As the UK prepares to leave the European Union, the ramifications of its departure remain anything but clear. What does Brexit mean—not only for the future of the EU and for the British economy, but for Western democracy? On this episode of The Big Question, Hal Weitzman is joined by Chicago Booth’s Christian Leuz, Randall S. Kroszner, and Lubos Pastor to discuss the factors that led to Brexit and the outcomes we can expect from it.
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Hal Weitzman: Four years ago, The Big Question asked whether the euro currency could be saved. We could now ask that same question about the European Union itself as we prepare for Brexit, witness the rise of nationalism across Europe, and enter the Trump era. So what next for the EU and all developed economies in the face of this antiglobalization backlash?
Welcome to The Big Question, the monthly video series from Chicago Booth Review. I’m Hal Weitzman, and with me to discuss the issue is an expert panel.
Randall Kroszner is the Norman R. Bobins Professor of Economics at Chicago Booth. He was a governor of the Federal Reserve from 2006 to 2009 and a member of president George W. Bush’s Council of Economic Advisers from 2001 to 2003. Christian Leuz is the Joseph Sondheimer Professor of International Economics, Finance, and Accounting at Chicago Booth. He’s also a codirector of the Initiative on Global Markets and an editor of the Journal on Accounting Research. And Lubos Pastor is the Charles P. McQuaid Professor of Finance at Chicago Booth. He also serves as codirector at Booth’s Fama-Miller Center for Research in Finance and he’s an associate editor of the Journal of Finance.
Panel, welcome to The Big Question. Christian Leuz, let me start with you. How will losing the UK affect the rest of the European Union?
Christian Leuz: Well, I think of the EU as largely a political project, and given that, the most severe consequences, I think, will be political in nature—aside from some of the economic consequences like restrictions on trade that likely will result. But on the political side, the EU has had a balance of power essentially between three of the large countries, the UK, Germany, and France, and to some extent Italy. And now with the UK leaving, that balance of power is substantially changed.
But on top of that, I think the UK was bringing to the table a force for promarket, was a promarket force, and that force is now lost for the EU. The French tend to be somewhat more interventionist and give a bigger role to the state. Germany to some extent as well. And the UK was kind of balancing that out, being more promarket. That is now lost. The Netherlands are still, for instance, very much so a promarket force, but they’re much smaller than the UK had been. So I think that will be one of the most important political consequences.
Hal Weitzman: So should we expect more regulation?
Christian Leuz: The EU has already gone through a number of initiatives and directives. And so it’s not obvious there’s going to be an immediate regulatory response, but you could see how, perhaps, in handling crises, there would be more of a tendency for the state to get involved.
And, in general, the way new regulations may get formed, we’re not having that force from the UK that would be speaking up for letting markets have a significant role to play. And perhaps the future of regulation in the EU may take a more interventionist or pro-state role than they would’ve otherwise taken with the UK still on board.
Hal Weitzman: OK, Randy Krozner, is this a big blow for the European Union?
Randall S. Kroszner: Well, it certainly will change the character. I agree very much with what Christian has said, because you’re going to have elections for the EU Parliament in 2019, so it’s likely that that’s one of the things motivating Theresa May to start the process now.
Hal Weitzman: The UK prime minister, of course.
Randall S. Kroszner: The UK prime minister. To start the process in March, so that there’s a formal exit before the vote. It would be rather odd for people who are just about to leave to be voting for an institution that they’re not going to be participating in.
But I think it will change the character of it, because you will lose the, let’s say, the level-headedness that often comes from the UK. And so you’ll have a very different mix in the Parliament, and I think that’s going to be a change for Europe. They have to decide how they’re going to go forward, not only with a different internal mix, but also, obviously, with respect to the UK.
Hal Weitzman: Lubos Pastor, what is your expectation about what this means for Europe to lose, or for the European Union, rather, to lose the UK?
Lubos Pastor: Well, in addition to what Randy and Christian have said, I believe the importance of the eurozone within the European Union is going to strengthen.
