July 2016 newsletter – Brexit seen from Berlin

Writing a few days (17 June) before the British referendum on continued EU membership, Michael Burda at the Humboldt University of Berlin reflects on the externalities involved in that decision.

Inundated by nonstop spamming that even an American in Germany can receive on Brexit, I have to paraphrase Winston Churchill: Never has so much been written by so many to be read by so few. Showboating and attention-grabbing in the social media are de rigueur with the most dire and outlandish statements on the consequences of Brexit in both directions. Our Donald would be impressed by the trumpeting; he has undoubtedly inspired some of the political tactics. While I think I know where the elite stands, the voting public is 50-50 and it will go to the wire.

Yes, there is a very real probability that in the referendum of 23 June, the United Kingdom, with 65 million inhabitants, will vote to leave the EU. Europe, with its rickety and presently unsustainable governance, will come dangerously close to ungluing itself. In this comment I’d like to point out what that means, seen from the land of Vorsprung durch Technik. I am writing this note not knowing the outcome, but as someone very concerned with its consequences. And the problem will not go away with a vote to Stay.

Regardless of the outcome, tensions leading up to the stay-or-leave vote strongly suggests that all of Europe — and not merely the UK — has reached an integration singularity. A large slice of the political class in most countries of the Union has concluded that deeper economic and especially political integration offer no further welfare gains, at least not for the median voter. Unfortunately, this defensible assessment has been conflated with one that the EU itself has outlived its usefulness and is of no further benefit, or even detracts from welfare. In this judgment, an accumulated capital stock of European law, rules, directives and regulations can be thrown to the wind, devaluing the knowledge and human capital accumulated by tens of thousands of UK civil servants over the decades. Tant mieux, many will say. Yet divorcing the EU will be a bonanza for lawyers, not for economists. (I remember that Shakespeare had some interesting thoughts about the lawyers.) There is no guarantee that what emerges in its stead will be any better. Anyone who doesn’t believe that need only look at Switzerland, Norway and Iceland, and the incredible protection enjoyed there by special interest groups, especially farmers.

My kin in the UK are on the fence. My uncle, long gone, fought in an artillery unit during the Second World War and helped liberate Bergen-Belsen. He had his own special opinion about the Germans and I am sure he would have voted to Leave, and he casts a long shadow over his offspring. Yet it is so telling but also so very curious that most of the Brexiteers are well over 40. But the fact that my relatives are undecided tells a story of its own. The present perception of UK voters is that the EU has robbed them of their sovereignty, not that it has opened markets for their companies or lowered prices for their consumers. The latter was the original intent of the Union, but in the minds of many, the former is reality. Again a quick look at Norway would be instructive. Rich, closed, and protected. Is that where Great Britain wants to be in the future?

Why is this happening now?
Critics of the EU certainly have a point, and the UK certainly does not have a monopoly on such critics. The European Union is cumbersome and ungovernable, and the behemoth grows larger with each new accession. Yet it is also cheap: 1 per cent of GDP remains a bargain for a common legal framework for business, human rights and legal principles, product market regulation and standardization, minimum labor standards including child labor, job safety standards, environmental protection… Where else in the world is there an automatic cap on the size of ‘big government’ like in the EU?

It is all too easy to forget how far Europe — and the UK in particular — has come is a result of the European Union, and not in spite of it. As Gordon Brown points out in a viral video filmed in the ruins of Coventry Cathedral, the counterfactual to the EU is more likely to be centuries of chronic warfare than the decades of peace since its founding. How can that not be related to common values and common prosperity?

Observing the process of economic integration since 1945, with ever deeper trade, migration, and capital mobility, one must conclude that it leads inexorably to interdependencies that are not only economic, but increasingly and ultimately political. And that is the trigger for the integration singularity. Europe — including the UK — obviously wants to remain a mosaic of peoples, each referring to its own culture, history, and common tradition. A common constitution, government, or even fiscal policy are difficult if not impossible even to imagine, let alone construct. Why not simply call a moratorium on further integration — rather than cancelling the whole project?

