Blog No. 102: Brexit: Arguments, Consequences and the Trump Factor

Even readers who have been preoccupied with the agonies of the Republican and Democratic primary campaigns are probably aware of the political battle being waged across the Atlantic over Brexit. That term, of course, refers to the proposal that Britain (with Northern Ireland, the United Kingdom) exit from the European Union. In more shorthand, the opposing sides are tersely referred to simply as Leave and Remain. The Brexit proposal will be put to the voters in a referendum on June 23, and to the questions “What will happen?” and “What will it mean?” there is clearly only one answer: no one really knows. Without attempting predictions, our view is that if the vote is to leave the EU, the risks to Britain, the EU, and ultimately the United States, could be significant.

Brexit is an issue over which the United States has no control and very little voice. When President Obama visited England in April, he cautioned against a departure from the EU and included a blunt warning that membership in the EU would not be quickly replaced by a bilateral trade agreement with the United States:

And on that matter, for example, I think it’s fair to say that maybe some point down the line there might be a UK-US trade agreement, but it’s not going to happen any time soon because our focus is in negotiating with a big bloc, the European Union, to get a trade agreement done. The UK is going to be in the back of the queue.

The President’s statement was perhaps not as presumptuous as it might appear since it was generally understood to have been given with the encouragement of the Cameron government. That Conservative government firmly supports Remain but has been plagued by a deep division in its own party and has been forced to rely on a rather flaccid effort from the Labour Party and its leader, Jeremy Corbyn. Indeed, some noting the use of “queue” rather than “line” even saw evidence of the hand of 10 Downing Street in the drafting. Nevertheless, the statement appeared to generate more backlash than support.

As the 23rd approaches, the British debate continues and polling indicates a close contest. While the advocates of Leave stress the cost and burdens of EU membership, the Remain campaign emphasizes the costs and risks of departure.

 

Arguments for Brexit 

The principal arguments advanced by the Leave proponents have centered on immigration, subsidizing the EU, over-regulation and the loss of sovereignty in complying with EU laws and court rulings.

Immigration. Leave proponents have pointed with alarm to an inflow of immigrants of 333,000 in 2015. On the other hand, immigrants make a substantial contribution to Britain’s economy. As a June 7 article in the New York Times noted:

From an economic perspective, Britain appears to benefit from immigration. Immigrants from Europe pay substantially more in taxes than they receive in benefits. And Britain appears to need more workers. Its unemployment rate is 5.1 percent. More revealing, the country’s employment rate, which records the proportion of people between 16 and 64 who are working, is 74.2 percent the highest level since comparable statistics began to be tracked in 1971.

Britain has not shared in the mass migration of refugees from the Middle East and Africa that has engulfed Europe, nor is it likely to. Britain is not a part of the Schengen zone of largely passport-free travel, and has the right to check everyone at its borders and can deny entry for a host of reasons. Britain has taken substantial measures to reduce immigration, raising the skills requirement for non-European Union citizens and reducing incentives for European Union citizens coming into the country for low-paid jobs.

Subsidizing the EU.  The Leave campaign claims that Britain sends 350 million pounds to the EU every week, but the claim is misleading.  Britain’s gross contribution to the European Union was 19.1 billion pounds (about $28 billion) in 2014, or 367 million pounds a week. After accounting for rebates and grants from the EU, the actual net contribution from Britain is about 9.9 billion pounds a year, or about 190 million pounds a week, a little more than half of what Leave claims. It is roughly 0.5 percent of British gross domestic product and around 1.3 percent of the current British budget of about £770 billion. A calculation of indirect economic benefits of membership in the EU should include the benefits of trade with the EU as well as the part that EU membership plays in making London a preeminent financial center.

Over-regulation. As described in a June 7 article in the New York Times, the Leave campaign portrays EU regulations in dire terms: “Britain is the victim of faceless, highly compensated bureaucrats in Brussels who meet in secret and churn out off-the-wall regulations costing businesses billions of pounds a year.” While there is no doubt something to that description, a report by the OECD (The Organisation for Economic Co-operation and Development) provides a different picture:

The public debate in the UK often fails to recognize the benefits from EU regulation. The 100 most expensive regulations cost the UK economy £27.4bn each year, whereas the benefits total £57.1bn, according to UK government impact assessments. Some individual regulations appear particularly costly, such as the Agency Workers Directive, which has a net cost of over £500m each year. The figures are contestable as the benefits are hard to estimate and some of the costs are due to gold-plating of standards by the UK.

The OECD regards the UK as the second least regulated product market after the Netherlands. Labour market regulation is comparable with the US, Canada and Australia and is much lower than other EU countries.

The OECD also points out that following Brexit, Britain would, as a trading partner with Europe, have to comply with many of the rules but would have lost the influence as an EU member to shape or modify them.

Sovereignty and the EU Court.  Advocates of Leave have cited the fact that Britain has lost 75 percent of the 131 cases brought against it in the European Court of Justice, principally on grounds of Britain’s failure to adopt European laws as required.

A comprehensive and seemingly neutral analysis of the current impact of EU membership, and the effect that Brexit would have, was published on June 8 by the Telegraph. The analysis included this summary regarding the impact of EU law:

Precise numbers are impossible to obtain, but [one study] estimates that 14 to 17 per cent of UK law is derived from our EU membership.

In the same study, the UK government estimated that about 50 per cent of UK legislation with “significant economic impact” originates from EU legislation.

The bulk of those laws – around 60 per cent – relate to the fields of agriculture, fisheries and trade with non-EU states, but abiding by EU law has a ripple-effect that impacts almost all aspects of British life, from small businesses, to immigration, welfare and the courts.

