Allgemein, BREXIT, Economic Forecasting, Economics, European integration, International Market Dynamics, New Political Economy, US

BREXIT: European Instability, a New Beginning Required for the European Union

 

Prof. Dr. Paul JJ Welfens, President of the European Institute for International Economic Relations (EIIW) at the University of Wuppertal; Non-resident Senior Research Fellow at AICGS/Johns Hopkins University; IZA Research Fellow, Bonn. Alfred Grosser Professorship 2007/08, Sciences Po (www.eiiw.eu) welfens@eiiw.uni-wuppertal.de

2015 = 20 Years EIIW/prize-winning analyses, worldwide network

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July 2, 2016, Brexit Referendum – UK goes, without reform and fresh ideas the EU is not fit for purpose going forward

 

 

40 years after the first Yes in a British EU-referendum – which took place in 1975 and resulted in a clear 2/3rds majority for membership – the Brexit-Referendum of June 23rd has concluded with a slight majority in favor of leaving the EU. Above all, older British voters opposed EU-integration, showing an inclination towards neo-nationalism which will now increase in other EU countries. Cameron’s resignation in the wake of the result is the logical conclusion, but it will be followed by massive devaluation of Sterling, inflation and recession in the United Kingdom and, within the next circa two years and following negotiations, the UK exiting the EU. As the EU will lose 13% of its population, 12% of exports and 18% of its Gross Domestic Product, the Eurozone must also count on a depreciation of the Euro – apart from against the Pound – and possibly also with a recession. Disintegration of the EU is now a fact, and if other countries should follow, its very existence is in danger. Political instability and a loss in growth are already foreseeable.

Furthermore, right-wing populism in many EU countries – and in the US – will continue to grow, with the BREXIT result, one can see the enormous frustration on the side of voters being aimed at the political elites: If the Britons had voted on doing away with zebra crossings – and Cameron had campaigned for keeping them – then it is likely an angry majority of voters would vote for their abolition; not the smart decisions, even a dangerous one, but emotionally the right one and the electorate are emotionally-driven actors.

The European Commission is also a big loser of this outcome, above all the silent Commission President Juncker, who during the run up to this historic moment did not have the courage to hold a pro-EU speech in London. That kind of weak political leadership in Brussels will be voted out sooner or later: A Commission boss who cannot engage in the debate with a speech in support of Remain such as that of Obama is not credible nor effective and certainly not a leadership figure. Juncker will go down in history as the Commission President who presided over the UK’s exit. That Juncker did not make a state visit to the US during his first year in office has also been noticed in circles beyond the White House. That is a policy-failure on the side of the EU.

The primary institutions of the EU are the European Commission, the European Parliament and the European Council – the coming together of heads of state and government in Brussels but also in power domestically in the member states. Political leadership in many EU countries is by and large incapable of self-criticism; this also applies in the case of Germany. That is not a solid basis for rational and prudent EU reforms which could, and indeed must, help to stabilize the EU and Eurozone, respectively. The terrible impression created by the Eurozone and indeed the crisis management of the EU during the Greek- and Euro-crises have seriously damaged the reputation of, and respect for, the European Union in the United Kingdom. From that perspective, BREXIT is the result of inadequate and unsatisfactory policies in the Eurozone: evidenced by years of weak regulatory enforcement and bad crisis management. However, nobody in the EU is willing to accept the responsibility for these shortcomings. The EU urgently requires reforms and a solution to the Greek crisis – including a pragmatically conditional debt-relief or haircut for Greece, which will help the country towards growth. The German position, which refuses to endorse an economically and legally (according to information from leading jurists from respected universities) sound and reasonable relief of debt, is completely irresponsible, not to mention a political mistake. If a new institutional solution, better than the current arrangement, cannot be achieved, then the EU will collapse in the face of new conflicts regarding the Euro which are constantly threatening. That the new President of the Commission wants to portray his constant bending of the rules regarding the deficit ratio as being politically intelligent is regrettable and also not very convincing. With BREXIT, the interest rate differentials within the Eurozone will become larger – there will be higher rates for Spain, Portugal, Italy and Greece – as all future crises will take place in the economic area of the EU27 which has been reduced and weakened by 18% economically. The flight of investors to high quality bonds in the wake of BREXIT will benefit Germany even more; while the UK could, for a time, appear to be doing well – until a new referendum on Scottish independence takes place.

