In the days and weeks immediately following the June 2016 Brexit referendum, the ramifications of the UK’s vote to leave the EU were shrouded in uncertainty. Would the UK slide into recession? When and how would it withdraw from the union? What would be the response of voters in other Western democracies? Why did the vote go the way it did?

Some of these questions still linger, and some will persist for years to come. But have months of reflection and analysis brought economists, policy makers, and voters any closer to understanding the drivers and consequences of the Brexit vote? In December, Chicago Booth’s Initiative on Global Markets convened an expert panel to discuss the referendum and what it will mean for the UK and for Europe. The panel, moderated by Chicago Booth’s Randall S. Kroszner, featured Booth faculty Christian Leuz, Lubos Pastor, and Marianne Bertrand, who collectively explored the political, cultural, and economic forces surrounding Brexit. Their discussion—an edited excerpt of which appears below—helped to demonstrate not only the diversity of perspectives, but the broad uncertainty that still remains.

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Randall S. Kroszner: Christian, you’ve made the comment that what the EU has lost with Brexit is a voice for open and flexible markets. What did you mean?

Christian Leuz: Let’s first step back and talk about the broader political ramifications of Brexit and set it into context, and then come back to what I meant by that comment. Many would agree that the EU is largely a political project that needs to be seen through a political lens. As can be seen on EU summits and in EU rule making, politics often prevail over economics. Therefore, I think some of the most important consequences of Brexit are going to be political consequences.

My sense is that the overall political dividend from the EU is huge. There have been many political and economic successes, and probably the biggest one has been peace among European countries. Think about the introduction of democracy and the transition from dictatorships in southern Europe, where the EU (or its predecessor) played a significant role, or the fact that nationalism, despite its recent rise, has been pushed back significantly.

Politically and economically, the UK was a counterweight to some of the more-continental European ways of doing things.

—Christian Leuz

Moreover, if you look at how conflicts among EU countries are now being handled, it’s not that conflicts of interest between countries have disappeared. But they’re getting dealt with in an entirely different way than they used to be. 

Europe is a leader when it comes to basic human rights and civil rights. Cultural diversity in Europe has gone up significantly. Student exchange programs are a very tangible benefit of European cooperation. Even institutions such as the EU court or EU rules, which often were a lightning rod in the Brexit debates, are significant achievements that, among other things, put meaningful constraints on countries. Even the largest country, Germany, has been told repeatedly that it can’t do certain things, like supporting its banks or its industries in certain unfair ways. And among the economic achievements, there is the common market and free trade.

These successes make me quite positive about the EU and actually quite optimistic. But these successes have not been communicated well, in part because many are not so tangible. They’re fairly abstract, and to people who are struggling to make ends meet, it’s more difficult to see these benefits.

What Brexit means is that the EU needs to find a new resolve. It needs to communicate much better what the European project is all about and where the benefits are. Leaders also need to find more tangible successes that are important to people. 

Another challenge is that, because the EU is a political project, many EU solutions are political compromises. They’re not clean solutions. They’re difficult to implement. They’re difficult to enforce. They’re messy in practice. This is something that people sense and that they are frustrated about. 

The euro is a good example. Without a fiscal union in the EU, the joint currency has posed a number of difficulties. Another example is immigration. The Schengen Agreement allows free movement within the EU and eliminated border controls. But the EU doesn’t have a joint asylum and immigration policy, which now poses significant challenges when you have free movement under the Schengen Agreement.

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See video of the entire Myron Scholes Forum discussion of Brexit here.

When it comes to the political compromises, this is where not having the UK in the EU is going to be a significant loss. The balance of power within the EU has been fundamentally changed. It was healthy to have three big countries in the EU—Germany, France, and the UK—playing a significant role. 

Politically and economically, the UK was a counterweight to some of the more-continental European ways of doing things. The French tend to be more interventionist, whereas the UK is much more promarket. The UK also plays, obviously, an important role from a foreign-policy perspective.

