“BREXIT: THE WORLD’S MOST EXPENSIVE DIVORCE”

CAN THE EU BREAK UP?

14th July 2016

It is legally possible for the EU to split up into its constituent countries, but – as Britain is finding out – the process is laborious and complex, needing several years. More to the point, for almost all EU members there are major economic advantages to staying inside.

These advantages are obvious to all the smaller members, such as Greece, Cyprus, Latvia, Romania and Portugal. They are net winners in the EU’s subsidy games, as is clear in Chart 3 showing countries’ net contributions per capita. They also derive important benefits from free access to the larger and more prosperous economies. The EU offers them free movement of people and capital as well as goods and services. In the case of Greece or Cyprus, exit from the EU and the Euro would have given their governments much more power to solve their recent banking crises, but they chose to stay in, because of the other benefits.

Chart 1.

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The complex relationships around the EU are outlined in Chart 1 above. Each country is represented by a circle, and the size of each circle is proportional to the size of each country’s economy. For the largest economies, 2015 GDP Eurodollar equivalent amounts are shown in each circle. The UK has never been fully integrated with the EU: like Romania, Bulgaria and Croatia, it doesn’t use the Euro and doesn’t allow passport-free travel.

The 19 countries in the Euro area are tightly integrated financially. As the failure of the “Grexit” fantasy demonstrated, it makes sense for a country to leave the Euro only if its new currency is likely to appreciate after exit, i.e. if the country has a strong economy, a balance of payments surplus, and large reserves of foreign exchange. Otherwise the departing country will face massive capital flight, starting with runs on all of its banks. Chart 2 below shows what happens in a countrywide bank run: deposits in the Greek banking system halved between 2009 and 2015. Some of the money went under mattresses, but most of it was moved to bank accounts in other EU countries.

Chart 2.

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Therefore the only country which could easily leave the Euro at present is Germany. (The other countries with similar economic strength are Norway and Switzerland, neither of which bothered to join the EU.) But the Euro is necessary for Germany’s exports: if it went back to using its own currency, the Deutschmark, the DM would be even more expensive than the Swiss franc, making all German exports unaffordable.

Chart 3.

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It follows that the countries best placed to leave the EU are the nine members which don’t use the Euro. Britain is already going – what about the rest? Bulgaria, Croatia, the Czech Republic, Hungary, Poland and Rumania are all poorer economies which have long land borders with the EU and enjoy real benefits from the unrestricted movement of people and exports. Therefore, they have sound economic reasons to remain, in addition to the fact that they are all net recipients of EU funds, as show in Chart 3. Hungary is holding a referendum in October about refusing to take its share of refugees, and other countries also want to minimize unwelcome immigrants. Is this a serious enough issue to exit the EU, and deprive yourself of the economic benefits of membership?

The two non-Euro countries which could easily leave the EU are Denmark and Sweden.  Their economies are prosperous, their currencies are strong against the Euro, and they are net contributors to the EU budget. But they are both relatively small economies. Sweden’s 2015 GDP was USD$0.6 trillion and Denmark’s was USD$0.3 trillion, compared to Germany’s USD$3.3 trillion and Britain’s USD$2.8 trillion. (Australia’s was USD$1.6 trillion.) Their departure would harm the EU, but not very much. Furthermore, neither country has yet started on the long and tortuous road to exit.

In short, the EU has its problems, but most of these focus on immigrants of various sorts. Most EU members are more integrated with other EU members than the UK ever was, so that exit is hardly an option.

 

Q.E.D.

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