Blaming outsiders for economic maladies appeals to base human instincts evolved over millennia to engender beliefs that the economy is zero-sum: one person’s gain is another’s loss. In the violent, resource-constrained world of our Paleolithic ancestors, such beliefs may have been rational. But in the modern world, in which we each specialize according to our abilities and trade for mutual gains, it is highly irrational. Competition, be it with your neighbor or a foreign company, drives innovation, as each party is motivated to develop better, less expensive products to meet felt needs.
The constitutions of the EU and U.S. both contain provisions intended to constrain the ability of states to impose restrictions on trade. Over time, however, these provisions (especially the Commerce Clause in the U.S. and Articles 34-36 in the EU) have increasingly been used to pass legislation intended to harmonize regulations, which in turn has empowered bureaucracies that are incentivized continuously to expand their role. The result has been a massive increase in the regulatory burden, hindering innovation and thereby slowing economic growth.
Over the course of the past century, states have increasingly taken on responsibility for redistributing resources from those with greater wealth to the less wealthy. This has increased the burden on taxpayers and created enormous unfunded liabilities. In the U.S., total unfunded liabilities of federal, state and local governments were recently estimated at $200 trillion – more than 10 times current annual GDP.
As the potential for direct resource transfers has become more politically difficult, some governments have sought to use regulation as an indirect mechanism for such transfers. But these often have the opposite effect to that intended. In the U.S., state and now federal health insurance mandates are intended to ensure coverage for certain conditions but in so doing they increase the cost of insurance. In the EU, regulations imposing price controls on interchange fees seek to reduce the cost to consumers but result in higher bank fees, harming especially the poorest in society. Meanwhile, minimum wage regulations incentivize manufacturers and retailers to introduce labor-saving technologies, which reduce employment, especially among the youth.
Perhaps the most egregious intervention by governments has been attempts to manage the money supply. For decades, governments have sought to manipulate interest rates, and more generally access to credit, as a means of engineering growth to coincide with elections. As a result, business cycles have been exacerbated, with higher rates of malinvestment during booms followed by longer recessions and overall slower rates of growth.
The coalescence of growth-stifling regulations, increased spending and perverse monetary interventions has resulted in increasingly distorted economies. While most of those who have become wealthy have likely done so through perfectly legitimate means, benefitting everyone in the process, some have had their wealth enhanced by regulations and transfers that have come at the expense of the majority of productive workers.
The dramatic increases in wealth of a relatively small number of super-rich, some unjustly so, combined with stagnating incomes of many, and large numbers of people effectively priced out of work have led to widespread feelings of disenfranchisement. Add to this both real and perceived threats from migrants, some of whom are violently opposed to liberty.
In combination, these conditions are highly conducive for populist politicians who claim that they will make nations great again. Ironically, however, populist policies that arbitrarily limit transactions, whether through restrictions on trade or migration, reduce innovation and growth and have the potential to result in a vicious cycle of stagnation and further disenfranchisement. Think: Argentina, Venezuela, Bolivia, and Greece.
While Britain’s vote to leave the EU owes something to fear of migrants, it was not entirely motivated by populism. Many voters and most of the intellectual leaders of the leave campaign were mainly concerned about the harm done by EU regulations and the direct net cost to taxpayers. As such, Brexit has the potential either to reinforce or to temper populist sentiments. If upon exiting the EU, Britain maintains essentially free trade in goods, capital and services with the EU, while removing barriers to trade with non-EU countries and establishes better rules on migration, then it will likely increase innovation and growth domestically, improving the lot of those who currently feel disenfranchised, thereby tempering populism.
Some EU officials have signaled that they want to “punish” Britain for exiting the EU. But such punishment would be more masochism than sadism and while sado-masochism is not unheard of in Brussels, it seems an unwise choice in this case. It is also unlikely. Britain imports more goods from the EU than it exports to the EU and the leaders of companies who export goods to Britain – especially large companies such as VW, Peugeot-Renault, LVMH, Bayer, and Danone – will lobby their governments to maintain open trade in goods. Meanwhile, financial firms such as Deutsche Bank and Santander that have a significant presence in the U.K. will want the U.K. to maintain its passporting rights.
If people in other EU countries see conditions improving in Britain as a result of Brexit, there will be pressure for realignment in the EU. One possibility is that Britain remains part of the European Free Trade Area (EFTA) and other countries – Denmark? Holland? – join, creating a new, powerful region of free trade that offers a competing model to the EU. In turn, the remaining members of the EU might push for reforms tempering the tendency towards bureaucratic centralization and thereby in turn mitigating the power of the populists.