The Eurozone will only be capable of functioning when the majority of Eurozone countries, including all the large countries, are obligated, under their national constitutions, to observe a sound debt-brake. Should a small number of small member states should refuse to implement such a rule, they would, in the event of a future crisis, naturally be candidates for insolvency and bankruptcy and if could foresee that at very most only a handful of small member states could present a problem, then the Eurozone as a whole would remain credible and a model of success in the slipstream of a sound monetary policy from the European Central Bank. Here, a speedy normalization of monetary policy is important, without reforms in the Eurozone or EU, respectively, these reforms will not be implemented.

BREXIT can cause problems for the EU in any number of ways: If the United Kingdom, as the second largest net contributor, should leave, then net recipients will worry about their precarious position – that will lead to political tension and conflict, above all in Eastern Europe. Thus, the United Kingdom has caused problems for the EU in two ways: A number of years ago the British government was responsible for forcing a reduction in the EU budget from 1.2% of EU GDP down to just 1%. That was completely inappropriate, as the EU, representing only 1/9th of the public consumption at a federal level in Washington DC, is inadequately equipped. The UK leaving the EU makes these budgetary problems even worse. The EU has, in the absence of smart principles, for years been pushed into undesirable fiscal and political developments by London – and then the UK leaves the Union.

That is an absurd situation and this foolish self-denial of the European Union cannot continue. To ignore the logic behind fiscal federalism is an economic mistake and always will be. At least one can hope that the European finance center will stay in the Eurozone; London, as a financial center, will lose above all US investors. Frankfurt and Paris have the chance to profit from this development; but naturally only if the Eurozone remains stable: With the current institutional framework, that stability cannot be guaranteed.

Moreover, there will no merger of the stock exchanges in London and Frankfurt: This will not happen due to the depreciation of the Pound, and will definitely not happen due to BREXIT. A London-Frankfurt joint exchange as the primary actor in the Eurozone, but subject to regulation under British policy would be nonsensical. Without further developments this fusion is not desirable in any event. The single capital market within the EU is in danger, as are, naturally, the liberal foundation of the Union’s economic policies and as a result its prosperity and stability. With the stepping down of Lord Hill, EU Commissioner for Financial Stability, Financial Services and the Capital Markets Union, in the direct aftermath of the BREXIT referendum, the UK has lost some of its power in Brussels. The claim of Leave campaigners, that the UK would have more influence without EU membership is wishful thinking to the greatest possible extent. With the UK withdrawing thousands of staff upon exiting the EU, in for example 2018, the Commission will also lose competence.

From the point of view of democracy, it is indeed problematic that the EU has a European Commission which not only takes on the role of a supranational government (executive organ) but also that of the legislator (legislative organ) – with some supplementary powers vested in the European Parliament. In this regard, the pro-BREXIT EU-critics have a point, that in the EU laws are made from the top down, passed down from the Commission to be applied in all EU member states with little legitimacy. This would change with an EU political union, then there would be an EU Parliament, an EU government, EU tax and also EU sovereign bonds; if this could be combined with a sound reform package, then the entire tax burden of national and supranational (Brussels) taxes would be less than before, due to the added efficiencies as a result of smarter vertical distribution of tasks and public expenditure.

From a German point of view, a heavyweight political partner will be lost when London leaves the EU – furthermore, that the Chancellor involved herself little in the BREXIT issue over the last year or so, will be seen as a political failure in Berlin. The United Kingdom, Germany, the Netherlands and Denmark, as the four traditionally liberal countries soon will no longer constitute a single bloc – and at least 35% of the population – to stand against economic dirigisme in the EU. Denmark could indeed follow the UK as the next country to exit the EU. If the number of countries seeking the exit should increase, the EU would rapidly collapse. It is now all the more important, that the EU itself undertakes a rigorous testing of its functions. As the pro-BREXIT campaigner, and Secretary of State for Justice, Michael Gove has said, there are far too man nonsensical and petty EU regulations. The EU should in future not occupy itself with many minor issues, and instead lay the large cornerstones of major policies – also by means of a much larger EU budget than before, whereby the national public expenditure will rise. The EU accession of Turkey is also now off the table, as the fear that ruling politicians have of populists will not shape the coming years of negotiations by national governments, in Germany the threat of AfD expansion threatens ruling parties.

