Brexit and the Global Economic Outlook

In an era full of “unthinkable” events, the world is now confronted with what might become the largest change in the global economic order since the end of the Cold War. Stemming from a close and angry UK election, we all woke up last Friday morning to find that the world’s fifth-largest economy will be terminating its membership in the European Union, the world’s largest common market. Both short-term and long-term forces generated this momentous fracture, from the growing frustration of many who felt left behind by the economic order of an integrating world economy to related concerns about immigration that have been heightened by the recent European refugee crisis.

The implications of the dramatic turn in Europe are global in nature and diverse in impact. The MAPI Foundation will be considering the long-term issues for manufacturing. The purpose of this first blog post is to offer some thoughts about the impact of Brexit on the short-term global economic outlook.

The outlook depends, to a large extent, on two dynamics that are difficult to predict. First, will other significant ruptures appear in both the UK and the EU? Is the threat of a Scottish referendum for separation from the United Kingdom real? And will other EU members make noises about leaving the European Union? Second, how bad will financial market volatility get? As we have all learned in recent years, financial market dislocations have real economic consequences. Among other things, they impact capital investment expenditures in an already investment-averse world economy.

At the moment, a few things seem clear. To the extent that the British exit from the EU is viewed as a crisis with global dimensions, it will put upward pressure on the dollar. This will bring about a further weakening of U.S. manufacturing growth in what has already been a difficult year. Adding to manufacturing woes, there is certainly the possibility of recession, or at least pronounced economic weakness, in both the UK and the EU, with downstream impacts for the critical economies around the world that sell into these markets, including the U.S. and China. The recession risk stems primarily from an uncertainty-generated hit to business investment. Beyond investment, trade activity is likely to be dampened. Both because of sluggish world growth and emerging political dynamics, it hasn’t been a great climate for global trade. Now it’s much worse.

This is both a slow story and a fast one. It is going to take years to negotiate the terms of the UK departure, keeping growth-killing uncertainty very much alive. However, we need to keep our eye on the evolving events in the UK and the EU to see what might transpire in the next few weeks or months. The curtain has by no means fallen on this world-changing drama.

EuropeKristin Graybill