What would Brexit cost the UK and Europe?

Fears triggered by last week’s terrorist attacks in Brussels by the Islamic State hang heavily over the prospects for Britain’s decision on whether or not to stay within the European Union. British Prime Minister David Cameron has called for a referendum on June 23 to decide on a “Brexit,” or a British exit from the EU.

The Brussels attacks, combined with concerns over the influx of migrants into the EU from the Middle East and North Africa, have provided more ammunition to right-wing political parties in the United Kingdom that are pro-Brexit. Recent polls put a Brexit closer to becoming a reality than it seemed a few months ago.

However, a Brexit will disrupt trade and hurt businesses both in the U.K. and the EU at a time when Europe needs investments and jobs, according to Wharton experts.

The Brussels attacks will certainly affect sentiment in favor of Brexit, noted Mauro Guillén, Wharton management professor and director of the school’s Lauder Institute. “There are people and parties in the U.K. that want to exploit any opportunity to their advantage,” he said, referring in particular to the U.K. Independence Party, or UKIP. “They can claim that the U.K. is at risk of more terrorist attacks if the country remains part of the European Union.”

Guillén said a vote against a Brexit is crucial for Cameron to survive in government. “If Brexit were to win the referendum, Cameron’s government would fall immediately. He would have no other option but to resign.”

Wharton finance professor Bulent Gultekin agreed that the sentiment has turned in favor of a Brexit following the Brussels attacks. “If one incident creates so much havoc, it signifies the underlying problems in Europe,” he pointed out. However, he noted that referendums are “notoriously difficult to predict.” Also, sentiments could change before the referendum in June. “In politics, three months is a long time.”

“[Right-wing political parties] can claim that the U.K. is at risk of more terrorist attacks if the country remains part of the European Union.”–Mauro Guillén

Guillén and Gultekin discussed the implications of Brexit for the U.K. and the European Union on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Power to the Right

Gultekin noted that recent reports of the Islamic State, or ISIS, moving more of its people across Europe for potential attacks has strengthened the argument of right-wing political parties against the migration of refugees into Europe. “The extreme right in Europe has risen in popularity,” he said, citing the National Front in France led by Marine Le Pen and True Finns in Finland as political parties that have used the platforms of anti-immigration, nationalism and populism to gain followers.

Guillén noted that no country has left the European bloc in the 50-year history of the EU and its predecessor, the European Economic Community. “[A Brexit] would be unprecedented and highly disruptive because [many] agreements and arrangements that facilitate trade would become void,” he said. It would have a major impact on the U.K. in the short run and also the EU over time, he added. “You’re putting everything at risk, and you don’t know if you’ll come back to the current status,” Guillén had said in a recent Knowledge@Wharton article on how a Brexit could sink the EU.

Gultekin pointed out that the founding fathers of the EU desired full integration. “The EU was supposed to be like a Catholic marriage – never going to split.”

‘Disastrous’ Impact

The impact on the U.K.’s financial sector would be “disastrous” if the country were to leave the U.K., predicted Gultekin. “[For] those who argue that [Britain could] pull a better deal with the EU, London [would no longer] be their financial center,” he added. “That would have a tremendous impact because the U.K. economy is very dependent on services.”

Already, the Schengen Agreement that allows free movement of EU citizens across Europe is not working in practice thanks to tighter border controls in the wake of the Brussels attacks, said Gultekin. “The whole idea of the EU is to get rid of borders and have one unified market,” he added.

If Britain stays in the EU, it will avoid export tariffs, its businesses will benefit from EU regulation that collapses several national standards into one European standard, and it will gain an extra seat on international forums, according to a report published by The Economist. If it exits the EU, it could negotiate a new EU relationship without being bound by EU law, regain control over employment law, health and safety, and exert more influence from outside in international trade forums than it could while being within the EU, the report added.

“If Brexit were to win the referendum, Cameron’s government would fall immediately. He would have no other option but to resign.”–Mauro Guillén

According to Guillén, the impact would be felt most by companies that assume free movement of people and goods across borders. “Many companies have set up operations in Europe assuming that there would be no borders,” he said. “Those controls would interfere with the logic of those investments companies have been making over the last 10 years.” The impact would be felt also in terms of worries about what the future holds. “Neither investors nor businesses in the real economy like uncertainty.”

