Lessons from Brexit: the fruits of globalisation must be shared with low- and middle-income groups

After six decades of increasing global integration, Western nations are turning inwards.

Protectionism has increased among G20 countries since the global financial crisis, and trade as a percentage of world GDP is on its longest decline in three decades. In the United States, reality TV celebrity Donald Trump rode a wave of anti-immigration and anti-trade sentiment to become the Republican presidential nominee. In Europe, extreme right parties have come within a hair’s-breadth of winning absolute election majorities.

Now, following the Brexit referendum on Friday, the United Kingdom will be the first country to exit the EU bloc, potentially unleashing a cascade of further division.

What is behind this unravelling?

Brexit voting patterns shed light on the cause: the frustration of low- and middle-income workers. The lower the income and education levels in a region, the stronger the vote to “leave”.

It is true, as British Prime Minister David Cameron argued, that the Brexit is an act of “economic self-harm”.

Yet the frustration of low-income Brexiteers is founded in very real economic changes – including globalisation and economic liberalisation – that have caused average workers’ incomes to stagnate for decades. Median income has shown no growth in either the US or the UK in the 21st century. In the US, most households have experienced little income growth since the 1970s.

New economic evidence clearly shows that globalisation can harm low- and middle-income workers. The rise of trade with China substantially accelerated the decline of manufacturing in the West. To stay competitive, Western industries have introduced technologies that have further displaced workers.

While the impacts of immigration are small overall, research suggests they may be important when concentrated on the most disadvantaged.

For workers who lose their jobs, whether through trade, technology, or immigration, the transition to new work is slower than economists had expected. Some are pushed out of the workforce permanently. Many more experience substantial and lasting pay cuts.

The result is unemployment, wage stagnation, greater welfare dependence, and increased criminal activity – characteristic of many of the communities that voted in favour of leaving the EU.

Balancing openness with support: the ‘grand bargain’

The fault is not, however, with globalisation and economic liberalism (or in shorthand, “economic openness”). Both of these forces operate to make countries as a whole significantly richer.

Increases in economic openness must, however, be undertaken with the understanding that the gains in wealth will not be spread evenly. There are winners and losers.

Under policies broadly pursued in the West, including under the Cameron government, the winners from globalisation have been mainly the rich and especially the extremely rich. In the US, former Treasury secretary Lawrence Summers estimates that around US$1 trillion in annual income has been shifted from the bottom 80% of workers to the top 1%.

This does not have to be the case. A straightforward set of complementary policies – a mix of efficient taxes with expanded investment in safety nets and income-supplementation – can easily spread the gains from openness more evenly.

In Australia in the 1980s, policymakers deliberately combined increased economic openness with a stronger safety net, in a kind of “grand bargain” between the winners and losers of economic reform. This combination underpinned Australia’s record-setting period of sustained economic growth while at the same time preventing increases in income inequality, although since the early 2000s the safety net has begun to fall behind.

With the benefits of openness spread widely, support for economic openness has been similarly broadly based.

Rise of the extremists

As inequality has continued to rise in much of the West, stagnation has spread from low-income workers to the middle class. Anger has followed, spreading to a critically large proportion of the population.

The past year has seen Cameron in the UK, a host of conservatives in the EU, and moderate Republican presidential hopefuls in the US routed by extreme right competitors. The extreme left has been less successful, partly because it tends to favour softer immigration and refugee policies.

The extreme right certainly present dangers for the beneficiaries of globalisation. Following the Brexit, the 15 richest people in the UK immediately lost around A$7.5 billion, and global investors more than A$2.5 trillion, in the largest-ever one-day fall in market valuation.

Yet the extreme right’s policies are also unlikely to bring lasting relief to low- and middle-income households. Countries captured by the far right can expect an experience somewhat like that of Russia – a combination of militaristic showmanship with poor economic performance, shrinking relevance in the global economy, and an increasingly hollowed-out democracy.

The rational path is precisely the opposite. Global openness should be further extended, its benefits spread much more evenly through far-reaching tax and fiscal reforms and democracy should be shielded from the influence of wealth.

The costs of turning inward

The last time the world rejected globalisation and returned to extreme nationalism, two world wars followed. We are not on the eve of such conflict, but nor should Western leaders be complacent.

Evidence suggests that as trade declines, militarisation rises. This is part of why the European project, and global integration, were pursued with such vigour in the second half of the 20th century. Integration is essential to more than just our economic future.

The frustration-driven disintegration of the West sends a clear message to political leaders and the moneyed interests that influence them: spread the benefits of economic openness. Political stability depends on it.

Failure to strike such a grand bargain between the winners and losers of economic change will see the West tumble further into the brittle world of nationalism. Then everyone loses.