Allgemein, Economics, European integration, International Market Dynamics, New Political Economy

After the BREXIT referendum: Europe seeking a new orientation?


European Institute for International Economic Relations

Prof. Dr. Paul JJ Welfens, Präsident des Europäischen Instituts für internationale Wirtschaftsbeziehungen (EIIW) an der Bergischen Universität Wuppertal; Non-resident Senior Research Fellow at AICGS/Johns Hopkins University; IZA Research Fellow, Bonn. Alfred Grosser Professorship 2007/08, Sciences Po

EIIW, Rainer Grünter Str. 21, D 42119 Wuppertal, Germany

Prof. Dr. Paul J.J. Welfens ©



After the BREXIT referendum: Europe seeking a new orientation?

The BREXIT referendum has witnessed narrow opinion poll results in the months prior to June 23rd – with the implied probability of a vote for leaving from betting firms lying below 45% a week before the referendum. The survey results have the weakness of having been confined to the UK so that the about 1.2 million British citizens living in other EU countries – obviously mostly in favor of remaining in the EU – are not included. The leave-position was thus overstated in the survey results of the UK. It should also be noted that a critical weight is assigned to the roughly 400 000 Irish residents in the UK that are eligible for voting in the BREXIT referendum. The tragic attack against Labour MP Mrs. Jo Cox is likely to finally tip the referendum for a No BREXIT majority.

As regards the result of the BREXIT referendum – the second EU referendum in the UK (the first was in 1975: 2/3 majority in favor of EU membership) – it will have a decisive impact on the UK and indeed the EU integration process. If the UK should leave the EU, the British economy will face massive depreciation of the pound and possibly a recession while the European Union would lose a heavyweight liberal member country which accounts for 18% of the EU’s gross domestic product, 12% of trade and 13% of the EU population. As the theory of regional economic integration shows, both country I and country II will benefit – in a two-country model; if now instead an existing regional integration club, namely the EU, is losing a key member, there will be economic welfare losses and transitorily or permanently lower output growth in the UK and in the EU27; by implication there will be a nominal and real depreciation of both the British Pound and the Euro (and other currencies of continental EU members which are not in the Euro area).

Secondly, major current international negotiations of the EU would face serious problems. For example, the TTIP project would probably be dead in the water as the German government has not been able to garner broad support for TTIP and the German industry’s campaign is also rather poor while anti-TTIP supporters from many environmental pressure groups have gained an upper hand in the public debate in 2015: Surprisingly, the EU country that is to gain most (relative to GDP) – along with the UK and Ireland – and has a large current account surplus-GDP ratio has not managed to establish a clear public majority in favor of TTIP. As regards the national government of France, that has many problems including a big long-standing current account deficit, it is also largely skeptical about TTIP; a position that is likely, however, to change if a conservative government would come to power in 2017. If the UK would leave the EU, one may thus argue that TTIP is unlikely. According to recent analysis by the European Institute for International Economic Relations at the University of Wuppertal, TTIP will bring about a 2% rise of Germany’s real GDP, mainly through innovation and FDI plus trade effects, and for the EU as a whole a similar order of magnitude would be missing without TTIP. A negative side-effect would thus be that the Brisbane promise of the G20 summit in 2014, according to which GDP should be raised by a least 2.1% relative to the business-as-usual benchmark development, could not be fulfilled by most of the big EU countries until 2018.

The EU’s capital market union will also be undermined if the UK should leave – knowing that the responsible Commissioner from the UK, Mr. Hill, is a lame duck will largely bury many EU financial market integration and modernization initiatives. It is also clear that the envisaged merger of the Frankfurt Stock Exchange and the London Stock Exchange will not take place in the case of BREXIT. All EU countries will take some time to sort out the mess that would be the consequence of BREXIT – beyond a decline of output in the UK. A major problem in the medium term would be the situation of some 600 000 Irish people living in the UK; once the UK is no longer an EU member country, say after 2018, many Irish citizens might want to leave the UK. Even worse, the easy daily travelling between Northern Ireland and the Irish Republic is likely to end and a new (old) border regime could even endanger the peace process in Ireland.

For the British universities, cooperation with EU universities will become rather complex and the UK is likely to seek more cooperation with the US in this situation. Rather difficult will also be the situation of about 1.2 million British citizens working in EU countries and of the roughly 3 million EU citizens working in the UK. Mr. Cameron would have to step down and Mr. Boris Johnson is likely to become the new British prime minister, but he would not be really welcome in EU countries after BREXIT. Several other EU countries are likely to also consider leaving the EU: Denmark and the Netherlands are two obvious cases and one should also not underestimate the risk that even France and Germany could start moving out of the EU. The political and economic prospects would be a disaster. More protectionism, less growth and more political instability and also political radicalization on the EU continent may be expected. Sooner or later the Western European countries will face a kind of 1910 situation in which the leading powers devote 4% of GDP for defense and this would be twice the share of GDP to devoted to defense in 2015. For Germany it would be almost 4 times as much. Higher income tax rates and lower growth again would be the economic price. Russia, facing an EU in disarray, will sooner or later start to become more aggressive again in the Ukraine and other parts of Eastern Europe. NATO could be the next victim of an EU in disarray. The US could come under pressure to seek broad compromise with China once the EU is no longer a stable partner and NATO looks like an unstable group. For Turkey, an EU in disarray will certainly reinforce those groups in Ankara seeking to establish a stronger regional role of Turkey in part of the former Soviet Union and this in turn will reinforce the risk of potential conflicts between Turkey and Russia.

The EU after a BREXIT would soon witness a much more protectionist economic policy since Germany’s traditional ally – along with Denmark and the Netherlands -, namely the UK, would no longer be on board. After a few years the UK might have regained, at a high price, including high net contributions to the EU without much say in Brussels, access to the EU single market. These uncertainties and technical problems will all undermine transitorily the EU growth.

While the UK citizens would henceforth save 80 pounds per year in net contributions to the EU, the net cost of BREXIT for the average UK citizen would be much higher. About 5% of GDP losses in both the UK and the EU27 over a decade or so could be the medium term costs in Europe. There will be an additional cost outside the EU, since EU disintegration is a sure recipe to stimulate disintegration in other parts of the world economy: ASEAN which just had started in 2015 an ASEAN single market modeled on the EU single market could come under pressure, as could MERCOSUR which already faces the disaster case of Venezuela in its own right since 2015. Other regional integration clubs in Africa and parts of the Arab world could also fall victim to BREXIT dynamics. The negative global economic effects would add up to a strong temporary decline of global output, more regional conflicts, stronger incentives to emigrate to the UK (the US and other countries) – certainly not what the BREXITEERs had anticipated or wished.

If the UK should leave the EU, this would not only be a signal that British voters are not really willing to support EU economic integration – although the UK net contribution per capita is less than 70€ per year – but that there is a broader mistrust of the British public against the political elites: This is an attitude that clearly dates back to the Transatlantic Banking Crisis of 2007-09 which has shaken the peoples’ confidence in both the political system, financial market regulators and leaders of big banking business in the US, the UK and some EU countries. So if government in the US suggests that it is in the self-interest of the UK that the country should remain in the EU, many voters are not believing this, moreover, many voters wish to effectively punish the political elites for the banking crisis – leading to massive wealth losses, higher government debt-GDP ratios (implying higher future tax rates) and higher tuition fees plus lower federal government transfers to the cities – via a non-EU vote. In this respect it is pure coincidence that the UK election calendar has the EU vote on the agenda; no referendum could be won by government in the present situation. Mr. Cameron has made things worse by undermining his own credibility when he announced that he would limit immigration to 150 000 per year – the UK government under EU single market rules has no instrument to easily limit immigration from other EU countries; only social benefits for immigrants from the EU could have been cut slightly, but this is unlikely to have a big impact. Rather some limitations on immigration from non-EU countries could be imposed. It is absolutely unclear why Mr. Cameron has promised something that he cannot deliver and why at the same time the British Prime Minister failed to pick up the key results of Economics Immigration Research saying that the UK has a clear net economic benefit from immigration since immigrants are relatively young and since the immigrant entrepreneurship in the UK is considerable. The fact that the EU referendum came on the agenda at all is finally the mistake of the strange institutional setup of the European Union in the field of European Parliamentary elections and the very construction of the EU. Mr. Cameron likes to argue – imitating the rhetoric of UKIP’s leader Nigel Farage – that the EU is too big and too much money is spent in Brussels. This, however, is nonsense as the research by the renowned Forschungsgruppe Wahlen (Germany’s leading election think-tank) in has shown: As regards German voters, they can easily tell you what the critical topics and issues at the local, regional and national policy layer are and hence a roughly rational voting behavior at these policy layers may be expected.

However, when it comes to the EU, the standard answer of voters asked is “no idea” and the consequence is a broad willingness to experiment in voting, usually in favor of smaller and radical parties. What is found in Germany is also relevant in the UK (and in probably any other EU country as well) and the consequence has been that the radical and small UKIP party has flourished at EU elections and has been able to use financial support from the EU for the votes obtained to start a broad political campaign at the national level where UKIP ended with about 1/3rd of the voter share obtained at the EU level. If the EU had clear and larger responsibilities where it makes sense in accordance with fiscal federalism, the voter turnout at European elections would have been much higher and the propensity of the average voter to squander his/her vote by experimenting with radical small parties would have been sharply reduced.

Mr. Farage’s party would almost certainly not exist and Mr. Cameron would never have faced the challenge to call for a national EU referendum that effectively mirrored the strange and actually unnatural strength of UKIP in the UK. The principle of subsidiarity, according to which tasks that can be better solved by the national level should not go to Brussels is ok, but the interpretation of this philosophy and the actually stated principle in the EU Lisbon Treaty is absurd in London’s conservative leadership. What would make sense is an EU allocation of tasks and supranational government expenditures that would look similar to the case of the US at its federal level where 9% of GDP was spent in 2014 – plus an additional almost 11% on social security. The EU expenditures should be not 1% of GDP – reduced under the pressure of Cameron in previous years down from 1,25% – but about 4-5% where key fields would be: large infrastructure projects, electricity market integration, ICT innovation policy, defense and paying for the first six months of unemployment, except for youth unemployment, rates (here national governments have a strong responsibility through their often irresponsible minimum wage policy such as is the case in Belgium and foremost in France, which is roughly five times the size of the average US state but which has imposed a very high nationwide minimum wage which was close to 10 € in 2015 while government handed out heavy subsidies, about 1% of GDP, to firms employing workers with a minimum wage). It should be noted that nobody needs a Commission with a hybrid institutional nature of being partly an executive government and partly a legislative body taking most initiatives for new laws in the European Parliament. The EU Parliament should be massively strengthened and half of the EU structural funds should be abolished as they generate no economic benefits in the respective regions of the EU. A bigger supranational EU government and a more efficient vertical division of labor in the EU would bring efficiency gains of overall government and hence allow to cut tax rates by 1 percentage point at least.

The UK referendum does not stand so much for Yes or No with respect to EU membership but it is reflecting the depth of political confusion in Downing Street. After the collapse of socialist Eastern Europe, the West has at first celebrated in certain political quarters the end of history and thought that only further market economy expansion would be the natural answer to all challenges in the world; and secondly, that financial markets would stand for superb economic wisdom and rationality. The first hypothesis – the end of history debate started by Francis Fukushima in the US – is nonsense. As regards big banks in the US and the EU, the best that one could say about these institutions is that they were largely led by managers with irresponsibly excessive ambitions, namely a rate of return on equity of about 25% (instead of about 12-13% that would already be a great return for banks and insurance companies) that would be possible only with excessive risk-taking. Big banks have organized frauds, exchange rate rigging and interest rate manipulations in many cases and have paid more than € 300 billion in damages and costs for out-of-court settlements, suggesting that this industry has not been properly regulated in the US and the EU for at least a decade. Hardly any of the, often foolish, directors of the incompetent prudential supervisors was held responsible by losing their jobs or sentenced in court – look at the UK, Ireland, Germany and the US.

