TAKEAWAYS

• Short-term risk of financial panic is low, but significant long-term economic challenges exist
• The need to reconceive and renegotiate the UK’s relationship with the rest of Europe will create an ongoing economic drag and source of uncertainty
• The UK faces the prospect of splintering as Scotland and Northern Ireland consider exiting
• The 27 remaining EU countries may end up more unified

Q: You thought a leave vote would be risky. A little less than a day after the referendum, are your concerns being borne out?

Andrew Metrick: I don’t have short-term concerns. Although I’m someone who worries a lot about financial crises, I don’t think that this is the type of event that is going to be destabilizing in the short run. We would expect it to affect markets. And we’ve seen stock markets fall, with banks getting hit particularly hard, long-term interest rates fall, the pound getting hurt badly. All of those things are to be expected, but a crisis leading to bank-runs—where people are worried about the fundamental soundness and viability of financial institutions—that’s not the case.

The bigger concerns are long run. The main thing that this does is political in that the European Union experiment really has only been going in one direction and that’s towards more union, more integration. There are some very important and noble goals for this project, which came on the heels of two horrible world wars and a desire to bind together the nations of Europe more tightly so that they would have no incentive to do that again. With the UK exiting, it’s the first time we’ve seen any significant pullback from this project, which had mixed success, but certainly kept alive its noble ideals.

The biggest uncertainty now is, who else will leave? And to what extent will Euro-skeptic parties across the union be emboldened by what just happened? A lot of the European Union project is unambiguously good—open borders, lower trade barriers, freer movement of goods and capital. That part now, I think, is in some danger.

There’s also tremendous uncertainty about how this is going to play out. Uncertainty discourages people from making long-term investments. People start to think, “Well, maybe I’ll wait a little while before I invest.” The concern is how much of senior-level people’s time is now going to be spent figuring out how the UK exits. That is going to be a short-run hit to productivity, and the size of it, we don’t know. How much planning and managerial time will go into questions like, How do we keep all of our employees if we are a UK corporation? What’s going to happen to the banking system? The financial markets? Is London going to remain a financial center? That is going to put a drag on productivity, but we just don’t know how much time it will take or how much innovation will or won’t happen because of it.

David Bach: Andrew is the expert on financial panics, and it doesn’t look like that is the concern. There are certainly people who are losing a lot of money, and some of that is going to get re-gained or re-allocated, but that’s what happens when you have shocks like this.

The AP had a great quote that Britain jumped and is now looking for the parachute. That’s right on. Very little thought went into what would come after Brexit. A separation like this has never been done before. These economies have grown together over 40 years. Three million EU citizens live and work in the UK, and 1.5 million UK citizens live in Europe. There are business, family, legal, constitutional, and political issues because the European Union has to think, on the one hand, about how to manage this exit in a way that protects the interests of the stakeholders in the 27 continuing EU countries, while at the same time not being overly accommodating and perhaps then encouraging others to exit.

My sense is that in the UK there is going to be a vacuum now. The Prime Minister [David Cameron] has said he is going to resign and there is no immediate successor. It also seems that the leaders of the “Leave” camp aren’t exactly sure what to do.

One thing that I would note—and it gives me a lot of pause—is that there are really at least three different groups within the “Leave” camp. You have conservative, neo-liberal types around Boris Johnson and others who feel that EU regulation was stifling business and want to control their own sovereignty. The second camp is around Nigel Farage and the UK Independence Party—the nativists who are anti-immigration. And then you have a third group, trade unionists who felt that Europe was too pro-business, and they want to go back to a model of greater protection. Now there will be an intense battle inside Britain about what the future of the UK is going to look like, against the backdrop of the UK dealing with its own separatists, potentially in Scotland and Northern Ireland. The complexity is just enormous.

Metrick: I think that Scotland will leave the UK. The main reason that they didn’t go last time is that they didn’t know if the EU would take them. Now they’d rather be in Europe than be with England.

Northern Ireland is really tricky. It is the case that they’ve had no borders with the Republic of Ireland for a while, but I don’t know whether the religious issues that made this split in the first place are going to be any less potent.

Bach: I think that is going to be a function of how quickly the rest of the UK adapts, or how severe a recession is going to be. To what extent is Ireland going to benefit as countries shift their money within the EU to the native English-speaking country that remains?

Metrick: They’ve still got Wales though.

Bach: When you look at it, though, there’s a big story about the disparities within the UK. You have London versus the Midlands. In the urban, global, more cosmopolitan centers, people took the EU for granted. They felt more integrated, they traveled, and they took advantage of these opportunities. Then there’s another part of the country where jobs have been lost, wages have been stagnant, and immigration is changing communities in a way that some people are not comfortable with. It hasn’t been working for them. Now, these people finally feel that they have a way to bend the arc of history.

In some ways, you can see a reflection in how the election cycle has been going here in the United States. You have people primarily near the coasts, who are affluent, well-educated and globally oriented, who can’t even fathom some of the things that are being proposed. And you have others who are asking, “Why not? What we currently have isn’t working for us.”

Q: Why has this vote for independence rattled markets around the world?

Metrick: While the UK is not Greece, there is one similarity. When the negotiations over Greece and Greek debt were rattling the world markets, it had nothing really to do with Greece. It had to do with what everyone thought would happen if they couldn’t hold the European experiment together. Now, that’s what we’re seeing again.

