The economic and political implications of the so-called Brexit are likely to be profound and long-lasting for Britain and the European Union. But the effects will also be felt much closer to home here in the U.S. and, in particular, Texas.
Although any impact will surely be less severe, and perhaps more indirect, than that in Europe, state lawmakers should still understand the potential consequences and the options available to help stop any adverse outcomes to our state because Texas is vulnerable.
The vote in favor of Brexit led to a major rise in financial uncertainty. The British pound depreciated substantially against several currencies, including the dollar, and major stock markets dipped considerably.
As is often the case with heightened uncertainty, demand for U.S. Treasury bonds and gold increased as investors fled to safe assets, leading to a drop in U.S. Treasury yields and a rise in gold price.
These sharp movements in asset prices, which have the potential to be persistent, could lead to negative wealth effects on American consumers and impair balance sheets of many corporations.
This could, in turn, feed into the real economy by depressing consumption, investment and output. Furthermore, the depreciation of the British pound is likely to increase U.S. imports from Britain while decreasing exports to Britain, thereby also depressing production.
This general national narrative also applies equally in Texas. The state is particularly exposed because of developments in commodity markets following Brexit, especially the decrease in oil prices that occurred due to increased uncertainty and pessimism about future global demand.
Texas output and employment are obviously quite dependent on the oil and gas industry. Recent estimates from the Federal Reserve Bank of Dallas show that this segment contributes to about 13 percent of total output and 2.5 percent of total employment. If oil prices remain at depressed levels, the Texas economy will get hurt more than the national economy.
The Brexit could also have bigger effects directly through foreign trade and investment. As current foreign trade and investment with the U.K. fall under European Union agreements, new treaties and agreements will be negotiated and written.
The process will be lengthy, and the outcomes of negotiations are uncertain, which is likely to depress Britain’s bilateral foreign trade and investment with the U.S.
The effect of this will apply to our state as well. The U.K. is a vital trade partner for Texas: Recent data from the U.S. Census Bureau show that the U.K. ranks 10th among source countries for Texas imports and 11th among destination countries for Texas exports.
Moreover, there are strong links in direct foreign investment between Texas and the U.K. Recent data from the office of the Governor of Texas show that the U.K. ranks first among source countries for greenfield foreign direct investment projects, or projects that build from the ground up, which amounts to $2.5 billion.
And the UK ranks second among source countries for merger and acquisition investment projects, amounting to $22 billion. Any barriers to these movements of goods, services and capital will only lower the well-being of Texas and its residents.
So how should America and Texas respond? A direct implication nationally is the need to continue, and perhaps even extend further, accommodative monetary policy. Given the possible negative effects on the economy, it now makes an increase in the interest rate by the Federal Reserve during the next several meetings imprudent.
Policymakers in Texas should also work hard to ensure that the state economy is built on an even more diversified base. They must remain vigilant to encourage and enhance the flow of goods and capital with the U.K. and provide appropriate incentives to the private sector. Texas may be vulnerable, but we can mitigate the effects if we make the right decisions.
Saroj Bhattarai is an assistant professor of economics at The University of Texas at Austin.
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