Denial and deficits set the terms for Brexit divorce
1 Jul 2016|

After Britain’s shock Auf Wiedersehen last Friday, politicians in the UK and Europe are now struggling to figure out what a Brexit divorce will look like. One way to do this is to look at the factors that will be at play behind three big new questions: will the EU opt for pragmatism or revenge; will the UK fragment; and will the UK’s current political parties survive?

First, the EU. The forces pushing for a non-amicable divorce are powerful because the EU is in shock. For people who’ve spent their working lives in EU institutions, the rightness of the EU nation-integration project was always a self-evident truth. Now, their cause has been spurned. Denial and anger will stalk Brussels and European capitals for months—possibly years—and that emotion will  upset rational decision-making.

Fortunately, the factor that steers the course of most divorces—money—will exert a sobering effect. With the EU’s second-biggest net contributor, the UK, removing £10 billion from the Unions’ income statement, Germany is now on the hook for almost 25% of the EU budget. German power has therefore just taken a big step forward. Regardless of how high emotions run in Brussels, Berlin will call the shots.

And what are German interests? In trade terms, Germany wants to keep UK trade as free as possible. Worth €89 billion per year, German exports to the UK are its third most valuable, after the US and France. What’s more, the balance is in Germany’s favour: export-import ratios to the UK run at roughly 2:1. Commercial self-interest will be the EU’s most powerful driver, so the EU probably will compromise on freedom of movement as the price of keeping UK in the Single Market.

But Germany’s also desperate to hold the EU together. In financial terms, a terminal domino-effect collapse is one that starts with rich, northern countries, not poor southern ones. While a knee-capping strategy might unduly impress Mediterranean suppliants, it won’t endear Scandinavian sceptics. So the forces in favour of amicability will remain in the ascendant, and Merkel’s call for calm will probably prevail.

The second question is whether Britain will continue to exist as it does today. Despite Nicola Sturgeon announcing plans to get the ball rolling for a second referendum, the cold calculus of Scottish independence actually looks bleaker than ever. As the implications of Brexit become more defined, it’ll become clear that independence from a non-EU UK is a far less attractive proposition than the one set before Scottish voters in 2014.

First, an independent Scotland will encounter whatever trade or customs barriers that emerge from the divorce. Since those barriers won’t be quantifiable for about two years, a Scottish referendum before then is implausible.

Second, English politicians have just learned what the electorate thinks of uncontrolled immigration. Attempting Scottish independence while simultaneously promising an EU membership that obliges the free movement of EU citizens will require finesse. Selling the idea at the precise moment that millions of English-speaking migrants can no longer look to England looks like political suicide.

Third, Scotland is already in financial trouble. Low oil revenues have sent the Scottish deficit to £7.8 billion, or 7.8% of GDP. And most perverse of all, if they get a second referendum, Scottish Nationalist will endure the unique liberation-movement challenge of campaigning to surrender powers—over agriculture, fisheries and development—their country has just acquired.

The last big question is the shape of UK politics in Westminster. That’s because the entire party political elite has just received an almighty intellectual thump. Only 158 out of 650 MPs supported Brexit—and only 10 Labour MPs, which is why the party is in deeper existential waters than the Tories.

Just as in Europe, the forces of denial will confuse politics for months. The sound of three-quarters of UK politicians trying to avoid facing up to the electorate’s instruction won’t be easy on the ear. But there’s one new factor in UK politics that’ll impact party re-alignment: deciding which commercial interests should predominate in the UK’s EU negotiations on access to the Single Market

Here, the political economy is fascinating. The UK has an £85.3 billion EU trade deficit that’s deteriorating by £10 billion per year. Against this, the UK’s £20 billion EU services surplus pales—and financial services only account for half that surplus. Post-Brexit politics cannot ignore commercial interests, because it’s laid bare in the political geography of the vote: London voted ‘Remain’; the industrial heartlands of the Midlands, the Northwest and the Northeast—which on close inspection don’t do too well out the Single Market—voted ‘Leave’.

How will this play out? Let’s say Jeremy Corbyn hangs on to a rump Labour Party, then at least his followers can reconnect with their traditional workers by campaigning for a semi-protectionist policy of trading with EU on WTO terms. That’s at least feasible: his right-wing ousters in the Labour Party currently have no-one obvious to reconnect with at all.

In the longer term, the Tory Party’s task is hardly less gruesome. Now they’ve won, Brexiteers have to balance the interests of London with those industrial and rural interests that gave them victory. As the party tries to agree a EU negotiating position, MPs will encounter one issue after another—the EU trade deficit in manufacturing,  agricultural subsidies, and financial services passporting—that divide economic liberals from Tories, and pitch City-sympathising conservatives against rural MPs. What happens then is anyone’s guess.