Brexit Will Not Break the Global Economy

In the wake of the decision by 52% of British voters to withdraw the United Kingdom from the European Union in last month’s referendum in the UK, many analysts have warned that the so-called “Brexit” would have wide-ranging repercussions.  Moreover, many experts have warned that the economic impact of Britain’s withdrawal from the EU will spread well beyond Britain and Europe and will have a major negative impact on the global economy.  Some have gone so far as to warn that global economic growth rates will fall significantly in the months and years ahead as a result of the British decision, even comparing the threat of “Brexit” to that of 2008’s financial crisis.  However, it is highly unlikely that the events underway in Britain and the European Union will have a significant impact outside of Europe, even as Europe and the UK reel from the impact of the British withdrawal.

Let’s start with the United Kingdom.  There is little doubt that the decision to withdraw from the European Union will have a massive impact on the British economy over the near-term, as the sharp rise in business and investor uncertainty will continue to destabilize the British economy, while the sharp fall in the value of the British pound will reduce consumer spending in the UK.  Over the longer-term, the key factor that will determine the impact of Brexit on the British economy will be Britain’s ability to attract foreign investment, as FDI inflows have been a major reason why the British economy has outperformed most of its continental European rivals over the past 25 years.  Despite the recent volatility, it is important to remember that the UK accounts for less than 4% of total global economic output, and thus, even a sharp recession in Britain will have but a minimal impact on overall global economic growth rates.  In fact, the greatest loss will be suffered by the European Union, as Britain had been the leading contributor to the EU’s overall economic growth in recent years.

Britain’s relatively strong economy had been the leading driver of growth in the European Union over the past 25 years and the loss of Britain will further reduce what have been already sluggish economic growth rates in the EU.  However, even if growth slows further in the European Union, this will have only a small impact on the performance of the global economy.  This is due to the fact that the European Union’s contribution to global economic growth has been declining steadily for decades and today accounts for a much lower share of global growth than either China or North America.  In fact, the European Union’s (minus the UK) average economic growth over the past 25 years has been just 1.5%, a rate that only surpasses that of Japan, a country that shares many of the same economic characteristics as the EU.  Moreover, 25 years ago, the EU (without the UK) accounted for nearly 25% of global economic output, a figure that today has declined to just 16%.  Moreover, within a decade, the EU without the UK will account for less than 12% of global economic output and this figure will continue to decline for the foreseeable future, reducing the EU’s impact on the health of the global economy.  In contrast, the United States and China will both account for nearly 25% of global output on their own, each more than double the size of the shrunken EU economy and each contributing much more growth to the global economy.  In fact, the world economy has largely adjusted to the fact that Europe (like Japan before it) will contribute little to global economic growth in the future. 

What the British withdrawal from the European Union has overshadowed is the fact that it is the uncertainty surrounding the Chinese economy that remains the single greatest threat to the global economy at the moment.  Over the past 18 months, official economic growth rates in China have fallen to below 7%.  Moreover, when one studies data from China that is more difficult to manipulate (electricity usage, steel production, freight transport, etc.), it appears that the actual rate of economic growth in China over the past 18 months is somewhere between 3% and 4%, a far cry from the three decades of 10% GDP growth recorded earlier in China.  This is important because China has recently overtaken the United States to become the leading contributor to growth for the global economy, as well as for exporters and investors around the world.  Should the Chinese economy fall even further in the coming years, a key pillar of economic growth would collapse and this would have a much greater impact on the global economy than Europe’s current problems.  As such, it is important to remember that, while Brexit is an unwelcome development for the global economy, it is far from being the most important issue facing the global economy in 2016, as it will be China that plays the greatest role in determining the direction of the global economy in the coming years.