Can Europe Make It?

Can Europe survive without Britain?

Most commentators have asked, “Can Britain survive without Europe?” Perhaps the opposite question is more pertinent.

Fernando Betancor
14 May 2014

On May 10, Angela Merkel hosted her French counterpart, François Hollande, in the German coastal city of Stralsund. The event was planned as a show of unity, with joint statements on the future of the Euro and the Union’s response to the ongoing crisis in Ukraine. And after 20 hours of discussions, the two did indeed hammer out some common positions they could sell to the press and their publics as a demonstration that all was well[i]. But in fact, the mood between the two ‘motors of Europe’ was better reflected by the iron grey skies over the Baltic port.

François Hollande and Angela Merkel

François Hollande and Angela Merkel. Demotix/Riccardo Valsecchi. All rights reserved.There are a number of reasons for pessimism in the partnership. France continues to face economic and fiscal challenges despite indications of growth in Europe as a whole. And the worse is far from over: there is a serious risk of deflation across the continent, with some nations like Spain already experiencing it in core prices[ii]. Deflation will increase the debt burden on the periphery economies that are already suffering from debt-to-GDP ratios well above 100%, regardless of the substantial drop in sovereign bond rates these countries have recently benefited from. Berlin and Paris remain at loggerheads over the value of the euro: France wants to weaken the exchange rate to benefit her exports, while Germany is comfortable with the current level, knowing that the single currency is undervalued against an independent deutschmark. ECB President Mario Draghi has promised aggressive action against deflationary risk should the situation continue into June, but so far his organization has followed the Germany position of leaving interest rates where they are.[iii]

European union or zollverein?

At the heart of this acerbic debate is the markedly differential performance of the 27 member states since the crisis. While GDP growth has returned to most markets, in many it can only be described as anaemic. The margin between growth and recession is narrow enough in these markets to be attributable to additional government deficit spending, as is the case in Spain, or one off corrections, as is the case in Greece. Most countries in Europe have not yet recovered their pre-crisis (2008) GDP levels; and some are still below their 2005 GDP levels.[iv] 

Map showing variation of indexed GDP

Figure 1. Variation of indexed GDP.The countries of the German production chain - Austria, Poland, Czech Republic, Hungary, Slovakia, Romania - never really suffered from the worst of the Great Recession, or else recovered as quickly as Germany did. Nations that depend heavily on the German market as a destination for their exports, like the Netherlands and Switzerland, also did well. All of these nations are characterized by having Germany as the overwhelmingly dominant trading partner, to the extent that it is not too much a stretch to call this region ‘Mitteleuropa’. 

Chart showing exports to and imports from Germany.

Figure 2. Exports to and imports from Germany/Outside the ‘German orbit’, things have gone less well. Unless you were a major oil and gas exporter, like Norway, or kept control of your currency, like Sweden and the United Kingdom - or both - then you were in trouble. The Mediterranean and Balkans countries have suffered terribly, and continue to suffer. Growth there remains fragile and disproportionately tied to large fiscal budget deficits, exports and wage deflation. France straddles the line: it is a large, diversified economy with world-class companies; but unemployment remains stubbornly high, growth sluggish and fiscal deficits large.

Just looking at GDP paints a rosier picture than what actually exists on the street. Gross Domestic Product is not a particularly good measure of what is going on in an economy, as Americans have discovered, and you can have growth without jobs. Growth of corporate profits, that is. In Europe, this is very much what we are seeing. Other than the German middle class (and that of a few other small economies) most of the growth in Europe has yet to benefit workers and unemployment levels remain intolerably high[v]

Map showing unemployment rates across Europe 2014

Figure 3. Unemployment rates across Europe.‘Mitteleuropa’ stands out even more starkly as the only region that has managed, as a bloc, to reduce unemployment rates below pre-crisis levels (2005 to 2008). Slovakia, Hungary and Romania are not yet there, but their unemployment is trending downwards. The Nordic markets and UK have also responded relatively well, thanks to their control over monetary policy, but unemployment is shockingly high across the Mediterranean Basin and the Balkans. In France, Italy, Portugal and Ireland job creation is barely occurring; while in Spain and Greece, ‘catastrophe’ is not too strong a description and unemployment levels are falling only because people are leaving the job market faster than jobs are being destroyed.

