team research project- brexit-final

Team Adam Smith Research Project: Brexit 1

Team Adam Smith Research Project: Brexit

BUS 512 E Managerial Economics

Marylhurst University

Josh Aman, Blaine Butcher, Larry Canete, & Angie Cole

August 22, 2016

Brexit: An Economic Introduction


“It’s a madhouse in here. It has been a bloodbath. Carnage,” said David Papier of foreign

exchange house ETX Capital in London on the day the referendum results were released.

(Brennan, 2016.) The referendum vote in favor of Britain leaving the European Union (EU) has

been greeted with strong economic predictions from around the world. Many economists foresee

a recession in the near future and the withdrawal of Scotland and Northern Ireland from the

United Kingdom. Others believe that Britain will be stronger as a result of having regained

autonomy of its governmental economic levers. Regardless of which way the country is heading

in the future, everyone agrees that major changes are in store for its citizens.

Britain had the 5th largest economy in the world in 2015, with a Gross Domestic Product

(GDP) of $2.85 trillion (International Monetary Fund, 2016.) Its GDP made up about 17% of the

EU’s GDP. London is world’s largest exporter of financial services. “London handled 36.7% of

global currency transactions in 2009 — an average daily turnover of US$1.85 trillion — with

more US dollars traded in London than New York, and more Euros traded than in every other

city in Europe combined” (World Heritage Encyclopedia, 2012, para 12.) The decision to leave

the EU will have definite economic repercussions throughout the world.

Internally, Britain will be looking to see how its EU exit will affect retail markets, the

telecom industry, manufacturing, construction, property values, insurance, transportation,

energy, mining, and basically all services tied to the global economy (Williams, 2016.) British

citizens will certainly see changes in the Consumer Price Index (CPI). Some industries such as

insurance and banking could benefit from fewer regulations. Energy on the other hand is

integrated closely with EU countries; a change in this industry would probably be more harmful

to the economic well-being of most Britons.


The purpose of this research paper is to examine Mankiw’s 10 Principles of Economics to

discover how they illuminate Britain’s decision to leave the EU. Each economic principle will be

highlighted specifically in reference to changes that are expected in the Brexit. The paper will

conclude with a brief summary of how the principles shed insight into this economic world

event.

People Face Tradeoffs

The United Kingdom’s referendum decision, commonly known as BREXIT, to leave the

European Union is a complicated matter and the driving forces behind the recent outcome can

best be understood when it is examined using Mankiw’s Ten Principles of Economics. The first

principle declares simply that, “people face trade-offs.” Said another way, in order to make a

decision one must “trade off one goal against another” (Mankiw, 2004, p 4-6). Recognizing that

you cannot receive something without giving something to get it is the foundation of a

functioning economy as it signals the reality that there must be an exchange of value. However,

recognizing that this trade-off exists is not in and of itself an indication of which way a decision

will go. Rational voters in the UK’s BREXIT referendum presumably cast their votes with this in

mind. Those wishing to leave the EU do so in hopes of achieving several key objectives, most

notably taking back complete control of the UK’s borders, reallocate money spent on

membership fees so they can be invested for domestic use, and freedom from what they deem to

be strict employment, product, and environmental restrictions (Hunt, 2016). In order to achieve

these means, those voting for a BREXIT must be willing to recognize there is a trade-off in order

to gain the desired “benefits.”

The Cost of Something is What You Give Up to Get It


The second principle of economics builds upon Mankiw’s first principle. The second

principle relates to the opportunity cost of making one decision versus another and states that the

cost of acquiring something is what you give up to get it (Mankiw, 2004, p 4-6). By voting to

leave the EU, the UK must sacrifice certain opportunities in order to break with the EU. There is

a cost/benefit to every action and alternative course of action that must be considered during the

decision-making process. Complicating matters with regard to BREXIT is that there is no simple

equation or answer that outlines what the true costs and benefits are to membership to the EU.

Those campaigning for the UK to leave the EU present one set of numbers that show a

cost/benefit analysis in favor of Brexit while those hoping to remain in the EU show a

cost/benefit analysis is beneficial to remain in the union and maintain a single, unified market.

