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October 31, 2016

Brexit and the American election

Opinion image

The divorce of the UK from the EU, after over 40 years of “marriage,” is crucially important for the entire European continent. Some politicians seem to believe that the multilateral (EU-wide) agreement on free trade and free mobility of labor under the EU can easily be replaced by a series of bilateral agreements, so that Brexit won’t matter. But obtaining individual agreements with other EU members will be a very difficult and time-consuming task. At least temporarily, Brexit will induce some cut in trade in the UK and Europe and a drop in demand.

This effect will spill over onto the world economy; but what is important as we face November 8 is how it will be modified by the outcome of the American presidential election. Mr Trump has said that he will abrogate (actually, probably attempt to abrogate) treaties like NAFTA and other agreements that have facilitated international trade. The Brexit-induced reductions in worldwide demand would, if we take Trump at face value, be magnified by further reductions generated by his trade policies. The makings of a deep worldwide recession could thus come together. Secretary Clinton is not proposing to scrap any trade agreements; but her backpedaling on the Transpacific Partnership is disturbing, since TPP is a step forward in growing worldwide demand.

What do these considerations have to do with labor markets? Everything! Reductions in trade reduce labor demand, initially leading to cuts in employment and eventually, as markets adjust, to cuts in wages and hence living standards. A Brexit-initiated, Trump-enhanced rise in effective trade barriers will, by cutting product demand, cut labor demand. We saw this in the early 1930s; and one would have hoped people do not wish to repeat even a milder version of that debacle if we know how to avoid it, as we do.

But perhaps Brexit will never happen. Perhaps Britons, seeing their currency having fallen by 20% against the dollar and euro since June 23; seeing that drop beginning to generate substantial increases in prices of consumer goods; and finding their holidays in Europe to be more expensive, will demand politicians hold off on Brexit. Perhaps too, Americans will realize that the populist anti-trade message that Trump pushes (and, to be fair that Bernie Sanders also pushed) will hurt precisely those lower- to middle-income workers who apparently find it so appealing.

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