SMITH BRAIN TRUST — The debate over whether Great Britain should exit the E.U. — to "Brexit" or not to "Brexit"? — is rippling outward from Europe into the world's major financial markets. The G20 nations, who met in Shanghai last weekend, warned of a "shock" to the world economy if Britain goes its own way.
Unlike Greece, which has also debated leaving the E.U., the U.K.'s economy is relatively solid. It also has more independence than the typical E.U. member, having stuck with the pound over the Euro, which lets its own central bank make decisions about monetary power. It has asserted more control over its borders, while its labor-market rules also tilt slightly more to the American free-market approach than is the case in most of the E.U.
Nonetheless, the pro-exit camp argues that the European Union has saddled the British economy with burdensome regulations, that Britain pays billions in membership fees for little in return and that the long-term goal of an "ever closer" European Union threatens British sovereignty. Those who want to leave for economic reasons are piggybacking on concerns about the E.U. policies of relatively open borders for workers, and welfare for migrants, which raises passions in Britain much as the immigration issue has inflamed American voters. A public referendum will come June 23.
E.U. membership serves basically as a master key that unlocks access to the 27 other member countries. "If the U.K. exited the E.U., there are two different models they could try to implement," says Albert "Pete" Kyle, the Charles E. Smith Chair Professor of Finance at the Robert H. Smith School of Business. "The first is what you could call the Swiss model, where you negotiate with each individual country on 100 different issues." Such bilateral agreements allow Switzerland to function in many ways as a member of the E.U. while going its own way on a few matters: not a bad deal for them. Then there is the Norwegian model: Norway gets blanket access to the E.U. market through its membership in the European Economic Area (but it pays nearly as much per person into the E.U. treasury as the U.K does, without getting a vote in E.U. policy).
The catch is that, contrary to the claims of Brexit boosters, neither of those paths may be available, Kyle points out. "The E.U. may want to punish the U.K. by making it difficult to get an arrangement that mimics either Switzerland or Norway," he says. "They may want to use the U.K. to set an example, so that no one else wants to leave the E.U." (Denmark is another country with an active anti-E.U. movement.) Prime Minister David Cameron has suggested that a decade of chaos would follow Britain's exit. Ready access to European markets is crucial for Britain, which does half of its trade with E.U. members.
The U.K. faces other potential blowback if it leaves. "Germany might make a big play for the E.U. banking market, to try to force it to Frankfurt," Kyle says. The EU, in a punitive mood, could grease the path toward this outcome by imposing new taxes and capital requirements on E.U. banks that do business in the U.K.
There are arguments for Britain staying in the E.U. that have less to do with the effects on Britain, per se, but on Britain's influence on Continental economies. "Probably one of the reasons that business interests and the banks want to keep things the way they are is that they think the UK has a strong, good influence on the EU," Kyle says. "Without the U.K.'s influence, they think that burdensome regulations in the E.U. would get even worse."
Cameron, a Tory, is campaigning strongly for remaining in the E.U., as is most of his cabinet, but he has lost some key allies, including his friend and justice secretary, Michael Gove, and the charismatic Tory mayor of London, Boris Johnson. A late-February poll by the Financial Times found that 46 percent of the British favored the status quo, 38 percent wanted to exit, and 15 percent were undecided.
By the way, Britain's decision to stay on the pound turned out to be very wise, Kyle thinks. When the economic crisis hit, England was able to significantly devalue its currency, an option unavailable if it had been part of the Eurozone. "The U.K. dodged a giant bullet," he says. "If the U.K. had joined the Euro, Britain's economy would have imploded like Ireland's — except worse, given how much larger the British economy is."
Kyle suspects that the British public will, in the end, stick with the status quo.