There are, however, several variables of the equation that remain constant and true regardless of

who is doing the math. The explicit costs and ramifications of a BREXIT would include

whatever exit “fee” the UK and EU agree upon in order to end the UK’s membership,

devaluation of the Pound, administrative costs associated with implementing new policies, and

increased inflation (Coggan, 2016), (Springford, 2014, p. 1-14).

The implicit, or opportunity, costs of the BREXIT are of the greatest concern as their macro

implications could be, and have thus far been, devastating. Implicit costs that will most likely

have international repercussions include the possibility the UK of no longer having access to

Europe’s single market, decreased attractiveness to international investors, decreased national

credit rating, and the abrupt departure of PM David Cameron and other high-level government

officials (Springford, 2014, p. 1-14). At a more micro, domestic, level the implicit costs include

more limited access to skilled labor, a decrease in potential tourism, time and effort spent

negotiating the exit which could take up to as many as six years (Hunt, 2016). Voting members


of the UK should give serious thought to what else could plausibly be achieved over the course

of those six years if the government assets were to be used for purposes other than negotiating a

BREXIT. With all of those costs at stake, most financial analysts, newspapers, journals, and

foreign nations have seemed to conduct their own neutral cost/benefit analysis and have

overwhelmingly concluded that there is very little benefit to a BREXIT and there is far too high

a cost to rationally justify such an action (Stern John Oliver Goes Off on Brexit: Britain Leaving

the EU Is ‘Absolutely Insane’ 2010), (Mankiw, 2004, p. 4-6).

Rational People Think at the Margin

Mankiw’s third principle of economics relates to the decision-making process of

individuals. The third principle states that “rational people think at the margin,” with rational

people defined as individuals who systematically and purposefully do the best they can to

achieve their objectives while marginal change is a small incremental adjustment to a plan of

action (Mankiw, 2004, p. 4-6), (Coggan, 2016). According to this principle and definition, the

decision to exit the EU is not an economically reasonable decision given the fact that the actions

are far from marginal and are not the smallest adjustments that could have been made to achieve

an objective. A report from the Centre for European Reform concluded that “the idea that the UK

would be freer outside the EU is based on a series of misconceptions” and that the UK has “very

little to gain and much to lose” (Springford, 2014, p. 1-14).

People Respond to Incentives

The fourth principle of economics is incentives, which play an important role. Incentives

are what influence a person to act based on the individual’s expectation of punishment or reward.

Rational people make decisions based the costs and benefits (Mankiw, 2012). The Brexit

decision should be based on the citizens’ analysis of the costs and benefits of staying or leaving


the European Union. Many of the top reasons to vote to exit are based on financial, immigration,

and sovereignty incentives. With a decision to leave, Britain would no longer be forced to

provide £18 billion of their taxes to the EU. They are the second biggest contributor to the EU

budget after Germany and having this tax revenue at their disposable is a big incentive

(Telegraph, 2016). The EU dictates who can enter its member countries, but with Brexit, the EU

no longer has control of Britain’s borders. An estimated 257,000 nationals arrived in the one-

year span of September 2014 to September 2015 to work and live in Britain (Telegraph, 2016).

Many citizens value the importance for Britain to be able to make policy decisions independent

of the EU. Some British laws are passed and implemented because of EU decisions, not their

own. “In 2010, the UK government estimated that about 50 per cent of UK legislation with

‘significant economic impact’ originates from EU legislation (Telegraph, 2016, para. 1).

Trade Can Make Everyone Better Off

The fifth principle of economics is that trade between two countries; can make each

country better off (Mankiw, 2012). When countries have the ability to trade with other countries,

it gives them the freedom to specialize in what they do best and the ability to enjoy a greater

variety of goods and services (Mankiw, 2012). Members of the EU have no tariffs on imports

and exports between fellow EU countries. They also have other established trade deals with

other nations around the world. Because of the Brexit decision Britain is going to lose access to

the EU trade agreement. On the other hand, this new opportunity frees them up to establish their

trade agreements (The Week, 2016). New trade deals would require renegotiation, but Britain

may be able to continue to trade with the EU with similar benefits and establish new trade deals

with other world powers.

