The United Kingdom’s vote to leave the European Union will have a negative impact on the European economy because it creates uncertainty and decreases business confidence for the foreseeable future, according to the International Monetary Fund’s recently updated World Economic Outlook. Beyond uncertainty, experts contend that the outcome of the June 23 vote on a so-called Brexit highlights structural issues within the Eurozone that have prevented significant growth following the 2008 financial crisis.
“There’s no doubt about the fact that this is a negative shock to growth,” Paul Sheard, executive vice president and chief economist at S&P Global, said of the British referendum. “In many ways, it’s worse for the Eurozone than it is for the United Kingdom,” he added.
Sheard noted that while the Eurozone’s GDP is just half a percentage point above its 2008 pre-crisis peak, the British GDP is 7 percent higher. He advocated the use of “more creative thinking, perhaps less dogma, and some flexibility to mobilize policy tools” to avoid another Eurozone crisis.
Sheard spoke at an event at the Atlantic Council on July 21. He was joined in a panel discussion by Gordon Bajnai, a former prime minister of Hungary; Stuart Eizenstat, a former US ambassador to the European Union (EU); and Jay Shambaugh, a member of the Council of Economic Advisers at the White House. The discussion was hosted by the EuroGrowth Initiative of the Atlantic Council’s Global Business and Economic Program. Andrea Montanino, the program’s director, moderated the discussion.
The EU is facing considerable criticism over its structural barriers to growth. Within the EU is the Economic and Monetary Union (EMU), a collection of nineteen Eurozone states bound by a single currency and monetary policy set by the European Central Bank (ECB), as well as other non-euro member states outside of the single currency. However, unlike the Federal Reserve and US Treasury, the ECB does not have the ability to set a single fiscal policy. This has created problems for growth as the EU cannot call for a stimulus, spending cuts, or tax adjustments in the midst of a recession.
“There’s no central attempt to take any action regarding the macro-economy. It’s one thing if every individual state were able to do so or if the states weren’t able to do so but the center did. But the fact is you wind up with a situation where you have neither,” said Shambaugh. “I think Brexit does just add to the need for this. If we were saying we need growth before Brexit, frankly, it just augments the need for it. And the challenge in Europe is to figure out the vehicle to do so, given that there is no central authority who really has the call to do so beyond the European Central Bank.”
Shambaugh added that there are temporary policy strategies that could increase growth in Europe, such as increased investment and capital stocks, unemployment insurance, and increased attention to infrastructure. Underscoring that these policies were short-term, he called for long-term reform.
Political barriers hinder reform.
“Political changes are overruling economic ones,” said Bajnai. The dominant narrative in Brussels, he said, is: “We all know what we need to do. What we don’t know is how to get re-elected if we do what we need to do.” This narrative, he said, is rooted in Europe’s legitimacy problem: Europeans do not recognize the authority of the EU to set macroeconomic policy as they do their member governments.
At the same time, the outcome of the Brexit referendum has put unprecedented pressure on the EU to do something, and fast. Many within the EU view the British decision to leave as one that needs to be quickly implemented, and prefer to weaken British ties as a way to rebuke what they see as being an economically unwise decision.
As Bajnai put it, the EU is viewed as, “The Noah’s Arc in a flood of globalization. There’s a strong instinct to show that those who are jumping off are drowning, but it’s not a good one.”
Indeed, the EU may not have the capacity to do as it pleases, especially in contrast to the fiscal flexibility the Bank of England allows the United Kingdom. According to Eizenstat, “Any attempt to punish has to balance the reality that we’re dealing with the fifth-largest economy in the world…The UK is structurally in better shape. It has a more flexible labor market, an enormous financial services community, etc. Structurally, they are poised to do better. But that is assuming uncertainty is cleared up.” Whereas in comparison, “[ECB President] Mario Draghi has pushed the mandate of the ECB as far as it can go. But fiscally, Europe is still more limited due to the ECB’s structure,” he added.
But perhaps what must come before these structural changes are changes in the way Europeans perceive the idea of a fiscal union.
“The EMU is not just economic. The monetary union essentially means that the member states are giving up one of the core, fundamental aspects of their sovereignty. So in that sense, it is a very political act,” said Sheard.
“But on the other side of the spectrum, the fiscal side, there’s this great aversion to pulling that sovereignty. I do not just see it as an economic system that does not make sense; I do not believe that a monetary union of this scale can survive longer term without fiscal union. But it also doesn’t make sense to me in terms of the internal logic…You can’t really have one leg in bed and one leg out,” he added.
Meghan Rowley is a communications intern at the Atlantic Council. You can follow her on Instagram and Twitter @megs_rowley.
Image: From left: Gordon Bajnai, a former prime minister of Hungary joins Stuart Eizenstat, a former US ambassador to the European Union; Jay Shambaugh, a member of the Council of Economic Advisers at the White House; and Paul Sheard, executive vice president and chief economist at S&P Global (not pictured) for a panel discussion on July 21. (Atlantic Council/Lilac Peterson)