David McWilliams: Why Brexit might not be as bad as feared

At this time of the year, newspapers are packed with predictions about what is likely to happen to the economy in the next 12 months. Underpinning all these views, whether negative or positive, is the pretence that the economic cycle in some way neatly follows the Roman calendar, as if the economic cycle begins on January 1st and ends at the stroke of midnight on December 31st.

Of course this is not how the economic world works. The economic cycle is impervious to our calendar cycle. Possibly because our human need for order, control and rhythm is so great, we feel compelled to align the economic cycle with the 12-month calendar cycle. In reality, the economy is a much more unregimented creature. The peak to trough of the economic cycle can last years. For example, the US is now in its 10th year of an economic upswing. Similarly, the Irish crash didn’t start on January 1st of any year, and end the following December. It kicked off abruptly and the subsequent recovery occurred slowly, bit by bit, over a number of calendar years.

So when talking economics, one of the first things to appreciate is that economic time and human time are not the same thing. There are simply too many components and variables in the economic cycle preventing it from behaving rationally and predictably. This doesn’t mean we shouldn’t try to forecast the year ahead; but we should be aware that trotting out an annual forecast, in economic terms at least, makes little sense.

Rarely does a singular important event have quite the impact expected but a small unexpected event can have significant ramifications

The economic cycle is as varied as the millions of factors that influence it: ephemeral concepts such as confidence, human nature, where the herd is going, optimism, attitudes to risk, profit margins, perceptions of interest rates, collective recklessness, all have a huge impact.

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Rarely does a singular important event have quite the impact expected but, all too often, a small unexpected event can have significant ramifications. This latter development is called a “Black Swan” event, where a seemingly small yet unknowable occurrence impacts on an already fragile system, destabilising everything, leading to panic. Indeed, the fragility of the system is rarely appreciated until it starts to unravel. These unknown, unexpected shocks are usually the ones that throw the system into chaos.

In contrast, events that are well flagged sometimes have a much smaller impact than we fear because, psychologically, even though we might not think so, we are prepared.

And maybe because of this division between expected and unexpected shocks, Brexit – although bizarre, unnecessary and unruly – might not have the catastrophic economic impact that many fear. It would be better for it not to come to pass – and there is a real chance that it might not go ahead imminently – but because it has been so thoroughly analysed, even a shock to trading conditions would be short and the essential vitality of the Irish economy might absorb the long-term ramifications.

This is not a fashionable position to take, not least because a veritable cottage industry has sprung up warning of the impending economic catastrophe of Brexit. Fuelling this cottage industry is the idea that our economy behaves in a mechanistic, almost hydraulic fashion, where a lever is pulled here and this has inevitable and quantifiable impact on the economy within a specific period. I don’t think this is how the modern economy works.

In contrast to the hydraulic, lever-pulling machine, maybe a more persuasive way of looking at the modern economy is through the lens offered by the Austrian economist Joseph Schumpeter.

Schumpeter saw the economy as an enormous, multi-faceted organism driven by an unforgiving process of creative destruction, where the human drive to innovate is constantly making old companies obsolete and is constantly replacing the old with the new. It is a relentless world, where nothing stands still. As a result, political shocks like Brexit are only one of millions of shocks going on all the time.

At the heart of this constantly churning economy is commercial self-expression, risk-taking and human ingenuity. This commercial cut and thrust which propels every business is the property that economist John Maynard Keynes described as the "animal spirits".

If we look at the act of setting up a company, and backing yourself in the market, as a creative act of will, driven by the human urge to innovate, then a very different picture of the economy emerges. In the same way as it would be preposterous to ban new musicians making new music in order to protect the back catalogue of older musicians, trying to hold the world in a fixed state, is not only unrealistic but is unhelpful and is actually damaging to the intrinsic driver of the economy, which is innovation in the face of adversity.

Brexit constitutes a challenge to business. Like any disturbance, it will also create opportunities and threats

The world is in a constant state of innovative flux, and Brexit is yet another example of this. It is a fact, an impulsive political act, made legitimate by a referendum with significant economic consequences. That’s it. Many believe – as I do – that it is based on a delusional image of British sovereign power, but who cares; it exists. Brexit constitutes a challenge to business, which, like any disruption, will demand an innovative response. Like any disturbance, it will also create opportunities and threats.

Politically it has exposed fragilities in British politics, shown up deficiencies in the UK’s diplomatic power, made light of their presumption of their own economic might and possibly started a process that might lead to a new, federal Britain. From an economic perspective it is a disruption but it has been extremely well ventilated. It is an act of aggression against globalisation, for which the UK may suffer prolonged capital outflows, but it won’t be an unexpected shock when it happens.

If the UK crashes out, it will be a failure of politics not economics which will not last long because if the outcome proves to be as immediately catastrophic as some suggest, the UK will ultimately sign anything put in front of it.

In the same way as we can’t impose calendar years on the economic cycle, we can’t stop the process of change, innovation and creative destruction.

Weird as it seems now, Brexit might not prove to be the big disruption of 2019. Something far more unknowable is likely to take that prize.