What ‘Brexit’ will mean in America
By Nelson D. Schwartz and Patricia Cohen
When the mills that birthed the industrial revolution in cities like Manchester and Birmingham still powered the British economy of the mid-20th century, Robert Stevenson was a frequent visitor to the Midlands.
Eastman Machine, the company his family helped start in upstate New York 128 years ago, had a big factory 100 miles north of London, and Britain accounted for roughly a fifth of the firm’s sales.
That was then. While Britain is still an important market for Eastman’s sophisticated cutting tools, its workshop there was shuttered in the 1970s, and British customers are now served by Eastman’s main factory in Buffalo, New York, and a smaller one in China.
So when the British electorate stunned the world Friday with the results of the vote to leave the European Union, it was a shock for Stevenson, but not because it poses an immediate threat to Eastman’s bottom line or the job security of its heavily blue-collar, 120-strong workforce in downtown Buffalo.
What most concerns Stevenson and owners of businesses big and small is what the “Brexit” says about the shape of economic things to come.
“You never know if there will be a domino effect, and we worry about other countries securing their borders,” Stevenson said. “We were certainly surprised.”
For all the shock and awe on Wall Street and financial markets around the globe Friday, the imminent danger to the underlying U.S. economy is relatively small. What’s far more worrisome is whether Britain’s decision represents an end to the economic integration and opening markets that have helped power sales at companies like Eastman over the past few decades.
Since the fall of Berlin Wall in 1989, politics and economics have mostly moved in one direction, with the elites on both sides of the Atlantic favoring policies like the North American Free Trade Agreement with Canada and Mexico, the introduction of the European currency and the entry of China into the World Trade Organization. Business has applauded these moves, but voters are not necessarily on board as they once were.
“I think a lot of the market reaction is less about the financial impact and more about populism and what it means for the liberal economic order,” said Glenn Hubbard, a top economic official to President George W. Bush who is now dean of the Columbia Business School.
The Brexit vote, he added, reflects a deep distrust of the benefits of the global economic system among a wide swath of voters in Europe and the United States, and a broadly held view that government institutions — whether in Washington or Brussels — are calcifying and don’t work well.
“Both of those forces have a lot of wind at their back,” he said.
“In the near term, you’re seeing markets being roiled, and feedback effects for the Federal Reserve,” Hubbard said. But for now, at least in the United States, “I don’t think it’s going to raise recession probabilities.”
When it comes to commerce, Britain is not even among the United States’ top five trading partners — it’s the seventh largest, according to the U.S. Census Bureau, which tracks trade data. U.S. exports to Britain last year totaled $56 billion, or just over 0.3 percentage point of gross domestic product.
Partly that’s a reflection of how the United States, despite leading the era of globalization, remains something of an economic island. Exports account for 13.4 percent of U.S. economic output, according to the World Bank, compared with roughly 30 percent for Britain.
The 2015 slowdown in the United States’ biggest trading partner — China — may have blunted domestic growth in the last year, but even that hardly threw the U.S. economy into a tailspin. Nor should Brexit, most experts say.
By Nelson D. Schwartz and Patricia Cohen
Jared Bernstein, a liberal economist who most recently served in the Obama administration and is now a senior fellow at the Center on Budget and Policy Priorities, sees minimal pain within U.S. borders. “It won’t be helpful for our economy,” Bernstein said, but “we won’t take anything like the direct hit that I expect will befall the economy.”
Several economists estimated that the fallout from the vote would probably end up decreasing growth in the US economy by about a quarter of a percentage point or less, while postponing any push by the Federal Reserve to raise interest rates, possibly through the end of the year.
“The flight to safety means lots of people are flocking to U.S. Treasury bonds, putting downward pressure on interest rates,” Bernstein said. “One possible outcome is that Fed’s path to higher interest rates may become flatter as these events play out.”
Brexit’s impact on the US economy will mostly be felt through the falling value of the pound and the euro against the dollar, Bernstein said, which is “likely to slow down inflation and exacerbate our trade deficit.”
A surging dollar would hurt U.S. exporters facing weaker demand from customers in Europe and Asia. In fact, Stevenson’s main worry on Friday was whether his British competitors might actually benefit in the short term.
“With the pound dropping 10 or 15 percent, it may strengthen a couple of our competitors in the U.K.,” he said. “I think they could be quite happy about it and gain market share.”
As befits the owner of a company that survived World Wars I and II, outlasted the Great Depression and the Great Recession, and survived the collapse of the U.S. textile industry — all without abandoning Buffalo — Stevenson has learned to adapt to potential shocks like Brexit.