Randall S. Kroszner: Lubos, why did the Brexit vote go the way it did? It surprised everyone not only that it went for “Leave,” but that it was a 4-percentage-point margin of victory. This was a near-landslide. What forces were driving it?

Lubos Pastor: Some people blame a poor campaign strategy on behalf of the “Remain” camp. It emphasized fear: if you vote Leave, then Britain will fall apart. They could have emphasized the benefits of the EU, along the lines of what Christian mentioned. And I think there’s some merit in that criticism of the campaign. Others emphasized that the EU institutions are too distant from EU citizens. Again, there’s some merit in that. But I don’t think either of those is the main reason.

To me, the most fundamental reason why Britain voted to exit is the broader pushback against globalization. I view Brexit as the same kind of event as the rise of the far-right parties in Europe, the same kind of event as the election of Donald Trump in the United States.

There’s this insurrection against the Western liberal order all over the Western world. Why is that? There are both economic and noneconomic reasons. On the economic side, we need to understand that globalization creates not only winners but losers. Globalization is a good thing for the planet as a whole; it makes the pie bigger and we all get a piece of that bigger pie, but the gains from globalization are unevenly distributed. And the losers from globalization are pushing back.

Economists agree that there’s a cost for Britain to exit, but maybe the British were not totally uninformed. Maybe it’s a cost that they’re willing to pay.

—Lubos Pastor

Now, who are those losers? If you look at the skilled people in rich countries, pretty much everyone has benefited from globalization. If you look at the developing world—China, India, Indonesia, Pakistan, etc.—it has benefited hugely from globalization. There is no pushback against globalization in those countries. Who has lost is the middle and lower classes in the rich world—in the US and in Western Europe mostly.

These are people whose skills are not sufficient to benefit from globalization. They can’t really reach out to the whole world applying their skills. Instead, they are competing with billions of people from other countries. Their wage growth has been basically nil over the past 20 years. From the economic perspective, it’s those people who are pushing back.

But that’s not the whole story. If this were the whole story, we would see only the poor voting for Trump and for Brexit. That hasn’t been the case because there are also noneconomic reasons. Let me use the example of immigration, which was, I think, the number one issue that pushed Britain toward Leave.

To be clear, this is not the immigration issue that you typically hear about in the news. It’s not the inflow of refugees from the Middle East and Africa into Europe. Instead, this is the flow of people mostly from Poland, Romania, countries such as those, inside the EU. 

Many Britons are worried that immigrants are stealing their jobs and competing for public services and public housing, etc. But they’re also worried that immigrants are diluting their culture and their traditions. If you’re an English person in the countryside and you go to your beautiful, picturesque church on Sunday, you want to see Aunt Margaret. Instead, the church is full of Polish people. Some people mind that.

I don’t think the British or Americans are racist or xenophobic. I think people simply value nonmaterial things. People put some value on culture, traditions. They prefer being in the presence of familiar people who have values similar to theirs. 

I think of that as a luxury good. If you’re poor, if you’re struggling to survive, you don’t think of these things. Once you reach the level of wealth that we have reached in the Western world, you do start thinking of these things. How much are you willing to pay in order to live in a world where people share your values? Clearly, people are willing to pay something. There are many people who have abandoned lucrative jobs in New York to move back to Bulgaria. People are willing to pay for this.

What we’ve seen in Britain is that people are willing to pay quite a bit. Different people value these things differently. Economists agree that there’s a cost for Britain to exit, but maybe the British were not totally uninformed. Maybe it’s a cost that they’re willing to pay.

Let me close by saying I think we need to speak up more for globalization—not enough people do. Because the benefits of globalization are widespread and the costs are fairly concentrated. We need to make a case for it because globalization makes the pie bigger. 

How do we resolve the problem with some people being losers? We can always make transfers. Instead of building walls, let’s build no walls and make transfers to compensate those who are hurt by globalization. That could be achieved by maybe more progressive taxation in the rich world, more job training for those who are hurt the most.

