On The Brink: How A Brexit Could Fracture A Fragile Europe by [email protected]
Wharton’s Mauro Guillen discusses the potential impacts of a Brexit.
British citizens are just days away from deciding whether England should exit the powerful European Union. The results of the June 23 referendum known as Brexit, an abbreviation for British Exit, will have long-lasting consequences for the United Kingdom and the entire continent as Europe grapples with its changing role in the global economy. In a recent segment on the [email protected] show on Wharton Business Radio on SiriusXM Channel 111, Wharton management professor Mauro Guillen, also director of The Lauder Institute at the University of Pennsylvania, discussed the complex issues facing Europe, including a possible recession.
An edited transcript of the conversation appears below.
[email protected]: This time last year was a really heady time for Europe. At the end of June 2015, Greek banks had closed and the European Central Bank began to freeze lending. There was talk about the beginning of the end for the eurozone, and things looked very bleak. Give us a recap of what’s been happening in Europe over the last year.
Mauro Guillen: The economies in the south and the east have been going through more problems with economic growth that has not really big enough or fast enough to reduce unemployment, except for in Ireland and in Spain. Even in those two countries, it’s not clear that growth is sustainable. At the same time, we have seen far more assertiveness on the part of the European Central Bank, led by Mario Draghi, in terms of engaging in quantitative easing, that is to say, purchases of not only government bonds but also corporate bonds, much to the dismay of the central European and northern European countries that are also part of the eurozone.
The euro continues to be a viable currency as long as the European Central Bank is willing to do whatever it takes — and remember those are Mario Draghi’s words from about three years ago. But the gap between north and south, the gap between east and west, the unemployment, all of those things continue with no end in sight, so we shall see what the future brings.
[email protected]: In the EU now, growth in the first quarter was about 0.5%, so that’s maybe about 2% a year. There was some reaction in the markets that maybe Europe is finally getting liftoff, maybe the economy is starting to rev up. Then you get the first not-so-wonderful numbers for the next quarter, and hopes get drained again. All of those concerns about deflation and inability to grow are still hanging around.
Guillen: The markets, especially these days, are always looking for good excuses to feel optimistic about things. If you look hard enough you can certainly find some good signals. I would say that by far the two most important positive developments of the last year and a half have been that the European Central Bank is now doing what the Federal Reserve did beginning in 2009 and 2010. It’s a little bit too late now, but it’s better than never.
“If there is a crisis of confidence in the European Union that undermines consumer spending and business confidence, then you are going to get into maybe even a third recession.”
The other important development is that German employees have more money in their pockets because wages have been rising in Germany, especially over the last three years. This is good because Germany is the largest economy, and more consumers there with money means that they spend more money. At least part of those purchases of goods and services go to the southern periphery in the European Union. What hasn’t happened yet is that the German government itself would be a little less frugal and would engage in a little bit more spending. But they are very adamant in that they want to have a balanced budget. Although they can borrow money at negative interest rates, they are not willing to do anything.
So here we are, with this interconnected set of economies in which we have essentially three groups — the east, the north and the south — each with very different conditions. But 19 countries in the eurozone, unfortunately, have the same monetary policy with the same scheme in place, so it’s very hard to get anything done in that situation.
[email protected]: You hear Mario Draghi sort of pleading in his quiet, diplomatic way for fiscal stimulus and not getting that response, which leaves him with quantitative easing, which has limits. Now we’re heading into the possibility of England leaving the eurozone. The impact of that could be as big or bigger than a hard landing in China.
Guillen: I don’t disagree with that. You made a distinction that may ultimately be an interesting one between the U.K. and England. Technically speaking, the nation state that is a member of the European Union is the United Kingdom, but public opinion is bitterly divided there between those who want to stay and those who don’t. If you go to Scotland, you find that most of the population is in favor of staying. One of the risks of Brexit is that Scotland might want to become independent because it really wants to remain within the European Union, and this would only fuel the independence movement there.
The European Union is the largest economy in the world. It’s not as rich as the U.S., but it is bigger in terms of gross domestic product if you combine those 28 countries. If there is a crisis of confidence that undermines consumer spending and business confidence, then you are going to get into maybe even a third recession. That would be devastating for Europe itself, but it would be really bad for everybody else in the world that has business with Europe, including the United States. Exporters to Europe and American companies that have investments in Europe are going to suffer. Companies such as GE or GM or Boeing, 20% to 30% of their business is in Europe, so it could have a large impact
If there is a Brexit, the pound sterling would lose value. The euro would also lose value because there would be such an erosion of confidence. These days, although the dollar is increasingly not that strong, it is perceived as being the only safe haven. What we would be witnessing then is a strengthening of the dollar, and that would also make it harder for American companies that export to do so, and that is going to have a negative impact on the United States. All of these chains of events that I have described are quite likely if there is a Brexit.
I don’t want to doubt Prime Minister David Cameron’s motives as to why he is organizing this Brexit referendum. He does want to put this question to rest within his party. He is playing with the future of Europe for the sake of settling a problem within his party, which is a pretty risky way of doing it. The U.K. has been in the European Union since 1973. It has always had doubts about it. If you remember, we went through several re-negotiations of