The UK GDP growth rate in the first and second year after the Brexit referendum stand at 1.9% and 1.3%. The numbers may come as a surprise to many as they appear markedly higher than the forecasts of most economic institutions made before the referendum. Some economists may point to positive contributing factors like unexpected strong global demand and rapid action by the Bank of England and argue the Brexit vote has already done significant damages to British economy. While there may be some truth in it, divided public opinion on the economic impact of Brexit – missing in macroeconomic models including those employed at major policy making institutions – is a crucial ingredient for understanding the UK economy retrospectively and prospectively.
Macroeconomic models suggest three main reasons why a Brexit vote would cause a big negative short-term impact on UK economy. First, a UK economy less open to trade reduces foreign direct investment, productivity and household incomes in the long term. Anticipating this, households and businesses will reduce spending and jobs will be cut immediately. Second, uncertainty about UK’s relation to the EU and domestic policy put off spending decisions. Third, the above two economic effects lead to rising financial market volatility, falling asset prices, and increasing borrowing rates for households and businesses. The worsening financial conditions amplify the first two effects.
All three economic effects operate via people’s expectations about future as the Brexit vote does not instantly change the UK’s relation to the EU. A common assumption underlying economic models is all households and businesses fully understand and unanimously agree on these economic effects.Particularly, all Britons in the models are assumed to believe that Brexit would make them poorer and increase uncertainty to the economy. This assumption is in stark contrast to a large body of evidence found from surveys of expectations and opinion polls.
The economic arguments are considerably attenuated by several perhaps unsurprising pieces of evidence on the public’s perceived economic consequence of Brexit. First, 50% – 60% of Britons, which may be labelled as “optimists,” believe Brexit would make no difference to British economy or Britain would be better off economically by leaving the EU. A similar fraction of optimists is found regarding the impact of Brexit on British jobs or personal financial situation. Moreover, the fraction of optimists increases significantly regarding the long-term economic impact of Brexit. Second, nearly half of Britons think remaining in the EU carries bigger uncertainty to British economy than leaving. Third, even among people who think Britain would be worse off economically by leaving the EU, labelled as “pessimists”, little indicate they would reduce consumption spending.
The outcome of Brexit negotiations remains uncertain. Looking ahead, a likely scenario is a deal with a transition period during which the UK continues to receive all or most economic benefits of EU membership. In the short term, the transition period would sustain the fraction of optimists and prop up UK economic growth and the value of pound. Optimism about British economy outside the EU and good macroeconomic performance, possibly supported by proper economic policy, would mutually reinforce each other. Even if Brexit makes UK economy worse off pronouncedly in the long term, with a smooth transition, it would take a long period of time for the optimism to fade and the deterioration of the economy to fully unfold.
Another likely scenario is no deal. People would tend to be more attentive to new information and quickly update their forecasts about future. While public opinion about the economic impact of Brexit has changed little since the referendum, a considerable shift of opinion would occur in this scenario, converting some optimists to pessimists and inducing some pessimists to be even more pessimistic. This would exacerbate the adverse economic impact. Yet the demand for second EU referendum may be boosted and a Remain vote becomes most likely if it indeed takes place.