 

Consequences of Brexit

The Remain campaign has pointed to the economic costs of leaving the EU. Yet their claims, like those of Leave are not free of exaggeration. For example, one claim was that three million jobs in Britain depend on membership in the European Union. One study did say “3.45 million jobs depend upon exports to the E.U.” But while there is no question that trade with European Union countries might be diminished to some degree after Brexit, much of it would continue. A Treasury study estimated that leaving the EU would reduce the nation’s GDP to the extent of an annual loss of income of 4,300 pounds (or $6,200) per household by 2030. The study rests, as most economic forecasts do, on a variety of debatable assumptions. Nevertheless, the consensus among economists is that leaving the EU will result in a reduction in GDP.

Even those who are not involved in the Brexit battle, and do not have a direct stake in it, have expressed concerns over the potential consequences.  It should be noted that in some respects the immediate effect of Brexit may be limited. The vote would not be self-executing, but would be followed by a period of extended negotiation that, some observers have suggested, could even result in another referendum. Nevertheless, the impact on the financial community could be more immediate.

On June 9, the Telegraph reported a warning by Standard and Poor’s and suggested that “Brexit might trigger a run on Britain’s record financial debts.” As the article explained:

Britain is the world’s most vulnerable state on a key measure of short-term debt and credit markets might suddenly seize up if voters opt for Brexit, Standard & Door’s has warned.

The US credit rating agency is crystal clear that Britain will be stripped of its coveted AAA status immediately and may face a double-barreled downgrade if the country takes a leap in the dark, jeopardizing its trading and financial ties to its biggest market.

The article also reported that the Bank of England had experienced an outflow of 65 billion pounds in March and April, the largest since the global financial crisis.

While markets have thus far appeared to give little weight to the June 23 event, that could change quickly. In a June 6 speech, Federal Reserve Chair Janet Yellen noted that a Brexit was one factor that the central bank would consider when deciding whether to raise interest rates. Her statement was briefly noted in U.S. Media, and the BBC took due note of her statement and that of another Fed Governor:

In her speech the Fed chair said: “A UK vote to exit the European Union could have significant economic repercussions.”

She stressed that investors’ “appetite for risk” could change quickly and that a UK exit from the EU would be likely to affect market sentiment.

Ms. Yellen’s remarks echo comments from other economists about the impact of a Brexit on the US economy.

On Friday Lael Brainard, a member of the Fed’s board of governors, suggested that a Brexit could have a “significant adverse reaction” to the US market.

“Because international financial markets are tightly linked, an adverse reaction in European financial markets could affect US financial markets, and, through them, real activity in the United States,” Ms. Brainard said.

Two days later, Reuters reported an observation by the world’s largest asset manager that financial markets, particularly equities, may be underpricing the risk of Britain leaving the European Union. Owen Murfin, co-lead manager for global bond strategies at Blackrock Inc., said that markets appeared to be treating the possibility of Brexit as a local event rather than a globally systemic risk. “There might be a little bit too much complacency. I would think that Brexit probably should be seen, in the context of the near term, as a bigger deal.” (Blackrock managed $4.7 trillion in assets globally as of March 31 of which $1.5 trillion was in fixed income assets.)

We claim no particular competence in financial prognostication, and do not want to indulge in fear-mongering, but the interconnection between global financial markets can hardly be ignored. It seems to us, therefore, that at the very least, Brexit is something to which investors and the public should be paying attention.

 

The Trump Factor

We believe that, viewed objectively, the costs and burdens of membership in the EU are significant, but the costs and risks of leaving are much greater. Thus, if Britain should vote for Brexit, the vote may rest more on emotion than careful thought. In that respect, we find some resonance with the support for Donald Trump in this country.  Along that line, former Treasury Secretary Lawrence Summers recently observed in the Financial Times that Brexit and the American election have much in common: “ Both could lead to outcomes that would have seemed inconceivable not long ago. Both pit angry populists against the political establishment.”

Moreover, as a British observer writing in the Washington Post reminded us:

Of course, Britain has always stood aloof from Europe. Generations of orators have channeled John of Gaunt, the patriot in Shakespeare’s “Richard II,” who celebrates “this scepter’d isle . . . this precious stone set in the silver sea. . . this blessed plot, this earth, this realm, this England.” When Michael Gove, the erudite leader of the anti-E.U. “Leave” campaign, calls on schools to give “children the ability to hear our island story,” he stands as the heir to a powerful tradition.

In that nostalgic vision, one can hear the echoes of the reported plea of a Trump supporter, “I want my country back.”

The most prominent supporter of Leave is Boris Johnson, the Conservative former Mayor of London and a rival of David Cameron. Johnson has sometimes been compared to Trump, but George Will, who detests Trump but is no friend of the EU, attempted to dismiss the comparison:

Johnson is frequently compared to Donald Trump. Johnson, however, is educated (Eton; an Oxford classics degree), intelligent, erudite (see his book on Roman Europe), articulate and witty…. So, Johnson’s only real resemblance to Trump, other than an odd mop of blond hair, is a penchant for flamboyant pronouncements, as when he said that Barack Obama opposes Brexit because Obama’s Kenyan background somehow disposes him against Britain.

Admiring of George Will as we often are, we are not convinced. Even granting Johnson’s superior intellect, the comparison is still compelling. Indeed, closing one’s eyes, it seems possible to hear Johnson promising to “make Britain great again.”

As for Trump himself, his comments have been characteristically insightful. As noted in The Hill, Trump was asked about Brexit by Michael Wolff of the Hollywood Reporter who elicited the following response:

And Brexit? Your position?” Wolff asked the billionaire.

“Huh?” Trump responded.

“Brexit,” Wolff reiterated.

“Hmm,” the real estate tycoon said.

“The Brits leaving the EU,” Wolff replied.

“Oh yeah, I think they should leave,” Trump said.

O tempora! O mores!