On June 23rd, the future of the European Union may be decided. Will Europe stick together through thick and thin, or is it starting to come apart at the seams? Should the UK vote to leave, “Brexit” will be a big deal for the entire global economy and specifically for the world’s financial markets.
Recent polls show the “leave” side may win – something considered unthinkable a few years ago. Yet successive financial crises (first the global crisis which began here in the United States, and then the sovereign debt crisis which began in Europe) may well have changed British popular opinion about the wisdom of staying in Europe’s grand experiment.
Just as immigration is front and center of the American political debate, immigration concerns are playing a central role in the UK’s. Concerns about illegal immigrants, including migrants and refugees, are prevalent in the both countries. However, UK voters are also worried about legal immigrants from other EU member countries who have come to the UK. Compounding these concerns are heightened signs of progress on Turkish EU membership, which has increased fears among some British citizens: Turkey would be the largest country in the EU after Germany, has lower wages, and would be the only majority Muslim country in the EU. Other arguments for leaving focus on ceding authority/sovereignty to ‘unaccountable bureaucrats’ in Brussels and the European Court of Justice on a variety of issues, with comedian John Cleese expressing popular sentiment in a tweet about EU bureaucracy taking away “any trace of democratic accountability.”
The Stay campaign’s arguments are largely based on the beneficial aspects of being EU members, which are plenty and focus on the economics. The UK Treasury has estimated that Brexit would cost a £4,300 loss to an average British household, which is considerable given that the median household disposable income in the UK is just over £25,000. A Brexit would slow UK growth and productivity and could mean a GDP drop of 6 points by 2020. In addition, markets may react unexpectedly to a Brexit with a sharp drop in the value of the British currency, estimated by some to be 10 percent or more. That would make imports substantially more expensive at the same time that a recession may occur due to a vote to depart the EU.
The United Kingdom has traditionally been in between continental Europe and America, not only in geography but also in policy. The UK differs from continental Europe generally, with more flexible labor markets, more developed capital markets, and less regulated industry. The UK has also chosen to keep its own currency, having never joined the Eurozone and thus keeping the Pound Sterling, which has recently been trading at historic lows as a result of uncertainty about Brexit.
The UK leaving the European Union would mean substantial upheaval for global markets, financial firms, and businesses that would likely leave London. Markets like certainty, and they do not want nor expect this kind of change. Already, markets are nervous, U.S. and global stocks are slumping, and money is pouring into safe haven sovereign debt: the yield on the 10-year U.S. Treasury note is approaching record lows, while Germany’s 10-year note broke a new record low — a negative yield! Investors in Europe are so skittish they are willing to pay money, over a decade, just to hold German debt. Economic relationships within the EU and the rest of the world will change, affecting rates of return and asset prices, but no one knows how and by how much; it is simply unknown how long it will take to redefine these relationships, and that’s what’s being reflected in markets — uncertainty.
The Bank of England’s Governor, Mark Carney, has spoken of the grave consequences of Brexit, impacting financial stability, with “risks emanating from the very high current account deficit, property markets, market liquidity, and possible negative spillovers to the rest of the EU.” Our own Fed chair, Janet Yellen, has said much of the same.
Yet some may believe that a Brexit would advantage the U.S. in the short-run – specifically a flight to safety reducing interest rates and potentially increasing American competitiveness in financial services compared to London, as London is Europe’s financial hub. In the short-term, it is possible that some sectors in the U.S. would gain, particularly in finance with New York and Wall Street gaining an event firmer foothold against London as the global financial capital. While it is unlikely that many firms would leave London entirely, they would probably scale back considerably, both now and in the future. The UK has the highest proportion of jobs in all the EU devoted to finance, and many of these firms are not just pan-European, but also global in nature. Those workers from other countries like France, Germany, Italy, and possibly America would simply return home, causing a brain drain for the UK.
Brexit would lead to a global fall in equity prices as investors fear the impact the vote could have on Britain’s economy, and could spell the first falling domino of European Union disintegration. Keep in mind the vote for Brexit would only be the first step for the United Kingdom’s actual departure the European Union. Terms of the departure would have to be mutually agreed to and those terms would set substantial precedent for other nations that chose to leave; the EU may try to punish the UK for its departure. But other countries might choose to follow suit, regardless. Greece, anyone? And if it votes to leave, it may not be that all parts of the UK would want to stay out. Indeed, Scottish support for staying in the EU (60 percent in favor) is higher than England’s (43 percent), according to recent polls. It is also not hard to imagine that Scotland might vote to secede from the UK, as it has tried in the past, and that it would impact Northern Ireland which has enjoyed a rare period of relative peace — in addition to setting off other European regional succession movements.
More importantly, we should view a vote on a British exit of the European Union with caution, and root for them to stay. Our economy does not need additional global headwinds. Global weakness and financial market uncertainty is not the recipe for stronger economic growth. A change like a Brexit could have ripple effects on us.
One final American experience may be worth remembering as we wait for the vote next week: during our financial crisis, public sentiment ran strongly against the proposed Troubled Asset Relief Program (TARP), seen by the public as a bailout for Wall Street excesses at the expense of Main Street. In a stunning surprise to markets and Congressional leaders, the House of Representatives originally voted down the TARP proposal in September 2008. Market reaction was swift, with the Dow falling over 750 points in a single day — the largest point drop in market history. Only a handful of days later, the same members of Congress voted to approve TARP as public sentiment changed sharply when the ramifications of failing to pass TARP became clearer.
The UK and U.S. have had one of the strongest, most stable, and most beneficial relationships between two countries in human history (past our early history). America spent enormous resources during the 20th Century engaging when continental Europeans fought each other, always aligned with Great Britain, in support of our “special relationship.” If Britain leaves, it raises the chances of another crisis in Europe which could spread to our shores. It is simply not in our interests to watch the UK walk away from the EU.
Brexit has been bad for Europe thus far.
The most immediate problem is bandwidth, particularly in London but also in EU-27 capitals, as endless Brexit debates distract attention from other challenges. For example, leaders scrapped a discussion on China at the March European Council to discuss Brexit deadlines. Even if a divorce is agreed, negotiations on the future relationship could take years.
Despite historic British resistance to deeper integration, the U.K. is a global player whose participation has benefitted EU policymaking. Although protracted Brexit arguments have strained relations, European diplomats lament the impending loss of regular contact with their British counterparts on a myriad of issues.
In economic terms, Brexit will affect the U.K. more than the EU. Yet the nature and extent of Brexit’s impact on all member states will depend on how Britain leaves the EU and the future degree of regulatory alignment. A no-deal departure would hinder continental supply chains and markets, whereas continued British participation in the Customs Union and/or Single Market would minimize disruption. Beyond quarrels about the backstop, Brexit has destabilized politics in Northern Ireland by resurfacing contentious identity and constitutional questions.