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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BREXIT – looking at the analysis of March 2016

This is my BREXIT analysis from March 2016 that picks up most of the key issues in a piece for AICGS/Johns Hopkins University. A difficult day for the UK, a dangerous day for the continent – and a shocking impulse for the populist politicians. Lack of critical reflection in Berlin, Paris and Brussels. As the UK has left the EU should move towards a European Political Union; a smaller weaker EU will disintegrate and implode. Effective tax policy and hence effective redistribution is only possible through more supranational policy.

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

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

After the BREXIT referendum: Europe seeking a new orientation?

EUROPÄISCHES INSTITUT FÜR INTERNATIONALE WIRTSCHAFTSBEZIEHUNGEN (EIIW)              www.eiiw.eu

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 © welfens@eiiw.uni-wuppertal.de

 

 

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

British Referendum Pains and the EU Implications of BREXIT: an Update

Prof. Dr. Paul J.J. Welfens, President of the European Institute for International Economic Relations (EIIW) at the University of Wuppertal; Professor in Macroeconomics and Jean Monnet Chair in European Economic Integration at the Schumpeter School of Business and Economics, University of Wuppertal and Research Fellow at IZA, Bonn; Non-resident Senior Fellow, AICGS/Johns Hopkins University, Washington DC. EIIW 2015 = 20 years of award-winning research

(www.eiiw.eu) welfens@eiiw.uni-wuppertal.de

April 6, 2016

British Referendum Pains and the EU Implications of BREXIT

On June 23, 2016, should a majority of British voters decide to leave the EU – nearly 45 years after joining the Community – the EU would lose 17% of its GDP and 12% of its population. This referendum result would reveal Prime Minister 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 sceptical about EU membership and immigration, respectively, is the fact that after the Transatlantic Banking Crisis national government funding of local communities has strongly been 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 or not 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 Mr. Cameron is not the only element to blame for the negative British referendum result, Mrs. 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 Mrs. 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 – and all the pictures of the EU refugee crisis of 2015 and early 2016 have simply illustrated the choatic refugee policy of Germany and the EU, respectively: with Greece being totally overwhelmed with the task of controlling its external borders and providing suffcicient humanitarian aid to the refugees.

Gideon Rachman’s contribution in the Financial Times of March 23, 2016 (p.9: Wake up – Brexit is looking ever more likely) 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 March 22, 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 – as the short-term economic gain is that the UK could save only about 0.5% 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 which 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 US, euro countries, Russia and Arabian 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 towards 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 can become very massive 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 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 will thus be Russia, the US 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 is already facing political destabilization when the populist new 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% 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 being an expert on monetary integration – and by late 2015 they already had left the AfD over internal conflicts and had created a new party “Alpha” which does not play any role in Germany. The AfD benefited from widespread uneasy feelings of many citizens that have become nervous not least from the very many alarmistic Ifo Institute reports on the Eurozone: In a biased approach to the issues only worst case scenarios were published that naturaly 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% of GDP in the euro crisis; the true costs are less than 1% of GDP so far. Mrs. Von Storch, a naïve 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 of the US and China, the two economic superpowers of the 21st century. There is nothing that the UK could gain from less political stability and lower economic growth in contintental Europe. Instead the UK would most likely come under increased pressure from the US to more often support US 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 directly be weakened, continental Europe will become weaker as well and the negative economic spillovers from the diminished EU to the weakened UK willl be strong. If the EU output should drop (disegarding the pure output reduction related to the UK’s leaving of the EU) by 2% in the long run through the immediate BREXIT effect, British output should decline by 1%-1.5%. This will come on top of the direct output reduction effect of BREXIT which could reach 3-5% in the long run. British output decline during the Great Depression of the 1930s was 6% 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 and Mercosur in Asia and 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 world wide. 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 Panama Papers Affair might further undermine the credibility of the conservative government and thus make a pro-EU compaign of Mr. Cameron less convincing.

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. The visit of the US President could also make a difference – the US 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 US President’s visit is a powerful multiplier for the pro-EU camp; the US logic partly is that British EU membership in the EU will reinforce a liberal European Union and contribute to the stability of NATO. The invisibility of EU Commission President Juncker in the campaign is a historical shame: a Commission president who is unwilling to defend the integrity of the Community should not remain at the top of the European Commission.

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

European Terror Crisis: Relocating EU Institutions from Brussels and Improving Security in Europe

Prof. Dr. Paul J.J. Welfens, President of the European Institute for International Economic Relations (EIIW) at the University of Wuppertal; Professor in Macroeconomics and Jean Monnet Chair in European Economic Integration at the Schumpeter School of Business and Economics, University of Wuppertal and Research Fellow at IZA, Bonn; Non-resident Senior Fellow, AICGS/Johns Hopkins University, Washington DC. EIIW 2015 = 20 years of award-winning research

(www.eiiw.eu) welfens@eiiw.uni-wuppertal.de

April, 5, 2016 (BrusselsEUterrorcrisis2016ENG)

 

The EU of 2016 is facing a fundamental crisis. The UK leaving after June 23 would deal a major blow to the process of EU integration and indeed the Juncker Commission – that Commission President Juncker has not made even one visit to London before June (in contrast to US President Obama) is an historical sign of weakness for which the whole Commission should be ashamed. What’s more, EU integration is facing a major security challenge from Brussels itself where dozens of ISIS supporters and several terrorists are living in the EU’s quasi-capital and the capital of Belgium, respectively. The terror attacks in Belgium on March 22 – at the Brussels airport and the Maelbeek metro station which is right in the centre of Brussels and just 400 meters away from top EU institutions – reveal the enormous weakness of the Belgian security forces. More than 30 dead and over 100 injured in March 2016 testify to the fact that the Belgian capital is not safe – Islamist terror groups can easily hide in Brussels; and it is also well known that several of the Islamist terrorists behind the brutal attacks in Paris in November 2015 also came from Brussels.

After almost two weeks, the closed Brussels airport could be reopened on April 3, however at a much reduced capacity, but Brussels still has a deeply rooted security problem which is visible in the form of the understaffing of security forces, a lack of cooperation between various police groups and security forces in Brussels in particular and in Belgium in general with its complex federal structure. Moreover, Belgium is similar to France, i.e. in a structurally bad position, since its youth unemployment rate has been twice as high as that of Germany for two decades and three times as high as in Switzerland. Terror experts have shown that Jihadists, to a considerable extent, are engineers or former students from technical fields on the one hand, while on the other hand they stem from petty criminal groups. High youth unemployment rates are a key driver of criminal careers of young men and this in turn implies that France and Belgium have a structural terror threat problem that is deeply rooted. The high youth unemployment rate in France and Belgium is large due to an excessively high minimum wage rate – the youth unemployment rate has been twice as high as in Germany for about two decades (see appendix).

There are several conclusions to be drawn if one wants to achieve full security in line with US or British standards: (1) massive investment in and a modernization of the Belgian security forces and enhanced cooperation in the EU; however, there is large mistrust of EU member countries amongst each other and the reputation of the EU – in the (likely) BREXIT year of 2016 – is very poor.

(2) As security in Brussels cannot be assured for many years to come, the EU’s main institutions should be relocated to Luxembourg or another major city (e.g. Trier which also could cooperate with Luxembourg); Luxembourg has the problem that about ½ of its labor force is from France (70 000 commuters per day), Belgium (70 000 commuters per day) and Germany (35 000 commuters per day). If border controls would be reimposed – possibly a necessary step after a terrorist attack – the economy of Luxembourg could collapse. The European Parliament has a second seat in Strasbourg, but this city in France does not seem any safer than Paris. Every year thousands of ordinary people visit the EU institutions and several dozen universities in Europe have a tradition of sending groups of students on excursions to EU institutions in Brussels. Millions of people visit Brussels as tourists, business people or as invited experts to the EU each year, but again security problems will remain unsolved for many years in Brussels. This also means that the many thousands of employees and civil servants working at the European Commission’s main institutions in Brussels face a threat to life when using the metro or using the airport in the future. The Belgian capital cannot be the capital of Europe – enjoying considerable economic benefits from this status – while not providing decent security for its own citizens, the people working in Brussels and the millions of visitors to Brussels every year. The reputation of the EU institutions has already weakened much since the Euro crisis and the younger generations will not broadly support EU integration if one cannot even visit the key EU institutions safely.

(3) Belgium must reduce the excessive minimum wage immediately and become much more serious in fighting youth unemployment; the same must be expected from France. For several years the borders with Belgium and France should be strictly controlled, the Schengen Treaty, meaning passport-free travel within the Schengen area, should be, in part, no longer applied.

(4) EU countries should be much more selective in inviting preachers from North African countries or even from Saudi Arabia, Qatar (the latter two stand for radical Islamist beliefs and also the generous financing of ISIS in Syria) and other Arab countries. It is strange that the Valls government under President Hollande has invited many Islamic preachers from Tunisia, whereas creating a decent education for Muslim clergy in France – similar to that in Germany – is cleary a better approach. It is also strange that investment funds from certain countries are accepted by the German government and the EU, respectively, e.g. in Germany – Qatar is a major investor in Mercedes Benz.

(5) The chaotic immigration and refugee policy that Chancellor Merkel has imposed on EU countries in 2015 should be stopped and reformed immediately; there can be no responsible immigration policy that leaves things unclear in relation to many thousands of immigrants or refugees entering Germany and other EU countries, respectively. In 2015, the German security forces, organized in the 16 states of Germany, used identification software that suffered from incompatibility issues so that an immigrant could be registered several times and possibly also under different names. Such technical pitfalls are totally unacceptable and endanger the whole of Europe; one terrorist attacker in Paris in January 2016 came from Germany – where he had seven different identities; he was shot while attempting to kill two policemen in the French capital. EU countries also suffer from the problem that the transliteration of Arabic or other foreign names are different in different languages and, since EU security forces are not using a multi-language algorithm for transaliteration, a terror suspect identified by French police can travel to Germany, Italy or Spain, and the national security forces of those other countries will most likely not identify this indiviudal as that person who has already been identified as a suspect individual in France. This lack of security integration is a scandal and highly dangerous.

(6) Several EU countries, above all France and Belgium, will attract lower foreign direct investment inflows from the US, China, Japan and Korea – security issues always figure high on the checklists of multinational companies. Lower economic growth and higher unemployment rates, new social conflicts and more political instability are likely side effects of this. Hence the threat of terrorism should be taken much more seriously in the future in the EU.

The poor impression created by Germany’s, and indeed the wider EU’s, immigration policy of 2015 and the Brussels terror attacks of 2016 have reinforced the fear of immigration in the UK and to the extent that the BREXIT debate is shaped by a fear of immigration, Chancellor Merkel’s poor refugee policy and the security problems in Belgium have tipped the balance in favor of EU ‘leavers’ in the United Kingdom in early 2016.

With the UK leaving the European Community and Brussels having become the most unsafe capital in the EU, the European Union and EU integration, respectively, are facing a serious problem. A process of EU disintegration has started in 2016 and EU member countries are silently watching this historical disintegration process unfold. If EU disintegration should proceed, it will lead to massive economic nationalism in Europe and to higher military expenditures relative to GDP, while political destabilization will bring about reduced economic growth.

Fighting Islamist terrorism requires a multi-pronged approach. Reducing youth unemployment rates is one critical aspect; no longer publishing pictures of terrorist attacks and media from ISIS websites with their threats of further terror is a desirable element of counter-terrorist policy – all the pictures shown on TV and in newspapers are broad propaganda in favor of terrorism as the terrorist achieves at zero cost an advertising platform to frighten even more people which is the very goal of all terrorism. EU countries should take the new wave of terrorism very seriously. The Schengen countries’ security standards are much weaker than those of the US and the UK; any extension of the Schengen area – e.g., including Croatia with its weakly patrolled southern borders to other Balkan coutries – is irresponsible. The EU should also put much more pressure on all neighbouring countries to also fight Islamist terrorism. The new terror risk will affect economic growth perspectives across EU countries in an asymmetric way, so that pressure on raising EU funds will increase in order to avoid a decline of economic and social cohesion. The cost of terror-related risks are enormous – if reduced security of consumption (including tourism) in the EU is equivalent to 0.5% of GDP of the EU, this amounts to € 140 bill.; add to this the extra cost of increasing the budget of security forces and the economic loss of all those poor people who have either been killed or injured in terror attacks, then the bill of terrorism is certainly above € 140 bill. in the EU. Without an EU Political Union there can be no security and no stable European Union. If there is continued disintegration, Europe will fall back into the late 19th century. This certainly is not in the interests of the 510 million people in the EU.

 

 

 

Fig. 1: Youth Unemployment Rate in Selected EU Countries (Age Group 15-25 Years)

Source: Eurostat

Fig. 2: Unemployment Rate in Selected EU Countries (Age Group 15-39 Years)

Source: Eurostat

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

British Referendum Pains and the EU Implications of BREXIT

 

Prof. Dr. Paul J.J. Welfens, President of the European Institute for International Economic Relations (EIIW) at the University of Wuppertal; Professor in Macroeconomics and Jean Monnet Chair in European Economic Integration at the Schumpeter School of Business and Economics, University of Wuppertal and Research Fellow at IZA, Bonn; Non-resident Senior Fellow, AICGS/Johns Hopkins University, Washington DC. EIIW 2015 = 20 years of award-winning research

(www.eiiw.eu) welfens@eiiw.uni-wuppertal.de

Beijing, March 27, 2016

British Referendum Pains and the EU Implications of BREXIT

On June 23, 2016, should a majority of British voters decide to leave the EU – nearly 45 years after joining the Community – the EU would lose 17% of its GDP and 12% of its population. This referendum result would reveal Prime Minister 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 defeat, there has been bitter moral failure on the part of the Prime Minister: He had assigned a special task force 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 – Mr. Cameron used taxpayers money to commission and pay for this report, but it was never actually published: for strategic reasons, read in order to get better negotations results from the EU, but even after the UK-EU negotiations had been completed in February 2016 the government stubbornly failed to publish the EU Commission’s findings. This is unfair and inadequate.

It is true that Mr. Cameron is not the only element to blame for the negative British referendum result, Mrs. 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 Mrs. 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 – and all the pictures of the EU refugee crisis of 2015 and early 2016 have simply illustrated the choatic refugee policy of Germany and the EU, respectively: with Greece being totally overwhelmed with the task of controlling its external borders and providing suffcicient humanitarian aid to the refugees.

Gideon Rachman’s contribution in the Financial Times of March 23, 2016 (p.9: Wake up – Brexit is looking ever more likely) 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 March 22, 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 – as the short-term economic gain is that the UK could save only about 0.4% 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 which 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 US, euro countries, Russia and Arabian 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 towards 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 can become very massive 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 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 will thus be Russia, the US 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 is already facing political destabilization when the populist new 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% 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 being an expert on monetary integration – and by late 2015 they already had left the AfD over internal conflicts and had created a new party “Alpha” which does not play any role in Germany. The AfD benefited from widespread uneasy feelings of many citizens that have become nervous not least from the very many alarmistic Ifo Institute reports on the Eurozone: In a biased approach to the issues only worst case scenarios were published that naturaly 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% of GDP in the euro crisis; the true costs are less than 1% of GDP so far. Mrs. Von Storch, a naïve 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 of the US and China, the two economic superpowers of the 21st century. There is nothing that the UK could gain from less political stability and lower economic growth in contintental Europe. Instead the UK would most likely come under increased pressure from the US to more often support US 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 directly be weakened, continental Europe will become weaker as well and the negative economic spillovers from the diminished EU to the weakened UK willl be strong. If the EU output should drop (disegarding the pure output reduction related to the UK’s leaving of the EU) by 2% in the long run through the immediate BREXIT effect, British output should decline by 1%-1.5%. This will come on top of the direct output reduction effect of BREXIT which could reach 3-5% in the long run. British output decline during the Great Depression of the 1930s was 6% 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 and Mercosur in Asia and 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 world wide. 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. The visit of the US President could also make a difference – the US 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 US President’s visit is a powerful multiplier for the pro-EU camp. The invisibility of EU Commission President Juncker in the campaign is a historical shame: a Commission president who is unwilling to defend the integrity of the Community should not remain at the top of the European Union.

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

EU Disintegration Pressure and Germany’s New Instability

 

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 (www.eiiw.eu) welfens@eiiw.uni-wuppertal.de

2015 = 20 years of award-winning EIIW research in Economics

 

March 21, 2016 EUdisintegrationEnglish2016MarchWelfens

EU Disintegration Pressure and Germany’s New Instability

After six decades of growing economic and political integration, in 2015/2016 the European Union is facing disintegration dynamics for the first time where the main impulses are Germany’s strange handling of the refugee wave in 2015 and the British BREXIT referendum of June 23, 2016. Both elements show that the EU cannot survive without a Political Union and that the collapse of the Soviet Union could indirectly translate into a collapse of the European Union: It was mainly a commonly shared fear of the Soviet Union and certain economic benefits which were the political glue keeping the EU together and without this common fear a lack of political discipline has become widespread – visible, for example, in the non-respect of the Eurozone/EU fiscal policy rules in the run-up to the euro crisis in Greece, Portugal, Ireland and Cyprus. Germany and other EU countries pretend that the Soviet collapse has not impacted the EU except for the fact that former eastern European member countries of the Soviet economic bloc would subsequently join the European Union.

An expansion of the EU budget, which could have generated new benefits for all EU member countries, was prevented, particularly by the British government, when the EU expenditures were reduced after the Transatlantic Banking Crisis from 1.24% to just 1% of GDP. It is the British government that now proposes to voters in the UK to consider a vote on the UK either remaining in or leaving the European Union and it effectively means that about three million UKIP voters – getting 12.6% at the national elections in 2015 – can put political pressure on 500 million people in the EU: Conservative Prime Minister David Cameron is under such pressure from UKIP – the British winner of the European elections – that he had to promise the aforementioned EU referendum. Such a referendum has become possible under the Lisbon Treaty which allows EU member countries to leave the European Union. One may point out that should the UK leave the EU other countries are likely to follow, since a smaller European Union is less attractive than a big EU (i.e. including the UK, which represents about 17% of the EU GDP) and since the external perception is that the EU is not a stable politico-economic club, this will reduce the international political leverage in all future negotiations of the EU; the latter effect might even occur if the pro-EU side should have a narrow victory in the BREXIT referendum. France under De Gaulle had always been resistant to allowing the British EU membership, as De Gaulle was not convinced that the UK would really be a strong member country in the EU.

Besides the UK, it is Germany under Chancellor Merkel which is leading the EU into disintegration. Until mid-2015, it was Germany’s standard political wisdom that the country would never again start a war in Europe, would defend Israel’s right of existence and would always be a reliable EU partner. The latter pillar of Germany’s political fundament was as good as destroyed in early September 2015 when Chancellor Merkel unilaterally – not calling for an EU summit to focus on the refugee crisis – decided to open Germany’s borders for refugees that had stranded in Hungary and Greece. Shortly after the decision, the German government then added that the refugee crisis was an EU problem. Most of the EU partners, having been ignored in September 2015, in effect said: No, Germany should take care of the problem itself.

Obviously, the Chancellor’s Office had become so arrogant in the context of the apparently bravely assumed EU leadership role in the face of the Euro crisis that Mrs. Merkel thought she could simply decide about an EU question on her own. Never would Helmut Kohl oder Helmut Schmidt, two former German Chancellors, have made a similar quasi-autocratic decision.

Founded upon of a very thin legal basis – so the view of renowned legal experts – Germany assumed the right to decide about more than half a million asylum-seekers whose case, under the so-called Dublin framework, could normally only be decided in Greece, the first EU country entered by so many refugees coming from Turkey – originally coming mostly from Syria, Iraq and Afghanistan. Greece in turn was unable to cope with its duties to examine the asylum requests of refugees – at first, due to its disastrous economic policy and as regards the sharp overall recession, which set a record for western industrialized countries after five years of consecutive recession, one could argue that Germany is also to blame for the Greek misery because the Merkel government has refused a debt haircut for sovereign creditors – although this would have been both possible and certainly also necessary economically speaking as the IMF has emphasized in 2015 (Germany’s Minister of Finance, Mr. Schäuble, claims that there are legal barriers to Greek debt cutting, but independent legal experts from several universities hold a different view). If Greece had been a normal country with a functional government and administration, Germany’s government would have had no right to assume the asylum examination procedures by effectively replacing Greece in 2015. The German government’s propensity, in the refugee crisis, to explore extreme interpretations of rules and laws – already partly visible in the euro crisis – is doubtful and has raised criticism among many legal experts who often have the impression that the EU no longer represents the traditional EU three pillars: the rule of law, democracy and the market economy.

The EU countries could, in late September 2015, agree that only 120 000 refugees who had at first landed in Italy and Greece would be reallocated across EU countries, but by mid-March 2016 less than 1 000 had actually been reallocated. The German approach to the refugee crisis did not work at all and the more than one million refugees coming to Germany in 2015 have revealed enormous overregulation and poor public service organization in Germany where many cities found themselves unable to cope with the big wave of refugees – fortunately, many private volunteers helped out in this difficult situation. The chaotic impression created by the refugee wave in Germany raised a very unfavorable impression about the federal government of Chancellor Merkel and on top of that came the incidents from the New Year’s Eve night at the Cologne central station, where more than 1 000 women reported being sexually molested and that mobile phones and/or wallets etc. had been stolen – apparently mostly by Muslim immigrants and refugees from North Africa. The political message understood by many voters in Germany was that the leading political parties and government at both a federal and regional level were unable to cope with the refugee challenge. The populist new right-wing AfD party harshly criticized Chancellor Merkel and partly joined forces with the east German xenophobic, anti-Islam Pegida movement.

The state elections – concerning Germany’s economic powerhouse Baden-Württemberg, the Rhineland-Palatinate and the small eastern German region of Saxony-Anhalt – ended with disastrous results for both parties in the federal grand coalition (i.e., the conservatie CDU and the social-democratic SPD; the latter could, however, gain about 0.5% of the votes in the election in Rhineland-Palatinate). The CDU and the SPD lost huge numbers of votes to the new populist right-wing party AfD (Alternative für Deutschland) who succeeded, on the basis of 240 party members in Saxony-Anhalt, in getting 24 members elected in the regional elections. The AfD, initially created by an economist from Hamburg University Mr. Bernd Lucke, who left the party in disappointment in 2015, had hovered in opinion polls at 3% in spring 2015, but due to Merkel’s strange refugee policy in autumn 2015 the AfD obtained double digit results in all three states (15% in Baden-Würrtemberg, 12% in Rhineland-Palatinate, 24% in Saxony-Anhalt). Part of the AfD, which is very well organized across Germany, is openly xenophobic, anti-US (e.g., in the context of the TTIP project) and favors physical violence coupled with racist prejudices.

A new problem since March 13, 2016, is that – following the bad precedent of the unstable Weimar Republic in the 1930s – a strong leftist party plus a strong populist party could, in the future, make a normal coalition of middle of the road parties unworkable; for example, in Saxony-Anhalt the two traditionally big parties, CDU and SPD, are so much weakened that they need the small Green Party to form a governing coalition and this is the only option existing. The AfD is likely to gain additional seats in upcoming regional elections as well as in the national election in autumn 2017. The rise of the AfD has been strongly supported in 2013-15 by the influential conservative newspaper Frankfurter Allgemeine Zeitung – more specifically, by its Economics and Business Section, with its strong long run opposition to the euro. A report by the Bertelsmann Foundation has shown in 2014 (spotlight Europe 2014/No. 2) that readers of the Frankfurter Allgemeine Zeitung internet-edition features a strong overlap with AfD voters. Who would ever think that a conservative newspaper would support a xenophobic right-wing populist party which destabilizes Germany and the EU? The level of economic competence of the Economics and Business Section is apparently quite low; e.g., for several years readers were told that the Eurozone countries’ euro rescue policy would lead to high inflation (in reality, the ECB had to start fighting deflation in 2015) and that civil servants are the richest group in Germany (complete nonsense as any careful statistical analysis shows: Entrepreneurs are, of course, the richest household group) – maybe this low level of analytical competence in key economic issues also extends to the quality of assessment of political developments.

In March 2016, the EU-Turkey summit brought a preliminary solution to the refugee crisis by undermining the business case of people smugglers and human traffickers in Turkey who had helped ship an estimated million people to Greece in 2015 when the country was totally overwhelmed by the refugee wave. The deal is such that as of March 20, 2016, illegal immigrants entering Greece from Turkey would be sent directly back to Turkey which could, in turn, send up to 72 000 Syrian refugees to the EU who would distribute the incoming refugees internally. Turkey would also get € 6 billion in EU support for the costs of refugee for Turkey, which has about 2.8 milllion refugees. Moreover, Turkish citizens will soon get visa-free access to the EU and the EU-Turkey membership negotiations would resume. The expectation is that the number of new refugees to the EU will strongly reduce in 2016, not least since the situation in UNHCR refugee camps in Iraq, Afghanistan, Lebanon, Jordan and Turkey should improve as the London donor conference of early 2016 raised new funds for bringing the provision of food and services back to a decent level – before the US, Kuwait and several EU countries had not paid over funds which had been promised to the UN, with the result that part of the refugee crisis was indeed triggered by the hunger and misery prevalent in many UNHCR camps.

