Yahoo Finance Grant Lewis: How Brexit could turn the UK economy Japanese
Theresa May, David Davis and their fellow Brexiteers probably aren’t great fans of early Eighties New Wave but if they were, they might have come across a bunch of one-hit wonders called The Vapors.
Their best-known song, Turning Japanese, was about teenage angst. But if I were in the Cabinet it would be at the top of my playlist over the next few months.
Japan offers us a warning that we’d be unwise to forget, 10 years on from the start of a crisis that could easily have plunged the rest of the world’s developed economies into Japan’s deflationary trap.
That it didn’t was thanks to good policymaking, in part thanks to those lessons from Japan’s malaise, which has lingered for more than two decades. Thus the great recession was prevented from becoming a great depression.
But the crisis has left scars. Though a slide into persistent deflation was avoided, it took more than five years for UK economic output to return to its pre-crisis level.
And the economy is not out of the woods. It is in the process of being hit by another negative shock, Brexit, which has the potential to cause greater damage than the financial crisis.
In fact, Brexit risks becoming what the late Nineties crisis in other Asian countries was to Japan: the second shock that tips the economy into deflation.
Certainly, some of the similarities with Japan are stark. Like their Japanese counterparts 20 years ago, UK policymakers believe they have little room for manoeuvre to respond to any new economic downturn.
The Bank of England already has rates at rock bottom, and the state of the Government’s finances make a fiscal boost politically impossible. And, although more money-printing is always possible, it’s not obvious it could do much to boost demand.
Meanwhile, the UK labour market has taken on a key characteristic of Japan’s, with real earnings growth over the past decade the weakest for 150 years, even as unemployment has fallen to multi-decade lows.
There’s a danger that as a Brexit slowdown drives unemployment higher, wage growth ratchets ever lower: it was ultimately falling wages that tipped Japan into deflation. Longer-term, Brexit risks turning the UK Japanese in other ways.
Though the economy has grown a little more than Japan’s since the crisis, GDP per capita has not.
This highlights the importance of the UK’s growing population in driving growth in recent years. The Government’s post-Brexit aim to reduce net immigration below 100,000 will cut population growth and, by definition, GDP growth.
Equally, a Brexit along the lines set out by the Prime Minister in her Lancaster House speech in January would represent the single most protectionist act by the UK since the war.
This, of course, will directly hit trade flows, not least in the services sector where the UK runs a large surplus. But it will also hit productivity growth, damped by a more closed economy.
Brexit will also seriously diminish the UK’s attractiveness as a destination for foreign investment: many firms choose to invest in the UK precisely because it provides frictionless trading with the rest of the EU.
Foreign-owned firms are more productive than domestically owned firms and invest more in R&D.
So, as firms shift EU investment away from the UK, that will reduce investment and provide a further brake on productivity, which has failed to grow since the crisis.
Even the differences with Japan aren’t exactly comforting. Japan has a large current-account surplus, supported by its world-leading manufacturers.
It is the world’s largest creditor, which means that, unlike the UK, it is not “reliant on the kindness of strangers”. Its huge debt pile, moreover, is easily financed by domestic savings.
The UK could not do the same if the Japanification of its economy decimates the fiscal outlook.
The UK previously heeded the lessons from the mistakes Japan made in the Nineties. But the tragedy is that the entirely self-inflicted damage that Brexit will cause could well push us over the edge.
Could we turn Japanese? With apologies to The Vapors, “I really think so”.
Grant Lewis is head of research at Daiwa Capital Markets Europe. The views expressed are the author’s own.
