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The United Kingdom’s (“UK”) vote to leave the European Union (“EU”) on June 23 represents a major change in the global economic order. This article explores the change that took place and why it may turn out to be a very important historical event that shapes the future of international trade and cooperation.

World Wars I and II served as a wake-up call to the world that something needed to be done to stop international conflict. The cost of conflict was simply too high. It was in part the terrible destruction of the World Wars and forceful diplomacy from the US that resulted in the beginnings of what was to become the European Union after World War II. The origins of the European Union were driven by the intersection of a determined effort to prevent war and an effort to rebuild shattered economies. Given the origins of the EU, it is safe to say that the EU has been a tremendous success for the past 70+ years. War, for the most part, has been avoided and the European economy has rebuild itself into an economic force rivaled only by the US in terms of size.

Many, many regional free trade agreements (FTAs) followed in the footsteps of the EU, including the Association of South East Asian Nations (ASEAN) FTA, Andean Community FTA, and the North American FTA (NAFTA). The list goes on and on. There are hundreds of FTAs. Some are between two countries (bilateral), some are between three or more countries (multilateral), and some are FTA to FTA or FTA to individual country. Unlike the EU, however, these agreements have their origins in a desire to increase economic competitiveness and economic gain.

The economic theory behind international trade goes back several centuries to Adam Smith in the late 1700s and David Ricardo in the early 1800s. The conventional wisdom since that time has been that there are gains from trade. Broadly speaking, most data does seem to support that countries that trade are more economically successful than countries that don’t trade. This is one reason that international trade agreements have been proliferating.

Understanding where gains from trade come from can be complex. It is useful to think of a very simple example. Imagine an isolationist economy, in this case an economy that is represented by a single person. This individual makes her own shoes, bakes her own bread and forges her own metal goods. She would likely be a tired, grumpy person with ugly, uncomfortable shoes, dry, tasteless bread and poor quality metal goods. Imagine instead a more efficient economy with a cobbler, a baker and a blacksmith. If they focus on what they do best and then trade with each other, then you can expect that they will all produce more shoes, bread and metal goods. The shoes will be very comfortable and will come in a range of styles and colors. The bread will be delicious and will come in French, sourdough, and gluten-free form. And the blacksmith will produce the straightest, strongest nails and fasteners for making better and better goods. All these goods will be made at a lower cost. There will be more time and money for innovation. They will hire more people. The economy will grow and all participants will be better off.

This is an overly simplistic example, but it shows the thinking behind how trade can boost efficiency and productivity and yield a better outcome for all participants. I’m describing a world where the pie grows for everyone. It’s a world where growth of one country’s slice of the global economic pie doesn’t need to come at the expense of another country’s slice. It’s also a world where the benefits of trade can be offered as a carrot to those countries that maintain reasonable working conditions and follow international environmental rules.

“I’m describing a world where the pie grows for everyone.”

This is the model of economics that has been the order of the day since World War II. Trade deals have often been controversial and drawn protests from organized labor, but, in the end, many have passed and become law and many more have been proposed, including the Trans Pacific Partnership (TPP). Recent economic history has seemed to be an inexorable march toward more and deeper economic integration and freer and freer trade.

This is why Brexit appears to be a very important moment in history. It represents a significant reversal in what has been mainstream economic wisdom. Many economists warned British voters prior to the referendum that a vote to leave the EU made no economic sense, and yet, that is exactly what the British people did. Why?

The reason is that ordinary, working class Britons did not feel that they were gaining from trade. They may have understood that the country as a whole enjoyed gains from trade, but they felt that the gains from trade were going to immigrants, other Britons and other countries, not to them.

The other reason that it could prove to be a very significant historical event is that Britons have sent a message through the ballot box that is clearly resonating beyond Britain in other countries and economies around the world, including the US. A very important question that Brexit raised and that will be answered over time is this: will Brexit serve as a cautionary tale to other countries and serve to teach them not to “go it alone” or will it embolden electorates around the world to reject politicians who support free trade?

“…will Brexit serve as a cautionary tale to other countries and serve to teach them not to “go it alone” or will it embolden electorates around the world to reject politicians who support free trade?”

Time will tell, but we are already hearing a more isolationist tone in the trade rhetoric coming from both major political parties in the US. Many people are aware that manufacturing jobs have been declining for some time, and that trend certainly plays a role in the anti-trade rhetoric of the current presidential campaign, especially when speeches are given in battleground manufacturing states like Ohio, Michigan, Wisconsin and Pennsylvania. According to the The Economist magazine, the manufacturing job loss trend began in earnest in 2000, about the same time as a surge in Chinese imports, but detailed studies suggest that only about 1 million of the 5.5 million U.S. manufacturing jobs lost between 1999 and 2011 were due to Chinese competition. So, what has caused the other 4.5 million lost manufacturing jobs? A big factor is technology, which is a topic for another article.

The reality is that many people in Britain, the US and around the world do not feel like freer trade is in their interest. What tends to be missing from political discussions of trade is a clear articulation of the gains that have been achieved as a result of trade, including more jobs in non-manufacturing sectors and lower prices on all matter of goods. If gains really do accrue to trading economies, and there is significant evidence that they do, politicians jeopardize one of the greatest tools to reverse the current slowdown in economic growth when they pursue isolationist policy because it’s the sound bite of the day.

The reality of international trade is nuanced and not fit for a politician’s sound bite or tweet. The costs and benefits of trade are complex, but it is vitally important for the health of the global economy that we don’t point to international trade as the root cause of all job insecurity. International trade will likely create more jobs than it destroys, but, as Brexit has taught us, none of that matters if people don’t believe trade is in their interest. If we want to avoid the next Brexit, we would be well-advised to ensure the gains from trade are felt more broadly and those who bear the costs of trade are well-supported.

John Cunnison

John Cunnison

Vice President | Senior Portfolio Manager