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The Brexit May Be Just The Beginning Of Anti-Europe Votes

One of the biggest consequences of the British vote to leave Europe is that other countries will consider doing the same. Populism and nationalism are on the rise all over the globe. Now that U.K. voters have been given a chance to express their preferences, I believe that it is almost inevitable that another government inside the EU will hold some sort of similar vote.1

Perhaps this will come about as it did in the U.K., where Prime Minister David Cameron — who submitted his resignation on Friday morning — offered up the vote as a way to tame the euro-skeptics in his own party. However, it could also be forced by a nationalist group getting into a parliament and then forcing a vote. The U.K. Independence Party was the only major party to campaign in favor of leaving.2 Its leader has already said that he expects something similar in Denmark, Sweden or the Netherlands.

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If other countries let people vote, it is likely to be difficult to forecast the outcome. In most of Europe, the public has very mixed views on the European Commission and the bureaucracy of the EU. At the same time, most seem to like the concept of a single currency (even if they are not especially trusting of the European Central Bank). No one knows how this will play out.

However, if an EU country that currently uses the euro, such as the Netherlands, were to vote to leave, the chaos that would ensue could be an order of magnitude more complicated than the exit of Britain, which never accepted the euro and held on to its pound. It is possible that a country could drop out of the EU and still try to keep the euro, but that would seem unlikely. A departing country in this case would have no vote over its monetary affairs and probably could not count on the European bank to serve as a lender of last resort. So if a country quit the EU, it would probably also need to replace its currency and set up its own central bank. This would necessitate a renegotiation of all the euro-denominated contracts throughout the economy.

In addition, trying to operate a banking system in a country that could possibly abandon the euro would be very difficult. There could be a bank run at the mere hint of a referendum. The elevation of these risks is probably one reason why markets in the core of Europe are reacting so badly to the Brexit vote.

The second fallout is the likely demise of London as the financial center of Europe. Right now, much of the trading and deal-making for the continent takes place in London, protected by U.K. law. However, London’s current primacy partly also depends on U.K’s membership in the EU. Being in the EU places some limits on what rules the U.K. can require regarding its market structure and regulations, and these limits matter to the others in the EU. I would be shocked if the remaining members of the EU will be content to allow the infrastructure and preferential treatment for businesses that currently resides in London to continue as is when the EU will have no formal authority over developments there. The next U.K. government will no doubt try to do everything possible to retain the status quo, but achieving that outcome can hardly be guaranteed.

I am not suggesting that there will be some immediate rule invoked by the EU to ban activities in London. Instead, I expect that there will be minor adjustments to the current rules that will make it increasingly inconvenient and impractical to continue to run a Europe-wide business from London. Some things will become too expensive to do from London, and rather than duplicate it in two locations, businesses will slowly migrate away.

The financial services industry generates 11 percent of U.K.’s tax revenues.3 If this kind of migration does occur, it will be disastrous for the U.K.’s budget. This deterioration in the fiscal outlook for the U.K. is probably one reason the domestic stock market in the U.K. has plunged and why the pound lost value Friday.

Just to clarify the next steps: The British public voted to leave, but in fact a decision to leave will require an act of Parliament, most of whose members were strongly in favor of remaining. Given that Cameron has already signaled his intention to resign, I assume the MPs will accede to the wishes of the public and take the necessary steps to enable an exit.

The U.K. will have to initiate the process to withdraw from the EU. This will involve negotiations over the future relations between the two. The onset of formal negotiations will be triggered by a decision by the U.K. to request an exit. Once this process begins, the current treaties presume that it will be done in two years. Cameron has indicated that he will not take the step to begin the process, a move he will leave to his successor. In the meantime, the U.K. will still be bound by the EU rules, but will presumably have much less influence on any decisions going forward.

Footnotes

  1. I have previously made real-time attempts to assess the effects of a Greek exit from the EU, as well as the bankruptcy of Lehman Brothers.
  2. Scores of Conservative members of Parliament, however, supported the exit.
  3. This is probably a low estimate of the overall effect because many businesses catering to the wealthy depend on the financial services employees as well.

Anil Kashyap is a professor of economics and finance at the University of Chicago Booth School of Business. His website is http://faculty.chicagobooth.edu/anil.kashyap/

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