Post-Brexit, the Real Risk Is Europe Could Fail
While the short-term economic consequences of Brexit are not to be dismissed, it is the impending failure of the European project that should provoke the bigger sense of concern. The EU's two biggest achievements since the establishment of the single market -- the euro and border-free travel -- are both under threat. These implosions would be a magnitude more painful than the British vote.
The two are closely linked. European governments realized in the 1980s that competitive currency devaluations were hindering the single market, which was supposed to bring more industrial specialization and economies of scale. A single currency, they hoped, would put an end to that game, bring low German interest rates to all and enable national governments to reduce deficit and debt levels, as enshrined in the Maastricht criteria.
But there would be a cost: Respecting these rules would create political pain as parts of the labor force were displaced. That is where the 1985 Schengen Agreement came in. The pain of fiscal restraint and adjustment would be eased by promoting free movement. People might lose their jobs in Fiat, but they could go and work in the Ruhr. The single market had already enshrined this freedom, but Schengen made it truly palpable by removing border controls.
Over time, cross-border trade, tourism and labor mobility increased markedly as a result. The freedom to retire, go on holiday or study in another EU country created important political constituencies in support of Europe. As Eurobarometer polls consistently showed, border-free travel was hugely popular. Both the euro and Schengen are now on life support.
Schengen has been unravelling for a while, under the strain of uncontrolled immigration from outside Europe and from the threat of terrorist attacks. Without Schengen, the European project loses a sense of common destiny, an aura of plausibility and a great deal of the cachet it held, particularly for the young. It is no longer possible to have "just" freedom of movement without borderless travel as it will now feel to Europeans as if a crucial freedom has been taken away.
The potential demise of Schengen has undermined support for the EU as a whole, and that in turn has compounded the problems faced by the euro -- recently described by the normally cryptic Alan Greenspan as vulnerable. Even that was an understatement. The European Central Bank has been all but screaming that monetary policy alone can buy time but not hold the unfinished euro zone together for ever. Germany, the ECB's largest shareholder, has watched successive rounds of QE with concern. Meanwhile, other euro zone economies have suffered under Germany's large current account surplus, so large that the country received a warning from the U.S. Treasury as a potential currency manipulator.
The high youth unemployment in southern countries and the lack of income on the savings of the elderly in Germany are a dangerous political cocktail. Uncontrolled waves of migration have only enhanced the sense that countries need to, as the Brexiters had it, "take back control." Across Europe, political parties surfing of this wave of discontent are increasing in popularity and openly calling for an end to euro membership.
Strengthening both Schengen and the euro -- or at least preventing their demise -- is not impossible. Better control of external borders and more robust intelligence sharing would make border-free travel safer and more defensible from a security perspective. But, crucially, there will also have to be less generous social benefits for those who have not contributed to the system, something Denmark's prime minister mooted on Thursday. That may be politically controversial, but it is possibly the only way to hold on to the social-democratic welfare models without creating an irrepressible appeal for poor migrants.
Removing the euro's vulnerabilities ultimately requires the kind of fiscal policy-sharing that EU countries have resisted. But even without that, there are ways to use the single currency to boost growth. Rather than subsidizing corporate bonds, stock buy-backs and social security programs, the liquidity provided by QE should be allocated for investment, which would create both jobs and opportunities for growth. Europe has made noises in that direction with its Investment Fund, but the resources dedicated to the effort (and the results so far) are paltry.
If it can't fix its flagship projects, the EU will face far more upheaval than simply a British vote to leave.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
To contact the author of this story:
Jean-Michel Paul at JPaul@acheroncapital.com
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Therese Raphael at email@example.com