In an attempt to ensure that the continent would never suffer another major conflict after World War II, Europe embarked on a movement toward both political and economic integration. At times there have been disagreements, but as a whole, the European experiment – viewing Europe as a single economic and political entity – has moved forward. The United Kingdom has negotiated changes to its membership in the European Union (EU) that were voted on and approved February 18-19 by EU member nations. As early as June, the U.K. will hold a referendum on whether it should leave the EU, an act referred to as “Brexit.” Other populist anti-European movements are growing and will no doubt be influenced by the EU’s approval of the U.K.’s request and the upcoming referendum.
In the decades after World War II, common trade policies created, most importantly a “customs union” in 1968. In a customs union, in addition to unfettered trade between member countries, they must also agree on a common tax regime for goods coming in from outside the region. Consequently, there are political ramifications as countries give up a major right of sovereignty – the ability to control trade at their borders and from members.
The U.K was granted membership in the European Economic Commission in 1975. But, it never embraced “Europe.” The U.K. and Denmark negotiated an exception to the mandatory use of the euro. Sweden refuses to accept the euro on what amounts to a technicality, though the EU has allowed this to go largely unchallenged. The removal of national currencies is perhaps the ultimate surrender of national sovereignty.
Where does that leave the U.K.? According to OECD statistics, the U.K. is less dependent on trade than any other major country in the EU and lags the rest of Europe in terms of productivity when measured by gross domestic product per hours worked. Perhaps it has forgone an economic benefit by not accepting the euro.
Economic difficulties have broad political implications throughout Europe. The most emotional issue involves immigration and the free movement of people within the EU borders. The Schengen Treaty, signed in 1985 by several European countries, allowed people to travel freely within the region without passports or other controls. This treaty was expanded over the years to become a core feature of the EU, to which all members must fully accede.
According to the Office of National Statistics, immigration to the U.K. has averaged from 500,000 to 600,000 between 2006 and 2014. Estimates for 2015 are 700,000. The number of people coming to the U.K. from within the EU and those coming from without are approximately equal. Refugees have been adding to the immigration issue. The U.K. would like to have greater control over the process. This means limiting entrance, enforcing residency requirements before social services are offered, limiting citizenship by marriage to prevent fraud, and other similar measures. Current EU rules limit the U.K. from enacting these measures.
Immigration grabs the headlines, but there are other issues, too. The U.K. is not part of the Eurozone, yet London operates as the European financial capital. The current government is concerned that countries in the Eurozone will pass regulations that will reduce the competiveness of U.K. banks and companies. It wants assurances that that the countries not using the euro will not be discriminated against and that U.K. regulators will remain the primary regulator of U.K financial institutions. The U.K. would also like to see a more relaxed regulatory burden on all businesses. This seemingly simple and obvious request is made difficult by the fact that the EU is comprised of 28 different countries. One nation’s view of onerous regulation is another’s guarantor of social harmony or environmental sensitivity. Even so, the EU is constantly pressing for an “ever closer union.” The U.K. would like to suspend that integration for the foreseeable future.
Polling data in in the U.K. suggest that support for the Brexit is growing. A non-partisan group from the London School of Economics suggests that the GDP would decline between 1.1% and 3.1% due to a reduction in trade. They also think that productivity would slow further. Perhaps the biggest wild card is what would happen to London as a banking center. While the data suggest that the U.K. would benefit from increased economic coordination, politics matter in ways that do not show up neatly on national accounts and mathematical models. It is not for us to say how either side should decide the issues before them. That said, in our view, the possible reversal of a 75 year trend toward integration and harmony will have negative ramifications. We also cannot ignore the rising tide of populism, both in the U.S. and Europe and question whether this tide will overwhelm more sober economic calculation.
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- Data provided by LPL Financial.
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