Brexit is a Question Mark, Not a Period

On June 24, the British people gave their verdict on the issue that has consumed their politics for months, and voted to leave the European Union. The country with a long history of keeping Europe at arm’s length went a step further, backing away from decades of European integration. The decision caused an instantaneous furor across the world, and upon receiving the news, investors sent the British pound plunging. Brexit inspired nearly unanimous horror from non-nationalist right global politicians, business elites, and media commentators, some of whom appeared to hit near-despondency. It is certainly true that Brexit is a risky move, one that could result in severe international ordeal, but the hysteria over Brexit hit such a fever pitch upon news of the decision that it seems worthwhile to examine the entire choice the British people faced. A fuller examination of the history and economics of exiting the European Union, I think, leads one to a more modest conclusion: Brexit may be a bad call, but there are also arguments that the EU, for all its promise, may be structurally broken. At the very least we should take these into account before immediately proclaiming the apocalypse.

In the short term, Britain (and, probably, countries with significant ties to Britain) will pay some level of economic price, though the exact magnitude is unclear and essentially impossible to predict given the unprecedented nature of this situation. If you see someone making a very high-confidence prediction, they are overweighting how much a person can anticipate about new events in the world. Inevitably some people’s predictions will be right, but those people will be somewhat lucky. It is very difficult to even forecast the rate of GDP growth in a stable country three months in advance, let alone the future course of a country leaving a pan-national block. But the direction of the change does have a quite strong consensus: leaving Europe’s free trade zone, if only because of the increased uncertainty alone, will have some level of short-run cost to GDP, and it may be painful.

Nevertheless, the history of the pan-European project suggests we should not freak out just yet. The EU was founded as part of a long line of post-World War II attempts to unify the continent and prevent anything like WWII from ever happening again. This structure has mostly involved military alliances, free trade agreements, and development of new political bodies, and has grown into what the EU has grown to consist of today, which includes: 1) open borders between nation-states in the EU for both people and goods; 2) monetary integration by way of the Euro and the European Central Bank (ECB), which has the power to set interest rates across Europe; and, 3) mild political integration in the form of various pan-European institutions like the European Parliament and European Court of Justice. The traditional nation-states within the EU get fiscal control over their own budgets, except for some mandatory dues they pay towards the EU and some restrictions that the EU sets on its member countries.

What this process amounts to in the long run is an attempt to create a body analogous to a United States of Europe, in the hope that this will stop the kind of forces that created WWII from ever rising to power again. This clearly has not worked (see Austria, France, Hungary, Sweden, etc., all of which have neo-fascist parties on the verge of entering government).

The EU, in its current iteration, tries to have monetary integration without fiscal integration by trying to put dozens of countries with wildly different cultures, histories, and economies into the same unit. The result is that Northern European countries like Germany have to shoulder the burden for Southern European countries like Greece, and they are tied together in perpetuity, with cycles of bailouts and rising antipathy. If the United States suffers an economic crisis that is localized, people can move to other states or communities. In Europe, if this happens, it is mass immigration, with all of the cultural upheaval that implies. In the United States, government transfers can help out people in certain affected areas because Americans recognize the rest of the country as part of the same cultural-political entity. In Europe, the most infamous dysfunction has taken the form of resentment in Germany against the redistribution of hard-won resources to Greece via bailouts, and the reciprocal resentment in Greece against the harsh austerity bailout conditions of Germany. This nation-state equivalent of a bad marriage has paralyzed European politics for years and ushered in the exact conditions the EU was supposed to prevent.

Additionally, in a centralized federation like America, if a state’s finances implode, the full faith and credit of the entire nation is not at risk. In the EU, by contrast, even a smaller economy like Greece (let alone a larger one like Italy) can drag down the entire continent through contagion without any real mechanism to stem the bleeding.

These sorts of imbalances are structural to the European Union. After the creation of the Euro, bond rates of countries in the EU equalized — the rates of, say, Spanish bonds nearly equalized to the rates of German bonds. This compression of bond rates towards Germany’s bond rate means that investors priced the risk of German default to be the same as the risk of Spanish default, as the same as the risk of Greek default, etc. That judgment seems ridiculous in hindsight, but those bond rates converged because the entire point of the EU is to pool risk and pool resources, and so the artificially low interest rates of Southern Europe and countries like Ireland created a massive, unsustainable boom that was arguably even worse than the housing boom we faced in the US. And all of that fake wealth was wiped out in the Euro crisis.

