Commentators have spent plenty of ink explaining Brexit’s consequences for the British economy, but much less attention has been paid to the effects on other European Union members. This is not surprising. By leaving the EU, the United Kingdom will face the cost of dealing with a group of countries that do not like to have a powerful competitor at their doorstep and might engage in preemptive strikes.
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However, the UK will have the opportunity to create a friendlier business environment than the EU’s, potentially attracting companies and entrepreneurs from all over the world. Much depends on whether the British government can engage in significant tax cuts and extensive deregulation, and avoid irritating the major continental economies.
Germany filling the vacuum
The picture looks less nuanced from the EU viewpoint. The advocates of an “ever closer union” have three reasons to rejoice. First, Brexit will remove the most formidable opponent to the idea of full integration. Second, a significant number of well-paid and influential executive positions within the EU bureaucracy can be redistributed to the remaining members. Third, UK-based companies might move to the continent to avoid possible discrimination by EU authorities and to monitor the regulatory dynamics from within.
The main players’ incentives are straightforward. The UK will aim for a soft split-up to avoid angering Brussels and reassure the large companies that might be tempted to leave. The EU will take a tougher approach: the more irritated and bellicose Brussels seems, the greater the chances that some companies will be scared into moving to the continent, so as not to fall victim to EU retaliation. Moreover, a muscular response to Brexit would set an example for all the EU states toying with the possibility of leaving the union (or the euro). From the UK’s perspective, the main benefits associated with Brexit depend on its ability to engage in institutional competition. Yet, Brussels would see that as a hostile move, leading to the very tensions London wants to avoid.
The current ineffectiveness of the EU bureaucracy and the general feeling of disenchantment with the EU ideal also play a role. These phenomena have created a vacuum of authority and legitimacy that Germany is filling. The future of EU-UK relations therefore depends heavily on Germany’s attitude toward Brexit.
One has the impression that Ms. Merkel is using Brexit to impose her country’s leadership on the other EU members
Tensions have already emerged on two fronts: the content of the agendas on the table and the procedure to follow. The British government has been trying to negotiate two different agendas: the terms of the divorce and the future of the UK vis-a-vis the EU. Prime Minister Theresa May is reluctant to pay large sums of money to Brussels to part from the EU and complete the Brexit process.
Brussels claims that London can leave only after having honored its past commitments, which involve contributions through 2023 that exceed 60 billion euros. Moreover, Britain wants to avoid discrimination once it reaches its post-Brexit status, while Brussels and Berlin claim that discrimination is certainly an option. Brussels rejects Prime Minister May’s proposal for keeping the two agendas separate and insists on making the future status of the UK dependent on whether London pays what is, de facto, an exit fee.
To complicate matters, the debate on the agendas and the payments that Britain allegedly owes the EU has ignited a debate within the bloc itself. Germany is digging in – it wants a binding commitment on the payments. Most other EU members are open to compromise; some of them could not care less.
The situation presents three conflicting views. Britain wants separate agendas; it wants to clinch a deal on its post-Brexit status and then negotiate the payments. Berlin also wants separate agendas but in reverse order: first Britain honors its alleged debts, while settling the UK’s post-Brexit status would follow. Brussels wants a common agenda to make compromise easier. One has the impression that German Chancellor Angela Merkel is using Brexit to impose her country’s leadership on the other EU members. Will she succeed? Are we heading toward rising tensions between Germany and the UK? What are the possible consequences for Britain?
Germany’s position might be strong on paper, but in practice it is weak. Observers are aware of Berlin’s desire to use Brexit to weaken the City and expand the role of Frankfurt as a financial center, and suspect that Ms. Merkel’s animosity is not just a matter of budgetary rigor.
But Frankfurt suffers from two disadvantages. First, financial appeal is not just a question of technical skills, which are in plentiful supply on the Main. It is also about tradition, informal rules and personal contacts. Moving office space and some key players from one location to another will not be enough. Second, financial firms may fear that political pressure (including from German and EU regulators) might be greater in Frankfurt than in London. If so, some companies might develop an office in Frankfurt, but keep operations in London.
The Germans could vex the British to help Frankfurt, but too much hostility could backfire. The world of finance does not like confrontational leaders who consider markets potential battlefields, not even when elections are due and easy populism is hard to resist.
Nothing to fear
The German government has started a fight that Europe does not need and that many other EU members will not support much longer, especially if its goal is to garner electoral consensus, scare international investors and strive to transform Frankfurt into a global financial center.
The key issue remains institutional competition – drastic deregulation and tax cuts
Tensions between Germany and the UK will likely be short-lived, especially if Ms. May takes her time, uses a conciliatory tone and waits until after the German elections take place. After all, no continental economy has an interest in starting a trade war with the UK, a major market for many EU exporters (including German car producers). And of course, the UK has no interest in antagonizing the EU. The UK does not have much to fear from this round of German bullying.
The key issue remains institutional competition – drastic deregulation and tax cuts. This would allow the British to make the most of Brexit and hope to revive its ailing productivity (which increased by less than 1.5 percent over the past 10 years), but it would also alarm bureaucrats in Brussels and in several European capitals.
The real negotiations will probably take off in October, after the German elections. At that point, the British government will promise to enforce the economic freedoms that characterized its pre-Brexit relationship with the other EU members and will also make reasonable proposals regarding the exit fee it will pay. If that happens, the Germans will appreciate that London has accepted their agenda and Brussels will be eager to get out of the impasse, before the EU’s prestige drops further.