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

Prof. Dr. Paul J.J. Welfens, President of the European Institute for International Economic Relations at the University of Wuppertal Jean Monnet Professor for European Economic Integration; Chair for Macroeconomics, (Rainer-Gruenter-Str. 21, D-42119 Wuppertal; +49 202 4391371), Alfred Grosser Professorship 2007/08, Sciences Po, Paris; Research Fellow, IZA, Bonn; Non-Resident Senior Fellow at AICGS/Johns Hopkins University, Washington

Prof. Dr. Paul J.J. Welfens, President of the European Institute for International Economic Relations at the University of Wuppertal Jean Monnet Professor for European Economic Integration; Chair for Macroeconomics, (Rainer-Gruenter-Str. 21, D-42119 Wuppertal; +49 202 4391371), Alfred Grosser Professorship 2007/08, Sciences Po, Paris; Research Fellow, IZA, Bonn; Non-Resident Senior Fellow at AICGS/Johns Hopkins University, Washington DC

Welfens has testified before the US Senate, the German Parliament, the European Parliament, the European Central Bank, the IMF, etc. Welfens is one of Europe’s leading economists and the author of An Accidental Brexit, London: Palgrave, September 2017

welfens@eiiw.uni-wuppertal.de , www.eiiw.eu

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Serious BREXIT-related Problems for the UK: Mystery surrounds the Suppression of Treasury Report Findings in Government Brochure

 

August 21, 2017

The British EU referendum of June 2016 resulted in a 51.9 percent majority in favor of Leave and Mrs. May, as the successor of the political loser David Cameron, has argued not only that she wants to implement BREXIT but that she will make a success of it. As her government’s White Paper on BREXIT (February 2017) argues in the Chapter Controlling Immigration, the UK had faced a high burden from EU immigration for more than a decade – while the accompanying graph actually indicates that it was non-EU immigration which was the real problem, at least in the sense that it clearly exceeded that from EU countries. The conjecture that EU immigration is a burden is in itself incorrect, as the OECD has shown that immigrants stand for a net contribution to the British budget. Given the fact that EU immigrants have a labor market participation rate that is higher than that of non-EU immigrants, and also higher than the British average, it is absolutely clear that their net contribution to the government budget of the UK is positive. Why is the May government presenting such a contradictory message?

One can certainly understand some of the criticism of the EU emanating from the UK, but the referendum of 2016 is a serious political pitfall since Mr. Cameron warned in the context of the Scottish Referendum of 2014 that every Scot would lose £1,400 Pounds in the case of independence, while in his 16-page information brochure sent to all households prior to the EU referendum in 2016 the same Mr. Cameron did not mention a single word about the Treasury Report’s (published April 18, 2016) main finding that BREXIT would bring a loss of £1,800 Pounds per capita considering the medium scenario on future British access to the EU single market. Using standard UK popularity functions to simulate the result of a correct referendum campaign, in which the Cameron information brochure would have included the Treasury Report’s 10% income loss as an expected BREXIT effect, the result would actually have been 52% for Remain.

The UK’s National Audit Office has argued in a note of 2017 that the Treasury study was rather extreme in its BREXIT analysis; the Treasury Report had argued that there will be a 6% income loss from weaker EU single market access in the future and an additional 4% income loss stemming from the UK’s non-participation in the agreed EU single market deepening that the Cameron government’s negotiations with the European Commission had envisaged. One may, however, argue that the Treasury Study’s analysis is rather close to the real damage to be expected and that the negative economic fallout from the BREXIT could be even bigger than 10%. Incidentally, it is quite strange that the mailing of the 16-page government information brochure on the EU referendum took place in England April 11/12, 2016, while the Treasury Study was published a week later – all key findings of that Study were, however, already known in government circles in early April 2016.