Carrying on the analogy between the US and the European Union, in the US, the differences in unemployment rates between states are relatively small — 5% or so at most. This is because the US is an integrated unit that has significant labor mobility. In Europe, this is not the case at all, and so there are countries like Germany with unemployment rates at around 5% and countries that had unemployment rates that hit over 30%. To have flexibility and success on the level of America’s labor market institutions, you would have to, for example, essentially depopulate much of Greece and instantaneously create a Greek diaspora across Europe that would further inflate resentment and backlash.

The EU is not an integrated fiscal unit, and the incentives of its member countries are often diametrically opposed. Some countries, depending on their balance of imports and exports, benefit from a higher exchange rate, and others benefit from a lower exchange rate. Some benefit from higher interest rates, some from lower interest rates. The list goes on. The ECB is meant to solve some of these coordination problems, but a central bank cannot fix the world, especially if the fiscal policy of governments can be structured as to directly counteract its effects. So, circa 2010, when Europe faced the simultaneous crises of a sovereign debt explosion, negative economic growth, and systematic, Europe-wide banking failure, there was no political leadership and everything fell apart even further.

The political effects of open borders and interlocked economic institutions mean that countries that have had a thousand-year plus history of fighting wars with each other are suddenly expected to subordinate their national identities and interests to “Europe”. They are suddenly expected to accept mass migration and the potential dilution of their cultures for the sake of an economic integration that has done nothing but fail many of them for years. Many European countries have debt-to-GDP ratios of over 100% and are on the verge of needing even more international loans, and they are shackled to a system in which they have to jostle with their supposed partners to sustain themselves economically.

It makes perfect sense then, given these conditions, that communism and fascism are rising again across Europe. It would be more surprising if they weren’t. The European project cannot survive in a halfway state in which Germany calls the shots, Southern Europe gets screwed, and the ECB tries to hold it all together. The current system does not work and must be replaced. Whether you think Brexit is a good thing probably ultimately depends on if you think the pan-European project is salvageable, and given the events of the past decade, and how the structural problems seem to be embedded within the very design of a pan-national United States of Europe, there is a non-trivial case to be made that at least the current edition of the project is ultimately going to be unsuccessful and Brexit is the beginning of a mercy killing.

It is true that by keeping the pound and refusing to adopt the euro, Britain has avoided some of the worst of these economic doldrums. In other words, the decision that Britain has viewed with greatest relief in recent years is their previous decision that involved directly defying European integration. The European project, after years of political chaos, has pressed on and only reaffirmed its commitment to the existence of the euro, with all its instability. Then, add into this cauldron the massive Middle Eastern migrant and refugee crisis. Yell at the Brexiters for being impulsive and at least a few of them for being simply racist if you want, but at least recognize that this situation follows years of mismanagement and that the EU is currently structurally designed to stoke legitimate cultural grievances as well as bigotry. As Ross Douthat of the New York Times put it, “the Brexit vote is a perilous moment. But the actual disaster isn’t the vote, it’s the eight years of policy that made it thinkable.” On the immigration point, an earlier Douthat article that argues, among other things, “native backlash against perceived cultural transformation is very powerful, and any politics that refuses to take account of it will fail,” deserves consideration.

To be clear: the current wretched state of the grand European project, hobbled by a structurally generated reversion to the nastiest and crudest forms of nationalism, is not the fault of evildoers. It is the result of faulty institutions that nearly all agree must be reformed some way or another, whose failures have created a vacuum in which figures like Nigel Farage and worse can rise. As to the ultimate fate of the project, it remains unclear whether the EU can ultimately be successful, and anyone who tells you they know for sure is vastly overconfident in their own political savvy. Brexit might be a short-term sacrifice to escape from a long-term malaise, or it might be a fit of pique that exiles Britain from what turns out to be one of the most ambitious and worthwhile projects ever undertaken. Voting for or against Brexit is a shot into this darkness, and history will not give us the luxury of knowing what would have happened under Vote Remain. No matter your vote, launching into hysteria obscures the very real issues at play.

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Andrew Granato, a rising senior studying economics, is a staff writer at Stanford Political Journal.