By Scott Sumner
In June, the British will vote on whether to leave the EU. There are lots of good arguments on both sides, and I have mixed feelings on the question. But in the end I believe the UK should stay in the EU.
From a libertarian perspective, there are strong arguments on both sides. Leaving the EU might reduce freedom to trade and migrate. On the other hand, Britain would be able to avoid certain undesirable regulations if it left the EU. The euro isn’t an issue here, as the UK is already outside that poorly designed single currency, and almost certain to stay that way.
People that know much more about the issue than I do suggest that some of the arguments for and against have been overstated. If Britain left the EU, it might negotiate some trade and migration agreements. And there are very few regulations that Britain has adopted only due to outside pressure. They are perfectly capable of producing bad labor market regs on their own, as when the Conservative government recently enacted a bill that will sharply boost the minimum wage rate.
In the end, I see the Brexit vote as being part of an epic global struggle of narrow-minded nationalism versus enlightened cosmopolitan neoliberalism. Elsewhere the issues are much starker, and the white hats and black hats are much easier to spot. But it’s the defining issue of our time, just as it was the defining issue of the first half of the 20th century. (This is not to imply that all Brexit fans are narrow-minded nationalists—I respect many supporters of Brexit—just that the issue has become tangled up in the global swing toward nationalism.)
Right now, nationalistic leaders like Putin are basically rooting for anything that creates economic turmoil in the West, hoping it will lead to nationalistic regimes that are sympathetic to his. And the rise of nationalism could have serious economic repercussions. Here’s the Financial Times:
Apocalyptic stories abound about what an exit would mean for the British economy. The current account deficit would be harder to finance, apparently, and the country could lose a big chunk of its export markets. By this logic, the pound would be the main loser if the polls start moving further in favour of the Leave campaign.
On deeper reflection, this does not seem to be the major investment risk. After all, foreign investors know that even if the UK were to leave, they will be paid in sterling. Their property rights and access to the courts, and the terms under which contracts are written in — all the things that make owning UK assets attractive — would also remain in place.
By contrast, Europe would face the departure of its largest export market. The EU is not a monopoly, or even the lowest cost supplier of anything bar French cheese. So a UK exit would make European products even more expensive, and increasingly likely to be substituted by Asian equivalents.
Now if the UK’s exit debate had been taking place at a time when the European economy was in a robust state of health — averaging yearly growth rates of, say, 2.5 per cent — then perhaps the EU could be a bit more relaxed.
But that is decidedly not the case. Italy — the eurozone’s third-largest economy — is in a debt trap from which it is struggling to escape. Just to stabilise its debt-to-GDP ratio at the current level of 130 per cent, it would need to deliver nominal economic growth of some 1.4 per cent per year over the next five years, our calculations show. For Portugal and Spain to achieve a similar feat, their economies would need to grow at an annual 1.3 per cent and 3.4 per cent respectively.
Over five years this might be achievable, but only with much more progress on structural reform. The problem with these forecasts is that they assume the next five years will be devoid of financial shocks. No one can guarantee that. On average, Europe suffers a recession every six years. Should a slump occur, none of the eurozone’s weak links will have sufficient fiscal ammunition.
Yet Europe’s financial troubles pale in comparison to its political problems.
Mainstream political parties have retreated in Greece, Spain and Ireland while in France the Front National is gaining ground. Germany is not immune from political turmoil, either. Chancellor Angela Merkel’s decision to open up the country’s borders to Syrian refugees has proved to be a boon for the populist and anti-EU Alternative for Germany party.
So, paradoxically, as the risk of Brexit increases, so too does the threat of Europe’s fragmentation.
Under these circumstances, financial markets would surely begin to discount the break-up of the eurozone. And it is not obvious which currency or assets investors might want to be left holding the day after the divorce. It could be that euro-denominated securities, not sterling-denominated ones, turn out to be the weakest link.
If the gold standard had magically disappeared in 1930, it would have been a huge boon to the world economy, perhaps preventing the Great Depression. But it failed gradually, and the slow process of disintegration made the Depression even worse. I’d say the same about the euro. If it was gone tomorrow, the eurozone would grow more rapidly for a few years (although many supply-side problems would remain.) But the gradual break-up of the eurozone (which is more likely than a quick end) could trigger another global recession—just when nationalism is on the rise.
Britain can do much more good within the EU, fighting against a federal Europe, than it can on the outside. If they fail, they can always exit at a later date, say if the EU decides to adopt a fiscal union. Now is the time for the British people to stand up for globalization, liberalization and openness, as much of the rest of the world reverts back to nationalism. This round of nationalism won’t last forever.