Britain is a great country. Combining a charming quirkiness with flexible markets for labour, services and goods as well as an admirable openness for skilled migrants, Great Britain today has the most dynamic economy of all major European countries as measured by its trend rate of GDP growth. Its superb armed forces, its top-notch intelligence services and its competent bureaucracy allow Britain to punch well above its weight on the global stage.
Unfortunately, the trend is no longer Britain’s friend. The obsession of Conservative hardliners with the alleged monster of a European “superstate” that few other reputable observers have ever spotted in Brussels, Berlin or Paris has unleashed forces that threaten to diminish the relative power and wealth of Britain over time.
AGAINST THE LOGIC OF HISTORY
Start with politics. For centuries, Britain abided by one supreme national necessity: it used its influence to prevent the emergence of a continental European hegemon that could threaten its interests. From the wars of the Spanish succession to those of Prussia’s Frederick the Great in the 18th century, from the Napoleonic wars to the dreadful carnage of the two World Wars of the 20th century, Britain sided with the lesser powers in Europe against any would-be hegemon. Britain did its best to maintain a balance of power on the other side of the Channel.
With the Brexit vote, Britain has now ditched this time-honoured approach. By leaving the EU, Britain is forsaking most of its influence on European decisions. However, these decisions will continue to impact the UK. Brexit can’t beat geography.
Even more importantly, Brexit is contributing to an “us against all of them” line-up in Europe. Brexit is strengthening those on the continent who want to turn the EU and the Eurozone into more coherent and politically relevant entities. Some British observers, usually the same who peddle the “Loch Ness”-type story of the Brussels supermonster, proclaim that Brexit could destroy the EU27 and the Eurozone. However, the opposite is the case: the travails of Nigel Farage, the downfall of David Cameron, the humbling of Theresa May and the glaring contrast between the big savings promised by Boris Johnson and the reality of a Brexit bill have curtailed the electoral appeal of EU-sceptics on the continent. In a similar vein, a European backlash against Trump, Putin and Erdogan is re-energising the pro-integration forces. Bonjour Mercron, as the Merkel-Macron duo has become known already.
For starters, Britain will have to negotiate issues that are vital for its own future such as the conditions of access to its major market with an unusually united EU27 team. If Mercron make any progress, this may just be the start. Instead of playing one European neighbour against the next, Britain may increasingly have to deal with a more united core Europe. This is the opposite of the balance-of-power game that had served Britain so well over the centuries.
Now turn to economics. Libertarian Brexiteers have long argued that the UK could thrive outside the EU as a free-market paradise, a “Singapore on Thames”. That never made much sense. Being a member of the EU did not prevent the UK from enjoying among the most open and flexible markets for labour and capital, for services and goods in the developed world. The scope for any further deregulation that could be politically feasible is close to zero. And the export prowess of Germany and the Netherlands has shown for a long time that the Common Market can be a great staging place for excelling on global markets for any country ready to exploit the opportunity.
Instead, Cameron’s failed referendum gamble and May’s botched election campaign have contributed to a lurch of British politics to the left. Having fallen under the sway of the hard left, the Labour party has done unexpectedly well under Jeremy Corbyn partly because Labour stands for a softer Brexit. Having ditched Cameron and Osborne, the Conservatives themselves have moved to the left on economic policies. The weak and wobbly government that Theresa May is trying to stitch together seems more likely to regulate than to deregulate, to offer expensive spending promises than to rein in Britain’s excessive fiscal deficit. Outside the EU, the UK could potentially turn into a more regulated economy than it was inside. The ascent of Corbyn shows that we cannot fully dismiss this risk.
Britain’s last great leader, Margaret Thatcher, had crushed bolshie trade unions, modernised the economy, deregulated the City of London and seen to it that the EU liberalised the service sector so that Greater London could find a vast market for its financial and other services right next door. With a domestic tilt to the left and by losing preferential access to the EU market for financial services, and possibly for other services and goods as well in case of a hard Brexit, Britain may undo parts of the pro-growth legacy of Thatcher.
By making Britain less attractive for skilled migrants and for inward investment, Brexit will likely reduce Britain’s trend rate of growth from 2.1% to a still solid 1.8%. A hard Brexit with a loss of preferential access to the EU27 market beyond the inevitable restrictions to be placed on UK-based providers of financial services could depress trend growth to 1.5%. Any significant surge in domestic regulation would compound the damage.
Even 1.5% trend growth would still be a reasonable pace. It is close to the German rate and well above France’s pre-Macron 1.2% trend. However, as a lasting legacy of Gordon Brown’s spending spree, Britain’s fiscal position has been very challenging at the recent trend growth rate of 2.1% already. Any fall in trend growth, let alone a drop from 2.1% to 1.5%, would require major offsetting tax hikes or expenditure cuts in years to come to keep the deficit under control. Trying to cover these fiscal costs of Brexit amid the anti-austerity mood that has taken hold among voters could tax the persuasive power of even the strongest government. Kicking the can down the road, as Britain could do for a quite a while, would only exacerbate the corrective fiscal squeeze that would be required later on.
HARD CHOICES FOR A WEAK GOVERNMENT
On many counts, the British economy is still in the pole position in Europe. But extrapolating the recent trends, Britain may soon be falling behind a still-dynamic Germany, a mostly reformed Spain and a France that is finally getting its act together. Of course, it is very early days. Britain may still avoid that fate if it goes for a soft Brexit, resists the urge to turn away from the neoliberal consensus of the post-Thatcher decades and fixes its budget in a way that does not weigh unduly on its productive capacity.
To some extent, last Thursday’s election result can be seen as a return to the common sense that had been missing in the Brexit debate last year: voters rebuked the hard Brexit line of Theresa May without handing the reins of power to Jeremy Corbyn. They also dealt a blow to Scottish dreams of a second independence referendum and abandoned UKIP in droves. Nonetheless, the UK is now saddled with an unusually weak and wobbly government that will have to make unusually hard choices before the end of the Brexit deadline in March 2019. And all that with a risk that new elections could bring Corbyn to power at any time.
The EU27 has outlined its Brexit strategy in significant detail. German chancellor Merkel probably caught the prevailing mood on the continent well when she warned that the UK may still be harbouring illusions about the kind of Brexit deal the EU can offer. Can a Conservative-led government with a wafer-thin majority in parliament find the strength to explain to its own supporters that much of the promises peddled by the Brexiteers a year ago were pure fantasy? Can it accept the kind of half-favourable transitional arrangement that the EU27 could sign up to? Can the British government resist the temptation to spend more when the appeal of Corbyn suggests that a more reckless fiscal policy and a bout of re-regulation would go down well with voters?
Some four years after Cameron pledged a referendum on EU membership for purely party-political reasons in January 2013, Britain’s political situation and its long-term economic outlook have become more precarious than they have been at any time since the late 1970s. Chances are that common sense will prevail with a soft Brexit and no turn towards Corbyn-type economic policies. Unfortunately, the risks to this call loom large.