The Prospect of a Brexit

Lawrence Zammit's article on The Times of Malta

This week Mario Draghi, the President of the European Central Bank, delivered his report to the Economic and Monetary Affairs Commission of the European Parliament. It came at a time when the index of most stock exchanges around the world lost value. It is also important to note that new banking regulation has come into force and banks in a number of countries are still under pressure in terms of their capital requirements.

In the meantime the price of oil has continued coming down and is now at levels last seen in 2003. The prices of raw materials is also coming down. The implication of these two events is that demand is likely to be weak in future and the compounded effect could be that inflation will still remain well below the 2% target set by the ECB. The economic sentiment ahs deteriorated since the beginning of December and markets have become more volatile.

The wider scenario includes other facets. In spite of the heavy monetary stimulus in the euro zone, investment has not taken off. Because of the increased capital requirements, banks have not been too willing to lend money, especially to small and medium sized enterprises. The structural reforms that several governments have been asked to implement are still on paper on a shelf gathering dust.

Thus although economic growth has been is moderate, it is still quite fragile. Draghi claimed that some economic sectors have still registered growth. He said that in the beginning of March the ECB will review the situation and may adopt a more aggressive stance in its quantitative easing policy.

Then came the bombshell by Draghi. He said that although the rules of the Stability Pact need to be respected, governments should reduce taxes and allocate more resources for investment. In other words he is suggesting that governments adopt an expansionary fiscal policy within the rules of the Stability Pact.

This is the first time that the President of the ECB has in effect spoken against austerity measures. And it opens once more the debate as to how best address the economic situation in a number of countries that are still reeling from the effects of the recession. The problem with the euro zone is the lack of homogeneity. The economic performance of the Maltese economy does not reflect the average performance in the euro zone. Even if were to take our country from the equation, one would still have the EU’s largest economy – Germany – that is performing better than other economies.

Thus the challenges faced by the different governments are different. This does not in any way mean that we should have some form of fiscal harmonisation. What it does mean is governments in the euro zone need to engage in a political debate as to how best to address the current economic situation.

I believe that the economic situation in most countries of the euro zone has been stabilised, even if growth may have remained weak. I also believe that the situation in the financial sector has also been stabilised. However this only means that we are no longer in a spiral trend downwards. Governments now need to deliver steady growth, even if we may have to accept that growth rates will be lower than we had been accustomed to before the crisis first hit in 2008.

The Italian Prime Minister, Matteo Renzi, has been quite vociferous in demanding that there be more flexibility in the way fiscal rules in the EU are applied. His claim was that strict economic austerity ahs not worked. The reality is that in most countries, political parties that have expressed themselves against economic austerity have gained in popularity. The recent election in Spain is one example of this.

So we seem to be entering another phase in tackling the current situation in the euro zone, where the word austerity will no longer take pride of place. The statement made by Mario Draghi must have left its effect, although it may not yet have been noticed.

I believe that Malta should play a role in all this. We do not have the economic problems that other countries are facing. Our size is such that an initiative on our part will not be looked at suspiciously. We should seek to broker a deal within the Euro group as a strong euro zone will serve us better than a weak euro zone.

In last week’s contribution, I questioned whether on economic issues, the European Union is becoming more like a pact based on strict rules rather than a union of people, as the founding fathers had envisioned it to be. This consideration was made following the conclusion of the negotiations between the United Kingdom and the other twenty seven member states on issues that the UK Government had wanted resolved prior to the referendum in that country on whether the UK should continue to form part of the EU.

I gave as examples one of these issues which the UK Government feels particularly strong about – the right of access to benefits under the UK welfare system for persons that come from other countries, especially from the Eastern European members of the EU. The other example I gave was the way rules on the fiscal deficit are being applied.

This week I would like to focus more on the prospect of a Brexit (British exit from the EU). If the British people do vote for a Brexit, there will be all sorts of complications as never before have we had a country leaving the EU, as much as we never had any country leaving the Euro zone. So it is really much easier said done.

The UK would need to enter into negotiations (probably very lengthy ones) on a new agreement that would regulate relations between it and the EU. One wonders on how tough the stance adopted by the negotiators on the EU side would be. So the prospect of a Brexit could have political implications that would be more serious than the economic ones.

However there needs to be a serious analysis of the economic impact on both our country and the EU as a whole if the UK were to leave the EU and if the UK were to stay in the EU under the new conditions. Given that one is speaking about hypothetical situations, it is always difficult to undertake such an assessment. Moreover it is easier to identify the costs of either decision but far more difficult to identify benefits.

If Britain were to leave the EU, one would need to understand what would happen to the millions of persons working in the UK coming from the other EU member states. Technically they would need employment permits. What sort of employment permits would the UK Government be willing to grant? Can the UK economy do without such workers?

On the other hand one can also imagine the impact on the economy of these countries from where such workers had come, if they were forced to leave the UK? Today such workers send remittances back to their country of origin. If they were forced to return to their country, they would become a very heavy burden on the country’s finances.

If they choose to relocate to another member state, which country/ies would they go to? Can the other member states absorb these workers? And what if they end up living on social benefits, as they have done in the UK? If we take our country as an example, I believe that given our size and given the significant number of non-Maltese persons already working in Malta, our absorptive capacity has reached its limit. These are the questions that arise from just one aspect – employment.

Another aspect would be the funding of the EU. The UK had already renegotiated during the premiership of Margaret Thatcher, the parameters of its contribution to the EU budget. Yet, the UK still remained a net contributor to the EU. If British decide to leave the UK, how will that impact the EU budget?

Will the European Social Fund, the European Regional Development Fund and similar funds have to reduce their transfers to the other member states. In other words, will there be less money flowing from the EU to the member states? How will the additional financial burden for the EU member states be shared? How will Malta be affected in such a situation?

If the British people were to vote to leave the EU, will there be increased pressure to change the taxation rules in the EU? Will there be a stronger drive to achieve tax harmonisation, that is having the same taxation rules across the EU? If so, then the impact on Malta may be a very negative one. We would need to introduce VAT on food items, which so far are tax exempt thanks a derogation we had obtained on entry into the EU. Our financial services sector would be lose a great deal of its attraction.

There are other issues to consider such as the impact on exports and imports and the impact on the tourism sector. A British exit from the EU would impact these as well. And the list is not exhaustive. I have also not mentioned anything about the impact of the UK staying in under the new conditions.

One hopes that while the British decide on their country’s way forward, there are studies being undertaken on the impact of both a Brexit decision and a “stay in” decision. Either way, the EU Governments need to keep in mind that the aspiration has always been to create a union of people, and it must remain so.

Latest News