It's time to pay the piper.
After months when economic data seemed to indicate that the British economy would shrug off its separation from the European Union, Prime Minister Theresa May announced a March goal for beginning negotiations over the terms divorce. Furthermore, she indicated that the British control of immigration to the U.K. take precedent over favorable access to the European market, news that sent the pound falling to a thirty-year low on Tuesday.
The FTSE 100 actually rose on the news, as Fortune's Geoffrey Smith reported today, but that's due to overrepresentation in the index of natural resource companies and manufacturers that earn much of their revenue overseas, and thus benefit from a weaker pound. It's also ironic, because the investing pros who benefit most from the short-term market bump may well have helped pave the way for the victory of the "Leave" forces in this summer's Brexit vote.
There is little reason to expect that the weakening pound will actually be good for the British economy over all. For one, the collapse of the pound will reduce the Bank of England's ability to keep its foot on the monetary pedal. Due to the weak sterling, higher import prices will mean "inflation is likely to rise materially over the coming months," according to John Wraith, head of U.K. rates strategy at UBS. That could prevent the Bank of England from lowering interest rates in the face of slower growth.
Meanwhile, the British economy is less favorably positioned to benefit from a cheaper pound sterling than other countries might be if their currencies fell. "Britain relies heavily on exports of financial services, which are not especially price-sensitive, and...the scope for growth of merchandise exports is limited by the subdued global demand," University of California at Berkeley economist and currency expert Barry Eichengreen writes. While Britain's trade deficit has shrunk some over the past year, it still sits at a whopping 5.9% of GDP, putting upward pressure on unemployment, which the Bank of England expects to rise from 4.9% to 5.6% over the next two years.
Eichengreen argues that Britain doesn't have the excess capacity to ramp up production of exportable goods, while the global economy doesn't have the demand to buy them. Furthermore, uncertainty surrounding just what sort of trade barriers the U.K. will face exporting to its biggest trading partner, the European Union, will seriously hamper any investment to build out capacity.
The Brexit tradeoff
In other words, British lawmakers are enacting the will of the people, which is to buy the right to restrict immigration in return for weaker economic growth. One reason the vote to exit the EU was so surprising to some is that this trade seems like an unbelievably bad deal to elite Britain, which has profited handsomely from the prospering of the financial services industry. Indeed, the best argument against Brexit was the likely serious damage that would do to that sector's ability to employ Britons, with PwC estimating that it would lead to up to 100,000 fewer financial services jobs by the year 2020.
This would in turn reduce tax revenues, which reduces the capacity for the British government to spend money supporting employment and social services in economically struggling areas of the country. This dynamic led commentators to heap scorn on "Leave" voters, whom they claimed were simply shooting themselves in the foot because of their provincial dislike of the immigrants that arrived in the country as a result of European Union rules guaranteeing freedom of movement.
But how much do citizens outside of London actually benefit from the financial services industry? A recent working paper from Italian economists Carlo Panico and Antonio Pinto shows that, at least in the U.S., there is a striking correlation between the rise of the financial services industry and the explosion of income inequality. They argue that the financialization of the economy can directly contribute to the stagnation of wages elsewhere in the economy, because it both encourages workers to take on more debt than they can handle and gives corporate managers greater incentive to increase profits and dividends at the expense of wages.
This is not to argue that Leave voters were aware of the complex interplay between the banking sector and their own paychecks. Far more likely was that many voters were protesting immigration. The same goes for Donald Trump supporters in the U.S., who are likely not endorsing his strange theories on how free trade agreements have affected the economy as much as they are protesting the changes to the country brought on by immigration. But studies like that above argue that these voters at the very least aren't voting against their economic self interest, because while the British and U.S. economy may be benefiting overall from financialization, immigration, and free trade, those benefits are being very unevenly distributed.
So as Britain continues to march down a road that will make the country poorer as a whole, its elites may consider devising ways to make sure that the wealth it has filters down to the country as a whole, rather than complaining about the short-sightedness of their countrymen.