After the ordeal. Thoughts on EU Referendum day about Europe’s future

It’s EU referendum day in the UK. Before the results become known, it is a good time to reflect on the campaign and think about the consequences – legal, political and economic – of different possible outcomes, both for the UK and the EU.

Referendum number two

More than forty years after holding a referendum that overwhelmingly confirmed the its membership of the then European Community (“Common Market”), today the UK is holding another plebiscite, on whether to reverse that decision and leave the European Union, as it has now become. The referendum was an election promise by Conservative PM David Cameron to suppress the vote of the anti-EU UKIP party and keep his Eurosceptic backbenchers on side. The political constellation is roughly the same as forty years ago: the centre right and left – the Establishment if you so will – against the right and left fringes. However, one thing is certain: today’s outcome will be much closer than the 2:1 majority for In in 1975.

The polls have tended to show small majorities for remaining in the EU. But a late swing to the Outs sent markets spinning – the pound and UK and European shares fell sharply, bond yields plunged even further. Recently the Ins have done better in the polls (and have been consistently ahead in the betting markets). In part this is a reaction to the murder of Jo Cox, a Labour MP, by (on available information) a far-right attacker for which tragedy the incendiary rhetoric of part of the Leave campaign was widely held to bear partial responsibility.

As I write, on referendum day, the polls and the financial markets are such that a majority for Leave would be a surprise. But then we have seen quite some electoral surprises in recent years.

The leaders of all the main parties, almost all trade unions, almost all economists, the Bank of England, leading international financial institutions, European and world leaders and many (but not all) public personalities in Britain have warned against the dangers of Brexit and called for a Remain vote. The Leave campaign has, though, been supported by most of the newspapers, by second-rank politicians from Labour and Conservatives and some far-right (especially UKIP) and far-left parties, along with some elements of the business community.

Why so close this time?

A number of factors can be cited for the likely close outcome given the apparent imbalance of forces.

• A widespread insurgency against the “liberal”, internationally oriented establishment – which has been discredited by the crisis – on both Right and Left (as manifested by the likes of Trump and Le Pen, and Sanders and, to some extent, Corbyn).
• Longstanding Euroscepticism in Great Britain (which has stayed aloof from many of the most important integration steps) heightened by more recent factors: the continuing social and economic aftermath of the Great Recession, the economic travails of the euro area and the inability to deal effectively with the refugee crisis.
• The power of the “yellow press”, owned largely by foreign billionaires, and which has for years fought a UK version of the US “culture wars”- against migration, crime and the EU – to fire up a base that is actually suffering the consequences of austerity and other inequality-enhancing policies. Weighed by circulation Brexit articles quantitatively overwhelm Remain articles by 4:1.
• Neither of the main party leaders is credible. For years Cameron disparaged the EU. He negotiated a deal making rather symbolic changes to the UK’s status, which he has been implausibly arguing is a game-changer. Labour MPs, members and voters – in that order – are pro-EU. But many of the latter are “hurting” economically and susceptible to the arguments of the press and UKIP that the immigrants and EU are to blame. The new leader himself comes from the small Eurosceptic wing of the party. He is an unconvincing champion and the party has certainly only belatedly mobilized. This has led to criticism. Let it not be forgotten, though, that it was the Conservative Party leadership called the referendum, for its own purposes, and Conservative voters will in their majority be for Leave, while Labour will vote In.

Let us turn now to the immediate future and the medium-run prospects. Somewhat artificially I will discuss legal, political and then the economic impacts in the UK, before turning to Europe.

The legal ramifications of the referendum outcome

It will take a majority decision by the British parliament to revoke the Act of Parliament that brought Britain into the EC. Formally, the House of Commons is “sovereign” and is not bound by the outcome. If the referendum produces a very clear outcome it will be impossible to ignore. This seems unlikely, however. If it is close we must distinguish between the two cases. If there is a small majority for Remain – given that MPs largely support staying in, and this is the “status quo” – the UK is certain to do so. In the opposite case, though, a Parliamentary majority to begin the exit process might not be forthcoming. In addition to the fact that a majority of MPs are for Remain a number of arguments could be fielded if the result is close:  one is that an irrevocable decision to change the status quo requires, politically, more than a simple majority of votes; another is that it is likely that Scotland, Wales and possibly Northern Ireland will vote Remain: if parliament goes along they would be forced out of the EU by an English majority. At least in the case of Scotland this would likely lead to a renewed attempt to break up the UK. It goes without saying that any discrepancy between the referendum and the parliamentary outcome would plunge the country into a bitter constitutional fight.

