Had Britain’s leaders rushed to dismantle long-standing trading systems and other arrangements with the EU before developing a credible alternative, the situation could have been much more volatile.
The aftermath of the United Kingdom’s unexpected vote in June to leave the European Union is being monitored closely. People all over the world—and particularly in Europe—want to know how Brexit will unfold, not just to manage its specific effects, but also to gain insight into what is likely to happen if other upcoming votes tip in favour of nationalist agendas.
Those agendas are certainly making a political comeback. In Germany, which will hold a general election in 2017, support for the far-right Alternative for Germany (AfD) is on the rise, exemplified in the party’s strong showing in recent state elections. In France, the National Front’s leader, Marine Le Pen, hopes to ride nationalism to power in next year’s presidential election.
The trend is not exclusive to Europe. In the United States, Republican presidential candidate Donald Trump has promised to impose trade tariffs on China, build a wall on the border with Mexico, and bar Muslims from entering the country.
So, what economic consequences would a vote for nationalism have? Judging by the Brexit referendum, the immediate effects could include financial-market turmoil and a shock to consumer and investor confidence. But this could give way rather quickly to an economic and financial calm. The real question is what comes next.
To be sure, the calm that has set in in Britain is tenuous. Pre-referendum predictions that a vote for Brexit would lead to substantial economic pain and financial volatility remain likely to materialise. The severity of the effects will depend on how the UK and its European partners negotiate their tricky separation, particularly the extent to which free trade and financial passporting are upheld.
But, for now, volatility remains contained. That can be attributed partly to prime minister Theresa May’s new government, which has purposely adopted a gradual approach to the Brexit process. May has also made it clear that she and her Cabinet members are not in the business of providing regular progress reports.
The Bank of England has also helped, by injecting liquidity into the economy almost immediately. Moreover, the BoE has convincingly reassured market participants that it is committed to maintaining financial stability and avoiding the disorder that malfunctioning markets can cause.
The BoE’s vigilance, together with the fact that economic and financial arrangements with Europe have yet to be altered, has convinced companies and households to postpone plans to change their behaviour. They are now waiting to see whether the UK negotiates a “soft” or “hard” Brexit before they make any significant moves.
Britain’s ability to restore a sense of calm amid far-reaching uncertainty about its economic and financial future shows how, with the right approach, political actors can manage shocks and surprises. Had Britain’s leaders rushed to dismantle long-standing trading systems and other economic and financial arrangements with the EU, before developing a credible and comprehensive alternative, the situation could be much more volatile. Others aspiring to advance similarly inward-looking agendas—be they nationalistic European parties seeking to roll back international connectivity or US presidential candidates proposing tariffs that could well trigger retaliation from trading partners—should take note.
Of course, under the current circumstances, there are limits to the beneficial effects of sound UK leadership. When the details of Britain’s divorce from the EU are eventually announced, companies and households will respond, particularly if the country’s trading, economic, and financial linkages with the EU change considerably. That response, it seems almost inevitable, will hurt economic growth and spur financial volatility.
But here, too, a measured and cautious approach can help. The UK government should do its utmost to conduct the most sensitive parts of the negotiations with its European partners in secret. When it is time to announce changes, it should do so in the context of a larger programme of credible domestic reforms that target strong, inclusive growth and improved financial stability.
It is not easy to keep an airplane flying smoothly while changing the engines. And that is precisely the challenge the May government faces. It is now preparing for this ultra-delicate manoeuvre by identifying and arranging the components of the new engine, and planning for their quick assembly; only then will it be able to dismantle the engine of European trade without risking heavy turbulence, or even a painful crash.
But even with a carefully sequenced plan in place, May’s government will need to show a level of resilience and agility far beyond what has been required of its predecessors, in order to manage the transition without veering off the path of growth and stability. The same would be true for any other nationalist political figure or party that came to power. The question is whether any of them would be equal to such a complex challenge.
El-Erian, chief economic adviser at Allianz, is chairman of US president Barack Obama’s Global Development Council and author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse