BREXIT: THE CATASTROPHE THAT ISN'T, WASN'T AND WON'T BE

The June 23, 2016 British referendum which rejected continued membership in the European Union has predictably caused much hyperventilation, despair as well as doomsday predictions among an assortment of supporters of what is still and international experiment even after sixty years.  The “exit” and “remain” sides in the United Kingdom and throughout Europe and in the pundit and investor classes in the U.S., generally broke down along lines that resembled the broad political divisions of “liberal” and “conservative”,  the major exception being the “remain” position of the head of the Conservative Party, Prime Minister David Cameron. The loss of his position on the issue was essentially a “no confidence vote” by referendum and the result was his decision to step down as Prime Minister in October of the current year.  

A less politically centered analysis would find the division characterized as “internationalist” and “nationalist”.  Financial interests, international businesses, banking and investors, who derived specific economic benefits from the EU single market structure obviously supported the “remain” position for less ideological reasons.

The immediate reaction was one of “over reaction” as British, European and American stock markets suffered large sell offs.  This of course made little actual sense and simply reflected the reaction of speculators and fund managers who were anticipating what other speculators and fund managers would do in a kind of emotional feed-back loop.  The conventional wisdom among EU and British officials is that the process of withdrawal will take up to two years so any actual non-speculative economic impact either in Britain or abroad, including the U.S,. certainly did not justify a mini-panic the day after the vote.  This obvious conclusion has since sunk in to the faint of heart as the markets have bounced back from their stunning declines the day after the Brexit result.

CNN Money reported July 4, 2016 that “Stock markets are extending their post-Brexit recovery as the pound steadies and government bond yields hold near record lows. After a firm Asia-Pacific performance, the pan-European Stoxx 600 is up 0.3 per cent with London’s FTSE 100 climbing 0.4 percent to a 10 month high.”

“New York’s S&P 500, the equity gauge that tends to set the global tone, closed . . .just 30 points shy of its record level, 5.6 per cent above the intraday low hit a week ago in the wake of the UKs decision to leave the EU.”

Of course there will be a period of economic adjustment for Britain and those who do business with British firms and banks but the nature of the new relationship with the EU institutions and  EU members states is still unknown as well as is the long term economic impact that will result. 

The new relationship between Britain and the EU will also depend on willingness of the political leadership of the member states, organized as the European Council, to create one that is mutually beneficial.  Once emotions level off the current attitude of anger exhibited by German Chancellor, Angela Merkel should diminish and she and French President Hollande who are the dominant players in the EU should accept the reality of the political situation and work to save the benefits of the integrated economies while reforming and accommodating the push back of large portions of the various member states populations to the loss of national sovereignty imposed by remote Eurocrats in Brussels.

Merkel’s petulance was exhibited by her statement that Britain cannot expect to enjoy the benefits of the EU without accepting the responsibilities. Thus she was announcing a policy of retribution designed to discourage other member states from following Britain’s path.  But it is exactly the “responsibilities”, not the trade relationship which led to the British withdrawal and which have encouraged similar movements in several other member states.

The “responsibilities” include and onerous immigration policy which is flooding the healthy economies of Western Europe with migrants from the poorer Eastern nations and is exacerbated by the Merkel led acceptance of millions of migrants from the Middle East and North Africa. When these immigrants, mostly from North Africa and Syria, are granted citizen ship in EU nations, they will join the influx from previous years. 

In 2014 out of the 889,139 citizenships granted by EU states, 89 per cent went to non-EU citizens.  In round numbers, 92,700 Moroccans, 41,000 Albanians and 37,500 Turks were granted citizenship by EU nations. Others included large numbers of Indians and Pakistanis.  Under the EU’s “free movement of people” with EU passports, all of these migrants were eligible to travel to Britain, which is more attractive than many of the other EU states because of its economy and the liberal benefits currently awarded to migrants.

Even before the current migration problems however, the responsibilities defined by Merkel were acquiescence to thousands of EU regulations on every aspect of governance from environmental rules to civil rights; banking and trade; taxation and transportation, agriculture and more.  It will not be enough to simply punish Britain through isolation and move on. The structural issues and lack of accountability of EU bureaucrats and politicians to ordinary citizens in the member states has generated political reactions in Austria, Sweden, Netherlands and France itself where the conservative National Front Party is gaining seats in regional bodies and whose leader Marine Le Pen will be a candidate for the Presidency in 2017.  

It is highly unlikely that populist political movements could bring about exits in most nations where they exist because the economies of most are more dependent on the benefits of EU membership than Britain, and unlike Britain, many are using the common currency of the Eurozone. However, their continued existence creates dangerous political instability in the member states and in the EU. 

Essentially, the integrative process of the nations of Western Europe and through inclusion in more recent years, of Eastern European states, has been too ambitious and too ideologically driven.  The process started in 1951 with the European Coal and Steel Community which sought to bind the war making capabilities of the major states to an international common market to control these essential military resources.  It was a response to the centuries of European conflict which culminated in World War II.  This six nation organization then led to the European Economic Community which was a customs union and free trade area established in 1958.   

But the leaders of the larger economies, France and Germany,  then pursued a model of political and economic integration that went far beyond the customs union/free market concept and through a series of treaties and expansion of membership culminated in the establishment of the European Union in 1993 by the Maastricht Treaty. The Treaty of Lisbon in 2002 updated and reformed the legislative procedures of the Union and furthered the political integration which exists today.

In view of the current concerns with a loss of national sovereignty it could be said that essentially, European political leaders over time outran the general populations of the member states who accepted their leadership without fully understanding the intrusive nature of the EU’s organizations. These are the European Council made up of the heads of government of the member states; the executive branch, the European Commission; the European Court of Auditors; the legislative branches, the Council of Ministers and the European Parliament; and the judicial branches, the European Court of Justice and the European Court of Human Rights. In addition the European Central Bank has attempted to dictate monetary policy for the eighteen economically diverse nations in the single currency Eurozone. 

The European Union will not dissolve and will not go back to the less intrusive, less integrative, simple free market and customs union status of its earlier history.  But the political elites now in office will have to address the issues, of complexity, lack of accountability, and overreach which are threatening the foundations of the organization or those elites will change after national elections in response to the populist unrest in their home countries and the threat to the organization will become more severe.

 

With respect to Britain’s withdrawal, a policy and attitude of accommodation should be the choice versus one of isolation. The British economy is the fifth largest in the current EU.  Britain’s trade with the EU is an important component  in both imports and exports.  Britain’s position as a world financial center is of utmost importance to the EU and the wider world.

A procedure to avoid unnecessary negative outcomes for both the EU and Britain is readily available and already in place with Norway, Switzerland, Iceland and Liechtenstein, none of which are EU members.  Instead all have association agreements through the European Free Trade Association which give them access to the EU market and vice versa.  Under these specific arrangements they have agreed to the single market requirement of “free movement of workers” holding EU passports to cross national borders.  However, since this is one of the reasons why British voters opted for independence from the EU it would not be unreasonable for EU leaders to negotiate a similar deal that fits the needs of the British electorate and avoids major disruption of trade which benefits no one. There is also no reason that Britain cannot negotiate bilateral trade agreements with individual EU states, and of course Britain and the EU are both members of the World Trade Organization which works to facilitate low trade barriers between its 164 members.

As mentioned above, leaders of some EU members, apparently with Germany and France in the forefront, will argue that such an accommodation would encourage other populist groups in other member states to seek similar withdrawals.  But most EU members receive more economic benefits from the EU than does Britain.  The EU derives significant income from the value added taxes on the sale of goods and services assessed by each EU member.  Britain’s value added tax is 20%.  These funds are redistributed as development and subsidy funds to the neediest regions in the member states under programs called Structural Funds and Cohesion Funds.  The stated goal of these funds is “to reduce regional disparities in income, wealth and opportunities”.  Thus, unlike Britain, member states that receive more from the EU than they contribute would not have a strong incentive for withdrawal. In 2015 Britain paid the EU $8.5 billion British Pounds more than it received or 23 million Pounds a day.

Of course there will be consequences, especially in the short to medium term.  Financial markets don’t like instability, or the unknown. British industries with significant export markets will suffer a loss of confidence and drag the broader markets down during the period of reorganization.  While some are predicting recession in the British economy due to cutbacks in these enterprises, the British market for EU exports should eventually stimulate some sober thinking among the currently angry EU leaders to work with the new British leaders to bring about a productive alternate relationship.

Still, currency markets are already affected and may continue to be until longer term trends in the British and EU economies are apparent.  In the shorter term the British pound will lose value against the U.S. dollar as will the EURO. This will make U.S. exports to these areas more expensive but will make British and EU exports less expensive which will help offset the loss of duty free markets for Britain.

Essentially what British voters were saying was they were not ready to give up their British national identity, national sovereignty (self rule) or British culture to a growing federal system run by unaccountable foreign bureaucrats.  They are not alone in these thoughts and the fact that French president Hollande and German Chancellor Merkel know this is demonstrated by their initial reaction to punish Britain as a deterrent to populist movements in other EU states.