This has ultimately created the impression that politicians cannot regulate big banks. Not only is this true, the IMF’s ability to come up with a consistent financial sector assessment programme (FSAP) has been poor in critical cases: The FSAP on Switzerland was totally wrong – saying prior to the Transatlantic Banking Crisis that UBS was in excellent shape while there were problems with Credit Suisse (in fact it was UBS that after 2008 faced the biggest financial loss in Swiss history and had to be rescued by the central bank); in the case of Ireland, the IMF published in mid-2006 an FSAP that argued that the banking system was fine, there were only problems in re-insurance – this report was ridiculous and to-date no consequences have been imposed due to these massive misreporting and misleading analyses. That the IMF did not dare to publish any FSAP analysis on the US was the biggest mistake, although one may argue that the US President George Bush Jr. prevented such a report from being published. However, the IMF should have written at least an internal FSAP on the US. It was the IMF and the western world that had argued in the aftermath of the Asian crisis that an FSAP would be necessary and helpful as a new regular instrument to avoid major regional financial crises in the future. As regards the Russian economic crisis of 1998, it was the IMF itself whose inadequate policy advice contributed massively to this economic disaster – the IMF suggestion had been to introduce fixed exchange rates in a country where the optimum currency area literature (decades old) would never have come with such a proposal for a country in which about 60% of export revenue was generated from just one sector, namely energy. The responsible head of the IMF’s Europe II department, Mr. Odlin Smeh, sent to Washington DC by the British government, never faced any consequences for his irresponsible strategy. This simply adds up to the finding that the western world’s biggest international organization is partly not contributing to more international prosperity and stability, rather occasionally, it actually destabilizes parts of the world economy.

The lack of parliamentary accountability of international organizations, such as the IMF, the WTO, the BIS and so on, is part and parcel of globalization risk and a creates a considerable risk of massive stabilization crises (having said this, one should not overlook that probably most standard working fields of the IMF deserve high respect and that its chief economist, Ragurham Rajan, gave a great presentation at the international central bankers’ Jackson Hole meeting in 2005, where he warned about the inadequate institutional framework of financial globalization and modern securitization, respectively). However, the majority of the western central bankers in Jackson Hole did not want to listen to this careful and excellent analysis. The list of the leading western central bankers at that time thus cannot stand for a high intellectual understanding of transatlantic banking; or to put it differently, the system that western governments have allowed to emerge in the 25 years after 1991 – the year of the end of the Soviet Union – is too complex for leading western central bankers to understand. Should the consequence not be to build a new system which is much less complex, creates less negative international external effects and carefully contributes more to prosperity and stability in the world economy? The fact that big banks can escape the identification of irresponsible and illegal management practices by resorting to out-of-court settlements on a super-large scale in the US and the EU is also not contributing to building a broader sense of responsibility and thus to nurture the reputation of institutions and the stable trust of voters in politicians. The rise of western right-wing populist parties and candidates after the Transatlantic Banking Crisis clearly testifies to this.

If BREXIT would come and be followed by US presidential elections won by Mr. Trump, the end of the post-1945 world would be seen. If populist parties would start to dominate the political process in the US and the UK, new uncertainties would undermine transatlantic economic growth and new rivalries would emerge among OECD countries.

If BREXIT can be avoided – a likely outcome -, the EU has some breathing space to reconsider all major issues, topics and problems. If no major reforms are adopted, the next BREXIT initiative will come soon – and if not in the UK a similar initiative could pop up elsewhere. Obviously, the European Commission and the European Parliament must come up with new ideas to make regional integration in Europe more attractive and EU policy far more consistent. A political euro union should be considered carefully.




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