This is something we should take seriously, because globalization is not irreversible. If you look back 100 years, globalization was in full bloom until it just stopped. In 1914, a hundred years ago, it went fast into reverse, with disastrous consequences for the world. Hopefully we can avoid that.

Randall S. Kroszner: That’s an important historical lesson. World War I changed things and then certainly the Great Depression in the 1930s changed things. The world became a much-less-open trading place. Trade as a percentage of GDP didn’t reach the levels that we had seen before the depression until very,
very recently.

Now, Lubos had mentioned some of the issues of income inequality. Marianne, what do you think are going to be the consequences of Brexit for wage inequality in the UK and the EU?

Marianne Bertrand: To go back to some of the things that Lubos said, the people who voted for Brexit, very much like the people who voted for Donald Trump, did so because of uncertainty about jobs and economic uncertainty in their daily life. I agree with Lubos that globalization and, in the UK context, immigration, was a really key factor.

It’s somewhat unfortunate that the big rise in the number of immigrants coming to the UK from Eastern Europe, which started in the mid-2000s, correlated with the financial crisis. In people’s minds, you had this big economic shock, and you were seeing more and more Polish people in your street. I think that phenomenon probably was quite relevant in people’s minds.

People have an easier time getting angry at all the humans than they have getting angry at machines.

—Marianne Bertrand

However, income inequality really has been growing. That’s a phenomenon that economists have been studying for two decades. There’s been an increase in economic returns to skilled workers; but if you don’t have an education, you’re going to find it harder to make a good living.

I think the explanation for this phenomenon, though, is way more complicated than just globalization. Maybe globalization and immigration play some role in it, but a big part of it is technology. In most of the economies that I’ve studied in respect to this phenomenon, technology is a bigger part of the story than trade is.

People have an easier time getting angry at all the humans than they have getting angry at machines. It’s easier to grasp. It’s easier for people to get upset at the foreigners, at the outsiders, than to get upset at the robots. 

Related to that, in the contexts of both Brexit and the US presidential election, there was really a failure to communicate facts. All the research that has been done on the impact of immigration on wages—a lot of it is done in the US, but there’s also been some research in Europe—has failed to find any negative impact for natives. The negative impact that occurs when more immigrants enter a country is on the wages of the prior generation of immigrants, because they’re the closest substitute. The overlap between the skills of the natives and those of the immigrants is just not that large.

I think there’s also a failure to communicate not just facts, but some of the main features of our models, which are sometimes complicated. Whenever we think about a given shock, there’s going to be a direct effect, which is typically what people can easily think about: “Let more immigrants in, wages are going to go down.” But there are also indirect effects, which take a bit more higher-order thinking to consider: “Let more immigrants in, there are going to be more people demanding goods, and that might be good for my job.”

It’s surprisingly hard for economists to communicate these higher-order, general-equilibrium kinds of dynamics. And I think we are really feeling that. 

Randall S. Kroszner: Speaking of the experts, we saw them say that Brexit would be a disaster for the British economy. And if you look at the FTSE [Financial Times Stock Exchange] 100 index, there was a big negative initial movement down, but then it moved to record levels. Now, you could say that was being driven by depreciation of the British pound, which is 10–15 percent off where it was prior to the vote, but the FTSE 100 is up 10 or 15 percent. Even in normalizing the world value of those assets, they didn’t change that much. If you look at the FTSE 250, which includes smaller firms that have a more domestic focus than the larger, more-export-focused firms in the FTSE 100, that’s also up—not as much as the FTSE 100, but up in the 5–10 percent range.

Why are the experts so consistently negative when the markets haven’t been as negative? Why is the market’s reaction so different from the experts’?

Lubos Pastor: The experts basically said this is going to be bad news for Britain, and I think it has been bad news for Britain. The only question is, in what form is that news going to materialize? We haven’t really seen a recession in Britain, but we have seen a mild slowdown in investment, which is not surprising. With more uncertainty, you get a slowdown in investment.