So as we know, of the 28 EU countries, only 19 are in the eurozone, and with the departure of the most important non-eurozone country from the EU, the others like Czech Republic, Poland, Sweden, are going to become weaker. More decisions will be made at the eurozone level. Banking unions, already kind of at the eurozone level. Other, you know, the Capital Markets Union . . . other initiatives might take place at the eurozone level. So I think this is going to be important.
Hal Weitzman: Could that actually strengthen the euro then? As a currency?
Lubos Pastor: It could. It could. So the effect on the EU is really ambiguous because there are two big forces pulling in opposite directions. On the one hand, you have—the odd man out is leaving, so it’s going to make it easier for the rest of Europe to get together.
On the other hand, the fundamental force that has driven out Britain, which is the skepticism of people toward globalization and the EU, is also present in the western European countries. And that’s going to pull the other way. And it’s really hard to tell which of them will prevail.
I also want to mention that it’s very unfortunate that European politicians will now be spending time solving Brexit instead of addressing more important issues.
Hal Weitzman: Why do you think that the European Union does have that image problem? You talked about lots of countries—you know, the vote for example, the referendum that took place in Italy last year became about the European Union, and it was predictably lost, even though it was about something completely different. Why does the EU have this image problem, Lubos Pastor?
Lubos Pastor: Well, in part, the EU institutions have become a little too distant from the European voters. Some people feel alienated too far from Brussels. It’s always easy to blame things on Brussels.
But I think the bigger thing is that the EU is a poster child for globalization. And we observe a broader pushback against globalization. The EU, you know, you have 28 countries with free movement of labor and capital and goods and services, it’s easy to blame the EU if you want to blame globalization.
Hal Weitzman: Is that your view as well, Christian?
Christian Leuz: I would agree with that view, although I would add, and it will connect with my earlier thought that the EU is largely a political project. I think that a lot of the benefits that the EU has and what makes the leaders, the political leaders so committed to the European Union is the fact that there are fairly abstract benefits. It’s things like peace. It’s the civil rights, the human rights that the EU stands for. And those are things that are much harder to communicate to people than things that people feel in their pocket or in their wallet. And so, some of the most important aspects, in my mind, are difficult to communicate. And that is, I think, what also makes it hard for the EU leaders in the current environment to sort of staunchly defend the EU and give people concrete examples. I think they should try.
To give you one example, for instance—this is a small example, but I think it illustrates that one can find these examples. For instance, there is a very successful student exchange program, the Erasmus Programme, that has been shipping students from all over Europe. And I bet you if you were to ask students that have had that experience and been a part of that program, they’re going to be much more pro-EU. They’re going to be much more seeing the benefits than when you sort of ask somebody who hasn’t been part of that.
And this is, again, just a small example. I think you can find others, but it’s those instances that you can easily communicate. Whereas the grander benefits of the EU, which, in my mind are huge and there is a huge political dividend, are going to be very hard to communicate to people.
Hal Weitzman: But how much of this is about Europe specifically and how much is about globalization? I mean, you talked about the benefits being diffuse, so in some cases it’s hard to explain. There wasn’t a war or something that didn’t happen that would’ve been negative, as opposed to, let’s say, losing jobs, or having communities change because of large-scale immigration or refugees or whatever. How much is it specifically about Europe, or how much does it connect to, let’s say, what happened in the United States with the election of Donald Trump and a more general attitude against, or concerns about trade, let’s say.
Christian Leuz: I think there’s a couple important differences. I think to some extent the EU is, like Lubos was saying, a poster child for sort of globalization or integration. And there actually have been, also I think, substantial benefits from trade, from the free movement of people. So the studies that have looked at, what are the effects of immigration, the free movement of people? What are the effects of trade? They’re on average overwhelmingly positive.
In some, for certain, for instance parts of the wage distribution, mostly the lower-skilled people are potentially negatively affected. But, for instance, the effect from immigration on native wages—these are the people that live in the country—is, on average, positive.
