Wolfgang Munchau: EU must deal fairly with UK over Brexit

After the Brexit referendum I noted a surprisingly large number of news stories and commentaries in Germany about the possibility of a change of heart – a Bremain, as it was called in the UK. The idea was that the British people would wake up from this nightmare one day, see the light and say sorry.

After the election of Donald Trump, I observed stories speculating on whether the electoral college would grow a conscience and vote for another candidate. And last week I saw a comment from a German member of the European Parliament, widely reported in the media, who said UK prime minister Theresa May was bluffing when she said Britain would leave the EU's single market.

There is a pattern here. Some continental Europeans find it extraordinarily hard to confront a reality they despise. There is more to this than just a tendency for wishful thinking. If you believe the UK will remain in the single market or that Mr Trump’s presidency is just a reality TV show you can switch off with a remote control, then you are not prepared for what lies ahead. And if you are not prepared, there is a chance that something big is going to hit you.

Agreement

Both the UK and the European Union can ill afford a Brexit without agreement. I disagree with the consensus view among European politicians and economists that a sudden Brexit would be a lot worse for the UK than for the EU. This is a dangerous misconception, which could do real damage if it were to persist. Brexit without a deal will, of course, hurt Britain. While I strongly disagreed with most of the gloomy forecasts of what would happen after the Brexit vote, there can be no doubt that a sudden exit would produce large frictional costs.

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But it could also end up permanently damaging the EU. Just consider the following three effects of a sudden Brexit. First, the euro zone remains dependent on the City of London for financial services and especially on settlement and clearing, the plumbing of the financial system. Mark Carney, governor of the Bank of England, who is not a Brexit cheerleader, said recently there was a bigger risk of a financial crisis in the EU than in the UK. The euro zone is unfortunate in that it allowed its main financial centre to be outside its borders. There is a clear potential for blackmail here.

Second, it is trivially true that Britain has a smaller weight in euro zone trade than the euro zone has in UK trade. This is because the euro zone is bigger. But do not underestimate that manufacturing supply chains work in both directions. A sudden break could disrupt manufacturing production everywhere. Remember that a single bank, Lehman Brothers, was able to blow up the global financial system in 2008. Dynamic effects are harder to calculate than the static ones but they can be much bigger.

Tax

Third, the UK is a member of the United Nations Security Council, the Group of 20 advanced industrial nations, and the Group of Seven. If EU countries want to fight tax avoidance by multinational companies, manage globalisation in a fairer way, reduce greenhouse gas emissions or come up with policies to combat terrorism, they will need the UK.

A hard Brexit would push Britain towards another business model, as UK chancellor Philip Hammond put it. In other words, instead of leading the western world in the fight against tax avoidance, the UK would become another tax haven. I do not believe the Singapore model would be a smart choice for a country the size of Britain. The former is essentially just a financial centre while the latter is a diversified economy and, as such, needs a broader strategy. It would be better to focus on innovation and on policies to raise productivity. But however suboptimal a low-tax strategy may be in economic terms, it constitutes a threat to the EU.

My conclusion is that both sides have a great deal to gain from a fair agreement and a lot to lose from an abrupt UK departure without a deal. The fact that the EU 27 is larger than the UK has misled some people to think that the forthcoming divorce negotiations are going to be one-sided.

Ms May concluded correctly that the only way to level the playing field is to make a credible threat to walk away from a bad deal, while offering the prospect of close co-operation between the EU and Britain after Brexit. I hope that the clarity of her position will help focus some of the more confused minds on the continent.

A fair agreement is clearly possible if both sides want it. The biggest dangers from Brexit would arise if one side were to overplay its hand, or if there was a lack of unity among the other 27 member states in the final stages of the negotiations. I expect that the UK and the EU will ultimately reach a fair deal but the probability of failure is clearly not zero. The alternative would be painful for all involved. – (Copyright The Financial Times Limited 2017)