Political and economic consequences of Brexit

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The Brexit referendum has sent a shockwave through the European Union but the perspective of Brexit as a clean break with the EU might be rather far-fetched.

The referendum caused one of the deepest political crisis in the British post-war history which is not only going to weaken UK internationally but also radically increases the chances of a territorial break-up of the country. However, the exact form of the exit and the politico-economic consequences of the referendum are still uncertain and depend among other things on the outcome of the withdrawal negotiations between the EU and UK. Interestingly, the influential German MEP Elmar Brok claimed this week that the Brexit referendum was merely consultative and the British Parliament can overrule it, in particular given its current pro-Remain majority. Also, the Austrian minister of finance Hans Jörg Schelling has argued recently that the UK will continue to be a full EU member. Alternatively, only England and Wales might leave, while Scotland and Northern Ireland will remain EU members.

To brexit or not to brexit?

There has been a growing criticism of the key EU players, such as Angela Merkel, Jean-Claude Juncker and Martin Schulz who had pressured the UK government to start exit negotiations according to article 50 of the Lisbon Treaty as soon as possible, also in a visible attempt to discourage other member states to use the threat of a referendum in order to blackmail the EU. Nevertheless, both a quick and complete exit from the EU is rather unlikely.

First, it looks like the most vocal Brexiters including Boris Johnson and Nigel Farage have only now realized the full extent of negative consequences Brexit can cause. Their silence and some ill-informed reactions to the potential harm to the British economy, losses to UK’s farmers and fishermen (as they will be cut off the EU’s agricultural policies and the new catching quota after the Brexit are unlikely to be more generous), British universities (which are huge beneficiaries of the EU’s research funds) and paralyzing the TTIP negotiations show the extent to which the reality has caught up with the Brexiters. If the economic downturn continues in UK causing increased unemployment and investment fallout, the Brexiters will be blamed for it.

Second, the pace of the withdrawal from the EU will depend on the new leader of the Conservative party. With Michael Gove (one of the main Brexiters and supporters of Boris Johnson), the withdrawal will become messier, as he envisages the UK leaving the single market completely. With Theresa May (the current home secretary who was in favour of Remain), the Tory government is likely to work towards the slowing down of the exit process and keeping as much of the British economy inside the EU as possible. In this case, the outcome is likely to be “Switzerland lite” (as Switzerland is member of the Schengen Zone, even though it is not EU member and the UK was never part of Schengen). There is a precedence case for this: the rather unspectacular withdrawal of Greenland from the then European Community in 1985. After some strenuous negotiations over fishing rights, Greenland still remained subject to the EU treaties through association of Overseas Countries and Territories, while it stopped participating in the decision-making within the EU. Consequently, the goal of the Brexit negotiations is likely to be some form of enhanced association agreement with the EU where both the mobility of capital and goods (the British main concern) and the mobility of people (the EU’s main concern) will be at stake. Therefore, all EU citizens living currently in the UK are likely to retain their current status and also the future intra-EU migrants should be able to keep the right of residency in the UK. Any limitation of the free mobility for EU citizens will result in restrictions for the British business in the remaining 27 member states, especially as there is no understanding or sympathy for the current Tory government among the key players of the EU, mainly Germany, France and Italy. In sum, the probable outcome at the end of the two-year negotiation period will be UK’s economic association with the EU but no political impact in the EU and limited access to EU funds. At the same time, the UK will largely remain subject to EU laws, which will be rather the opposite of the “Take back control” slogan of the Brexiters.

Who is to lose and who is to win?

For Central and Eastern Europe (CEE) there will be mainly political consequences, even though there still might be some direct economic impact. Economically, CEE currencies have experienced value losses, as investors shifted towards dollar and euro denominated assets. But regarding trade and FDI no catastrophic consequences are to be expected, as long as the UK will be a part of the European Economic Area. Thus, the Polish exports to UK (6,6 per cent in 2014) or the Hungarian ones (3.2 per cent in 2014) are likely to remain unaffected. Nevertheless, Brexit will have consequences for the EU budget. Until 2020 the UK contributions are hard-wired into the EU budget. Even with the Brexit negotiations, it will not be easy for Britain to stop paying, as the EU budget framework is a highly complex legal construction. Moreover, a unilateral decision by London to stop paying, presumably in 2018, would seriously damage the UK’s reputation in the eyes of its creditors. That is why London will be very careful in this issue.