The British Pound has experienced a 15% devaluation in the year since the EU referendum and this has three crucial implications: (1) there will be a rise of the inflation rate to about 3% in late 2017, much higher than was anticipated by observers in 2016. The rather weak British trade unions will hardly be able to obtain full compensation for this loss of purchasing power in the medium term, (2) the UK’s political leverage at the international negotiation table is weakened by roughly 15% since this is the loss of the British share in world gross domestic product (GDP) within a year, (3) the strong devaluation will bring about a rise of cumulated inward FDI which stood at 27% of the UK’s net capital stock in 2016, but which could increase to about 35% in the medium term. Considering the fact that profits in the UK are about one third of gross domestic product, the international dividends accruing to foreign investors in the UK will increase from 9% of GDP in 2016 to almost 12% in the medium term (the link between inward FDI, in the form of international mergers and acquisitions, and the real exchange rate has been explained in a clear way by FROOT/STEIN in the QJE, 1991). The implication from this is that the growth rate of the UK’s real gross national product (GNP) will be weaker than the already weakened growth rate of real gross domestic product. For welfare analysis it is indeed the growth rate of real GNP which matters and hence the order of magnitude of the Treasury Report study seems to be fairly adequate (although this point was not actually mentioned in the Report itself). Moreover, from a theoretical perspective, the UK’s moving out of the EU single market requires to consider both effects on trade, foreign direct investment and innovation dynamics – this approach has been emphasized by JUNGMITTAG/WELFENS (2016) in the context of a TTIP analysis for 20 EU countries (the revised version of the paper presented at the IMF can be downloaded from www.eiiw.eu).

On the question of EU membership, the British population may decide whatever way it considers as adequate, but the Cameron information blunder in the campaign of the UK referendum of 2016 has been quite decisive; not to mention that Mr. Cameron himself introduced a new young voter registration measure in 2015 that may have reduced the number of young voters – usually not with broad support for the Tories – by about 800,000 in the national election of 2015. These mostly pro-European young voters were then also missing a year later when Mr. Cameron called for a vote in favor of Remain. As regards the British EU referendum of 2016, one may call this a disorderly political event since it remains a mystery why Cameron’s information brochure was totally silent on the Treasury Study’s key findings. The British political system is in a state of crisis if it cannot organize an orderly referendum; one may argue that there is a broader crisis facing the Western system and the fact that Mrs. May has been seeking to forge a strong political alliance with the protectionist US under President Trump may be called a strange perspective for the basically pro-free trade UK government.

The May government’s announcement that the new “Global Britain” approach will generate more free trade for the UK in the context of a series of new free trade agreements after 2019 may be called illusory. Certainly, a free trade agreement with the US will be possible, but British exports to the US stand for just 2.5% of the UK’s gross domestic product, while British exports to the EU represents more than 12% of GDP. A free trade agreement with China is also illusory, the British manufacturing industry would dramatically shrink if such an agreement would be realized – on top of that, the US is unlikely to welcome such an agreement. A free trade agreement might be considered with India, but the Indian government will want to raise the issue of immigration and visas; with the May government arguing that no more than 100,000 immigrants can be accepted at all, the perspectives for a UK-India deal is also quite modest. Free trade agreements with New Zealand and Australia will be possible, but the quantitative benefits for the UK will be small. Also it is quite unclear how the UK could pursue a Global Britain approach easily in a period in which its key partner, the US, is aiming at weakening the leading international organizations, particularly the World Trade Organization and the Bank for International Settlements.

The Office for Budget Responsibility’s forecast for 2017-2019 – with a slight fall of output growth in 2017 followed by rising output growth in 2018/19 – is rather fanciful. The Eurozone’s GDP growth is likely to exceed that of the UK in 2017-2019. It is not really clear whether or not this will stimulate the BREXIT debate in the UK.

Whatever the results of the two envisaged EU-UK treaties, namely one on the UK’s exit from the EU and the other on the UK’s future access to the EU single market, the May government is not very likely to find a majority in the British Parliament in March 2019. This suggests that the UK could have a serious political crisis in the spring 2019, new national elections later in 2019 and possibly even a second referendum. If the UK government implements BREXIT, the question of a new Scottish independence referendum will re-emerge. If there would be BREXIT, there will be new conflicts between Northern Ireland and the Republic of Ireland in the context of a new border regime. In the end, the UK might want to adopt a written constitution with careful rules on national referendum procedures. At the same time, the EU would be wise if it were to adopt major reforms – possibly on the basis of a German-French initiative.

A constitutional debt brake in all EU countries, and for the EU/Eurozone itself, would be useful and Greece in particular should adopt particularly broad constitutional reforms. Less regulation on the one hand, but a bigger EU budget – with considerable expenditures on EU infrastructure and defense plus the first six month of unemployment insurance (except for youth unemployment, for which national governments with their national minimum wage policy bear strong responsibility) would be important points that would give the EU more political visibility and would allow the EU/Eurozone to implement its own fiscal policy as a counter-cyclical tool. The latter would be useful considering the IMF’s finding that a 1% GDP shock to the Eurozone and the US will reduce the consumption-GDP ratio in the Eurozone three times as much as in the United States. The former is necessary to bring about a higher intensity of political competition in the European elections and in Brussels, respectively, so that the efficiency of the political process in Brussels would increase. Moreover, the very small EU budget of 1% is part of the problem that voters cannot identify what the EU’s relevant policy areas really are – the German voting expert group Forschungsgruppe Wahlen has argued that due to a lack of a clear EU profile, many voters feel encouraged to experiment at European elections and to vote for rather radical parties. High expenditures at the supranational level should go along with reduced national government expenditures. In a reformed EU/Eurozone it would be possible in the end to reduce the income tax rate since efficiency gains in government expenditure programs (e.g. in defense procurement) at the supranational level can be expected from the reforms suggested.