Clouds over Investments, Political Peace

Those worries come on top of concerns over global economic headwinds such as falling commodity prices, the slowdown in China or what would happen more broadly with emerging markets like Brazil, said Guillén. “[This is occurring] precisely at a time when you need more investment in Europe, more job creation, so that the consequences of the crisis, especially in terms of unemployment, are addressed. [These concerns] send a signal to many companies that maybe they should put their investment plans on hold.”

Amid all those worries, it hasn’t helped that the EU did not do a good job in dealing with either the eurozone crisis or the recent refugee influx, said Gultekin. In the eurozone sovereign debt crisis that began in 2009, Greece, Portugal, Ireland, Italy, Spain and Cyprus were unable to meet their debt obligations and needed the intervention of the European Central Bank and the International Monetary Fund. Now, with the refugee crisis, “the entire European Union is falling apart,” he added.

According to Guillén, “Cameron had better win this referendum … because most of the population in Scotland is unambiguously pro-European.” He explained that most of the people who want the U.K. out of the EU are in England, and not in Scotland. A vote in favor of Brexit “will just add more fuel to the independence movement in Scotland because most Scots want Scotland to be part of the EU.” A Brexit would also create a border between the Republic of Ireland and Northern Ireland, becoming “a very difficult situation to manage,” he added.

Chances of a Brexit

Guillén put the chances of a Brexit at “less than 50%” even as recent polls show more people veering towards it. Gultekin noted that much depends on the participation in the referendum. “The people who are emotional about this issue are the ones who would vote ‘no’ in the referendum,” he said. He did not expect a magic deal to materialize before June 23. “The other members of the EU are reluctant to make concessions to the U.K because that would undermine the very essence of the union, which is a more integrated Europe,” said Guillén.

Guillén noted that all along, Britain has played a positive role as a member of the EU. Its position has been one of wanting to be part of the EU but not participate in some aspects such as subsidies for less developed countries. “Over the years, Britain has played a pragmatic role, and that has been beneficial — asking Europe to think carefully about all of the different steps,” he explained. “It has always questioned why certain things need to be done.”

“If one incident [like the Brussels terrorist attacks] creates so much havoc, it signifies the underlying problems in Europe.”–Bulent Gultekin

Guillén recalled how the U.K. resisted the introduction of the single currency before putting in place the necessary institutional mechanisms. Eventually, Britain opted to stay out of the single currency, as did Denmark, he noted. It also opted to stay out of the Schengen Agreement, “and for good reason,” he added. “Now, we see that the police and intelligence forces of Europe are not prepared for the free movement of people within Europe.”

Challenges of Integration

Much work needs to be done, and done better to make integration work within the EU, said Guillén. “Europe is a mosaic of different kinds of countries, cultures, attitudes and people … [and it has] different economies and different drivers of competitiveness,” he explained. “It is remarkably difficult to impose a homogenous set of institutions and treaties on all of those. So a European Union is good, but only if the steps that you are taking towards that goal are justifiable and you have the foundations in place to take those additional steps towards integration. The problem is over the last 10-12 years, Europe has taken perhaps too many steps towards integration, and now we are seeing some of the problems.”

Gultekin hoped the worries after the Brussels attacks would dissipate over time. He recalled that similar fears arose after the September 11, 2001, attacks in the U.S., but eventually settled down. It was “very difficult for the first six months to a year” in the U.S. in the immediate aftermath of the 9/11 attacks. Europe would go through something similar, he added.

Europe has not had sufficient time to integrate after the Maastricht Treaty of 1992, Gultekin noted. “It is a short period of time – almost one generation to accomplish a union,” he said. “If you look at the U.S., it took years after the Civil War to get there. So it is not going to be easy, especially on a continent [that is very] heterogeneous.”

Navigating the rise of populism and the frustration among people has also not been easy, Gultekin said. “Everyone is finding the Muslims, the refugees or the EU as the source of a problem, whereas those problems are far more complex,” he added. “It takes a seminar to explain, whereas people are ready to listen to only sound bites.”