Wolfgang Münchau: Ireland may have to consider leaving EU

‘Unsustainable business model’ in an EU where taxes are harmonised could see ‘Irexit’

Speaking on the BBC’s Andrew Marr show, British prime minister Theresa May says Article 50 will be triggered by the end of March 2017, meaning Britain looks set to leave the EU by summer 2019. Video: BBC

 

It is quite instructive to recast the narrative about Europe’s multiple economic crises in terms of the business models of nations. The EU has a number that are unsustainable. A much-cited example is Germany’s overreliance on manufacturing. Another is Britain’s overreliance on finance.

The failure of national business models takes time to play out. Germany will probably still be ubercompetitive in a decade’s time. But Brexit will accelerate the demise of Britain’s business model.

The City of London will surely remain Europe’s premier financial centre but it will not be able to retain its role as the financial hub of the euro zone. The single EU passport for financial services has enabled UK-registered financial institutions to operate throughout the union without subjecting themselves to local regulation and supervision. For 17 years, Britain was able to play this game without adopting the euro.

The City will now have to seek a new role because Theresa May’s insistence on immigration controls settles the issue. The UK prime minister’s Brexit doctrine leaves the EU no choice but to insist on a hard Brexit. Angela Merkel and François Hollande, the leaders of Germany and France, last week told us so. There is no scope for a fudge. Brexit means that Britain will leave the single market and the customs union.

So we are about to witness a shift away from an old unsustainable business model to something new. We should not pretend that this will be cost-free. The overt xenophobia at last week’s Conservative party conference may end up driving the very foreigners away the UK can least afford to lose.

There is a risk that Brexit and the associated change in model business will go wrong. Brexit is not necessarily a bad decision. But it requires the right kind of policies to work.

The British prime minister is right to balance a hard Brexit with a shift in the direction of the UK economy away from transactional capitalism towards a more inclusive version of a free-market economy. This makes sense. One way to think about this is the theory by Mancur Olson, a 20th-century US political economist, who tried to explain why Germany and Japan did so well after the second World War. In his 1982 book The Rise and Decline of Nations, he notes that powerful lobby groups can hold a country to ransom up to the point when a shock destroys the economic system.

Reinvention

In the case of Germany and Japan, this point was wartime defeat that allowed both countries to reinvent themselves. Brexit could do the same in the UK. This is why a dual strategy of a hard Brexit and a shift in the nature of British capitalism is intriguing. The first constitutes the shock, the second the shift. Olsen would have liked it.

The City will not perish in this scenario. It might even do well with new fintech-type business models, or as a deregulated financial centre, Singapore-style. But its relative weight within the British economy may well decline.

There is another country in Europe with an unsustainable business model: Ireland. It offers low corporate tax rates and legal tax avoidance to foreign investors. The ruling by the European Commission to force Apple to pay €13 billion to the Irish Government in taxes is a sign that this model may not be sustainable for much longer. Brussels is also pushing towards a harmonisation of the corporate tax basis – the rules of what to tax.

Dublin has been resisting such a change, but with the UK out of the EU it will lose an ally in the fight against EU-imposed tax harmonisation. Ireland has done well from its tax haven status. But this model is unsustainable.

Confluence

Perhaps the confluence of Brexit and the long-term loss of a business model will persuade Ireland to follow the UK out of the EU. This will obviously depend on whether Ireland can find an alternative model inside the EU. It is possible, but not inevitable. An Irish exit will not happen unless and until there is more clarity of the costs of Brexit. It will also depend on whether the euro zone successfully manages the various crises facing it.

If all this develops as I expect – badly – the economic case for an Irish exit would strengthen. Ireland might choose to stay in the EU for political reasons. But those in Ireland in favour of EU membership should give some thought to what could go wrong. They might otherwise end up in the same place as the overconfident Remain supporters in the UK: bitter and without influence.

The notion of national business models may sound counterintuitive but offers a framework of how to think about the future of the European economies. Brexit is a rare example of an Olson-type shift in real time. My expectation is that it will not be the last one.

– Copyright The Financial Times Limited 2016