An Accidental Brexit – Key Insights Beyond the Snap Election

Paul J.J. Welfens

European Institute for International Economic Relations

Prof. Dr. Paul J.J. Welfens was a Geoeconomics Non-Resident Senior Fellow at AICGS. He was 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; and Research Fellow, IZA, Bonn.

 The British EU-referendum of 2016 resulted in a 51.9 percent majority in favor of Brexit. There are, however, serious doubts about whether this referendum was an orderly one. One can also raise the issue of why the anti-EU immigration rhetoric of both the Cameron and May governments was so misleading: They argued that immigration from the EU was a burden on the UK, despite the OECD having shown that immigrants stood, on average, for a net contribution to the UK budget of more than €3,000 per immigrant (figures that were known to the British government since 2014). David Cameron’s anti-EU immigration rhetoric—emphasized since 2013—was obviously a strategy to find a scapegoat for the massive cuts to transfers from central government to local communities (3.5 percent of national income within five years). These cuts were partly necessary to bring down the enormous deficits arising from the banking crisis of 2007-2009 (peaked at 11 percent of GDP).

The under-provision of local services was, in fact, the consequence of Mr. Cameron’s own reductions of budget transfers to local communities, but the irresponsible and misleading anti-immigration rhetoric became a key element in the debate about the EU referendum. From this perspective, the Transatlantic Banking Crisis is one driver of Brexit. The biggest pitfall of Cameron’s government was the omission of the key finding from the Treasury study on the long-term benefits of British EU membership in the sixteen-page referendum information brochure sent to all households. That key finding was a 10 percent income gain from EU membership and hence, for the case of Brexit, a 10 percent decline of income (6 percent as a long-term income reduction from Brexit, assuming limited UK access to the EU single market in the future, and another 4 percent from the non-realization of the benefits of EU single market deepening in the fields of electricity and information and communication technology and services). Based on standard UK popularity functions (which show the link between real income growth and government popularity), one can calculate that had households had prior knowledge about the risk of a 10 percent income reduction, the referendum result would have been 52 percent in favor of Remain—just the opposite of the result of June 23, 2016.

Thus one can only conclude that the legitimacy of the Brexit vote is very weak and, therefore, there is no basis for the hard Brexit that Theresa May has emphasized since she succeeded Cameron in the office of Prime Minister. Cameron was disappointed that a majority of the electorate had not followed his recommendation for a vote for Remain at the EU referendum and he became a victim of his own political speculation that originally was primarily aimed at bringing down the anti-EU group within the Conservative Party. May not only supported Cameron’s anti-EU immigration rhetoric for years, in her White Paper of February 2017 she even published a chapter titled “Controlling Immigration” in which she repeated the conjecture about the decade-long overburden caused by EU immigration while showing a graph that clearly indicates that non-EU immigration was a more significant issue than EU immigration. What is the logic of leaving the EU when EU immigrants are net contributors to the UK budget, represent an annual population growth of just 0.3 percent, and indeed have raised British GDP growth? A politically dishonest government usually cannot succeed.

For Germany, the UK is the third most important trading partner and therefore the results of the snap UK election in June 2017 are quite important, as are the unresolved issues concerning Brexit and future UK-EU relations. With a minority British government in office in June 2017 a soft Brexit is expected. Prime Minister May’s policy of implementing a “Global Britain” strategy to generate higher growth through a series of free trade arrangements is quite doubtful and the negative medium-term consequences of Brexit are indeed considerable for both the UK and Germany/EU27, as well as the U.S. The British interest in a broad free trade strategy is undermined by the weakening of the World Trade Organization, the Bank for International Settlements, and other international organizations by the Trump administration.

Facing lower growth rates, the British government is likely to implement new financial deregulation, along similar steps to that planned by the Trump administration. The consequence will be the next banking crisis that is likely to again negatively affect the whole Western world. Under flexible exchange rates there is a high likelihood that excessive deregulation of financial markets will take place and Europe might soon face not only a politico-economic crisis in the UK, but broader instabilities as well. The EU clearly needs broad reforms that would reinforce the benefits of EU membership; stabilization of the euro zone is urgently needed and constitutional reforms in Greece, the epicenter of the euro crisis, have thus far not even been considered although such reforms are crucial. Without such reforms, there is little hope that any new government in Athens will be able to restore growth, prosperity, confidence, and full employment to Greece. To achieve this is not only a challenge for Greece, but for all EU countries. The current EU is over-regulated on the one hand, but its budget is too small on the other hand. More infrastructure projects, defense, and the first six month of unemployment insurance should be financed in the future from Brussels, which needs to assume a bigger role—while the overall tax rate (cumulated over all government layers) should drop—so that voters at European elections can really understand the role of the European Union. Only then will political competition be reinforced in the EU. Since 2016, the Western world has been destabilized by the interaction of Brexit and Trump’s new policies. With the results of the 2017 British snap election, the policy of the UK is now reloaded with new contradictions and instabilities. By contrast Germany seems to be fairly stable in the EU.

To read more about Brexit, read the author’s new book: An Accidental Brexit: New EU and Transatlantic Economic Perspectives (out in August 2017).