In addition, the vote represents a level of revenge for the weak image with the EU portrayed during the Euro and Refugee Crises – for that, Chancellor Merkel must should some of the blame for British, and indeed worldwide, perception that the EU is an integration club without a sustainable order and carefully considered crisis management. The United Kingdom itself could disintegrate: The next independence referendum in Scotland is fast approaching and could this time get a majority in favor, the pro-EU referendum results in Scotland could indicate the future accession to the EU of almost 5 million Scots. The European Union is destabilized politically, which costs growth and brings with it higher interest rates. The topic of financial safe-havens is once again on the agenda, Switzerland will shows a very high appreciation of its currency and the price of gold will climb. The potential victims of BREXIT include the TTIP project, the planned transatlantic free-trade agreement between the EU and US, as one could expect that without British support in the European Union, the weak pro-TTIP campaign Germany would not get majority support. France represents a huge source of danger, the election of the leader of the Front National, Marine Le Pen, would sound the death knell for the EU.

Europe is threatened by a return to the 19th century. Should the EU collapse, Germany would be left with good institutions but rudderless – and facing the pressure of AfD populism. As from an economic point of view, large EU countries would be instable in the event of EU disintegration, the stability of Europe could be weakened, economically, politically and militarily. The leading powers in Europe at the end of the 19th century spent 4% of GDP on defense, a situation large European countries could return to. With BREXIT the EU is weakened, and with it NATO too – and a large silent winner on the margin of this debate is Russia’s Putin. All of the above is not in the interests of the people in the EU, nevertheless the UK has taken this historic step, which can be regarded as a major error; the ability to reach rational decisions appears, in the context of BREXIT, appears to be greatly reduced in the United Kingdom. One could also argue that an emotional “plus”, from the point of view of the feeling of neo-nationalism supported by the Leave camp, has overtaken the clearly recognizable economic “minus” as a result of BREXIT:

What developments can one expect going forward, what will happen in the UK, what reforms does the EU require? It is questionable what a BREXIT majority will bring forth: Is the €80 net per capita contribution to the EU too large, and under 150,000 immigrants per year from EU member states for a country of 65 million inhabitants too many? Hardly. It is obvious that certain EU regulations are annoying for the economy and that the EU did not present itself in the best light during the Euro Crisis; not to mention the Refugee Crisis. However, in truth the BREXIT referendum was only partly about EU-related issues. Above all, the population wanted to show the political establishment in London a red card and thereby to make a huge smoldering trust conflict, apparent since the Banking Crisis, clear to the ruling political circles. The citizens hardly want to accept the advice of the government in the United Kingdom at face value. The disenchantment and disillusionment brought about by the Banking Crisis between 2007 and 2009, with its huge losses in terms of jobs and wealth, the following massive increase in the state’s deficit and a raising of the national debt by 30% and the doubling of University fees to increase income in the state coffers. At the same time, the public were becoming aware of the massive incomes of the, often incompetent, managers of some large banks; a top banker even dodged the fares of his commute to work by rail for years. The reputation of the British political elites, who created the false framework for the finance markets and banks, respectively, has been massively impaired.

That Prime Minister Cameron promised that he would limit immigration to 100,000 was the biggest erroneous claim by the head of government in London, as the foundations of the EU’s internal single market make clear that free movement of persons cannot be restricted. Why Cameron promised things, which he could not deliver based on the institutional makeup of the EU, is incomprehensible and illustrative of a lack of political professionalism. The British government wanted the freedoms of the Single Market for many years and in 1985 also signed the Single European Act (the single market started at the beginning of 1993).

