British Referendum Pains and the EU Implications of BREXIT
European Institute for International Economic Relations
Prof. Dr. Paul J.J. Welfens is a Geoeconomics Non-Resident Senior Fellow at AICGS. He is Jean Monnet Professor for European Economic Integration; chair for Macroeconomics; president of the European Institute for International Economic Relations (EIIW) at the University of Wuppertal; Alfred Grosser Professorship 2007/08, Sciences Po, Paris; Research Fellow, IZA, Bonn; and a Non-Resident Fellow at AICGS/Johns Hopkins University, Washington DC.
On 23 June 2016, should a majority of British voters decide to leave the EU—nearly forty-five years after joining the Community—the EU would lose 17 percent of its GDP and 12 percent of its population. This referendum result would reveal Prime Minister David Cameron’s poor political calculations and he would now find that his pro-EU membership campaign has failed miserably. The great winner of the British election of 2015 will step down as prime minister after the failed referendum, while the UKIP anti-EU activists cheer on the developments as do other anti-EU forces. As regards Cameron’s potential defeat, there has been a moral failure on the part of the prime minister: He had assigned a special taskforce of scientists to write a critical EU Report in 2014 and the result had been that in no field was the EU a serious impediment to British interest and British policy; the division of competences between Brussels and London could be improved in some fields but there were no serious inconsistencies—a message that was not clearly communicated to the British public. The final chapters of the report were published in 2015.
The main reason that so many British citizens are rather skeptical about EU membership and immigration, respectively, is the fact that after the Transatlantic Banking Crisis national government funding of local communities has been strongly reduced—sometimes not only reflecting adjustment pressure from high government deficit-GDP ratios, but conservative ideology as well; in communities facing reduced government services and excess demand problems in the health care system, sustained immigration pressure from the EU partner countries (and other countries) has created a general impression of overcrowding problems. It is unclear whether the pro-EU supporters can convey the message that EU membership for the UK is a rational choice, since leaving the UK will raise the question about the future relationship between the UK and the EU—if the UK would follow the Swiss or Norwegian model, the price tag for full access to the EU single market will be not only to accept most EU rules, but to contribute to the EU budget as well.
It is true that Cameron is not the only element to blame for the negative British referendum result. Angela Merkel’s chaotic refugee policy of 2015 has certainly reinforced those British voters who are afraid of immigration and the EU’s immigration policy, which has exposed just how poor the EU’s ability to defend its own southern external borders really is. As Margaret Thatcher once said in the context of Britain potentially joining the EU Schengen Treaty, which allows the free circulation of people in continental EU countries: We are not going to rely on Greek civil servants to effectively control the access of foreigners to the UK. All the pictures of the EU refugee crisis of 2015 and early 2016 have simply illustrated the chaotic refugee policy of Germany and the EU, respectively: with Greece being totally overwhelmed with the task of controlling its external borders and providing sufficient humanitarian aid to the refugees.
Gideon Rachman’s article in the Financial Times of 21 March 2016 describes the post-transatlantic banking crisis world where many voters are fed up with the old political elites. There exists the problem that “the political establishments in Washington and London find it hard to believe the public will ultimately make a choice that the establishment regards as self-evidently stupid. However, in Britain, as in the US, politics has taken a populist and unpredictable turn. The financial crisis and its aftermath have undermined faith in the judgement of elites. High levels of immigration and fear of terrorism have increased the temptation to try and pull up the drawbridge and retreat behind national frontiers.”
The Brussels terror attack of 22 March 2016, has reinforced the fear of terrorism and many British citizens think—reinforced by Leave activists—that living outside the EU, and thus being somehow protected from terrorist attack, is an argument in favor of BREXIT. Anti-terror specialists would not agree with this, but simple answers are always popular.
The anti-EU supporters think that the UK alone will be better off than being a member country of the EU. The economic logic contradicts this view completely: the short-term economic gain is that the UK could save only about 0.4 percent of GDP in net contributions to the EU, but the rather poor future UK position at the international negotiating table will certainly cost the UK far more than this relatively small amount, while the UK will also experience a decrease in attractiveness for foreign investors who instead will want to invest more in continental EU countries in the future. A real depreciation of the British pound along with BREXIT means that British exports will increase in real terms, but in the end the key message is that, for a given amount of imports of goods, the average British citizen will have to export more domestically produced goods so that there is a welfare loss.
Moreover, a real depreciation means that foreign investors will obtain British assets at a discount, but this is only an advantage to investors from the U.S., euro countries, Russia, and Arab countries. In order to get access to the EU single market in the future, the UK would have to follow most EU regulations and would also have to make some payments toward the EU’s budget so that even on the budget side there would not be a net gain for the UK. The devaluation of the British pound in the run-up to June 23 could become very significant and force the Bank of England to massively intervene in the market as liquidity could dry out and asset prices could fall dramatically as international investors anticipate the UK leaving the EU. One cannot rule out that such financial turmoil will be a last minute signal to tilt the balance at the BREXIT referendum in favor of pro-EU votes. Undecided voters will be influenced by financial market signals.
