In order to understand the long-term impact of Brexit on the UK economy, imagine a river running upstream to downstream and out into the ocean.
With this in mind, view conventional long-term economic performance as very much downstream, at the mouth of the river, with an emphasis on the performance of productivity and competitiveness. But that, of course, begs the question as to what causes the performance. Is there an explanation which can be found further up the river mid-stream?
Mid-stream explanations focus on the role of institutions. Institutions are the rules of the game, such as tax, regulation and the impact of the state, all of which affect performance (most notably explained by Daron Acemoglu and James A Robinson in their international bestseller, Why Nations Fail: The origins of power, prosperity and poverty).
The essence of Acemoglu and Robinson’s hypothesis is that: “Economic institutions shape economic incentives: the incentives to become educated, to save and invest, to innovate and adopt new technologies… as institutions influence behaviour and incentives in real life, they forge the success or failure of nations.”
You know the next question. If institutions determine performance, what determines institutions?
Acemoglu and Robinson argue that critical junctures in history, such as the Glorious Revolution at the end of the seventeenth century in Britain, have determined institutions. They reject the idea that there could be an explanation further upstream, towards the source of the river, in the form of culture. Their rejection is understandable, as defining culture is no easy task. At times it’s akin to trying to nail jelly to a wall. But this does not mean we should ignore culture.
Culture is the set of values and beliefs people have about the way the world works, as well as the norms of behaviour derived from those values. Essentially, culture is the underlying worldview people hold.
One of the world’s leading economic historians, David Landes, wrote in his book The Wealth and Poverty of Nations that “if we learn anything from the history of economic development it is that culture makes all the difference.”
This is not to deny that institutional change can occur without a shift in culture. The culture first rule is not absolute. But it does provide a fascinating insight into the consequences of Brexit.
Extending the river analogy, imagine Brexit as a change in the rules of the game, a mid-stream institutional shift that will impact economic performance downstream. Leavers will argue positively, Remainers (mistakenly in my view) the opposite.
But this is not the end of the story. Adapting Acemoglu and Robinson’s critical junctures argument, Brexit could be seen as potentially transformative of both culture and institutions.
What might this mean in practice? Brexit could help stimulate a greater sense of economic liberty, responsibility and vitality. Economic freedom is paramount for prosperity, in shaping perceptions of how much freedom and control people feel they have over the way their lives unfold. With regard to responsibility, the more that is taken on by the individual, the less that is required of the state, thereby enhancing economic efficiency.
There is one final element, and that is vitality. This would involve a recognition that post materialist values can be negative for growth and future prosperity, and that vitality has been lost inside the EU. The link between vitality, competition and innovation has been described by the Nobel Laureate Edmund Phelps as the “imaginarium” economy.
The greatest windfall from Brexit would be if it helps change culture and institutions in the UK, to shrink the state. This would be an even greater Brexit dividend. Arguments about the Single Market are trivial when set against this.