A broad feeling of being disenfranchised and undesirable developments combined to create the perfect storm, for which a majority of UK voters held the British government responsible. That also applies to the growth in income of the Top 1% of earners in the UK, which between 1990 and 2010 was circa 8%, almost as large as the increase in America where the Top 1% now account for a further 10% of income. The real incomes of the average earners – marking the point on the trend line between the top half of earners and the poorer bottom 50% – have reduced in the USA between 1999 and 2012, in parts of Great Britain too. The EU Commission faces the challenge of tabling a reform package; to set the stage for a move towards political union. Less bureaucracy, but more cooperation with a larger EU budget: For infrastructure, defense and promoting innovation. With the UK now no longer being a brake on progress, the first steps towards a political union are conceivable.

An EU which would seek to simply carry on just as before as a smaller community would disintegrate piece by piece. A large European debate on the future of the EU is required; if that does not happen or if such a debate would not being convincing results on integration then the EU will, within decades, become ever small and ever more instable through other member states leaving – lacking leadership and hampered by conflict, the EU would, by 2025, become insignificant on the world stage. If the EU disintegrates, that would be a disaster for Europe; other integration projects around the world could also descend into conflict – threatening more military conflicts and lower economic growth. Following a collapse of the EU, member states would be increasingly dependent on the United States, China and also on Russia, the 21st century would be an era shaped by non-European powers. Disintegration phases – whether one considers the Hapsburg Monarchy following the First World War or indeed BREXIT – are always periods of slower growth and high trade protectionism, the latter having a causal relationship to the former. BREXIT weakens the UK and the EU for about a decade, also in terms of growth. The largest EU member countries had promised at the G20 summit in Brisbane in 2014, to realize an additional 2% in growth in real income between 2014 and 2018. In making this commitment Prime Minister Cameron obviously did not think that he was a shrewd national politician who was also not particularly sound.

The British process to exit the EU should, from an EU point of view, be organized quickly, however, nobody is likely to believe that such a weak Commission will perform particularly well against a professional British diplomatic corps. The disintegration process, which currently threatens, has foreseeable risky regions: Parts of Eastern Europe, which could fall again under Russian influence, Germany could seek to create its own sphere of influence – a new Central Europe; and would that not be a return to the 19th century. There is also the insights of the Forschungsgruppe-Wahlen-Analyse to be considered, namely that the current EU, with its 1% mini-budget, is not noticeable for the voters; this is opposed to the situation regarding the relevant themes for elections to the Bundestag (German federal parliament) or to the regional governments – and therefore in European elections voters in Germany tend to vote impulsively for small, radical parties. The same applies to British voters. One need only consider: According to CNN, the day after the BREXIT referendum, the second most common BREXIT-related Google search in the UK was “What is the European Union?”. Former German Chancellor Schröder once said: In European elections a governing party cannot win votes using European issues; meaning that even when one has good policies, because of the confusion surrounding EU political issues, in the voting booth decision-making via EU ballot papers boils down to the voter extracting some delight in ‘punishing’ national politicians – and that is absurd. Only in a political union with more EU power would there be increased political competition in Brussels, which would only benefit the efficiency of the hereto often weak EU policies.

The level of anger of many voters feel towards the political establishment is extremely high, as can be seen from the BREXIT vote, during which dozens of economists and over 1,000 business leaders and managers from large firms in contributions and advertisements in the Times clearly warned of the negative economic consequences of BREXIT. If the contra-BREXIT comments were coming from bankers, most readers, already annoyed at bankers over the Banking Crisis, did not take them seriously. Nevertheless, half of the Conservative Party and the majority of the Labour MPs in the United Kingdom were against BREXIT. Despite that, the majority of voters decided otherwise; and that is illustrative not only of displeasure with the political establishment but also of a criticism of globalization, which the politicians did not take seriously enough. More globalization works only with sensible accompanying measures and with a sound individualized better innovation and economic policy: at a regional, national and supranational level.

The rationality of political decisions in western countries and in particular in the EU has, as the BREXIT case shows, weakened. The simple solution would be to quickly create a visible EU political union by means of the infrastructure and defense expenditures transferred to Brussels, as well as a certain amount of income redistribution directly to relatively poorer households. Some liberals shout down such ideas with cries about the principle of subsidiarity, despite the fact that the principle is being misinterpreted in this instance. In the US the federal level in Washington DC stands for 9% of public expenditure and a further 11% in social expenditures. If the EU would first achieve spending of 4-5%, that would be a sensible and in keeping with the economic theory of fiscal federalism, which seeks to explain at which political level various categories of expenditure should be based. A lack of political innovation and the stubborn cultivation of mental blocks in Berlin are no less to blame for the bad situation at the EU than the subtle excuses on the part of France and Span, which is why they have not been able to reduce the deficits more over the years; not to mention the political sacred cow in Greece – an allergy to privatization. If the shock of BREXIT does not make the EU countries of continental Europe regroup, reconsider and quick to undertake large reforms, the European Union will fail.