Markets Are Usually a Good Way to Organize Economic Activity


Mankiw’s sixth principle of economics is that many countries have a market economy

where there is no central planner, rather economic decisions, are made by the decisions of many

firms and households. Companies and households interact with each other in the marketplace

with prices and self-interest guiding their decisions (Mankiw, 2012). The British have concerns

that after Brexit their economy will become weak. Businesses were polled about their confidence

and reported grim outlooks, but after the Brexit vote people still shop, hire, and create wealth just

as before (The Spectator, 2016). “The Bank of England’s assessment of business activity in the

month of the referendum reports ‘business as usual with firms hiring, borrowing and investing as

normal” (The Spectator, 2016, para. 8). The British Economy is more open now than ever

without the EU regulations. The EU isn’t perfect, and it still has its problems. One of the world’s

top credit rating agencies, Standard and Poor’s, recently warned that the European Union is,

“unsustainable in its current form” (The Spectator, 2016, para 9).

Governments Can Sometimes Improve Market Outcomes

“One reason we need government is that the invisible hand can work its magic only if the

government enforces the rules and maintains the institutions that are key to a market economy”

(Mankiw, 2012, p. 11.) The belief that governments can exert influence on a market economy is

one of the major motivations for why Britons voted to leave the EU. According to Mankiw, there

are two broad reasons for a government to regulate its economy: to promote efficiency and to

promote equality. Many felt that the EU had too much control of Britain’s government spending,

in fact, one estimate was that Britain sent “£355 million a week to the EU” (Full Fact, 2016, para

36.) Britain receives back less than a third of the money it pays to the EU; it is paid back in

services and contribution. It was assumed that Britain’s membership in the EU also brought it

economic benefits, but those benefits have not been definitively quantified.


Monetary policy is now firmly in the hands of the British government. Britain had been

on schedule to join the Euro-zone in Finance has been an economic strength for the country; the

British pound is one of the most stable currencies in the world. Their system of fiat money was

something they did not want to cede to the EU. Britain will retain the ability to set key short-term

lending rates, issue government bonds, and increase the money supply. They will be able to use

these economic levers to stabilize the economy during difficult times.

Britain now has full control over its unemployment programs and government

entitlements. It can also determine the regulations for businesses regarding minimum wage,

holidays, vacation. and healthcare. Another key area is the regulation of farming and fishing

industries; the EU took away Britain’s sovereignty to regulate and make requirements for

businesses in these industries. With the Brexit, the country can now decide what policies are best

for its population, the environment, and its economy. The government will be able to more

directly influence market outcomes. (Trade policies are a huge area of government influence, but

those were discussed in economic principle five.)

A Country's Standard of Living Depends on Its Ability to Produce Goods & Services

“Standard of living in an economy depends on the economy’s ability to produce goods

and services. Productivity, in turn, depends on the physical capital, human capital, natural

resources, and technical knowledge available to workers”. (Mankiw, 2012, p369).

The United Kingdom is regarded as one of the highly developed industrial nation in the

world. Based on the latest European Union report, the United Kingdom’s Gross National Product

for 2015 amounts to 2.569 Trillion Euros. Germany, China, and the United States are its main

import partners. (EUROPA.The United Kingdom).


One the main concern that brought about the decision of the United Kingdom (UK) to

pull out of the European Union (EU) was directly related on how its local businesses compete

with the rest of the member countries of the EU. For years, local businesses in the UK have been

complaining about losing their ability to compete in the European regional market because of the

lower prices offered by other member nations in the EU.

Prices Rise When the Government Prints Too Much Money

“A government can pay for some it’s spending simply by printing money. When

countries rely heavily on this “inflation tax”, the result is hyperinflation”. (Mankiw, 2012, p.

482).

At the time when the European Union has adopted the Euro as its common currency as

early as 1995 (as managed by European Central Bank), it has proven and maintained its stability

against a volatile world market. As of January 2015, the Euro’s inflation rate stands at -0.6%

(Wikipedia. History of the Euro) .

Uniquely, even when the United Kingdom was part of the European Union, it has

maintained a dual standard when it comes to monetary currency. The Sterling Pound has

remained to be in use in the UK despite the common use of the Euro currency throughout the

European Union.

When 51.9% of the voting population in the UK decided to leave the European

Union, there was a great concern in the world financial market about a repeat of the financial

crisis that hit the United States a few years back. But according to Bank of England governor

Mark Carney, Britain’s current economic problems will not be a repeat of the financial crisis.

