will precipitate a British recession, or at least a drastic slowdown in the short run? Where are those coming from?
The trade arguments are about the economy’s supply side: less trade means lower productivity and hence lower productive capacity. But the kind of recession we’re talking about here is a demand-side phenomenon – a slump brought on by inadequate spending. And why, exactly, is that supposed to happen?
As best I can tell, the case for a UK recession or at least slowdown rests on two not entirely distinct propositions: the idea that uncertainty will deter investment and possibly consumption, and the idea that an increase in perceived risks will worsen financial conditions. Let’s take these on in turn.
On the first: Brexit certainly does increase uncertainty – but is this necessarily bad for investment? That’s not at all clear from the theoretical literature: firms might actually invest more in the face of uncertainty, in effect to cover their bases. So why is the proposition that uncertainty will deter investment so readily accepted in this case? In part, I suspect that it’s a kind of word game. When business people talk about “increased uncertainty,” they generally aren’t talking about mean-preserving spreads – they’re talking about an increased probability that bad things will happen. And maybe that’s what people writing about increased uncertainty in the wake of Brexit mean, too.
But in that case we’re saying that bad things will happen because firms will perceive an increased probability of bad things happening. That’s either circular reasoning, assuming one’s conclusion, or both.
I’d also note that any major policy change creates uncertainty, because nobody knows how it will work out. So why don’t we hear recession warnings when countries are contemplating major trade liberalization, or privatization schemes, or labor market reforms? The “uncertainty depresses investment” argument seems to be rolled out selectively, only deployed against policies economists dislike for other reasons.
Meanwhile, what about the argument that Brexit will worsen financial conditions, increasing risk spreads? Well, this seems to me to be another circular argument – it’s claiming that bad things will happen because investors will expect bad things to happen.
In other words, the arguments for big short-run damage from Brexit look quite weak. An economist who tried to make similar arguments for or against most policies would face a lot of criticism. But in this case we have a near-consensus accepting these weak arguments. Why?
Well, there is a historical tendency on the part of economists to loosen their intellectual standards whenever trade issues come up – a sort of sense that sloppy thinking in the defense of free trade is no vice. Claims that Smoot-Hawley caused the Great Depression have been pretty thoroughly refuted, but keep being made. Claims that trade liberalization is a great job creator are similarly widespread even though they aren’t grounded in any standard model. As I’ve written before, some attacks on Trumponomics – which is really terrible – nonetheless cut intellectual corners, making strange new assumptions on the fly (e.g., tariffs will reduce spending on imports, but none of that spending will be diverted to domestic production.)
My suspicion is that the same thing is happening here. Economists have very good reasons to believe that Brexit will do bad things in the long run, but are strongly tempted to sex up their arguments by making very dubious claims about the short run. And the fact that so many respectable people are making these dubious claims makes them seem well-reasoned when they aren’t.
Unfortunately, that sort of thing, aside from being inherently a bad practice, can all too easily backfire. Indeed, the rebound in British stocks, which are now above pre-Brexit levels, is already causing some backlash against conventional economists and their Chicken Little warnings.
Sorry, people, sloppy thinking is always a vice, no matter what cause it’s used for.