The threat of populism is still reasonably small on the continent, if it should grow then the EU could disintegrate into a number of half-autocratic systems and a group of democracies. The laziness of democratic national political parties not to found real EU-wide organized parties, is also a part of the problems of the EU/Eurozone problems. In the US, a deficit fraud such as occurred in Greece in 2009 could not happen, because 49 of the 50 US states have a ban on structural deficits in their respective state constitutions; and should a US governor ever have the crazy idea to buy an election victory with a 15% budget deficit, s/he would not be stopped by the voters but simply following a telephone call from the chair of their respective party – Democrat or Republican – sent to the political wilderness. These institutional details and the historical experience, that the federal government, in the event of a debt crises in seven states, did not provide the help requested, is the basis for the relatively stable US structure. The EU member states (or at least a large majority of the Eurozone countries) must now gradually consider if they cannot within the next decade, by 2026, 250 years after the independence of the US, have achieved reaching even half the political structures of the US.

In international power games, the winners are US, Russia – thanks to a weakened NATO and smaller EU – and China, which from a weakened EU will achieve benefits in terms of easier concessions in many policy fields than would have been possible from the EU28. That these points were thoughtlessly and carelessly overlooked in the BREXIT debate will surely give many voters pause for thought one day. Within the EU, the leading countries are damaged, including Poland, the EU could experience problems with financing, transfers and funding cuts in the future and the pressure from Russia will be increased. BREXIT is the largest self-inflicted damage in the West since 1945. Only with the passage of time will the true impact of the decision be recognizable.

That David Cameron will go down in the history books as one of Europe’s a not very clever leaders is already almost guaranteed. It remains to be seen if the United Kingdom can, from 2018, follow a Norway-EU model or Swiss-EU model, under which the UK would have access to the single market; but at the price of quasi-normal contribution payments. That will have to be dealt with by a new Prime Minister from autumn 2016. The UK, with almost 50% of their exports going to EU partner countries, urgently needs that access. Boris Johnson, the former mayor of London, who got involved in the campaign against Cameron, i.e. for a BREXIT, will not become the new leader of the Conservative Party (and Prime Minister). As a man he is full of contradictions, the grandfather of Boris Johnson, who spoke repeatedly about immigration during the BREXIT campaign, was himself part of the history of immigration to the UK having fled Turkey for London.

With the UK, the EU should strive for a reasonable separation and a sound new relationship, however no softly-softly approach or conditions should be applied. The UK will, after this politically extraordinary development, surely expect little concessions and goodwill from the side of the EU; the most important would be quasi-integration with younger generations – students, young researchers and scientists, could, on the basis of the well-known breakdown of BREXIT voting patterns represent a good bridge between London and the continent. From that starting point, there may one day be the possibility of re-integration or reunification in Europe. Furthermore, it is crucial that no new conflict, i.e. a reigniting of the previous conflict, emerges in Ireland. This is now a threat after BREXIT, if the border between Northern Ireland and the Republic of Ireland can no longer be crossed with ease. A new EU-integration initiative would be important not just for Europe but for many similar integration projects around the globe who might now appear insecure. That a majority in the Great British nation, in a democratic referendum, reached such a decision on BREXIT, which will seriously damage themselves and many others, needs to be considered carefully; in the end it shows that the price of the banking crisis and the forerunning inadequate banking regulation will be enormous. In the USA, a Trump victory in the presidential election or even a strong result for Trump threatens to also replace rational policymaking with neo-nationalism.

A strange element of the British government’s anti-BREXIT campaign is the incomplete information about the EU single market. In a short film on the website www.EUgovernment.gov.uk it is indicated that the single market brings only duty free access to the EU partner countries’ markets; there is not a single word on the fact that the single market also means free labor mobility. Never in (political) life can one win a great cause without telling the truth and those who conceal important elements of the truth will get in trouble sooner or later.