Still, the new budget negotiations for the years 2020-2026 will be more difficult, given that the “cake” will become smaller, unless the EU finds new sources of revenues. One of solutions could be to expand the direct sources of revenues of the EU budget, mainly sugar and customs duties, as well as a share of VAT revenues, thus bypassing the member states entirely.

Politically, non-euro countries including Poland, Hungary and the Czech Republic will further lose influence in the EU, as they become a structural minority. Together with the UK the non-euro member states make up around 40 per cent of the EU’s GDP and with 170 million inhabitants about 33 per cent of the EU population. The financial impact of the non-euro countries was strengthened in 2011, when the seat of the European Banking Authority (tasked to carry out stress test for the European banks) was determined to be in London. With Brexit this and other EU institutions will leave UK and the financial and economic role of remaining non-euro member states will be marginal in the EU: 16 per cent of the EU’s GDP and around 20 per cent of the EU population. Consequently, the pressure on the non-euro member states is likely to grow in the next two years. The president of the European Commission Jean-Paul Juncker claimed after the Brexit referendum that the EU has to deepen through the expansion of the Eurozone. This pressure might even become part of the negotiations for the budget framework 2020-2026.

Nonetheless, some Eastern European countries have new hopes for additional FDI or brain drain from UK. In Romania an ad campaign “Move to Transylvania” is trying to convince UK firms to invest in the region praising easy flight connections, fast internet, high number of IT specialist and low salaries, while the Poland’s Deputy Prime Minister Mateusz Morawiecki tried to put a positive spin on Brexit arguing that it would give an opportunity to the government to invite some of the Polish migrants back home. Still, it seems doubtful that CEE will be able to attract highly specialized employees, since their salaries in CEE are not competitive in comparison to UK, Germany and the Netherlands, unless governments of these countries introduce additional financial or career incentives.

The major winner of the Brexit will be Germany, mainly politically. Since the political decision-making system depends strongly on the population size of the member states, the fallout of UK will strengthen the largest member states, in particular Germany with its more than 80 million inhabitants. At the same time, Germany has the strongest economy of the EU and enjoys the highest credit rating, while the EU’s dealing with all its recent crises (the sovereign debt crisis, the Ukraine crisis, the migration crisis) had a German signature written all over them. Germany will become more influential, also because France and Italy cannot balance Germany’s quasi-hegemonic position given their domestic economic and financial downturn. Still, some German companies will be also affected negatively by Brexit. According to the estimates of the Association of German Chambers of Commerce and Industry more than 33 per cent of German enterprises in the UK plan to reduce their investments and around 25 per cent are getting ready to cut employment. There are currently around 2,500 German firms in the UK employing about 400,000 people. One of the more serious cases is the German electricity producer RWE facing bankruptcy, mainly due to the 2011 decision of the German government to force electricity producers to surrender their nuclear power plants which in the case of RWE caused a 70 per cent loss of the company’s value. Brexit is likely to damage economic activates of RWE in the UK, while the value loss of the British pound will put additional strain on the RWE’s balance, likely to produce one of the biggest bankruptcies in the German economic history.

Of course the main loser will be the British economy which is likely to be plagued by weak currency vis-à-vis the US dollar and the Euro. This will in turn have negative consequences for UK’s financial sector. In addition, the economic growth is likely to considerably slow down by the end of 2016 which in turn will increase the economic uncertainty even further and have negative impact on private consumption. It is expected that this will put pressure on the Bank of England to reduce the interest rates, probably to zero by the end of 2016, which will make UK bonds quite unattractive, producing further capital flight from the UK. After the referendum results were announced, some UK real estate funds (including Standard Life, Aviva and M&G Investments) even suspended temporarily their trading, as their shares lost around 6-8 per cent. The reason for it was a massive increase in investor redemptions due to high level of uncertainty regarding the British commercial property. Consequently, London is expected to lose some of its relevance as a pivotal place for financial services in Europe. Even though the London stock exchange FTSE increased in value last week, mainly due to good performance of international corporations, such as BP or Shell, unaffected by the UK economic climate, the banks and airlines have experienced serious losses. For instance, the Royal Bank of Scotland lost 30 per cent of its value within 10 days. This increases the chances for Frankfurt to replace London as the financial centre of Europe. Simultaneously, Germany is expecting a transfer of around 10,000 jobs in the banking sector from London to Frankfurt, mainly due to political stability and the high credit rating of Germany. Some banks might move to Dublin or Luxemburg where the tax system is friendlier to financial services than it is in Germany. According to the analysis of Boston Consulting the transfer of some banks’ headquarters will take place within the next 2 years while 20 per cent of jobs in the banking sector will leave the UK. According to the estimates of Munich Re, the leading international reinsurer, it is Dublin that will attract many insurance companies which will weaken the insurance market, Lloyd’s of London. Moreover, the merger of the German Stock exchange and the London Stock Exchange will not cause the new entity to have its headquarters only in London but also in Frankfurt if the merger will take place at all.