Many EU countries have erected new national border controls in order to fend off refugees coming from Greece or via other EU entry countries. This in turn shows that there are serious problems with respect to controlling the EU’s external borders – with poor countries, such as Greece and Bulgaria, left to fend for themselves instead of organizing a joint financing of external border control. As a consequence of the resurrection of national border controls, the Schengen Treaty – relevant for all EU countries except for the UK and Ireland – that brings free movement of people without border controls between continental EU countries is impaired: Thus the GDP of the EU could be reduced by 0.8% in the long run and two to three million additional unemployed people can be expected. It is noteworthy that Mrs. Margaret Thatcher, in responding to a question about whether the UK should join the Schengen Treaty, responded (to paraphrase) ‘No, since we do not want a situation in which Greek civil servants would effectively control access to the UK’.

The EU will face serious challenges. With France facing serious economic problems plus a new broad fear of terrorism and Germany being politically destabilized through Merkel’s decision-making in September 2015 as regards the refugee crisis and the following enormous rise of the AfD, there will be lower economic growth in Germany and the eurozone, respectively (Germany accounts for about 23% of EU GDP; France for 16%); what’s more, the xenophobic AfD will impair Germany’s FDI inflow and thus innovation and growth dynamics and a move towards more well-paid skilled jobs. There will be lack of EU leadership and this in turn will undermine the EU’s stability. A weakened EU implies a weaker NATO and this should worry the EU.

Mr. Putin is likely to cheer this new EU weakness and the rise of the AfD and the number of populist xenophobic parties in many EU countries is bound to increase. The only positive perspective for 2017 in Germany concerns the election victory of the Green Party Baden-Württemberg Minister-President, Winfried Kretschmann, who was not only re-elected but his party is now No. 1 in that state with 31% of the vote. If Kretschmann should become the first green candidate for Chancellor in Germany, he should be able to get about 40% of the votes in Baden-Württemberg and about 20% for Germany as a whole in the national elections in 2017. This might be enough to create a conservative-green coalition government that may be expected to push for ecological innovation and green growth.

The political pitfall of a visible non-EU spirit of Chancellor Merkel is another argument for calling for an EU political union in the long run. An EU that spends only 1% of GDP in Brussels is much too small in fiscal terms. The US federal government expenditure relative to GDP of 9% (without social security expenditures) is so much higher than the relative level of EU expenditure, but Germany and the UK are the main countries that so far prevent an adequate reform of vertical government expenditure. With infrastructure and military expenditures largely concentrated in Brussels, the Eurozone/the EU could have a much more effective fiscal policy and fiscal federalism also gives clear arguments that the EU’s government expenditures are much too small. The strange hybrid institution of a European Commission that is both a legislative and an executive institution is also doubtful; a true Eurozone Parliament and a Eurozone government is what is needed, plus a distinct EU income tax. The overall tax burden should, however, fall in the EU, if all political layers are added up – efficiency gains in a political union could lead to this result. If the EU should disintegrate, there will be globally negative spillover effects since other regional integration schemes will also be destabilized (for example, ASEAN and Mercosur). The British steps towards a BREXIT will dearly cost the UK and continental Europe plus the world economy at large. Like Mrs. Merkel, Mr. Cameron is a conservative politician – both not having a bright intellectual perspective. The expansion of populist right-wing parties in the EU will lead to more protectionist policies in key European countries. This is neither in the interest of Europeans nor of the US, China, ASEAN or Japan. The AfD has also indicated that its leaders favor more cooperation with Putin’s Russia and they are against the proposed Transatlantic Trade and Investment Partnership of the EU and the US. The AfD, UKIP, Front National and other right wing populist parties will lead Europe back into the late 19th century. One can only worry about such irresponsible perspectives. Historically, Chancellor Merkel’s ill-guided refugee policy amounts to a broad political destabilization of Germany and the EU, respectively.

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