05 July 2016

Martin Wolf: How Europe should respond to Brexit

[...] The UK has long been semi-detached and is now well on its way to becoming fully detached. The pending divorce poses a huge challenge for the UK. But it also brings challenges for the EU. To thrive, perhaps even to survive, it must change. The UK’s departure is a threat but also perhaps an opportunity.

This is not to argue that divorce was predestined. Ending up where we are now was the result of a series of accidents including, not least, the amazing incompetence of David Cameron, the outgoing prime minister. If just 2 per cent of those who voted Leave had voted Remain, the latter would have won. If Mr Cameron had not won the last general election, the referendum would not have happened. If David Miliband had been leader of the opposition Labour party, Mr Cameron would probably not have won the election. One could go on. Nevertheless, the UK’s disenchantment with the EU project and lack of belief in its existential purpose always made this sad outcome possible.

Brexit might still not happen. The referendum is, after all, purely advisory. It does not bind parliament and, what is more, parliament cannot bind its successors. Furthermore, the referendum result merely specified that the UK should leave the EU. It did not indicate what Leave meant. As choices become clearer to the public, the latter might be subject to a severe fit of buyers’ remorse. Another referendum is not inconceivable but it is very unlikely. The political costs of ignoring, or seeking to overturn, the result exceed those of acceptance. Even if that did not have to be so, all the candidates to replace Mr Cameron believe it. The UK is leaving. That has to be the assumption of its EU partners, particularly if free movement of people remains an inviolable principle. So how should the rest of the bloc respond?

The UK’s almost certain departure is a threat to the EU on two dimensions.

First, the UK is a neighbour, a market, a financial centre, a security partner and a link to the wider world. It is in the EU’s interest to achieve a mutually satisfactory relationship, however infuriating the UK must be. This argues for the pragmatic position taken by Alain Juppé, frontrunner in the race for the French centre-right presidential nomination. He even suggests that restrictions on free movement of people should be negotiable. If so, that would surely have obviated Brexit.

Second, Brexit is a precedent. The first country to leave the EU is, inevitably, an example to those that wish to follow suit and a warning to those who oppose it. It is natural for the latter to seek to undermine the appeal of the former by punishing the UK. I sympathise. The question they must ask themselves, however, is whether the best way to preserve the EU is to make it a prison, rather than a desirable place of refuge. This is not to argue for indulgence. But it is to argue against vindictiveness.

Yes, it is understandable that the EU establishment wishes to reduce the appeal of populists. But the best way to do so must be to give Europeans the security and prosperity they seek. One of the reasons so many in the UK wanted to leave is that the EU is no longer seen to deliver on these promises. That has not just been a difficulty in the UK. It is a difficulty throughout the bloc.

Thus the core challenge for the EU is to make it work — and be seen to work — for the benefit of the great majority of its citizens. As Donald Tusk, president of the European Council, argues: “The spectre of a break-up is haunting Europe and a vision of a federation doesn’t seem to me to be the best answer to it.” This is sensible. The failure of the EU lies not in its political structures but in its policies. It must secure legitimacy via practical achievements rather than further erosion of national autonomy.

The paramount example of recent failure lies inside the eurozone. That has nothing to do with the UK. The sad truth is that, far from launching a period of prosperity, the euro has delivered a lengthy period of stagnation and massive divergences in living standards. Between the first quarters of 2008 and 2016, aggregate eurozone real gross domestic product rose by a mere 0.5 per cent, while real aggregate demand fell by 2.4 per cent. This is grim enough. Even worse, between 2007 and 2016, real GDP per head is forecast to rise 11 per cent in Germany, stagnate in France and fall by 8 per cent and 11 per cent in Spain and Italy respectively.

These dire outcomes are no accident. They are the product of a misdiagnosis of the crisis as mainly fiscal, of asymmetrical macroeconomic adjustment, and of obscurantist opposition to fiscal stimulus, even at a time of negative real interest rates on long-term borrowing. Germany has done well out of the euro. Its principal partners have not. This divergence poses a big threat. No effective plan exists to end it. (See charts.)

The EU is unlikely to gain the legitimacy that comes from democratic accountability: it is too big and diverse for that. The best route to legitimacy consists, instead, of managing the practical challenges it confronts. Dealing with migration is an extremely important and difficult practical challenge. But making the eurozone prosperous is indispensable. Brexit is a nuisance. The priority is a practical plan for widely shared economic growth.

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