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I would characterise the state of UK-EU relations as hopeless but not serious. They are hopeless because of Brexit. The first European Council meeting of Prime Minister Theresa May was a frosty affair. But the crisis is not serious because the divorce will be amicable. There are two reasons why I believe this will be so. The first is the national interest of the other 27 member states. The second is that, while a “hard Brexit” would hurt Britain, it could also knock the eurozone back into crisis. It would be a pointless double suicide.
Of the two reasons, the first matters more in the beginning. Mrs May said that the Article 50 negotiations for Britain’s exit from the EU may take longer than the scheduled two years. This suggests she plans to negotiate more than just boring technicalities. I would not be surprised if she and her ministers were planning to negotiate a free-trade agreement within that timeframe, in parallel with the Article 50 negotiations. I think such a strategy is feasible, contrary to the majority of commentators.
Their argument is that trade negotiations between the EU and third countries normally last many years. And it takes a few more years for those deals to be ratified. Just look at the Comprehensive Economic and Trade Agreement (CETA) between the EU and Canada, which ran into trouble after the Belgian region of Wallonia voted against the deal. But in my view the CETA disaster can only mean that the British government would be ill-advised to follow the slippery route of a bilateral post-Brexit trade deal. The EU would not be able to conclude one.
From Britain’s perspective, it would therefore make more sense to fast-track a bilateral FTA in order to circumvent national ratification processes — which is technically possible — and do this as soon as possible. This will require that the EU co-operates. Will it? Does the EU not want to punish the UK?
Up to now, the European Council has maintained unity by rejecting suggestions of UK membership of the single market. That is a sensible position after Mrs May said she would prioritise immigration controls. I see no scope for compromise here. But the European Council will hardly be able to maintain unity behind a position that forces a nasty and sudden Brexit. The ogre of a hard Brexit was the scare story of the Remain campaign during the referendum, and the basis for numerous ludicrous economic projections. It is not going to happen for the simple reason that national interests will intrude.
I was looking at UK-German trade data and found something that surprised me. Germany is not only exporting more goods to the UK, which we knew; it also has a surplus in services, including finance, according to the Federal Statistics Office. UK services exports to Germany were €24bn in 2015, while the UK imported services of €41bn from Germany.
If a hard Brexit were to force the UK and the EU to impose quotas on traded goods and to suspend trade in most services, Germany would be harder hit than the UK. Now, it is true the UK stands to lose more in total because it also trades with 26 other EU countries. But each EU country looks at its own position separately. Each has a vote in the European Council.
The Germans have an interest in maintaining free trade in both goods and services. Most other EU countries would come to a similar conclusion once they calculate the implications a hard Brexit would have for them. We just cannot get around the fact that the UK had a current account deficit of more than 5 per cent of gross domestic product last year. Having an unsustainable external position is a rare benefit when you want to negotiate a trade deal.
It would be different if the EU had leaders who put the common interest before their own. The eurozone crisis taught us they do not. That is also true of Angela Merkel. The German chancellor vetoed debt relief for Greece, joint eurozone debt instruments and common deposit insurance for the eurozone. She may pretend that she wants to be tough on Britain — but once German jobs are at risk I would expect her principled position to crumble.
If the Brexit negotiations get stuck — as they undoubtedly will at some point — we may find that macroeconomic considerations become more important. A hard Brexit may knock a couple of percentage points off UK gross domestic product but would presage a crisis in the EU. The total effect on GDP in the eurozone would be smaller but the dynamics may be worse. Brexit, for example, would risk pushing Italy into a recession, and that could trigger another financial crisis.
My conclusion is that both sides have an interest in a fair and square deal. The purpose of UK diplomacy in the next three years will be to remind the Europeans that the risks are more symmetrical than they think.
Full article on Financial Times (subscription required)