And so, in that sense, first I want to sort of say that I think the EU is a good example and it shows the benefits from globalization. Where I think there’s differences with the debate we had in the US, for instance, is that the UK is actually pro-trade. I don’t think that the anti-trade movement that we saw in the Trump election featured very prominently in the Brexit discussion. The immigration did. But it wasn’t immigration from outside the EU, it was actually more immigration within the EU that featured prominently in the Brexit discussion.
Randall S. Kroszner: But I think that issue of sort of within versus without is an important issue on the continent. Because I think without the European Union being able to come up with a common border policy, one of the issues that is lurking there is, how do you deal with refugees. That has become much more prominent. And I also think that there’s been a lot of mixing of the two issues. Of sort of the free migration of EU citizens versus the refugee issue. I think that’s caused a lot of consternation, a lot of distress, and I think that’s going to be one of the issues as we see the elections going forward this year.
Hal Weitzman: Trade, though, in general, when you ask people in opinion polls, people say they like the idea of trade. When it comes to elections though, particularly here and in other places, they voted against free trade. The perception is that free trade has harmed jobs and economic growth. Why do you think there’s that mismatch?
Randall S. Kroszner: Well, I think certainly we’ve seen a lot of challenges in many areas of job creation, whether it’s in Europe or the US. It’s very easy to sort of blame a particular force on the outside for that. But in any dynamic economy, there’s going to be change over time. And I think that’s a change in dislocation.
One of the things that I think economists have not been as good at as we should have been is being sympathetic to the distributional impacts. Because, exactly as you were saying, it’s something that is, on average, a clear benefit. But that doesn’t mean that every individual is benefiting from that. And in a political process, you have to take into account not just the average, but how it’s going to affect people across the entire spectrum. And we haven’t been as sensitive to that.
One of the challenges is we haven’t figured out how to do a good job of dealing with it. We’ve had a lots of trade adjustment assistance programs in the US, retraining programs, but none of those have been particularly effective. And so I think that’s something that really needs a lot more focus, both within Europe and the US.
Christian Leuz: Can I jump in? So two things that I wanted to add to this. I think economic theory and economics and some of the empirical studies that we’ve done show the gains from trade. And they show that certain transfers could be made. But whether the transfers are being made or not often is actually a political decision, not one that the economists get to decide. And so, one of the important issues that I think the current debate is bringing up is, to what extent have the transfers been made? To what extent have we distributed the gains from trade in a way that brings people on board and that softens the blow to those people that are perhaps the losers, or the more negatively affected from trade.
And the second thing that I wanted to add to this, I think this goes back to your earlier point also asking about globalization. A very important aspect of globalization has been technology. And I think a lot of what’s currently being blamed on globalization and free trade and the free movement of people actually is technology. And I wouldn’t be surprised, if you asked people what their views are on manufacturing jobs in China, I think many people might be surprised that manufacturing jobs in China have also been on the decline in certain sectors, simply because they have been replaced by technology. Just in the same way they’ve been replaced in the West.
And so that is something that we need to communicate much better to people, that certain jobs are just not going to come back because you can’t turn the clock back on technology.
Hal Weitzman: Is this more of an issue of communication though? You know, globalization is good. . . . Automation is to blame for job loss, not immigration, or whatever—or is it more about policy? Helping people adjust to the new reality?
Christian Leuz: I think it starts with communication, but then it can’t stop there because, as I said, the issue of redistribution is a political one. And the gains from trade and globalization are unevenly distributed, and I think it takes a political and a policy decision to say, we’re going to adjust and we’re going to redistribute some of that.
Hal Weitzman: Lubos?
Lubos Pastor: I agree with Christian. It’s both globalization and technology. You can tell that globalization is powerful, though, from the fact that this backlash that we see is all in the richer countries. So we have Donald Trump in the United States, we have Brexit in the UK, and we have populous movements in western Europe, but not so much in China, India, and countries that have benefited from globalization.