In the case of a vote by parliament to leave, the Prime Minister would apply to the EU to leave the club, invoking Article 50 of the EU treaty. The legal negotiations process is extremely complex and would be expected to take years.

British constitutional experts warn that devolution of powers to Scotland, Wales and Northern Ireland make repatriating powers from Brussels extremely difficult. Some powers were on paper devolved to, for example, Scotland, but actually exercised by the EU: but on repatriation they would have to be handed over to Edinburgh. The Good Friday Agreement which ended the conflict in Northern Ireland is also an example of legislation that is woven into legal structures related to EU membership. What is to be done with case law, important in the UK, which has been established on the basis of EU laws which Britain would like to ditch? In short, massive amounts of legislation would need redrafting. Each redraft will mark a separate political battle.

Meanwhile Article 50 only grants the leaving country a two-year negotiation period, putting British negotiators at a disadvantage. If there is no agreement, Brexit will be automatic and the UK will be “just another country” for the EU, trading under standard WTO rules. The willingness of EU bureaucrats and other national governments to devote valuable resources to interminable negotiations with a would-be leaver will be limited, all the more so given pressing problems in the euro area. Any agreement has to be accepted by the other member states (qualified majority) and by the European Parliament. If the EU plays hardball it will tell the UK to choose between the European Economic Area or nothing. Membership of the EEA – the Norway option – implies submitting to many of the rules and duties that Britons want to leave the EU to avoid, notably free movement and financial obligations. It is hard to see how this could be sold to voters on a victorious leave side, though. But as noted, view among Leavers of the desirable status outside the EU vary widely.

The political ramifications in the UK of the referendum outcome

If Remain wins the existing British government and senior ministers will remain in place. It is not clear what the Eurosceptic wing of the conservative party will then do. The campaign has been much more bitterly fought within the Tory party than within Labour. Try and regroup within the party, defect to Ukip, or attempt to make-up and adapt to the new reality? Probably we will see some mixture of all three strategies.

The position of the Labour party ought to be strengthened. Labour votes saved the country from the abyss and the Tory leaders from the chop. The TUC and virtually all the unions campaigned for Remain. It will be hard for Cameron to attack Labour in the way he until recently did. At the same time the labour Eurosceptics – including those in the leadership – will be weakened.

Overall one would therefore expect a restrengthening of the political centre right and left at the expense of the recently stronger more extreme wings. Possibly though, a sizeable fraction of eurosceptics (above all on the right but maybe also on the left) coalesces around UKIP. It is possible that disappointment – especially if the vote is tight there will surely be cries of “foul” and complaints about a “Jo Cox effect” – will initially boost that movement. However, it would lastingly split the right of British politics, and under the British electoral system this is unlikely to be a winning strategy.

If Leave wins and the process of Brexit is set in motion, views differ on whether the current Conservative party leadership and government can continue. The Brexiteers have said Cameron should stay on and he has also indicated a willingness to assume responsibility for applying under Article 50. Politically, also on a personal level given the nature of the campaign, it seems inconceivable, however. At the very least the conservative Brexiteers will have to be given important government posts. (This might happen also after a Remain vote as part of a Tory kiss-and-make-up strategy.) And UKIP, especially Nigel Farage, will surely want their political pound of flesh. What form could that take?

In short a serious shift to the nationalistic right and to neoliberal economic policies is to be expected in the case of Brexit. (It is not the least for this reason that I have criticised what I see as political naivety on the part of Brexiteers on the left.)

The Labour Party (and the unions) would be seen to have fought and lost. The leadership will be accused of having done Cameron’s dirty work for him to no gain. The debate will be reignited about the party’s inability to connect with a disgruntled (white) working class. While such a debate is not in itself a bad thing, it is likely to turn very bitter and damaging in the recriminatory atmosphere of a lost referendum. (It is presumably recognition of this danger that latterly led the more skeptical elements, not least those around Jeremy Corbyn, to intensify campaigning.)

The economic ramifications of the referendum outcome

Apart from more technical issues associated with any economic forecast, there is a more basic problem in assessing the likely economic impacts of Brexit. Not only is there uncertainty about what impact certain policy changes will have on outcomes, there is a fundamental uncertainty as to the post-EU UK’s relationship with the former club, and also on how long it will take to get there. A notable feature of the leave campaign – which includes UKIP but also the Socialist Workers Party – is a lack of a unified alternative vision to EU membership. Leave voters are, similiarly, protesting against lots of different things they dislike about the EU, from business red tape on the one hand, to a view that the four freedoms undermine workers’ rights and bargaining power on the other. (The one unifying theme seems to be a dislike of inward migration, aka freedom of movement).