The primary effect of this is going to be in the UK and tons of time and energy are going to be spent on this. An enormous fraction of GDP comes from London’s role as a financial center and that’s in some jeopardy. They clearly were the preferred financial center for the EU, despite the fact they are not in the Euro. England, by itself, could plunge into a deep recession. I don’t think that is going to happen, and the impact that would have around the world on areas that are not England’s largest trading partners would be small anyway. The uncertainty about where we go from here though is huge and that’s what rattles markets.

Bach: The same is true at the government level. You go back 15 years and Europe set a goal for itself to be the most competitive region in the world. In hindsight, that seems kind of silly, because the EU has been so focused on itself and figuring out its governance and political issue. Now we are going to get that inward focus, squared. They’re going to have to look at the mechanics of disentangling and the fallout of it, as well as dealing with similar movements in other countries. The big challenges we have from sustainability, climate change, weaknesses in emerging markets, competition from China and India, are going to get less attention because we are trying to fix a self-inflicted wound in many ways.

Metrick: I have a question for my multilingual friend here. David, what happens to English as what had become the most important language in the EU?

Bach: I hadn’t thought about this. All official documents are translated into all languages, but English and French have been the predominant languages. Most meetings are either conducted in English or French, and the shift has been towards more English, particularly with the inclusion of more countries from Eastern Europe.

Metrick: Think about how much time will be spent on this and subjects like this.

Every company will be hiring lawyers and consultants and others to work on this, but it’s not productive labor. It doesn’t lead to long-term economic growth. It doesn’t lead to new technologies. It’s much like what happens after a hurricane.

Q: Who are the big institutional players who will determine how this goes forward?

Bach: There is a provision for when something like this happens. It’s Article 50 of the Lisbon Treaty. Until the early 2000s, when this was passed, there was nothing there to prepare the EU for the moment should a member state leave. The presumption was that if we used Article 50, it was going to be some small Eastern European nation that couldn’t keep up with the regulations. Nobody thought that one of the biggest economies would use this. Once the UK triggers Article 50, they have two years to negotiate a new status, but then it has to get adopted by the European Council unanimously. So the other 27 nations, all the way down to Malta and Slovenia, effectively have a veto on the terms.

After two years, if they don’t have an agreement, they have to negotiate from the outside.

Metrick: My understanding is that the EU has no intention to give any concession of any kind at this stage. But I expect the UK will effectively stay in the common economic area and grandfather people in to allow them to stay in each other’s countries. There’s just too much at stake. But I don’t expect that the UK is going to get to leave with any of the family’s nice china.

Bach: So there are three potential models as far as trade and market access is concerned. One is the European Economic Area, that’s Norway. You basically have the same access to the market for the free flow of goods, capital, and labor. Much of the EU regulation is binding, you pay less in membership fees, but you effectively have no seat at the table. That’s probably worse for the UK than what they had, particularly around the free movement of people, which they want to restrict.

The next option is a free trade agreement, along the lines of what they have with Canada, for example. But you have to negotiate that. That takes time.

The third option is that all of these countries are World Trade Organization members and that becomes your default.

The UK would probably want the same access to the European market that Norway has without many of the constraints and obligations. That would require concessions and I don’t think that the EU member states are going to go out of their way to make it easy.

Metrick: I agree with that, but I think they will get there. The disruption is too great and both sides have too much to lose.

The really big question is how emboldened are the Euro-skeptic and populist, right-leaning parties going to be in other countries?

Q: What would you be looking for to know if that’s happening?

Bach: The first test is that Spain has an election this Sunday and there is already an expectation that the Euro-skeptic far left is going to do well. We’ll see how well they do. We have the French and German elections next year, and in both, you have populist right-wing movements that are, to some degree, anti-immigrant and anti-EU. You already have a far-right call for a referendum in the Netherlands. Now so far, these parties represent maybe at most 15 to 20% of voters, the way that UKIP did. You’ll want to see whether the government’s strategy for dealing with them is to embrace them and say, “Now is the time for the EU to reform so we don’t end up in this situation again,” or whether they’re going to lock-arms across borders and say, “No, we are not going to let this movement go mainstream again and hijack the national political discourse.”

Another way of looking at this is that British reluctance to fully engage has been holding Europe back. Great Britain is the only place in the EU I know of where, when people said “Europe,” they meant somewhere else. We talked about Italy, and Spain, but they’ve embraced European identity with a vengeance. They might have concerns, they might find the ECB too remote, but they haven’t historically had this lukewarm relationship with the European Union.

I do think that the liberal drive that Britain brings will be missed in the EU, but certainly dealing with Greece and other issues has been made much more complicated by the fact that such an important economy was not part of the Euro. On every single treaty, the British wanted special treatment. There is a possibility that it will become easier to set a direction for the rest of Europe. The worst thing for Europe now would be stasis and lamenting all of the horrible things that are happening, as opposed to moving ahead and setting goals. There is opportunity there.

Metrick: No one believes the optimal size of government is everybody under one government. There are always going to be certain things we want local control over. This is a battle we have a lot of experience with in the United States, and we fought a civil war over it. If the UK didn’t really belong, it could get easier for Europe, but I think the danger is that it’s still destabilizing.