Brexit – Lessons for the European Union
The result of the British referendum (51.9% pro-Brexit) surprised the financial markets, but also the policy-makers (recently, the UK Treasury admitted the lack of a plan for this scenario).
The pound depreciated significantly, to the lowest level since June 1985 against the US dollar. At the same time, the uncertainties regarding the future of the UK-EU relations have had a strong impact on the banking sector, given the role of London in the global and European financial industry (the banks’ stock index decreased by over 20% in EU since the 23rd of June, compared with a decline of only 7% in the US).
The international financial flows strongly entered the bonds markets after the British referendum (given the increase of the risk perception): the sovereign bonds’ yields decreased to record low levels (negative values in Germany) on account of increased demand for a safe harbor for capital.
The British economy is the most affected by the results of the referendum: the economic indicators are deteriorating, while the pro-Brexit risks are crystalizing (with impact in terms of financial stability). At the same time, the S&P Agency cut the sovereign rating by two notches to AA and the outlook of the British banks from stable to negative. Last, but not least, some investment funds with exposure on the UK real estate market suspended the trading.
The deterioration of the investment climate in the UK seems to spill over to the main economic partners (Euro Area included).
The degree of uncertainty is high, as the UK is facing a political crisis – Prime Minister David Cameron is set to resign after the referendum. For the moment, the British authorities seem unwilling or unready to trigger the Article 50 exit procedures under the Treaty of Lisbon, given the unfavorable economic consequences. In this context, at the EU27 Summit organized on the 29th of June the political leaders pointed out that the future access of the post-Brexit UK to the EU markets would depend on applying the free movement of all production factors (human capital included, one of the topics that contributed to the result of the referendum).
In other words, the UK seems to have fallen in a trap that it cannot get out of without economic costs: either in EU or outside EU, the country should respect the free movement of people. Furthermore, in the case of Brexit, the UK risks not only economic isolation but also important challenges (including the possibility of a renewed push for a second independence referendum in Scotland).
Until the political crisis ends in the UK, we will see in the public space and the public discourse an increasing aversion towards Brexit, as the British society is acknowledging the costs of this scenario.
It is interesting that the pro-Brexit vote happened after four decades of membership in the so-called project of “United States of Europe” (as named by the former PM Churchill).
It is truly difficult to assess the impact of the events in the UK on the EU and world economies. The preliminary estimates of the European Central Bank indicate the slowdown of the rate of economic growth by a cumulated level of 0.5 percentage points over three years in case of Brexit.
For the moment, the impact of the pro-Brexit vote is limited. The US Dow Jones index returned to the pre-referendum levels and the UK is not member of the Euro Zone, while the depreciation of the British pound should limit the impact of the shock.
However, the persistence of uncertainties and confusion regarding the future of the UK would encourage many companies to re-assess their investment plans.
The pro-Brexit vote is an important lesson for the EU, from the economic, social and political points of view, with possible implications for the global economy, in a context of increasing frequency of clashes between contradictory forces: unbalanced economic policy mix in the developed countries; structural challenges (with delayed reforms) in the emerging countries; the increasing populist pressure without economic support (the gap between the political speech and the economic reality) etc.
On the one hand, the EU is a project built on minimal political integration, but with a maximum interdependence among the member countries from the economic point of view (to such an extent that the exit of one country is not desirable, given the huge unfavorable economic consequences).
The EU is a strong project, as confirmed by the resilience to all the risk factors over the past decades. On the other hand, the British vote may open the doors for further referendum initiatives in other EU countries.
At the same time, the EU is a unique project from the perspective of co-existence of several degrees of integration. This reflects the unity in diversity mantra. However, the result of the British referendum also underlines the urgent need for fresh EU leadership and a new Treaty to address the political and social challenges as the economy enters the post-crisis economic cycle.
The EU countries have been strongly integrated from the economic point of view, but one cannot say the same thing for the political and social Europe. In this context, the future of Europe depends on the responsibility-solidarity relation (in this order), an aspect recently underlined by the President of the European Central Bank (Mr. Mario Draghi).
Consequently, the EU would be stronger if the member countries apply this mechanism and also the principles of the real economic convergence. On the contrary, the increasing pressure of the historical pride (without economic support) would cleave a wider gulf between the EU and the US in terms of overall wellbeing (which is the opposite of the intent of the endeavors of the EU’s political leaders).