One has to pray that on Thursday June 23 the United Kingdom electorate will have the good sense to vote to remain in Europe. A vote to leave Europe would not only have profoundly negative consequences for the British, the European, and the global economies. It would also throw into serious question both the survival of the United Kingdom and the European Union in their present forms.
Among the principal reasons for concern about the forthcoming Brexit referendum is that it will be taking place at a highly inauspicious time for both the United Kingdom and the European economies. As Bank of England Governor Mark Carney recently reminded us, the United Kingdom is presently running an external current account deficit amounting to 7 percent of GDP. The financing of that deficit, which is the largest in the post-war period, makes the United Kingdom uncomfortably dependent on the kindness of strangers, who must not be expected to take well to economic uncertainty.
At the same time, the United Kingdom is currently riven by strong separatist tendencies especially in Scotland, whose electorate overwhelmingly would like to remain in Europe. Also of concern for future domestic political stability is the fact that the European issue has unleashed a full scale civil war within the ruling Conservative Party that could leave it deeply divided in the event of a Brexit vote.
Europe is also not in a particularly good position to withstand the blow from a British exit. Its economic recovery is already sputtering at a time it has been benefitting from strong tailwinds in the form of extraordinarily low interest rates, a weak Euro, and highly favorable international oil prices. A measure of the weakness of the European economy is that it has only just regained its pre-2008 peak level of economic output.
At the same time that it has a weak economy, Europe is now struggling with an immigration crisis that is putting wind in the sails of the populist and separatist movements across the continent. As if to underline this point, a recent Pew survey of European attitudes revealed that today barely 50 percent of the European electorate thinks that the European Union is a good idea.
After recklessly having committed the United Kingdom to a referendum, Prime Minister David Cameron is now correctly warning that a vote to leave Europe would be to take a leap into the dark. This is not least because of the investor uncertainty that would inevitably follow during the expected two-year period of renegotiation of the United Kingdom’s relations with Europe. Investors must be expected to fear that after having been spurned, Europe is unlikely to grant the United Kingdom favorable terms in those negotiations. This is especially the case if Europe wishes to set an example to other countries that might be contemplating following the United Kingdom out of the Union.
In the event that there were to be a Brexit, the United Kingdom should brace itself for a full blown sterling crisis that would seriously cloud the country’s economic prospects and offset any possible long run benefits from leaving. In a climate of uncertainty, investors must be expected to balk at financing the country’s gaping external current account deficit. This would especially be the case at a time that important parts of the City of London might feel obliged to relocate to European capitals upon loss of their “financial passport” to the European market.
At the political level, in the event of a vote in favor of Brexit, the United Kingdom should brace itself for calls for another Scottish independence referendum. Such a referendum could very well presage the dissolution of the United Kingdom in its present form since, given the choice, most Scots would be expected to opt for membership in the European Union rather than in the United Kingdom.
Brexit would also be very bad news for the European and global economies. The last thing that a struggling European economy now needs is a big economic setback to one of its major trade partners or a fresh political boost to its separatist tendencies. As European policymakers keep warning us, there is the all too real risk that a vote in favor of Brexit could fuel demands for similar exit referendums in countries like France, Italy, and the Netherlands.
Similarly, the last thing that the global economy now needs is the collapse of one of the world’s major currencies that could be the last straw that moves the world to an outright currency war. Such a currency war would almost certainly roil global financial markets at a particularly delicate juncture in the global economic cycle.
For all of these reasons, one must hope that Brexit does not occur. However, given how close the polls remain in the run-up to next week’s referendum, one must also hope that global economic policymakers are planning for the worst.
Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.
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