The impact of Brexit on the EU

Insight
Charles Grant
24 June 2016

Brexit will weaken those forces in the EU that favour greater integration. It will also make Germany even more preponderant. Meanwhile the British face a lengthy and difficult negotiation for a new relationship – probably along lines of the ‘Canadian model’.

Last December Marine Le Pen said that if the UK voted to leave the EU, it would be the equivalent of the Berlin Wall falling in 1989. She was right. Brexit is a momentous event in the history of Europe and from now on the narrative will be one of disintegration not integration.

That doesn’t mean that the EU will fall apart, or even that another country will leave, which is highly unlikely in the foreseeable future. But the centrist politicians who run nearly every EU member-state will henceforth be on the defensive against the populist forces who oppose them and the EU.

In the top echelons of the EU there are two competing approaches to the future of Europe. The European Commission, led by President Jean-Claude Juncker, believes in further integration. It generally seeks to respond to crises by pressing member-states to accept ‘European’ solutions that involve extra powers for EU institutions. The Commission does not seek to grab power in a cynical way – it genuinely believes that many problems require ‘more Europe’. And sometimes it is right.

But the President of the European Council, Donald Tusk, takes a different line. In recent weeks he has repeatedly warned that more centralisation would turn citizens against the EU. “Obsessed with the idea of instant and total integration, we failed to notice that ordinary people, the citizens of Europe, do not share our Euro-enthusiasm,” he said. Tusk also cited comments by Hubert Védrine, the former French foreign minister: “You see governments and parties all over, jumping up and down asking for ‘more Europe, more Europe’. If you want people to massively reject Europe, just keep on.” A few days ago, Wolfgang Schäuble, the German finance minister, chipped in, criticising the “excessive level of self-regard in the institutions in Brussels and Luxembourg …to some extent [we] lost contact with our citizens.”

As the EU ponders how to respond to Brexit, Tusk’s pragmatism rather than Juncker’s federalism will prevail. In recent years there have been discussions in Paris and Berlin about a new EU treaty, focused on a more integrated eurozone. But such talk has petered out. There are several reasons for this new caution. The eurozone, though beset with difficulties, faces no immediate risk of dissolution. France and Germany cannot agree on how to fix the euro’s problems (should there be a transfer union or stricter rules to police budget deficits and structural reform?). And even if those two countries could agree, neither the French nor the German parliaments would be willing to transfer significant powers to eurozone or EU institutions. In any case, a new EU treaty would require referendums in Denmark, Ireland, the Netherlands and perhaps France – which could easily be lost. So there is not going to be a major new EU treaty.

From now on, European leaders will have to work on reforming the EU through the passage of laws, the revision of the budget (the mid-term review of the 2014-20 budget cycle soon gets underway) or inter-governmental agreements. At some point EU leaders may need to accept new laws that tackle particular aspects of the eurozone’s difficulties or the refugee situation, and these laws may give new powers to EU institutions. But the governments will keep the Commission (and its close ally, the European Parliament) under a tight rein. They will not let the Brussels institutions set the agenda.

In recent years both France’s weakness and the UK’s semi-detached status have made Germany the dominant country in the EU. On issues such as the eurozone crisis, refugees and the war in Ukraine, Germany has determined the EU’s response. Fears of even greater German dominance explain why politicians in Rome, Paris and Warsaw are so horrified by the prospect of Brexit.

The Germans themselves are particularly unhappy about Brexit, and not only because they worry that other EU countries – now even more anxious about German dominance – may be tempted to form an alliance against them. The Germans have seen the British as allies for the causes of economic liberalism and smaller EU budgets.

But despite German worries, the EU is unlikely to become significantly more protectionist. Many EU governments, including those in the Nordic countries, Central Europe and the Netherlands, share the UK’s free market instincts. Nevertheless, as CER researchers concluded before the referendum, without the British there will be less pressure for completing trade agreements and extending the single market into services.

Policy-makers in the US are horrified by the referendum result. They saw the UK as a bridge between themselves and continental Europe.  And they knew that on foreign policy questions, the UK often helped to steer the EU towards relatively tough or US-friendly positions. The Americans now worry that, without British firmness supporting the hard line of Angela Merkel and other northern European leaders, the EU will be more likely to relax the sanctions on Russia that it imposed after the intervention in Ukraine.

EU policy-makers already have a whole load of problems on their plate, including the Greek economy, instability in the European neighbourhood and influxes of refugees. But they must now find extra time to handle the complexities of the Brexit talks, which may drag on for five years or longer.

David Cameron’s successor will have to request a particular model of association with the EU. The EU will say that if Britain wants to stay in the single market, like Norway and Switzerland, it will have to accept free movement of labour and pay into the EU budget, as well as adopt single market laws that it will not be allowed to vote on.

Given the political toxicity of free movement in the UK, the new prime minister will probably prefer the ‘Canada option’, meaning a free trade agreement (FTA). That would give very limited access to the single market and be particularly painful to the City of London: an FTA would not allow the ‘passporting’ system whereby a bank regulated in London is free to do business across the EU, without the need to be regulated by anyone else. Some foreign banks in the City are already planning to move significant numbers of staff to Frankfurt, Paris, Luxembourg or Dublin.

European leaders will have an interest in ensuring that the EU maintains a close economic relationship with the UK, for everyone’s benefit. But they will not compromise on fundamental principles, such as free movement of labour, as the price for single market access. And they will not want the exit talks to be pain-free, easy or pleasant for the British, since they wish to deter others from following the UK’s example.

Charles Grant is the director of the Centre for European Reform.