On the issue of communication, which you just brought up, I don’t think it’s . . . so often it’s economists that are blamed for not communicating enough or communicating clearly with the rest of the world. I actually don’t think we are so much to blame. I think we are communicating. It’s just that our message is not getting through to the people who need to hear it.
So for example, this video we’re shooting here, The Big Question video. I’m sure it’s going to be tweeted and channeled to all of our alumni and to friends of the Booth school, who are probably sympathetic to the ideas that we are raising here, anyway.
Hal Weitzman: Right. It’s an echo chamber.
Lubos Pastor: And it’s not going to get tweeted to the people who really need to hear it, the Trump supporters and Brexit supporters. So I don’t think it’s so much that we’re not talking, it’s just the message is not getting through, and that’s something we need to work on.
Christian Leuz: So recently there’s been a lot of criticism, again, of the economists and the economic forecasting in the context of the short-term impact of Brexit on the British economy. Where a lot of people have said, people had forecasted that there was going to be immediate negative consequences, and at this point those immediate negative consequences have not shown up in the data. And so some people have said, well, this again shows that economics is in a deep crisis.
And if we take that example, people had made, I think, sensible forecasts as to what the impact of Brexit would be—in the short term and long term—on the British economy. And the short-term forecasts were basically predicated on two important and, I think, very reasonable assumptions. One was that there would be a decline in consumer confidence. For instance, because there would be precautionary savings that people would do after a Brexit vote. And then secondly, there would be a spike in uncertainty, which then would lead to a decline in investment and have negative economic consequences.
Now, what we’ve now learned is that the decline in consumer confidence is where we erred. That is actually something that did not happen. Now, what we can now do is use economic analysis and ask, why is that actually the case? Why did it not decline?
And there’s a couple sensible hypotheses you could have. One, you could argue that the immediate decline in the pound, which was very severe, was something that people understood that that would mean that import prices in the medium term would likely rise, and therefore were making purchases in a way, accelerating purchases that they otherwise would’ve made at a later point.
That’s a fairly rational response, and that could be in the data. If that’s the case, then it actually would give us a prediction for 2017 that would be much more negative.
It’s also possible that consumers simply felt buoyant because of the Brexit vote, and they felt vindicated politically, and consumer mood has been up as a result. That is something that I think we’re not as good in economics, building that into our models.
But I think if you sort of now were to update the models and say, well, consumer spending kept up, I think the forecasting would not be as negative. And in a way, it’s a vindication of some of the models. I think what we need to do is to sort of go back, ask where did we go wrong, and use the economic reasoning to update our forecast.
Hal Weitzman: So you were right all along?
Randall S. Kroszner: I don’t think so.
Christian Leuz: The point is, I don’t think we should throw out economic theory, we’d be losing a compass just because we’ve missed the forecast. I think we should understand that forecasts are probabilistic and that sometimes you turn out to be wrong.
Hal Weitzman: I guess it was that part of the messaging that didn’t quite get through, the last part.
Randall S. Kroszner: I do think that the economists were too pessimistic on what would happen. And one key policy change that they didn’t take into account, but which was very, very clearly communicated, is that if Brexit occurred, monetary policy in the UK would change dramatically.
And I think that’s accounted for a significant, at least initial move in the pound. Because Mark Carney and his colleagues at the Bank of England made it very, very clear that if Brexit occurs, they’re going to try to prevent the economy from going off the cliff. What do they do? They cut interest rates very significantly. They started buying securities.
And so I think that has been something that certainly would lead to a much lower pound. Because when you have a much more easy monetary policy, lower interest rates, all other things being equal, that’s going to lead to lower value of the exchange rate. And that should’ve been taken into account, I think both in terms of economists’ forecasts and the way people were perceiving things. And I think that’s one of the reasons why we haven’t seen—
Hal Weitzman: And yet wasn’t the Bank of England one of those very organizations that was warning about what would happen?