These results are beyond worrying. The dislocation between top-line GDP growth and street-level stagnation is leading to massive disillusionment with European leaders and the European project on the part of voters. Across the continent, polls find trust in European leadership elites plummeting[vi]

Even in a relatively prosperous Germany, 70% of voters indicated that they didn’t trust mainstream politicians, though Ms. Merkel enjoys higher support. This discontent has left the door wide open to far right parties in the upcoming European elections. The Swiss have already voted this year on a referendum to limit immigration to their country even from within the EU. There are also extremist parties in Austria, Belgium, Bulgaria, Cyprus, Denmark, Greece, Hungary, Italy, Latvia, Sweden, and Slovakia that stand to benefit. And they are beginning to organize between themselves, joined by a common dislike of non-European foreigners (i.e. Muslims) and the EU itself.

Historically, each nation’s far-right has been focused on domestic politics and fragmented, but late last year Marine Le Pen’s National Front and Geert Wilders’ Freedom Party agreed to coordinate strategy across the continent.

Not enough Britain

The challenge posed by the waspish MEP Nigel Farage and his openly Eurosceptic UKIP is a growing one. Recent polling data makes grim reading for UK conservatives. The Tories have trailed Labour in the polls since late 2010[vii] – ever since Mr. Osborne unveiled the budget with the largest spending cuts in decades.[viii] However, UKIP has recently experienced a surge that has not only solidified their lead over their mainstream conservative rivals, but has also eclipsed Labour for the first time since May 2013. Although still a far cry from being a threat in the national elections, UKIP looks set to win a comfortable majority in the European elections.

Evolution of British voting intentions

Figure 4. Evolution of British voting intentionsMr. Cameron has sought to aggressively counter his disadvantage at his weakest point: Europe. By finally promising his party their long sought-after referendum on remaining in the EU, he has become the hero of the hour for Tory MP’s as well as conservative voters, though he hopes the effects of his speech will last longer than that.

Even the most anti-Europe MP is unlikely to buck the PM now. UKIP continues to bang on the drum of EU exit; but at least they are not as likely to steal Tory voters any more. With an eye beyond the European vote, Mr. Cameron has also been positioning himself as the ONLY man who could deliver a referendum to the British public: UKIP would never win a national election, and Labour would never deliver on the plebiscite promise[ix].

There is no question that Mr. Cameron is aware of the potential costs of an exit from the common market and he has been very clear that he personally does not want Britain to leave Europe. By leaving the referendum in the distant future, and predicating it on a Tory victory in 2015, Mr. Cameron is hoping to reap the short-term domestic benefits without conceding much in the long-term. There is evidence that seems to support this view.

While Britons’ visceral rejection of all things from Brussels is almost proverbial, much if not all of the dislike is focused on social issues and immigration, rather than economic complaints. While business leaders grouse about ‘excessive regulation’ from EU bodies, the reality is that most people concede that British firms and the British economy have benefited mightily from the Common Market.

Mr. Cameron clearly feels that in the long run-up to an actual referendum, pragmatism would win out… as long as he can secure an acceptable deal from his European partners. But the threat remains a real one: voting intention on an EU referendum fluctuate around 40% in favour and 40% against staying in the union, with a disconcertingly large 16% to 20% undecided. Misreading the sentiment of the voters could have enormous consequences for the future of the United Kingdom and the European Union.

Graphs showing how British voting intentions in a future referendum

Figure 5. Future British voting intentions.

Too much Germany

Some European leaders are betting that the referendum will never happen. After all, for Britain to leave the Common Market would be economic suicide, they argue. Europe accounts for half of all British trade[x] and the UK is a major trading partner for all of Europe’s largest economies. However, Great Britain is only a small part of the exports of any European market in particular. With the exception of Norway, exports to the UK represent only 6% to 7% of total exports for most European states. And the European share of Britain’s total trade has been on the decline for over a decade.

That places Mr. Cameron in a somewhat awkward position: the UK stands to lose up to €269 billion in trade – on aggregate – from departing the Common Market, but none of her trading partners will individually lose more than €70 billion, even if the EU would lose more the Britain – on aggregate.

This could lead to the perverse dynamic of individual states with little to lose in British trade blocking any revisions to the current relationship, even if states with more to lose might be willing to make concessions.