The Irish or the Swiss lesson for the Brits?

One of the solutions could be to call for a new election and then allow the new parliament to decide again about Brexit. The Brexit referendum in Scotland showed clearly that the question of Scottish independence is not over yet. The next two years will not only be spent on painstaking negotiations with the EU over the Brexit details but also on the issue of when the next Scottish independence referendum will be organized. As the Scottish first Minister Nicola Sturgeon said numerous times, Scotland wants to remain part of the EU and to carry out a new independence referendum as soon as possible. Early elections could prevent the new Scottish independence referendum and the possible break-up of the country, since a possible coalition government of Labour and the SNP might stop the Brexit by calling for a new referendum in, for instance, 2 years’ time. Even though next elections are scheduled to take place in 2020, the question remains how the main opposition parties: the Labour Party and the Scottish National Party (SNP) will cope with Brexit, since both parties were strongly in favour of Remain. Currently, both opposition parties do not have enough seats to call for an effective vote of no confidence against the Tory government. However, there is a majority of Remain votes in the parliament, as many Tory MPs are against Brexit and a pragmatic Tory leader, such as Theresa May, might take the option of early elections, in particular if the Conservative Party and the Tory government is to remain deeply divided over Brexit.

The procedure of recurrent referenda on the same issue has been a constant feature of the EU’s political history (Denmark in 1992 and 1993 on the Maastricht Treaty, Ireland in 2001 and 2002 on the Nice Treaty, Ireland in 2008 and 2009 on the Lisbon Treaty). The Irish case is particularly instructive, as Ireland rejected the Lisbon Treaty with 53.2% in 2008 but accepted the unchanged treaty with 67.1 % in 2009. In 2014 the Swiss narrowly voted (50.3%) in a referendum to renegotiate the country’s agreement on free mobility with the EU in order to introduce limitations for migrants, including the EU citizens. As a response, the EU started a process of excluding Switzerland from privileged cooperation scheme, such as the Erasmus research programmes, and refused to negotiate with Bern arguing that free movement is a part of a more complex deal granting Switzerland preferential access to the single market. instead The EU has suggested a new Swiss referendum should be held on the issue of mobility. This time the chances that the referendum will turn out to be in favour of dropping the mobility restrictions for EU citizens in Switzerland are higher.

In addition, a new referendum might be less costly and also easier than Brexit negotiations. There are serious doubts that two years will be sufficient to negotiate the extent to which all 35 chapters of the so-called acquis communautaire (the accumulated body of all EU’s laws, regulations and court decisions) still apply to Britain. As British and German reports point out there is a shortage of public employees who are able to deal with the often specialized and technical issues of the EU law. That is why the British government is reaching out to international consulting firms such as KPMG, McKinsey and PwC. Still, even with their assistance, it is going to be a long and controversial process.

In sum, much will depend on the ability of the key players in the EU including the European Commission, Germany and France to deal with the Brexit consequences. First, the Brexit negotiations, including the EU budget framework regulating UK’s contributions, will determine how much uncertainty and economic damage will be done to both British and the EU’s economy. Second, the key players need to step carefully regarding the non-euro members, as too much pressure or threats of exclusion might produce the opposite effects with further referenda in the CEE. Any “old Europe” solutions (based on the six founding member states) will damage the EU’s economy further and destabilize the EU politically diminishing its international role, for instance in the future TTIP negotiations.

Ireneusz Pawel Karolewski is an Associate Professor of Political Science, Willy Brandt Centre for German and European Studies, University of Wroclaw in Poland. He was Kosciuszko foundation fellow at Center for European Studies, Harvard University in 2014 and Visiting professor at the John F. Kennedy School of Government, Harvard University in 2015. His research interests are social and political theory, European Union governance and EU foreign policy. 

 

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