Suspension of the Schengen system would hurt Hungary the most

The unprecedented influx of refugees is putting one of the cornerstones of the EU Single Market, the ability to move around without any border-controls within the so-called Schengen area, at risk, analysts at Morgan Stanley said in a research note on 1 March. In an attempt to salvage Schengen, EU governments will hold a summit on the refugee crisis on March 7.

What impacts could the breakup of Schengen have?

“The main risk associated with the suspension of Schengen would be a reduction of intra-European trade, causing the benefits of the Single Market, e.g. product specialisation, economies of scale, and institutional competition, to be reversed," the analysts said.

“The hit to bilateral trade flows within the EU could be as high as 10 to 20% if Schengen is suspended," they estimated.

“A simulation of a 5% increase in transport costs suggests that next to the transport sector itself, manufacturing would likely be affected the most. Assuming that companies have little ability to pass on the higher transport costs, we calculate that suspension of Schengen would amount to a 2% hit to the gross operating surplus (GOS) in the manufacturing industry."

The analysts estimate that the overall loss of GDP growth resulting from a 5% rise in transport costs would amount to 0.2%, once the direct impact on transport and indirect effects on other sectors are taken into account. This is roughly twice as high as the direct costs of the suspension of Schengen estimated by the European Commission.

There-introduction of border controls would likely also reduce the number of tourists visiting Schengen countries both from within the area and from outside because the common Schengen Visa would likely cease to exist. At the moment, tourism accounts for almost 3% of GDP and 5.0% of employment in the European Union, the analysts noted. In their view, the ratio could be even higher in the case of southern countries where labour conditions are worse therefore the measure would hit them even harder.

“Re-instating border controls would materially impact those citizens that commute across borders on a daily basis. It would depend on the specific labour market situation and on whether workers would be able to translate the longer commute times into higher wage demands, thus likely causing a decline in job opportunities. In any case, the local labour market mismatch is likely to go up."

Which countries could lose the most?

Morgan Stanley created a scorecard to see how the suspension of the Schengen system would affect the member states. The cost of suspending Schengen fall into four broader categories. The direct costs stemming from the immediate impact on cross-border transport of goods, on workers who commute across border, international tourism, and border control costs to the public sector.

Due to its extremely tight trade relations with the European Union, Hungary is on top of the scorecard.
The degree of openness to international goods trade is the highest in Slovakia but Hungary is next. Hungary’s links to the EU are also tight in terms of intermediate goods, international haulage, tourism, and cross-border commuters.

Croatia is right behind Hungary, primarily due to the large number of tourists arriving there from the EU, followed by Estonia and Slovenia, mainly over their high degree of integration into European trade.

The smallest negative impacts would be exerted on France, Germany and Denmark, at least according to the aforementioned aspects.

Long-term consequences of the suspension of the Schengen system

Morgan Stanley’s analysts pointed out that beyond the economic impact, its suspension could also have long-term political consequences by further undermining public support for European integration.

The freedom of movement facilitated by Schengen is one of the distinctive and most valued achievements of European integration, according to the latest euro barometer, where the freedom of movement is the second most frequently quoted achievement of the EU.

At around 55%, it is quoted on par with peace amongst the member states and well ahead of any other achievement such as the euro or social welfare.

“As a result, there is a risk that public support for European integration starts to drop materially if freedom of movement is revoked."

Contrary to the Brexit process, which would follow an orderly legal procedure if implemented, the risk surrounding a suspension of Schengen is that it could lead to disorderly political developments related to border controls, which in turn could cause a material hit to private sector confidence.

The analysts noted that “this uncertainty would likely lead to a material decline in investment spending, especially if the suspension of Schengen coincided with an exit of the UK."

MS also noted that a suspension of Schengen would mark the first reversal of European integration, with potentially major consequences on the popular support for theEU.

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• brexit,
• morgan stanley,
• migration,
• economy,
• schengen,
• refugee,
• migrant