Perverse or not, €300 billion is still a very great deal of money to lose, and European economies are not in a position to be leaving any money on the table. The economic damage to Britain’s partners goes beyond a simple calculation of export volume: British industries are heavily involved in Airbus and the parent company, EADS. European pharmaceuticals have a critical research and manufacturing presence in the United Kingdom; the automotive sector in the UK is also pan-European. Great Britain is a major exporter of petroleum and its derivatives to Europe. The City of London provides vital financial services to many European companies and is the only global financial centre in Europe.

Mr. Cameron is also aware of his economy’s declining stake in Europe. British firms have made a sustained effort since the middle of the last decade to better position themselves in emerging markets. This strategy has borne fruit, with exports to the EU steadily declining as a percentage of total exports. There is an apocryphal story of a debate between pro- and anti-Europe British politicians. Where the pro-EU politician states smugly that British trade with the Netherlands was greater than that with China, the anti-EU politician replies, “That is precisely the problem.” 

Graph showing percentage of total UK exports by region, 2000 – 2013

Figure 6. Percentage of total UK exports by region, 200 – 2013There is another, political reason, why Europeans, particularly Germany, should want Britain to stay and may be willing to give Mr. Cameron some face-saving concessions to take to the voters. Today, the European Union is relatively well-balanced, with four great economies dominating: Germany, France, United Kingdom and Italy[xi]. No economy dominates, though Germany is clearly the most important and influential member of the club. Absent the United Kingdom, however, and the Common Market starts to look an awful lot like a continental version of the Prussian Zollverein of the late nineteenth century. 

Graphic showing Europe with and without UK by GDP

Figure7. Europe with and without UK by GDP.The European Union desperately needs the stability provided by a “semi-independent” UK, preventing the formation of a too dominant Germany. The only possible alternative would be a coalition of Mediterranean states, led by France, to counterbalance the Teutonic giant.

There have already been some serious proposals made in this direction, including the potentially disastrous idea of a ‘two-speed Euro’. Such a shift in the internal dynamics of the Union could have profound and highly negative impacts on the future of the institution. German power is already being reviled in markets where ‘Germanic’ austerity has bitten the hardest.

Germany is well-aware of this negative perception and has been actively attempting to mitigate it. The Germans want to be the good Europeans; and to an admirable extent, they have succeeded. It is probable that Berlin would be extremely sensitive to enhancing perceptions of ‘dominating Europe’; and they do not want the formation of a permanent ‘Club Med’ working against their interests. Germans value the British commitment to free and open markets, to trade liberalization and to the avoidance of undue regulations.

Most commentators have asked, “Can Britain survive without Europe?” Perhaps the opposite question is more pertinent. It seems clear that both Britain and Europe stand to lose a very great deal from a divorce, no matter how accommodating it is. The British economy would weather the storm eventually, though the cost might be more than the British public is willing to bear. It is, after all, a nation state. The European Union is not a nation state and its institutions remain fragile – it is less clear to me that it could survive a British departure. The economic costs, though significant, are affordable: what is difficult to reconcile is the fundamental realignment of power within a Europe limited to the continent, a Europe even more obviously dominated by Germany.

On one point, Mr. Cameron should give no ground. The referendum should go forward. The EU has changed dramatically since the last time the British public voted on membership and they have the right to expect their voices to be heard. For an institution that ostensibly supports democracy, the European Union has proven to be remarkably allergic to the democratic process. The fact that the United Kingdom is setting this example is very necessary to the long-term health of Europe. After all, if Europe cannot convince its citizens that the benefits far outweigh the costs of membership, what future does it really have?

Sources and Notes

[i] Noah Barkin, “Franco-German show of unity masks policy divide,” Reuters, 12 May 2014

[ii] Milton Ezrati, “Be Afraid: The EU’s Next Economic Crisis is Looming,”  The National Interest, 09 May 2014

[iii] Claire Jones, “European Central Bank signals monetary loosening in June,” Financial Times, 08 May 2014

[iv] Eurostat

[v] Ibid

[vi] Antonia Malloy, “Ukip set to win in European elections, poll suggests,” The Independent, 12 May 2014

[vii] ComRes Poll, Ipsos-Mori Poll, Poll of Polls, Populus Poll -  BBC News Poll Tracker

[viii]Spending Review 2010: George Osborne wields the axe,” BBC News, 20 October 2010

[ix] “Only Tories Can Deliver EU Referendum, Says PM,” SkyNews, 02 May 2014

[x] See note 11.

[xi] Spain could be included as a courtesy, but it is only 66% of Italian GDP

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