Randall S. Kroszner: Exactly, so their view was this is not a good thing. Because, basically, they didn’t want to have to be the only one, in some sense, they were the only adult in town. So they came in and said, you kids, you did something that we really don’t think is right, but we’re not going to make you pay for it. It’s our responsibility to make sure that things are as good as possible. And so we’re going to try to make the best of not a great situation.
And I think that has lead to a very significant change in the value of the pound. The pound is now down roughly 15 percent or so from its highs. But you can see the economy is doing OK. The stock market is at record highs, that’s both for the FTSE 100, which is just the large exporters, who are going to benefit a lot from a weaker pound. But if you look at the broader FTSE 250, that’s up even more than the FTSE 100 is. And those tend to be more domestic firms.
So I think having that cushion from the Bank of England has been very helpful and I think that’s something that we should’ve taken into account. But part of what it was, as you said, since the Bank of England was so negative on this, it wasn’t comfortable for them to say, well, we don’t think you should do this, but if you do do it, we’re going to make it not so bad.
Hal Weitzman: Right. If the UK economy grows and is successful while it’s Brexiting, will that kind of be a boon for the antiglobalization crowd, Lubos?
Lubos Pastor: Yeah, I mean clearly the UK is setting a precedent for the other 27 countries in the European Union. And if those countries see that the UK has benefited from exiting, then there will be more pressure toward exiting France and the Netherlands, etc. I personally do not expect a boom in Britain.
I do believe, like Randy and Christian have said, that it’s the cheaper pound that has spurred the British economy in the short run. It has also made the Britains poor. The average Britain is now significantly poorer, relative to a Polish person or an American, than they used to be.
I also think that this exit is setting a precedent in other ways. It’s setting a precedent for the negotiations that are going to take place between the EU and Britain. If you think about bargaining power in that negotiation, I think it’s firmly on the side of the European Union, precisely because of this precedent. They do not want EU citizens to see that Britain is benefiting from this exit. And they will stand firm, I believe. I don’t think Britain’s going to get a deal nearly as good as it has had within the single market.
Hal Weitzman: Randy Kroszner, what about here in the US? If the US economy grows healthily under Donald Trump, could there be talk of a new economic model, a more nationalistic model?
Randall S. Kroszner: I’m not sure it’d be the new, more nationalistic model. I mean, if you look at the key things that I think the markets are responding to and the consumer confidence index is responding to are lower taxes, less regulation, and fiscal spending that will try to boost productivity. So break down some of the bottlenecks that are there and some of the challenges that we have in infrastructure. I mean, that’s in some sense just a very sensible, traditional economic program you would have. And it’s no surprise that the markets are responding positively to that. I think part of it is that—
Hal Weitzman: You also have companies living in fear that they’re going to be tweeted about moving abroad.
Randall S. Kroszner: So there still may be some hits that individual companies take, but I think the broad direction—so you’re looking at the market overall rather than, I’m not commenting on individual stocks—I think the broad direction is one in which that’s going to be positive for economic growth and positive for the economy.
There are actually a lot of parallels between what Reagan did when he first came in and what Donald Trump and his team are proposing. Deregulation, lower taxes. And we forget that Ronald Reagan actually was a very big spender initially. He spent on military and he spent on, actually, on entitlements in other areas. A number of years later, there was a very significant tax increase, because the budget was not being balanced. But at least the initial elements of the plan are similar.
And also something that’s an interesting parallel is that the voluntary exports restraints that the US was able to get Japan to agree to—because back in the old days, Japan was sort of the China of today, in that they were the big Asian powerhouse, the world’s second-largest economy. They were taking over, particularly the auto industry. It was under Reagan in 1981, ’82 that they negotiated the voluntary export restraints, getting the Japanese to restrain their exports to the US. So even though, broadly, Reagan was a free-trader and maintained the free-trade rhetoric, very different from Donald Trump, the policy, you could say, was not an especially pro–free trade policy. At least initially.
Hal Weitzman: OK. We talked earlier about adjustments and globalization, the policy, the correct policy response, and you all sort of hinted at how we need to help people who have been harmed. Be more specific, Christian Leuz, what should developed economies be doing? Is it about training? Is it about direct transfers? What would be the answer?
