27 June 2016

Bruegel: Six lessons about “real” people, Brexit, and the EU

The result of the UK referendum on 23 June has been portrayed as a victory for "real people". But what consequences will the result have, and how should the UK and EU now react?, writes Guntram Wolff.

2. Constitutional and political crisis

The referendum has left the UK in a political and constitutional crisis. Clearly, Brexiteers had not believed they could or even should win and looked ill-prepared. Scotland’s first minister has already announced that Scotland may call a second referendum to remain in the EU, while half of the Labour party leadership has stepped down.

So far, no one has accepted the responsibility of triggering the Article 50 exit negotiations (and it may well be that the article is never triggered).

In such circumstances, external pressure from the six foreign ministers of the EU founding members as well as the European Parliament is unlikely to be helpful. It is the UK that legally and formally has to start the official process and the EU should respect that. The political and constitutional crisis in the UK can only be solved there – even though delays will be costly for all EU economies and societies. [...]

4. Negotiations

How should the EU negotiate with the UK if and when it triggers Article 50? We can already see two different approaches. German Chancellor Angela Merkel is willing to give time and to be accommodating to some of the UK’s likely demands, not least in view of domestic economic interests. She has also emphasised the need to focus on the EU 27. France, in turn, seems to take a rather hard line towards the UK and puts the focus on the euro area.

In my view, our approach should be based on our principles: If the UK wants to trade with the continent, it must respect the acquis. For example, if it does not respect the above mentioned workers’ rights directive, trade should be penalised to avoid social dumping on the continent and so on. It will be central to insist on all the achievements of the single market.

A central area of negotiations will be about financial services. The resignation of the British Commissioner Jonathan Hill is a sign of how British influence on financial matters is set to shrink. It is an important but open question how much of financial services will move from London.

The EU budget dimension is probably less important. Certainly, many will argue that the rebate should be ended and the UK should pay like everybody else. Let us not forget that the budget is agreed to help regions that are performing worse. Some may not like the support of farmers but a single market for agricultural products only works if all receive the same financial support.

5. Does the EU need reform?

The answer is yes… And many Bruegel scholars have been calling for and proposing reforms before this crisis. The need to reform has now only increased. In an interconnected world where contagion reaches everyone, you cannot achieve reform, you cannot improve the lives of ‘real’ citizens, by taking an isolationist approach. A successful reform agenda will only be achieved together, with partners who can, and do, trust each other. And there is no better way to cement friendship and trust than through concrete action. And while we certainly need a narrative and a vision, we also need to build trust through concrete actions in the short term that are feasible within the existing treaties.

What kind of reforms should we be focussing on? I would emphasize three concrete steps:

• The euro area and its governance with a particular emphasis on achieving policies of better demand management and relative price adjustment.
• The relations between the euro area and the remaining countries outside the euro area. In fact, those outside will represent only 15% of EU GDP once the UK has left. And as André Sapir and myself have argued elsewhere, a deepening of EMU will almost inevitably affect those outside. Migration and defence policies may be more neutral but are also highly controversial. Perhaps most promising would be a single market agenda as I argued elsewhere.
• A sustainable and inclusive growth model. The EU was a leader in sustainable and inclusive growth and had productivity gains and world leadership in some of these markets. It is important to develop a vision of how we want to shape the future growth model to the benefits of our societies. And we can certainly not accept the intergenerational divide.

6. Urgent action on the economy

First, policymakers must manage financial stability. This is mostly a task for central banks. But politicians should be supportive, in particular regarding any necessary ECB action to stabilise the economy.

Second, macroeconomic policies must react. Stock markets are already heavily affected across the board, and the Brexit shock is likely to weigh on the euro area recovery. With inflation rates close to zero and the monetary policy at the constraining zero lower bound, it will be important that fiscal policies and structural policies are ready to act. We certainly cannot afford another recession.

More difficult is the macroeconomic stabilisation of the UK economy. There is little space for more monetary policy, and the fiscal deficit combined with the current account deficit is another limiting factor. Of course, the depreciation will help the UK economy but the reputational damage of the fallout will likely decrease British competitiveness for years to come. It will be important to closely look at capital outflows and the decline of investment.

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