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June 24, 2016


The Long Goodbye

The crisis is back in a big way. The UK voted to leave the EU with a clear margin of 52-48, and on a high turnout of 72%.

The vote will have big implications for the future of the United Kingdom – which may even require a different name soon, as Scotland could break off and rejoin the EU. Today's decision could cause a lot of damage to the EU - it is the first time a member state is leaving. But there are also some some potential upsides. David Cameron’s dirty little deal with the EU from February has now lapsed. And there is a chance that the eurozone may move forward, given the severity of the crisis it is likely to face if it doesn’t. And oh yes, Cameron will almost certainly have to go, but this is now only a minor news item. Before he goes, he will have to decide whether to invoke Art 50 TEU as a parting shot, or leave the decision to his successor.

Global markets were in a meltdown this morning, but the situation may reverse. We have a separate story on the financial implications below. There is a possibility that the eurozone crisis will re-emerge, but the backstops remain in place, including of course the OMT.

Before we turn to our main theme of the consequences of the vote, we would first like to make a few points points about why we think this happened:

  1. the UK effectively left the EU a long time ago when it negotiated its opt-outs – a divorce that was ultimately consummated when Gordon Brown, then chancellor, and his side-kick Ed Ball,s won the debate inside the Labour Party for the country not to join the euro. We found it utterly pathetic to see exactly those people – John Major, Tony Blair, Brown, Balls – claiming the pro-Remain mantle. We have argued for a long time that it is not a sustainable position for the UK to be in the single market, but in virtually no other EU policy area. A process of alienation would eventually set in, and interests would eventually diverge. This has now happened.
  2. over the last few days and weeks we have been talking to a lot of ordinary people with no particular professional interest in this issue. Many of these supported Brexit. They are not, by and large, tabloid-reading morons buying into the promises of Independence Day – as the Sun newspaper put it yesterday morning. The problem is that their lives are disengaged from the EU. And, after 20 years of anti-European news bombardment, including from people who now purport to be in favour of Remain like Cameron himself, this result should come as no surprise. 
  3. the defence of EU membership on purely economic grounds was a disaster from a campaigning standpoint, and it was dishonest intellectually. The economics profession is guilty of imperial overreach in trying to pretend that you could justify EU membership on purely technical grounds. The opportunity cost of this approach was a lack of political argument in favour of further European integration. The profession is widely unaware of its generalised loss of reputation after the financial crisis. And we should also like to point out that EU and its institutions are the biggest sponsor of economic research. And, as it happens so often, the profession was mixing up its own personal and political preference with its technical prognostications, and did so without disclaimer. 
  4. do not ever rely on opinion polls. There exists such a thing as genuine, total uncertainty. There are things we simply do not know. And forget prediction markets. If uncertainty is genuine, no market can provide insights.

So what we are the broader implications of this vote?

  1. we consider the risk of contagion as high, but the EU will not disintegrate. There is a chance that the British departure will galvanise the EU into further integration. We think it is possible and even probable that other permanent non-eurozone EU states, could leave the EU as well. The current coexistence is pure poison. But therein lies an opportunity as much as a threat. One very likely consequence is that Scotland will vote overwhelmingly to support EU membership, and we would expect that Scotland will have another referendum on independence, the result of which will not be in doubt. We will expect the EU to accept Scottish EU membership. This will mitigate the overall impact of Brexit.
  2. One of the most important issues to be decided now is how to start the Brexit procedures under Art 50 TEU. The early indications are that Britain will try not to invoke Art 50. This was the view of Gus O’Donnell, a former cabinet secretary. Martin Schulz said he expected the Art 50 negotiations to start immediately.  
  3. the next referendum to be held in the EU will be Italy’s referendum on constitutional reform, to which Matteo Renzi has linked his career. We expect this referendum to turn into another No vote. As we reported yesterday, Renzi is attempting to wiggle out of his promise. But, whether he does or not, we expect the Five Star Movement to form the next Italian government. And Beppe Grillo just doubled down on his promise on a euro referendum. 
  4. Germany will not automatically assume a leadership role. We think it is important that other member states will need to apply pressure on Angela Merkel to agree on substantive eurozone reform. If she gets away with blocking further eurozone integration, the other member states should confront Merkel and threaten a break, which would be a complete and utter disaster for the German economy. If the other member states miss this opportunity to force reform of the eurozone, we think that the risk of a eurozone collapse in the longer term will increase dramatically.
  5. we think it is nonsense that the Brexit vote will imply a Donald Trump victory in the US, or a Le Pen victory in France. There were very specific reasons for what happened in the UK. This is in part an insurrection against establishment policies, but this cannot explain the vote in full. There were many issues specific to the UK’s relationship with the EU – issues that are not present in other EU member states. Also remember that the vote was relatively tight. 48% supported Remain.

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