Consequently guestimates of the costs and benefits of Brexit are forced to pick counterfactuals and make an assumption about the length of transition to the new “steady state”.

Having said that, overall the findings are remarkable in their degree of unanimity regarding the direction of effects. They are virtually all negative. Particularly for the UK itself but explicitly or by implication also for the European economy. The standard channels are escalating uncertainty in the short and medium run, associated falls in foreign and direct investment, the inflationary impact of a depreciation of the pound (creating a dilemma for monetary policy). On top may well come significant financial turbulence. A key UK weakness is the large current account deficit (7% GDP); it must be financed by capital imports, which might suffer a “sudden stop”.

In the medium and longer run more costly trade and the resulting dynamic efficiency losses are the key issue. The trade effects are not just direct but also relate to the deals with third countries negotiated as part of the EU. The reduction of immigration – whose magnitude is obviously also a key uncertainty but could be large given the motivation of Brexit voters and that half of immigrants are from the EU – also impacts growth prospects. (Clearly this is rather less true of per capita output trends. However, almost all available predictions are in terms of GDP).

A summary of forecasts and some more qualitative predictions by economic research institutes and international financial institutions is given in the table below. The consensus is for rather severe short-term losses in output and employment of the order of 2-3% of GDP compared with the baseline. In short a recession is likely. Whether these growth losses are subsequently recouped, maintained, or exacerbated in the “steady state” depends on how quickly agreement on the new trading and other relations can be reached and how close they are to the existing ones (Norway or EEA scenario on the one hand WTO scenario on the other).

There is one exception. Patrick Minford from Economists for Brexit (and University of Cardiff). The model of the former adviser to Margaret Thatcher delivers positive output and employment effects on the basis that Britain would swiftly and unilaterally abolish its import tariffs (regardless of whether this is reciprocated) and burdenesome labour market and other regulation.

I am not aware of quantitative forecasts of the impact on the European economy. A fairly mechanistic calculation by the DIW suggests short-run direct effects on Germany (via falling exports to the UK) could be fairly substantial (0.5pp of GDP in 2017; other indirect impacts are considered unforecastable.

Organisation	Impacts	Scenario/key assumptions	Notes
NIESR	-2.1%, -3.5% to 2020	Optimistic scenario (EEA), Pessimistic scenario (WTO)
UK Treasury	-6% GDP 2019	Severe shock (WTO)
Institute for Fiscal Studies	+GBP 20-40 bn fiscal deficit	Range from 2 NIESR scenarios	Debate on whether fiscal losses would lead to procyclical tightening or not
NIESR, Centre Economic Performance, treasury	c. loss of 7pp of GDP in longer run (2030)	WTO scenario permanent ( dynamic trade-driven) effects	As summarized by IFS
Economist	-1% GDP 2017, 6% GDP loss by 2020, 350k higher unemployment 2018	Relatively rapid agreement on close trading arrangement	Impact especially hard on finance sector
OECD	-3.3% by 2020 2.7%, 5.1% 7.7% GDP loss by 2030	Optimistic, neutral, pessimistic scenarios	Central scenario equivalent to GBP 3200 per household in today’s prices
Bank of England	Qualitative statements: biggest risk to forecast, downward revision, real risk of recession, inflation and unemployment higher		BoE draw attention to conflict for monetary policy in dealing with effects. Intervention in debate highly controversial
IMF	Substantial and negative effects Up to 5% off GDP		Interventions primarily qualitative in context of Article IV discussion. Accusations of collusion with Treasury, scaremongering (house, share prices)
Open Europe	+0.6%–0.8% GDP by 2030	Depending on how liberal/protectionist trade regime is	Scarcely measureable effects over such a long period
Patrick Minford/Economists for Brexit	+4% GDP by 2020	Assumes UK unilaterally scraps all import tariffs and bonfire of red tape	Model and motivation of the author widely derided.
DIW (for Germany)	€15bn reduction in German exports, 0.5% loss of GDP 2017, 0.1% 2016	This is only the direct trade effect; confidence, financial etc effects impossible to gauge.	UK 3rd largest trade partner of Germany, exports €120 bn of goods and services

 

Political ramifications for the EU

What about the EU, after the ordeal of the EU referendum?

