NOTE

After Brexit: Chaos and Buyer’s Remorse?

by Jacob Funk Kirkegaard | June 27, 2016

After the fateful decision of the British electorate to leave the European Union on June 23, the first contours of where Europe and the United Kingdom are heading are emerging. The indications might not be great for Europe but are deeply troubling for the UK. The EU’s remaining 27 members must first decide how aggressive they should be in making demands to the UK as it launches the formal Article 50 procedure to leave, clearing the way for the two sides to negotiate the future economic and political status and relationship for Britain. The second question is what if any institutional response the EU should adopt.

Not surprisingly, a political divide has opened over timing and how much pressure to apply on Britain. On one side are the representatives of the EU institutions (European Commission, Parliament) and on the other are the leaders of other member states. The former group wants to press ahead as soon as possible with the divorce from the UK in order to get to the second question, which is of course more interesting to them, as it would involve them accumulating even more power in an EU without Britain railing against the power of Brussels. The Commission, Parliament, and to a degree also EU foreign ministers (perhaps envisioning the prospects for a common foreign policy) are pushing a rapid timetable. But member states led by Chancellor Angela Merkel of Germany are taking a more cautious approach and signaling they are prepared to wait months for the divorce decree. Because member states call the shots in the EU, one can expect Merkel’s patience to carry the day.

A major point of contention will be over labor mobility. It is too early to make predictions, but it continues to be implausible that the UK can retain access to the EU’s internal market, including “financial services passporting”—the ability of UK-based financial services firms to offer cross-border financial services to the entire EU market—without accepting the status quo on free movement of labor. But of course the ability of EU members to take jobs in Britain was a major factor in the British voters’ revolt against the EU, and such a provision is unlikely to be accepted by any post-Brexit Conservative government. Hence in any conceivable future relationship, the UK economy, the City of London, and government finances stand to suffer a significant economic blow from departing the EU. The EU and the UK could agree to maintaining completely free trade in goods, but the UK has a large trade deficit with the EU and is unlikely to derive large economic benefits from such a limited accord.

In the wake of Brexit, the EU is hardly likely to launch new political or institutional integrationist steps, which would require referenda in several of the 27 EU members. As a result, “more Europe” cannot be the answer to the current crisis. Rather the EU will simply have to make do with the existing institutional structure and try to get itself closer to the average EU citizen by doing more things that people actually care about—a difficult challenge.

One obvious subject on the minds of many is immigration and border control. As argued earlier on RealTime, the EU could work within the existing budgetary structure (due for an overhaul after the British departure) to devote the necessary funds to strengthen external border control. An increase in the size of the EU budget derived from each country’s gross national income (GNI) could accomplish this objective without the time-consuming process of changing the EU institutional structure. For example, EU-funded border guards can begin to wear EU insignia without the need for Treaty changes. Such guards can take over functions carried out currently by national border control institutions, bypassing an overhaul of EU or national immigration legislation.

To stem the stock price declines in the EU banking sector, the EU could also rapidly conclude negotiations to produce a fully mutualized euro area deposit insurance scheme for banks. An agreement now would be useful, even if implementation occurs during a long transition period.

Giving Britain time to launch its Article 50 separation procedure will sidestep an immediate crisis in the EU-UK relationship, while giving Brexit proponents more rope with which to hang themselves as they decide what the Brexit vote actually means.

The referendum has plunged the UK into a political crisis, in which both the Conservative and Labour Parties are in open civil war. Meanwhile, Scotland and the Scottish National Party (SNP) are on the direct political path to a new referendum on independence from the UK. The chaos is real, and the surrounding uncertainty will continue to drive down the value of UK assets and investments.

Following Prime Minister David Cameron’s withdrawal, the Conservative Party’s leadership contest is scheduled to conclude in early September. The frontrunners to succeed him are former mayor of London Boris Johnson, the favorite, and Theresa May, the home secretary.

More interesting than the personality contest is how the next Conservative government will negotiate with the rest of the EU. Conservative backers of Brexit are already walking back some of their main populist selling points, such as promising to reduce immigration and redirect the £350 million a week contribution to the EU to other areas like the National Health Service. Redefining their approach to Brexit does not mean that the new party leaders will be less anti-EU. On most issues, they will be to the right of Cameron. But the climb-downs suggest that the next Conservative government will be willing to break many campaign promises to get an agreement with the rest of the EU.

The Labour Party’s divisions are even deeper than those in the Conservative Party, with leading parliament members seeking the ouster of Jeremy Corbin for allegedly campaigning half-heartedly to remain in the EU. They also fear he is too far left to win a UK general election. Corbin opposed limits to UK immigration, even as many traditional Labour voters embraced Brexit over immigration fears, for example. Yet Corbin is unlikely to be replaced. His mandate came from party members, not other members of parliament. Thus the Labour Party faces the same clash between traditional blue-collar anti-immigration sentiment and more traditional leftist humanitarianism and multiculturalism that has gripped other center-left parties across Europe. Weakened as it is, Labour will struggle to mount a serious challenge to the Conservative Party in a general election. Nor can it easily present itself as a credible centrist pro-European party to “remain” voters.

The splits in both the Conservative and Labour Parties offer opportunities for the United Kingdom Independence Party (UKIP) and the Liberal Democrats. If, as seems likely, neither the Conservatives nor Labour adopts a tougher anti-immigration policy, UKIP has a clearer political path to lasting representation in Westminster. One should not expect the party to fade away after winning on Brexit. Instead it will likely evolve into a more traditional anti-establishment and anti-immigration party appealing to the “fed up” districts in Northern and Eastern England.

Brexit might also propel the Liberal Democrats back to political relevance as Britain’s only credible pro-EU party. Its leader, Tim Harron, is already pledging to fight the next UK general election on a promise to keep the UK in the EU. Given that neither the Conservative nor Labour Party is credibly Pro-Europe now, and that 48 percent of the electorate voted to stay in the EU, Liberal Democrats may capitalize on the issue, especially if an early election is held this fall.

Assuming that the SNP retains the vast majority of Scottish seats in the UK Parliament, and that at least some Labour and Conservative members of parliament might also back continued EU membership, a new election could actually yield a majority that would scrap Brexit. Could SNP votes be decisive in keeping the UK in the EU? That would be ironic and farfetched. But the referendum was merely consultative and does not need to legally be enforced in the face of accelerating political and economic costs.

Another option avoiding a Brexit may occur if the next Conservative government launches the Article 50 negotiations to leave and then calls a general election to ratify an agreement on terms. The UK electorate would then effectively vote on whether to remain or leave, knowing the costs and benefits more clearly. This course of action would offer the UK a final opportunity to change its mind. Such a scenario presents the EU with a strong incentive to play hardball in the negotiations, ushering in a lengthy period of economically damaging uncertainty.

Yet, as economic suffering deepens, British voters may not mind being overruled by their newly elected representatives.

Copyright 2016 the Peterson Institute.