Gerard Caprio, Jr.
Senior Fellow
Banking and Finance and Public Policy
Dr. Gerard Caprio, Jr., is the William Brough professor of economics at Williams College and chair of the Center for Development Economics there. He has taught at Trinity College, Dublin (as a Fulbright scholar), and visited at George Washington University.
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Brexit Lessons for the UK and the U.S.

By: Gerard Caprio, Jr.
June 30, 2016

The Brexit crisis offers many lessons, in addition to the foolishness of deciding a key policy issue, one that will have lasting economic repercussions, by a single referendum with a simple majority. The slim, 51.5 percent majority stands in sharp contrast to the 2-1 margin in favor of remaining in the EEC in the 1970s. To be sure, much has changed since then: austerity macro policies in the wake of a crisis, resulting in higher unemployment, especially among younger workers; a surge in immigration, but mostly within the EU from new eastern members; and the ability of the media to promulgate lies on both sides of the debate, but notably on the side of Brexit. One suspects that blue collar workers and retirees in England (ex-London) and Wales, where the majority of Brexiters reside, will be waiting indefinitely to see the 350 million pounds that was said to be transferred weekly from the UK to Brussels (net, only half that amount). Ironically, many of the poorest areas in England and Wales, a core pro-Brexit area, were significant recipients of benefits from the EU that will cease with Brexit. 

Although the vote need not necessarily imply an exit—UK referenda are not legally binding, and some “buyers’ remorse” appears to be happening—assume that it does. Why did it happen? According to polls, two-thirds of those with less than a university degree voted in favor of exit, and this is precisely the group that has been outright hurt by greater integration and globalization (and sounds like a core part of Donald Trump’s support). Economists often argue that the gains from trade improve welfare, but to the extent that gainers from trade do not compensate losers, a voter backlash should not be a surprise. Clearly, those faced with the threat or reality of job loss, lower pay, or the need for retraining do not appreciate “taking one for the team.” When increased openness means increased immigration and greater competition for jobs, a similar backlash can be expected. Note to the retirees who voted for exit: Those EU immigrants that you are making feel most unwelcome are the ones helping to pay for your retirement benefits. Note to immigrants in the UK: You are welcome to come here and contribute to retirement benefits here!

A key implication of the Brexit vote is that governments and politicians that have or are pushing for greater economic openness not only need to educate their voters on why it matters, they also need to beef up programs to help those who might bear the burden. Job training programs and where needed (the U.S. being a prime example) increased spending on repairing and upgrading infrastructure, converting to clean forms of energy, etc., should be a priority, especially when these efforts can be financed at record low interest rates. One imagines that another Clinton is in the process of getting the message, “It’s the economy, stupid!”

Second, that message applies to the EU in spades. The vote and the many polls showing that the EU is even less popular in many core countries is a loud wakeup call. EU politicians might respond with efforts to make the EU more democratic, but without help for the middle classes soon, one can expect that centrifugal forces will continue. The EU can complain that the British always had one foot out the door, but if other countries choose to leave, it begins to look as though the EU has a design problem. Similarly, the Brexit vote might mean the exit of Scotland and Northern Ireland from the UK, as both areas voted solidly to remain in the EU. With all of these uncertainties, investment spending, already weak, will take a hit.

Third, Brexit growth will put more pressure on euro countries that already are suffering—Spain, Portugal, Italy, Greece—as demand for their output declines further. Without increased spending, expect to see great pressure on that currency arrangement. And remember, a number of EU banks, notably those in Italy, already have a high ratio of bad loans. In the World Bank-IMF database on banking crises, some of them (e.g., Turkey in the early 2000s) began with a political crisis, but ended with a financial one.

Fortunately there are glimmers of positive news. EU President Donald Tusk just said that the 27 leaders minus Britain’s David Cameron would undertake reflection on a “new impulse for Europe,” which could include significant policies. However, as always in the EU, the problem will be in attaining sufficient agreement among a diverse set of countries. Without the UK, Germany accounts for a much larger share of GDP and can be expected to have even greater influence. And in Germany, life is good.

Finally, without a robust response on the part of the EU authorities, expect to see a quicker decline of Europe’s influence in the world economy and in global organizations. European growth is hindered by demographics and a less favorable environment for innovation. The Brexit crisis, unless handled amazingly well—and today, European officials were digging in their heals, so that is not a good bet—will accelerate the transfer of the center of economic power from the North Atlantic to the Pacific. The sun may be setting on a still smaller Britain, and a smaller Europe.


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