Christian Leuz: I think we would probably need a portfolio of measures to address . . . And I think training needs to be an important part. Education needs to be an important part. Especially if the diagnosis is that technology played an important role. Then we need to basically make it possible for people to retrain, pick up training programs, and so on. But I think where, um—
Hal Weitzman: Are there going to be enough jobs for those people who want to retrain, if there’s so much automation?
Christian Leuz: I think that is a very significant challenge, and this is something where I, that’s why I was hesitant a little bit in my answer, because I think, to some extent, given how massive the forecasts are for the impact on jobs—and people talk about self-driving cars and so on—that even the service sector will be significantly disrupted.
And so if the impact on jobs is as significant as some people forecast, then I think it’s not just a matter of—the training is not going to do it. Especially not at the speed of adjustment. The jobs we’ve lost very quickly—if we just think about how Uber, within a short period of time, has disrupted the taxi industry.
It’s not clear that training and retraining people is going to be fast enough. And so, I think we need to think about things like universal income. But a very significant challenge of universal income and basically direct transfers to people is, first of all, we understand that just making transfers to people is often problematic from an incentive point of view.
And then the other issue that we face is that people are not very happy. People want also dignity; they don’t just want transfers. Everybody I guess would want jobs that are satisfying and that allow them to make a good living.
And so figuring out how we deal with these challenges is a very significant issue going forward, and I don’t pretend to have the solution already figured out to that.
Hal Weitzman: Lubos Pastor, the global economy has been going through a very slow period the past decade. We’ve had a refugee crisis the past four or five years. Are these phenomena that we’ve been talking about cyclical? If we hold our breath will everything go away and go back to normal?
Lubos Pastor: They are somewhat cyclical, but I think there is a permanent component to all of this. We see slowing demographics in the developed world. We see a slowdown in productivity. People talk about secular stagnation. If the slower growth is here to stay, and I think there’s a good chance it is, then the tensions that we have seen develop in the Western world are also here to stay. I mean, if the economy is not growing, then people are essentially fighting over the same pie, right? The economy becomes a zero-sum game. You’ll see much more tension within democratic societies.
So I think it’s our best hope to try to jump-start that growth. There’s not much we can do about demographics, but productivity is something that we have at least partial control over. If we support research, education, hopefully productivity growth will come back up.
Hal Weitzman: OK. But will these tensions ease, Randy Krozner, if the global economy gets going again?
Randall S. Kroszner: Sure. When the pie is growing, that helps to ease tensions.
But what’s very interesting is what happened in Japan. So as I mentioned before, Japan is in some sense considered the China of 30 years ago: second-largest economy, growing really rapidly. And exactly as Lubos has said, demographics hit. They aged very rapidly. And so the labor force is not growing, much older labor force, and they’ve had very, very little growth.
And that’s going to be hitting a lot of countries, including in China. China has just passed its peak working-age population, and because of the heritage, the legacy of the one-child policy, they’re going to be aging very, very rapidly. And I think this has some very important implications, both domestically and globally.
The interesting thing is that somehow Japan has been able to deal with this without major political disruption. So we see the least of this revulsion against globalization, revulsion against more-traditional economic policies in Japan than we do in other major countries. And so I think Japan would be an extremely interesting experiment to look at because, in some sense, they’ve had a lot of the challenges before many of the other countries have, and somehow they’ve been able to deal with it a little bit better on the political side. So I think there’s a glimmer of hope there, because Japan has been able to do it. But I don’t want to claim that I understand it, but I think that’ll be the research proposal for my next set of graduate students.
Hal Weitzman: Perfect. Well, on that glimmer of hope, unfortunately our time is up. My thanks to our panel, Randall Kroszner, Christian Leuz, and Lubos Pastor.
For more research, analysis, and commentary, visit us online at review.chicagobooth.edu, and join us again next time for another The Big Question.
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