The US experience on the gains from intelligent integration holds valuable lessons for Europe. In the early 20th century, the US was emerging as a nation which could project power around the world, yet was hampered by the presumptive powers of individual states guaranteed by the 14th Amendment; in a form of automatic subsidiarity, those rights not expressly granted to the Federal Government are reserved for the constituent states. This arrangement was no accident: In the 1780s, different ex-colonies had distinctly different economic, social and cultural interests, and mutual respect for those interests was synonymous with preserving the Union. But increasing trade integration and factor mobility spurred the growth of large corporations and large-scale commerce that transcended state boundaries. Corporations were forced to deal with regulations and governments state by state in the Progressive Era, at a time when consumers and workers demanded decisive improvements in food quality standards, product safety, worker protection and common liability rules. It was only natural and efficient to establish institutions to transcend state boundaries, like the Interstate Commerce Commission (1887), the Food and Drug Administration (1906), the Federal Trade Commission (1914) and the Federal Reserve System (1913), to be followed later by the banking union via the Federal Deposit Insurance Corporation (1933), the Federal Communications Commission (1934) and the Social Security Administration (1935). Federal agencies emerged as the right option for presenting a single regulatory face not only to large corporations but also to an increasingly mobile population. This was a natural development, and Europe has followed a similar path, although more readily in some dimensions (food health and safety standards, Social Charter, antitrust law) than others (common currency, banking union, capital market regime, unemployment benefits).

Exit, voice, loyalty and the unanticipated consequences of Brexit 
On June 23, 65 million Britons — of which perhaps half will actually vote — will choose the course of European integration for almost 510 million persons in the EU over the next two or three decades. To many in this country, this is seen as unfair. Yet Germany, led by Chancellor Angela Merkel, pulled the same stunt in August 2015, when it unilaterally opened its borders to refugees. In a EU world of open borders, this decision had immediate consequences for its neighbors — not just for Greece, Italy, Hungary and the Nordic countries, but even for the insular Britons. Apparently it had never occurred to the Brussels bureaucrats that any full blown migration crisis, which could just as well have come from the Ukraine or Maghreb as from Turkey or Syria, would blow apart the Schengen consensus and severely threaten the four freedoms, even in the Nordic countries. But this catastrophe is not a reason to leave the EU; it is a reason to lead and reform it.

Recently I picked up Albert O. Hirschman’s classic work Exit, Voice and Loyalty, which had spent three decades of gathering dust on my shelf. In that masterpiece, the author — exiled to the US by the Nazis in the 1930s — describes the conundrum of how to deal with a deteriorating situation -— a market, the workplace, a labor union, a country or region, a club, or some other association. Leave (exit) or stay and invest time and energy in change (voice)? Hirschman presciently points out that while exit gives immediate liberation from the problem at hand, it is possibly suboptimal. Moreover, exit creates external effects on the stayers, possibly nudging them into resolving the problem, in which case the leaver is the loser. Sometimes collective action within can be more effective. It is probably in the UK’s narrow interests to stay inside and assemble coalitions to improve the EU’s workings than to leave empty-handed.


Will the UK lose as well? Possibly, if they have to renegotiate everything (remember the lawyers). Probably, if thousands of UK farmers lose access to CAP payments (estimate: more than €3bn), including some land-endowed aristocrats. Most significantly, leaving means renouncing any influence on EU standards that govern 50 per cent of UK exports. Give up influence on those standards and relegate yourselves to the status of Iceland, Russia, Norway, Turkey or Switzerland? Madness.

Just as Merkel’s hubris-laden decision had far-reaching consequences for other EU members, Brexit has potentially even more unimaginable ones. Like the dogs of war, Brexit will unleash a genie of anti-European feelings and a chain reaction of unpredictable and uncontrollable events throughout the continent. It is likely to spur referenda on the EU in the Netherlands, Denmark, and Poland while strengthening separatist movements in Catalonia, northern Italy, Scotland, Northern Ireland, possibly even southern Germany.

This letter is about externalities in a continent of close neighbors. The Brits were swamped by eastern European immigrants who have claims on the system of public goods and the welfare system. Part of this spillover originates in Germany's unwillingness to accept Polish immigration until eight years after their accession. Yet the Poles provided a mass of industrious workers needed in a long-neglected low pay sector; could not the spurt in GDP per capita growth which has occurred in the past 10 years be a function of this supply-side bump, pulling it ahead of Germany? Whatever the case, Great Britain is not an island — nor is Germany. On June 23, Britons decide on remaining in or leaving the EU, but they will also effectively decide the future of Europe. To abuse Churchill again: Never has so much been decided for so many by so few. The stakes are very, very high.

Best regards from Berlin.

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