On the one hand it seems clear that the political ramifications of the British decision, especially if it is to leave, would be substantial. The EU is in any case in crisis and in soul-searching mode. It would be the first country “lost” to the cause of European integration since the Rome Treaty. And the UK is the second-largest European economy. However, precisely which direction or directions a Leave decision would pull the EU in is far from clear.

A number of immediate considerations present themselves. Clearly the weight of the EU on the world stage would be diminished; the UK is the 5^th largest economy globally. The gap between the EU and the euro area becomes appreciably smaller with the departure of the only large and rich non-euro country. This would likely lead to pressure to further marginalise the “outs” within EU decision-making, a trend that only the Brits had the clout to resist.

Clearly European citizens and the world at large will be witness to a “performance competition” between the UK (pursuing a national or go-it-alone strategy) and the remaining EU member states (pursuing a cooperative or supranational strategy). For this reason the EU can be expected to play hardball with the UK. It has little incentive to see it flourish, which would likely encourager les autres to try their luck too.

Some federalists (such as Paul DeGrauwe) see Brexit as a chance to deepen economic and political integration without the tiresome opposition of the Brits. Although sympathetic to European federalism I am skeptical. This view exaggerates the salience of Anglo-Saxon oppositionalism. As non-members the Brits have been scarcely able to block (needed) integration of policymaking in the euro area (although defence of the real or perceived interests of the London City does cause problems in many policy areas). The real blockages in the euro area lie elsewhere, with its member states, especially Germany, and its institutions.

Nor is it clear to me that the UK did more to block EU integration than others, or whether, to the extent that this is in fact the case, Brexit will merely lead other countries – the Dutch, the Scandinavians for instance – to themselves actively prevent initiatives they do not like because they can no longer shelter passively behind the Brits. The key point is that the decision-making problems facing EU integration are more fundamental than the bloody-mindedness of any one country. There are, in short, too many veto points against the background of substantial heterogeneity of interests.

At the same time, anti-federalists will argue that the British decision to Leave shows the perils of excessive integration. They will draw the opposte conclusion: greater repatriation is needed if the EU is to survive. And of course those opposed to the EU tout court will try their luck – Marine Le Pen has already promised a referendum in France. Italy, the Netherlands and some Scandinavian countries are likely to see similar demands.

How this (old) debate within the EU would pan out in the aftermath of Brexit is unclear. One (old) solution would be internal differentiation along some core/periphery, two or multi-speed model. What is certain is that the stakes would be higher as a quite rapid unravelling of the EU is not precluded.

What if the UK remains? What will have changed for and within the EU thanks to the referendum campaign?

The Anglo-East European alliance (pro enlargement, free movement and liberal economic and social policies) has been broken, perhaps fatally. (This is not just due to the Brexit campaign and the associated anti-migrant rhetoric, but also to rising authoritarianism in eastern Europe). This and a likely sentiment that one has indulged the difficult Brits for long enough and they should now  not miss any opportunities to shut up could shift the balance of power within the EU somewhat towards the old west European core. If so, are the Six willing and able to use it?

At the same time it should not be forgotten that, prior to the referendum, the UK obtained promises for a new settlement, for recognition of its “special” needs and concerns. One can debate the substantive importance of these concessions (especially against the background of the UKs already rather distant relationship).  Be that as it may, other countries, or rather their governments, are likely to be tempted to pursue the same course. Negotiate a better deal under the shadow of a referendum (and thus a threat to exit), and then seek popular backing for staying in. If this strategy is pursued a highly chaotic form of internal differentiation – Europe a la carte – would result, which would call the effectiveness of the Union into question.

In short the future direction of travel for the EU is far from clear, either in the Leave or the Remain case. The only safe prediction seems to be that the struggle between the more federalistically inclined countries and social forces and their opponents will intensify. In the Remain case we might see a dualisation between ins and outs of the euro area. If Britain leaves, maybe a marginalisation of the non-Euro countries will be the consequence (and then their exit from the EU?).  One thing is certain: irrespective of the British decision the case for greater euro area policymaking integration is unanswerable, driven as it is by the revealed weaknesses of economic governance of the common currency area.

Voting ends in a few hours. By tomorrow morning at the latest we will know what the British people – or at last those eligible to vote: I and many other long-term ex pats were not – have decided. The referendum seems unlikely to have helped solve old problems. It might well have created new ones.