Increasingly, that’s meant focusing on making high-tech, software-driven equipment to cut composites and carbon-based fabrics for the aerospace industry and automakers, rather than the woolens and cotton Eastman’s equipment was once designed to slice.
Many of Stevenson’s customers in Britain are in these sectors, he noted. The dressmakers and hosiers and other clothiers that once populated England’s redbrick towns have long departed.
“Our focus has been to understand where the market is going,” Stevenson said. Twenty years ago, 70 percent of Eastman’s products were of traditional fabrics; the rest were space-age materials. Now, it is the reverse, which is among the reasons a fifth generation of Stevensons will have a company to take over.
“Our goal has been to maintain the company in Buffalo and as a family business,” Stevenson said. “My son is 40, and I’m 65, and he is focused on these new materials. This saved our butt.”
For those exporters that have managed to hang on in the industrial heartland of Britain, the Brexit could actually be good news, simply because the pound’s plunge against currencies like the euro and the dollar makes their goods more competitive.
British exports like Rolls-Royce jet engines, high-end Jaguar automobiles and certain food products could get a lift. Last month, for example, Britain exported the largest cargo of wheat to the United States in more than two decades.
So would British hotels and restaurants, eager to host American visitors looking for what could amount to a 10 percent to 20 percent-off sale.
“If you wanted to buy a nice little house in Scotland, today’s the day,” said Kevin A. Hassett, an economist at the conservative American Enterprise Institute.
Chief executives of major U.S. companies are paid well to see around corners, and must adapt their businesses even to trends they oppose, or face the consequences in the form of falling stock prices and angry shareholders.
That’s among the reasons General Electric, which relies on foreign markets for more than half its revenue, has been preparing for the kind of political retreat from open markets that the British vote to leave the European Union represents.
“Companies must navigate the world on their own,” GE’s chief executive, Jeffrey R. Immelt, said in the commencement speech last month at the NYU Stern School of Business.
For GE, he said that meant seeking to achieve “a local capability inside a global footprint.” Today, its 420 factories spread across the world give GE “tremendous flexibility,” Immelt said, with jet engines, power generators and rail locomotives increasingly manufactured at several sites to ensure market access.
“A localization strategy,” Immelt said, “can’t be shut down by protectionist politics.”
GE had prepared for the risk that Britain might vote to leave the EU by hedging in foreign currency markets. But beyond that immediate step, a GE spokeswoman said Friday that it was too early to discuss longer-term moves the company might make.
Immelt, in a statement, said that GE, America’s largest manufacturer, which employs 22,000 people in Britain and 100,000 in Europe overall, remains “firmly committed” to both Britain and Europe.
While Brexit’s impact on Britain’s overall economy may be mixed, its London-based financial sector is likely to feel the full force of the coming storm. The City, as London’s equivalent of Wall Street is known, has boomed in the past 20 years as a global financial capital, especially for Continental banks seeking a more market-friendly home than Frankfurt, Germany, or Paris.
With a recession in Britain now a distinct possibility, some experts worry that a government desperate to create and maintain jobs could seek to save the financial sector by making the City more attractive as an offshore haven.
“This could lead to London becoming even more like the Cayman Islands and other British territories, skirting around regulations, in a race to the bottom for the financial sector,” said Adam S. Posen, a former member of the rate-setting committee at the Bank of England and now president of the Peterson Institute for International Economics in Washington. “This potentially could leave pretty big holes in the financial safety net.”
He pointed to the 2008 crisis involving insurance giant American International Group, where a hedge-fund-like subsidiary operating in London and under less stringent rules nearly brought down the company and contributed to the financial crash.
“They could get away with things in London that they couldn’t get away with in New York,” Posen said, “So imagine repeating that on a larger scale or a more frequent scale.”
Of course, dangers like those are the hardest to anticipate.
“Right now we’re in one of those points in history,” Hassett of the American Enterprise Institute said, “where there are lot of ‘unknown unknowns,'” referring to the infamous comment by former Defense Secretary Donald Rumsfeld on the Iraq War.
Consider two very different types of uncertainty, Hassett explained, citing a well-known economic metaphor. If you bet on a roulette wheel, you know all the possible outcomes and the attendant risks. But now imagine a game where you don’t know all the places the roulette ball might land, or the chances of it falling into different slots or even the prizes if you are fortunate enough to bet correctly.
“In those types of situations,” he said, “anything can happen. And if you don’t know what will happen, the optimal strategy might be to assume the worst.”