The economic cost of BREXIT will be rather large: A fall of UK output of 5-6% in the long run and a short run recession (in 2017) and an additional long run fall of output of EU countries by about 1% from BREXIT plus the non-realization of TTIP – the envisaged EU-US free trade and investment liberalization treaty has become quite unlikely since without the UK there is no longer a strong supporting group of EU countries in favor of TTIP. The French Prime Minister Valls has indicated only a few days after the referendum that France no longer considers TTIP to be an adequate project, the German government – which, in trade issues, has been a traditional partner of Denmark, the Netherlands and the UK – is quite hesitant in the field of TTIP. Since TTIP could bring about a rise of the real gross domestic product of about 2 percent in the EU (see the analysis by Jungmittag/Welfens – http://www.eiiw.eu/fileadmin/eiiw/Daten/Publikationen/Gelbe_Reihe/disbei212.pdf) and also of about 2 percent in the USA, non-TTIP is equivalent to a loss of output of about 1% for the world economy. Rarely in history has a referendum caused such political chaos in the referendum country and simultaneously massive international economic damage as the British BREXIT referendum has done.

Many critics of the EU argue that less EU integration would be an adequate answer to the BREXIT. While it is true that less regulatory intervention of the EU would often be useful, it is also clear that the theory of Fiscal Federalism suggests that one should indeed assign certain policy fields to the highest vertical policy layer – the federal government in Washington DC in the case of the US; and the supranational government in Brussels in the case of the EU. While after the BREXIT shock few governments/parliaments in EU countries seem willing to endorse a political union, it is only a question of time until this issue will be on the political agenda. Failure to adopt a political union will bring about a disintegration spiral in the EU and political and economic instability for the whole of Europe. If the EU disintegrates, it will only be a question of time until NATO faces disintegration. From EU and US perspectives, there is every reason to consider BREXIT as a dangerous political development in the UK and Europe, respectively. The fact that a day after the BREXIT referendum “what is the EU?” was the second most popular BREXIT-related question on Google in the UK suggests that the degree of information about the consequences of BREXIT was quite poor. A second referendum in the UK should not be excluded and indeed the British minister of health has suggested this hardly a week after the BREXIT referendum. In Ireland, with its history of rather frequent referenda, there is a Referendum Commission – composed of independent experts – that serves as a source of reliable information for citizens (http://www.refcom.ie/en/). Unfortunately, no such institution exists in the UK and the range of nonsense statements on BREXIT in British politics thus was rather broad: For example, a slogan carried on Mr. Boris Johnson’s campaign bus claimed that the UK pays 350 million pounds per week as a contribution payment to Brussels while in reality the net payment is only about ½ this amount. It is also noteworthy that Mr. Arron Banks – a British multimillionaire supporting BREXIT – has explained that the Leave.eu BREXIT campaign relied partly on US campaigning and election experts who have helped creating the right BREXIT mood, while not really relying on facts. Note: The popular claim of Mr. Boris Johnson that a post-BREXIT UK could easily retain or get access to the EU single market is totally implausible; even limited access to the single market in a model similar to the EU-Norway deal or the EU-Switzerland deal implies that the UK would not only have to contribute to the EU budget but would have to accept the four freedoms of the EU single market as well, including the free movement of labor and thus EU immigration. The fact that the British conservative government has made a big fuss about some 150 000 immigrants from Eastern European countries during the BREXIT campaign – not to mention the populist and racist UKIP campaign – is a sign of political and intellectual weakness of the UK. In the days immediately after the BREXIT referendum racist incidents occurred in many parts of England. The weak leadership observed in the UK raises worries about that country and the stability of Europe. Some Western democracies run the risk of being considered by people in many countries of the world to no longer be examples for rational government, stability and prosperity. The next decade will be quite decisive for Europe and the whole western world.

 

PS: My BREXIT analysis for the AICGS/Johns Hopkins University, dated early April 2016, covered the important points

http://www.aicgs.org/issue/british-referendum-pains-and-the-eu-implications-of-brexit/

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