Recently, the Bank of England has cut interest rate to a low of 025% and unveiled measures

amounting to 170 billion pounds to counter the shock of the UK leaving the European Union.


(Fortune.com.”Bank of England Says Brexit Won’t Cause a Repeat Financial Crisis”).

Society Faces a Short-Run Tradeoff Between Inflation and Unemployment

“All societies experience short-run economic fluctuations around long-run trends. These

fluctuations are irregular and largely unpredictable. When recessions do occur, real GDP and

other measures of income, spending, and production fall, and unemployment rises.” (Mankiw,

2012, p. 520). The aggregate demand and aggregate supply is the model most economists use to

explain short-run fluctuations in economic activities around its long-run trend. According to this

model, the price level and the quantity of output adjust to bring aggregate demand and aggregate

supply into balance. (Mankiw, 2012, p. 493).

If we place this economic concept into the context of Brexit, the United Kingdom (UK) is

on ‘damage control’ mode and bracing for the big wave of economic challenges that’s in rolling

in like a steamroller in the nation’s economy. Theresa May, the new prime minister, has made

encouraging noises about a fiscal stimulus, though the budget deficit is already at about 4% of

GDP, she does not have much room to maneuver. A future reduction cannot be far away: as the

economy slows, it will soon need all the help it can get. (The Economist, July 2016, The

economic Impact of Brexit).

Summary

In the words of Adam Smith, “I am always willing to run some hazard of being tedious,

in order to be sure that I am perspicuous,” and so please forgive the redundancy in this

summary as conclusions are highlighted (Smith, 1776.) This paper began by looking at

Mankiw’s first principle: “people face trade-offs.” The voters in the Brexit referendum

concluded that the benefits gained by becoming an autonomous independent country were

greater than the privileges that were lost by leaving the EU. Mankiw’s second principle, “the


cost of something is what you give up to get it,” was certainly in the mind of many analysts who

judged that Britain gave up way too many opportunities and will run into many obstacles as it set

the course to make its own policies free of the EU. “Rational people think at the margin,” is

principle number three. The Brexit does not appear to be a small incremental adjustment to an

existing plan of action, but if new trade agreements are similar to the deals Britain had in the EU,

then many economists believe the exit from the EU will not have a big economic impact. The

fourth principle, “people respond to incentives,” seems to be at the crest of the exit vote. Britons

saw many benefits to withdrawal such as lower taxes, more control over international borders,

and legislation derived from within the county. “Trade can make everyone better off,” the fifth

economic principle, could play a key role as to whether Britain will see a bright new future or

face years of recession. Most analysts agree that the degree to which Britain can keep or

negotiate trade agreements similar to what it enjoyed in the EU will strongly influence its

success as an autonomous nation. The sixth principle, “markets are usually a good way to

organize economic activity, has been central to Britain’s success in the 21st century. Freedom

from EU regulations could further boost its economic activity. Principle number seven,

“Governments can sometimes improve market outcomes,” was a motivating factor in voting for

the withdrawal of the EU. Many Britons felt that having more control in governing policies

affecting their country would bring about better market conditions. The eight principle, “a

country's standard of living depends on its ability to produce goods and services,” Britain will

still have the same physical capital, human capital, natural resources, and technical knowledge

that it had when it was a member of the EU. Thus, it should continue to have a similar standard

of living outside of the EU. “Prices rise when the government prints too much money,” is the

ninth principle, which has not been an issue for the EU, whether Britain can continue to be


prudent remains to be seen. The last of Mankiw’s ten economic principles is “society faces a

short-run tradeoff between inflation and unemployment.” Had Britain adopted the Euro, it would

not be able to implement short-run spending increases to offset unemployment or stimulate the

economy. Leaving the EU gives Britain another economic lever to use in a recession.

Studying Mankiw’s Ten Economic Principles in relation to the Brexit provides insight as

to why Britain voted to withdraw from the EU and also what it can expect in the future. How the

British government functions are covered in principles five through ten, and how British citizens

decide is found in principles one through four. Essentially, Britons believed that they would be

better off, if their national government had total control of economic policies and regulations.

Using the logic of Mawkin’s principles as a guide, it will be interesting to see how Great Britain

fares in independence.

References

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