The UK will lose its position in all EU-funded research projects and British innovation dynamics will suffer from this, as well as from the fact that UK tuition fees for students from the EU will strongly increase so that less skilled talent from the European continent will be attracted to study there. The UK will be a weaker actor in Europe and in the world economy—as will the EU itself without the UK. The European Union would look like a fragile union after BREXIT and this means that its political weight would decline internationally. The true winners in a global perspective would thus be Russia, the U.S., and China. From a European perspective, the winners will also be anti-EU parties, particularly those in the euro area, and this could also bring new problems for the euro area. Since March 2016, Germany has faced political destabilization when the populist Alternative for Germany (AfD), a right-wing party expressing xenophobic sentiments, obtained double-digit voting shares in three German states, including the economic powerhouse of Baden-Württemberg, which has 13 percent of the population of Germany.
The AfD is the mirror party of UKIP to some extent and it was created in 2013 as an anti-euro party mainly by a group of concerned German economists (Bernd Lucke, Joachim Starbatty, Olaf Henkel), none of them an expert on monetary integration. By late 2015 they already had left the AfD over internal conflicts and had created a new party “Alpha,” which does not play a role in Germany. The AfD benefited from a widespread uneasy feeling among many citizens who have become nervous—not least from the very many alarmistic Ifo Institute reports on the euro zone. In a biased approach to the issues, only worst-case scenarios were published that naturally were picked up by the popular press according to the old saying “bad news is good news.” Hans Werner Sinn, the president of the partly government financed Ifo Institute in Munich, argued in his worst-case scenarios in 2012/2013 that German taxpayers could lose up to 30 percent of GDP in the euro crisis; the true costs are less than 1 percent of GDP so far. Beatrix Von Storch, a leading AfD figure, was so nervous at some point that she took AfD funds from the bank to keep it in cash at home since she was afraid that the euro could go out of business.
With more regional elections coming—and the national election in 2017—the AfD will no doubt expand further and this undermines political stability in Germany and a fortiori in the EU. Less political stability implies that there will be a risk premium expected from the perspective of foreign investors and hence Germany will have lower foreign direct investment (disregarding a temporary higher inflow stemming from disappointed foreign investors after BREXIT shifting investment from the UK to Germany) and hence lower innovation dynamics and weaker economic growth. All this will be reinforced by the xenophobic AfD, which also sends a negative signal to foreign investors. For Germany, there will be some temptation to really become the dominant EU country of this smaller Community, but that this would be a useful development for the EU as a whole may be doubted.
A weaker EU is less attractive as a political and economic partner for the U.S. and China, the two economic superpowers of the twenty-first century. There is nothing that the UK could gain from less political stability and lower economic growth in continental Europe. Instead, the UK would most likely come under increased pressure from the U.S. to more often support U.S. foreign policy maneuvers and military actions—and this is certainly not a free lunch either.
It is absolutely clear, therefore, that the long-run result of BREXIT will be quite negative for the UK. The British economy will be directly weakened, continental Europe will become weaker as well, and the negative economic spillovers from the diminished EU to the weakened UK will be strong. If the EU output should drop (disregarding the pure output reduction related to the UK’s leaving of the EU) by 2 percent in the long run through the immediate BREXIT effect, British output should decline by 1 percent to 1.5 percent. This will come on top of the direct output reduction effect of BREXIT, which could reach 3 percent to 5 percent in the long run. British output decline during the Great Depression of the 1930s was 6 percent over two consecutive years of recession. The main difference now will be that the British output decline will be spread over about a decade or so.
A shrinking and unstable EU will cause further instability in the world economy, as other regional integration schemes—e.g., ASEAN in Asia and Mercosur in Latin America—will also be destabilized. With the EU no longer being a stable integration club, there will be doubts about the stability of other integration clubs as well and this will contribute to more regional conflicts and reduced global growth as well as more political nationalism and economic protectionism. Reduced international economic integration typically also means more conflicts so that military expenditures will increase in Europe and indeed worldwide. The BREXIT equation has no winners, but will have many losers. Whether BREXIT will, in the end, also lead to a new Scottish independence referendum also remains to be seen. At the bottom line, BREXIT stands for political brinkmanship in the UK.
The only two eminent political personalities who could make a difference in the run-up to the British referendum are David Cameron—the prime minister must clearly announce that he would immediately step down in the case of a negative referendum result—and President Barack Obama. A visit by the U.S. president could also make a difference: the U.S. clearly has an interest in the UK remaining firmly anchored in the EU and President Obama will say so during his April visit to London. As regards the popular press, the U.S. president’s visit is a powerful multiplier for the pro-EU camp. The invisibility of EU Commission President Jean-Claude Juncker in the campaign is a shame: a Commission president who is unwilling to defend the integrity of the Community should not remain at the top of the European Commission.
Prof. Dr. Paul J.J. Welfens is Jean Monnet Professor for European Economic Integration; chair for Macroeconomics; president of the European Institute for International Economic Relations (EIIW) at the University of Wuppertal; Alfred Grosser Professorship 2007/08, Sciences Po, Paris; Research Fellow, IZA, Bonn; and a Non-Resident Fellow at AGI/Johns Hopkins University, Washington DC.
This article was updated on 8 April 2016.