Brexit: The Next Domino Could Be Italy

One year after the Greek referendum, a new shock hit the wobbly European edifice. On June 23^rd, UK voters decided to leave the European Union. This put an end to the sequence of events that started with Cameron’s promise of a referendum, aiming to curb the outflow of votes benefiting the extremist UKIP party.

The referendum’s outcome stunned everyone. The leave side won despite the emotional impact of Jo Cox’s murder and the large support for the remain side given by major parties and most of European intellectuals. However, as Krugman pointed out in his blog, one had to be blind not to see a crisis of this kind engulfing the European project.

The terms of the issue should be made clear. The referendum is not binding: the UK Parliament is sovereign and can decide to ignore it. This would be a bad decision underlining even more the gulf between the people of Leave and their national political representatives. In addition, it would probably benefit UKIP’s leader Nigel Farage, always antagonistic to the EU’s political and economic construction. However, it would not be the first time that the EU or Member States deliberately ignores a ballot-box result (the Danish ‘no’ to Maastricht in 1992, the defeats in the referenda on the constitution in 2005 in France and Holland and the Greek OXI). Moreover, as a matter of fact, some Labour MPs have formally asked to ignore the result, somehow revealing the complicated relationship between Corbyn’s party and important sectors of the British working class, which largely voted for exit.

If the UK decided to go ahead and invoke Article 50 of the Treaty on European Union, which regulates the exit of a Member State, negotiations with the EU would start together with those on a simultaneous access of the UK to the EEA as a part of the deal. The process would last a maximum of two years but the actual duration of the process may vary significantly depending on how the situation will evolve.

The economic consequences would be largely determined by the access conditions to the EEA. For the time being, the largest threat to the UK economy is the current account deficit, of around 5% of GDP, which has characterized the country’s economy since 1985 (although with varying magnitude). The financing of this deficit is not in principle problematic for three reasons: 1) the City of London is a center of attraction for capital; 2) the UK has its own currency and borrows in pounds, eliminating any balance sheet effects from the devaluation in place; 3) London shares with the EU the ideology of fiscal austerity and deflationary policies. According to IMF data, for instance, since 2010 Cameron and Osborne have cut government spending by almost 5 GDP points, without being forced to do so by the European fiscal compact.

However, the imposition of “punitive” terms of access to EEA would generate a dangerous recession in the UK spreading out over the EU as a whole and further fueling nationalist parties. Indeed, the UK’s current account deficit is due, for 53%, to imports from the EU so it is not in Europe’s interests to resort to any retaliatory measures against London; the UK still accounts for 10% of intra-EU imports (Eurostat data). Moreover, this decision would sound like an imperialist threat that might potentially provide more fodder for UKIP. All other proposals to punish the City or to offer special tax arrangements to divert multinationals’ headquarters to the EU mainland are either unreliable – financial services represent 7% of the British GDP and depend largely on comparative advantages – or harmful, because they would deepen inequalities all over Europe (these grow whenever the capital to income ratio increases.)

On the other hand, English populism will still have to face up to reality: EEA access implies the adoption of European regulations and standards, the acceptance of European rules about people’s freedom to move within the area as well as a budgetary contribution if slightly smaller compared to the one paid to the EU.

What about Europe? Those who care about the European project knew that the contradictions would have exploded sooner or later. If this happened in the UK, which always had a certain resistance to agreeing on European integration processes, this is only because of historical contingencies. The European institutional system is unable to cope with asymmetric shocks, which consequently raise internal imbalances. The 2008 crisis clearly showed this pattern with austerity measures plunging the weakest countries into recession while the strongest one could instead benefit from low interest rates.

Since 2009, the integration process has gone forward as never before. However, this occurred only in the direction of ensuring a favorable environment for capital flows despite increasing inequalities and rising threats of the EU’s disintegration: the adoption of the single currency and its consequent asymmetries between external debtors and creditors; the introduction of constitutional rules constraining budgetary deficits without mutual guarantees on governments’ debts; the development of a banking union, without a common deposit insurance. The EU demonstrates in the final analysis an institutional schizophrenia, and one could legitimately be scared of what might happen with a common Ministry of Finance.

The same institutional schizophrenia is at the roots of the debate about the control over migration flows. Major issues in the Brexit debate, namely welfare tourism and migration, are exacerbated by this lack of convergence within the EU. Schengen and quota agreements are incompatible with the wide gaps in incomes. Welfare tourism is fed by increasing divergence — in terms of economic and social conditions – among member states. Finally, weak countries like Greece and Italy have to manage the common border but they are also victims of austerity and therefore lack the necessary resources to do so, since rich countries do not want to share the burden.

At this time, guessing on the scenarios that the EU-UK negotiations will comprise is anything but an easy task. Nevertheless, the first events characterizing the post-leave era are already a source of remarkable insights. First, uncertainty has risen as European leaders do not seem to share a blueprint on how to address the current situation. Fears and confusion are spreading around and EU leaders’ declarations are a clear signal in this regard. Listening to Matteo Renzi saying: ‘…No jokes with democracy, British people expressed themselves and we must respect their voice…’ and this is somehow weird, since we did not hear anything similar when the Greek people shouted out their OXI. From this point of view, Italian government’s claims of a quick and radical reform of the EU seem like the desperate cries of those who share significant responsibilities for what is happening. Cries signalling also that the next domino piece might well be Italy, as the euros 150 billions of collateral just allocated by the EU against a potential Italian banking crisis seems to suggest.

Therefore, with the risk of a possible domino effect and further tensions regarding integration, the EU is at a major crossroads. It faces either accelerating or clearly freezing the integration process, allowing the member states to recover part of their political and economic sovereignty. In the first case, we don’t see how this further integration will take place without the existing neoliberal bias or without deepening the existing institutional design problems. Politically, this could also accelerate the growth of right-wing parties as the latest elections for the most part clearly show.

In the second case, we could move to a political and economic cooperation agreement, with no vetos in the debate, starting from questioning free capital movements. Given the success of right-wing parties in exploiting the anti-European anger of the popular classes, each option deserves to be considered and evaluated carefully. Such evaluation should be carried out having as the only parameter the improvement of living conditions – particularly in terms of employment and income – of those classes that suffer more from the consequences of this dramatically flawed European configuration.