The Bank of England warned last week that a disorderly no-deal Brexit would cut GDP by between 4.75 and 7.75 per cent by 2023, and raise unemployment to between 5.7 and 7.5 per cent. These scenarios – the Bank denies they are forecasts – have been widely criticised even by sympathisers with the Bank. Andrew Sentence, a former MPC member and Remain supporter, called them “bogus”.
I agree. To see why, recall what happened to some US inner-cities in the 1960s. They experienced 'white flight'. At first, a few white people moved out but many then followed, with the result that cities became racially segregated, with inner-cities being almost all black and suburbs almost all white.
This didn’t happen solely because whites were racist and didn’t want to live among black folk. As the economist Thomas Schelling showed, it could have happened even if whites were happy with moderately mixed neighbourhoods. But, he warned, if such white people feared the mix would fall below a certain point, they would move out leaving the neighbourhood all black. And, he stressed, what matters isn’t just reality but expectations. “People do not wait until the alien colony exceeds their toleration before departing” he wrote in his classic book Micromotives and Macrobehaviour, “as long as they can foresee the numbers increasing with any confidence”.
In this sense, the economic effects of a no-deal Brexit depend upon self-fulfilling prophecies. If companies believe it will be disastrous, they’ll leave in anticipation of others leaving and so it will indeed be disastrous. But if they think it’ll be tolerable, they’ll stay and so the effects will be moderate.
Another analogy here is with runs on banks. If depositors believe a bank will become insolvent, they’ll rush to withdraw their money and so the bank will collapse. Even if the bank is otherwise sound, the belief can therefore be self-fulfilling.
And here’s the thing. We cannot predict these processes in advance, because we cannot know what companies’ thresholds for relocating are. Some might accept the loss of a few neighbouring companies but others might be more resilient. Or less so. And everybody’s expectation will depend upon others’ expectations. As Christopher Carroll at Johns Hopkins University has shown, forecasts can spread across populations in the same way as diseases do. And some diseases can ravage a population while others don't.
This means that precise forecasts of the impact of a no-deal Brexit are silly. They are a pretence to knowledge which we cannot in fact possess. We cannot quantify everything. We can identify relevant mechanisms but we cannot say in advance to what extent these will operate.
Investors should not, however, be too harsh upon the Bank. They too sometimes overweight numerical information such as earnings and cash flow and under-estimate 'softer' information which might be more relevant to future returns such as corporate culture or investor sentiment. Like the Bank, they forget the words of Jerry Muller in The Tyranny of Metrics: “measurement may provide us with distorted knowledge – knowledge that seems solid but is actually deceptive”.
