Thinking About the Day after Brexit
Will they or won’t they?
The question facing voters in the United Kingdom (UK) on June 23—whether or not to leave the European Union (EU)—has emerged as the biggest economic threat facing Europe in 2016. I believe the odds of a British exit, or Brexit, remain low at 10 to 15 percent, barring an unforeseen event, such as a terrorist attack or another massive migrant inflow across the Mediterranean into Italy, persuading Britons of the necessity of sealing borders.
As is generally the case in EU-related referenda, the “no” or “out” has the easier argument. Railing against faraway unelected European elites out of touch with member state values and circumstances, and demanding the right to determine one’s own future, is more seductive than favoring an EU Treaty change. In the case of the UK referendum, however, Brexit proponents have the burden of changing the status quo, at the risk of serious economic effects for Britain. A simple protest vote must thus address the potential for economic downsides.
Polling indicates that the traditional pocketbook issues remain paramount. We know from Daniel Kahneman, Amos Tversky, and behavioral economics that people are generally loss averse, preferring to avoid giving up what they possess to acquire a new gain. Accordingly, the only rational approach for the British government is a fear-based strategy of highlighting the potential costs of leaving the EU. Going negative works, especially when what people care about is the economy. Even if Prime Minister David Cameron could prove that the newly negotiated deal for the UK inside the EU was a great boost to British growth, campaigning on that basis makes no electoral sense.
That said, Cameron should stay on his negative message and outsource a positive message to visiting oratory supermen. President Barack Obama, visiting London in April, delivered a visionary argument for why a strong UK inside a strong EU is important for Western values, unity, and US national interests. As a bonus, he dismissed as a fantasy the nostalgic idea of an Anglo-Saxon entity of global reach outside the EU. By simply stating that the UK would be at the “end of the queue” on economic deals, Obama demolished a principal argument of the Brexit campaign. As an additional bonus for Cameron, Brexit leaders missed a great opportunity to shut up, instead questioning Obama’s motives with racially tinged dog-whistling rhetoric. It was not a smart way to attack a president who remains popular among undecided UK voters.
It further simply makes a difference that the incumbent prime minister is in favor of staying, as it ensures that the vast majority of British government resources will work towards remaining in the EU. The deck is in other words invariably stacked against the brexiteers. Combined with what will be Cameron’s fear-based arguments, this virtually guarantees that the Brexit campaign will further aggravate an already bitter split over the European issue inside the Conservative Party.
Nor is the issue likely to go away even if British voters decide to remain in the EU. Brexit advocates are certain to demand another “fairer vote,” unless the vote to remain is a sweep on the order of 60-40. A final driver in any fear-based campaign is the financial markets, which Cameron and the other UK leaders seem deliberately trying to scare by maximizing uncertainty. Were the British to vote to leave the EU, the deal struck in February for a new UK relation with Brussels would become null and void as Cameron launches an application to leave the EU under the EU Treaty’s Article 50.
Brexit would not be an amicable divorce. Other EU leaders surrounded by political parties at home also demanding to exit the EU would, to try to maintain EU unity, impose a dear price on the UK for leaving. Negotiations will therefore be very tough and likely drawn out, and there is no reason to assume that the treaty-specified two-year window for negotiations to be concluded will not have to be extended. Financial markets will in time come to understand this and will take precautions against such prolonged uncertainty ahead of the votes being cast.
Should opinion polls remain tight in the weeks ahead, a continuing decline in larger dealmaking, new business investment, and mergers and acquisitions in the UK—with some short-term negative implications for the UK labor market—must therefore be the base case until June 23. At the same time, more liquid UK assets and the pound sterling in particular are likely to see more volatility driven by the more day-to-day progress of the campaign. A good week for David Cameron—such as following President Obama’s visit—will boost the value of the pound, whereas successful interventions by the Leave Campaign will weaken it. This short-term volatility will likely get more violent as the referendum approaches. At the same time, though, should voters in the end reject Brexit, these trends will reverse and the UK economy will get a boost in the second half of 2016.