In June of last year, slightly more than half of voters in the UK decided to leave the European Union. On March 29th, Prime Minister Theresa May sent a letter to the European Council invoking Article 50, thereby solidifying what has come to be known as Brexit. The UK will now have two years to negotiate a new relationship with the rest of Europe before their withdrawal becomes final. It’s easy to brush off the negotiations as just another political sideshow, similar to the many meetings that take place between foreign leaders and diplomats every day, but the reality is that the European Union is a large economic power of which Britain has played an important role since its inception and their withdrawal is the first of its kind. As such, how they negotiate their exit will have huge implications for the British economy and, in some ways, will set a precedent for other countries pushing for closed borders.
One of the struggles Ms. May is currently facing is following through on her promise to maintain a healthy trade policy with the rest of Europe while simultaneously backing out of a decade's long relationship with the EU. Many voters chose to leave the union on the basis of unwanted immigration. One of the benefits of being a member of the European Union is that you get to participate in an open European market meaning goods and services can move freely across borders much like they do between states here in America. However, with that also comes the free movement of people. In many ways, Prime Minister May and her government are telling the people of Britain that they can have all of the benefits of the EU's single market without having to pay any of the costs, but as the saying goes: you can’t have your cake and eat it too.
Not only is this an important lesson for foreign markets but a reminder for our domestic one as well. Just last week President Trump met with President Xi Jinping of China where they discussed a variety of issues. In keeping with his promise to bring jobs and companies back to America, Trump wants to impose higher tariffs on Chinese goods thereby decreasing exports to the US and pressuring manufacturers to return to the states. This sounds simple enough, but China has its own economic goals and high tariffs would likely cause retaliation from them. Some of the byproducts of this dispute would be higher prices for American consumers and lower profitability for US companies who create jobs and wealth.
A common tenet of macroeconomics is that trade grows the pie. When we trade goods, everyone is better off. When we close our borders trade becomes more difficult and things become more expensive – hence the many warnings of inflation we see in the news these days. One of the reasons we enjoy low-cost products from big box retailers like Walmart is that the items are cheaper to make abroad. If we want those companies to make those products locally, labor will likely cost more – a cost that companies will pass on to consumers. Thus we find ourselves in a complex situation where job creation is important but so is maintaining the affordability of goods. The answers are not clear and simple, but what is important is keeping an eye on how negotiations pan out and the implications they have for the financial markets.
The Economist." Britain's Brutal Encounter with Reality." The Economist, April 1, 2017. http://www.economist.com/news/leaders/21719793-time-be-honest-about-trade-offs-ahead-britains-brutal-encounter-reality.