Today’s news coverage is non-stop Brexit. And this is a big event. But it is the political implications which matter; the economic impact will be more muted.
For one, the uncertainty regarding capital investment which economists talked about after the referendum is more likely to be felt now than it was then. In addition, increased inflation that was spurred by a lower currency level has made the likelihood of rate hikes higher. Ans so Brexit will have a cyclical impact via lower inflation-adjusted wage growth, lower consumption demand, higher borrowing costs, and potentially lower capital investment. Brexit will also have a permanent impact via lower growth due to increased frictions from trade.
But how high are these costs, really? No one is talking about a cyclical downturn induced by Brexit anymore. They were after the referendum. And — even in the hardest of Brexit exits with no trade deal in two years — the permanent losses will be fractions of a percent annually of GDP at most. That’s not small beer on a cumulative basis, but it’s not a big price tag either, frankly. This is not a Greek scenario.
The political impact is what matters here. Of course, some Britons will feel a real loss — almost as if they were no longer a part of Europe. But this is no more true than it is for Norwegians or Swiss – or for Austrians, Swedes, and Finns before 1995. But of course, the UK was never a part of the Euro, never a part of the Schengen agreement or any of that. Where the rubber hits the road for ordinary Britons in Europe concerns work rights and travel rights. And that is something that will be a key negotiating point over the next two years
But there are other potentially more important political impacts — specifically that the EU is no longer inviolable. British PM Theresa May was quite right when she told Parliament today that, “this is an historic moment from which there can be no turning back.” This is as true for the EU as it is for the UK. Now, this fact is of little near-term practical importance because, for now, no nation is likely to follow Britain out the door. But the precedent has been set. And it is one that countries outside the euro but within the EU like Poland, Sweden, and Denmark now have as a template were political attitudes to change.
That’s actually a big reason the euro exists. It makes it much harder for countries like Greece to leave EU. But the UK does set a precedent of sorts for even euro area nations. The question about leaving the euro goes to political and economic leverage. And that means larger countries like Italy, France and Germany have the most leverage in forcing a eurozone breakup. And of course, of euro countries, that means Italy is the most likely to cause a eurozone breakup.
I see further impacts beyond Europe too. The UK’s departure from the EU is the biggest marker to date for the disintegration of both globalization and of an ever closer union in Europe. The first marker was Iceland’s capital controls during the sovereign debt crisis. It marked the first time that the free movement of capital was questioned in places like the IMF. And it is a template for what we can expect in currency crises in the future. Donald Trump’s election in the United States is a second marker because, for now at least, it has legitimized protectionism and trade barriers as a response to globalization. How well his presidency fares will decide how strong a marker this actually has been.
But the connection between European disintegration and the fade of globalization comes in the form of a multi-speed Europe. The reaction of Europe to Brexit has not been to reform democratic processes and remake the institutional architecture of Europe. Instead, it has been to stand by the existing arrangements while making allowances for different levels of future European integration. The Rome Declaration, signed by the leaders of the remaining 27 EU member states this past Saturday March 25, the 60th anniversary of the Rome Treaty which started the EU on its course, most definitely contains language that paves the way for a multi-speed Europe.
So the stage is now set. The UK will leave the EU. And in response, EU integration has been halted, transformed into an option rather than a demand. Will the EU and the world economy handle this transition well? The next cyclical downturn will be the test.