The EU should clearly accelerate its digital single market program where decision-making so far takes much too long. The historical lead in mobile telephony of the EU over the US under the GSM standard has been lost and many policymakers do not understand that the share of real value-added in information & communication technology (ICT) relative to real GDP has now been increasing over more than three decades; the popular focus on the ratio of nominal ICT value-added to nominal GDP is totally misleading – and indeed it shows a peak for leading OECD countries, but as explained here this is totally irrelevant in economic terms: Given more than three decades of absolutely falling ICT price indices in leading OECD countries, only taking a look at the ratio of real ICT value-added to real GDP is an economically relevant perspective. The EU should also push much harder to get a broad free trade agreement with the whole of ASEAN, the current approach on agreements with individual countries is quite inadequate in the EU-ASEAN case which both have a single market. The political and economic transaction costs that the EU’s firms will be facing in the case of country-by-country approach are much higher than in an EU-ASEAN agreement. The EU should also put pressure on China so that EU firms face a level playing-field in terms of the foreign direct investment framework: EU firms often cannot have majority ownership in China, such barriers clearly should be removed if China wants to face a liberal regime for its foreign direct investment in the EU.

As regards financial market rules, the EU should put pressure on the UK to maintain a joint institutional framework and a common prudential supervision approach as there will be strong pressure in the UK – facing modest economic growth after 2016 – to again liberalize banking rules. Here, the UK would follow the US lead where the Trump Administration has already started to push for a new deregulation of US financial markets in 2017. If the EU would once again face joint deregulation pressure from the US and the UK – as in the years before the Transatlantic Banking Crisis of 2007-09 – the EU would most likely switch to a new excessive deregulation wave and then the next international banking crisis would come within a few years; and it could be much more dangerous and even more costly than the 2007-09 crisis.

BREXIT will weaken the UK, but also the EU which will lose about 1/5th of its economic weight. A 6 % UK output decline – due to BREXIT – implies a roughly 1% output decline in the EU27. The UK output growth could also be undermined by a wave of EU immigrants returning to continental Europe in case that the UK-EU negotiations on the exit conditions would not go well. It is fairly clear that with the UK leaving after 46 years of membership, the EU in 2019 will be taking a historical step away from EU integration for a century. The EU27 would face a shifting internal policy balance as some smaller EU countries that so far have enjoyed strategic cooperation with the UK – e.g. the case of the Netherlands eager to avoid being dominated by the German-French couple – will have to position themselves in a new way where more cooperation among smaller countries is one likely outcome of this process. The politico-economic power of Germany – mainly on economic grounds – and France (mainly for political and military reasons) will be reinforced after BREXIT. It is unclear whether or not a solution to the Eurozone problems can be found quickly, the critical case of Greece should not be repeated, but the Eurozone reforms adopted so far have not created an adequate institutional setup. Populism in Eastern Europe, and indeed parts of Western Europe, remains a major challenge in the EU. A weaker EU is certainly also undermining regional trade integration dynamics in ASEAN, Mercosur and other regional integration clubs, so that a loss of global political and economic stability could be a side-effect of BREXIT. From the perspective of China and Russia, BREXIT clearly means a weakening of the West, the UK and the EU27. At the bottom line, the disorderly referendum of 2016 in the UK raises serious questions about the ability of the British system to deliver high quality political services to British citizens. The cost of a half-baked referendum campaign and the BREXIT itself could easily exceed 10% of GDP in the long run (and the loss in terms of real GDNP will be even higher), the benefits from reduced EU contributions – or possibly zero contributions in the future – could be rather limited if one considers that 0.3% of British GDP, the current UK net contributions to the EU, capitalized at 3% interest rate is 10% of GDP. In the end, the growth rate of British per capita consumption will also be reduced considerably, not least since the growth rate of real gross national income will decline.

 

 

JUNGMITTAG, A.; WELFENS, P.J.J. (2016), Beyond EU-US Trade Dynamics: TTIP Effects Related to Foreign Direct Investment and Innovation, EIIW Discussion Paper No. 212 www.eiiw.eu.

 

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