The main adjustment that has taken place was the drop in the pound. Brexit made Britain less attractive internationally for foreign direct investment, and the pound had to drop significantly to adjust so that people now continue being happy investing
in Britain.

If the adjustment takes place only through the weaker pound, that’s going to be great news for Britain. In principle, the weaker pound is going to allow them to export more. Of course, the weaker pound has made the British poorer by about 15 percent relative to Germans and Poles and Americans, but maybe that’s the price they’re willing to pay.

Christian Leuz: In terms of the stock market reaction to Brexit, we’ve gone through waves, given that there’s still a lot of uncertainty. People initially were dismayed and surprised, and then sentiment moved to, “This is just going to be some form of soft exit and we’re going to find ways; common sense will prevail.” But then people realized that maybe that’s not so clear, which explains some of the volatility in markets.

If freer trade is restricted, that is clearly going to be a negative. If you look at the forecasts—be they from the IMF [International Monetary Fund], the OECD [Organisation for Economic Co-Operation and Development], or the UK’s own Office for Budget Responsibility—all of them are saying, “We’re going to lower our forecast for growth over the next couple of years.” And that’s not even having built in much of a Brexit model. In addition, Britain may have to do significant borrowing to soften the blow from Brexit.

Randall S. Kroszner: I’m a bit uncertain about what the consequences are going to be, because it’s unleashing some different political and policy-making forces. It could be that one of the responses to Brexit will be structural change in the affected countries, regulatory reforms.

Getting back to Christian’s point, Europe may be losing this voice for more-open and more-flexible markets, but it may respond by having more-flexible markets domestically, lower corporate taxes, and such. This gets to Marianne’s point about the second-order effects: with policy as is, Brexit would have negative consequences; but if it’s a jolt to the policy process, it may not necessarily be as negative as the experts had suggested.

But this comes back to politics both in the UK and Europe. So what does this mean for the fragmentation of both the UK and Europe? 

Lubos Pastor: Scotland voted 62 percent to remain. Northern Ireland voted something like 55 percent to remain. Have you heard the one about the Englishman, the Scotsman, and the Irishman walking into a bar? The Englishman wanted to go, so they all had to leave. That’s pretty much what’s going to happen. The question is, how is the UK going to balance the different wishes of the English people, the Scottish people, and the Northern Irish?

Northern Ireland has arguably the most to lose from Brexit. It shares the same island with the Republic of Ireland, which is part of the European Union. It’s hard to imagine border checks coming up again, separating the two countries. 

With Scotland, there’s the question of another referendum and whether the country’s going to go independent. I’m not sure, but I doubt it. Scotland would love to stay in the EU, but it needs the UK more than it needs the EU. Two-thirds of Scottish exports go to the rest of the UK and only about one-sixth go to the EU. There’s also the question of Scottish fiscal sustainability, because Scotland receives transfers from the rest of the UK, and if they were to separate, they would have to run Greek-style austerity to stay alive.

Randall S. Kroszner: How about continental Europe? Germany, France?

Christian Leuz: Germany is and has been one of the staunchest supporters of the EU and the European project for historical reasons, and it’s ingrained in many ways in the German psyche. At the same time, we now see right-wing, anti-EU movements in Germany that are similar to those in other EU countries. At the moment, they’re not as big a force as the pro-EU sentiment, but this development is still worrisome.

This is where my earlier comments come in: the EU and, in particular, Germany need to do a much better job communicating to people why there are some very tangible benefits of EU participation and what the EU is all about. Take the example of the Greek bailouts: Merkel didn’t do a good job of explaining to the German public why supporting Greece was important. The same can be said about explaining why Germany has accepted a large number of asylum seekers.

To me, that is the biggest challenge that Europe needs to figure out: not just how to communicate the big ideas such as peace, freedom, democracy, and civil rights, but how to address the demands that people have. They want certain protections; they want to feel safe; they want to have an economic living. These are legitimate and basic demands. EU leaders have to take them seriously and have to explain to people how they’re going to address them. At the moment there’s a big deficit there, and that makes me worried with regard to some of these populist movements.

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