Brexit and the Future EU

With the prospect of a “no-deal” British exit (Brexit) from the EU looming just over the horizon, the continued viability of the French-German duopoly at the core of the EU is being thrown into doubt. Ever since the signing of the Maastricht Treaty in 1993, the concept of an EU has been predicated on the ability of Europe’s two most influential nations, France and Germany, to bridge their considerable economic and societal differences to provide a solid foundation for the EU and the basis for its expansion and success. Maintaining this duopoly has been a challenge. Germany operates a decentralized economy, governed by strict budgets and even stricter adherence to rules and regulations. France operates in a much more centralized fashion, with fewer budgetary restrictions and greater use of deficits to ease social and economic pressures. Bridging this “Rhine Divide” — a term made popular by the Princeton economist Markus Brunnermeier — has been an ongoing challenge even in the best of times. It will become much more difficult in the face of a “no-deal” Brexit, possibly leading to economic and political dislocation that could in turn harm the region’s highly integrated energy markets.

For historical context, the end of World War II left Europe in social, political and economic turmoil. Economic integration was put forward by European statesmen and political theorists as a means of fostering economic stability and political unity that would assist in preventing another war in Europe. France and West Germany initiated this process in 1951, forming the European Coal and Steel Community (ECSC). While the purpose of the ECSC was to create a vehicle for France to monitor German industry and allay concerns over potential German militarization, the real impact was the creation of supranational supervisory bodies that ultimately led to the EU. The success of the ECSC prompted Italy, Belgium, the Netherlands and Luxembourg to join.

In 1957 the six ECSC nations met in Rome to expand their relationship by creating the European Economic Council (EEC) and the European Atomic Energy Community (Euratom) which, together with the ECSC, would be served by a single council of ministers, representative assembly and court of justice. Trade barriers were eliminated, and common economic and trade policies were crafted and implemented. Eventually, labor and capital were permitted to move freely between these nations, which, in 1967, were amalgamated into the European Community (EC).

The EEC was not immediately popular among other European nations, the UK first and foremost among them. But when the EC Common Market began to significantly outperform the British-led European Free Trade Association, opposition to joining the EEC soon evaporated. The UK, together with Ireland and Denmark, joined the EC in 1973, followed by Greece, Spain and the former East Germany (as part of a unified Germany). The success of the EC led to the Treaty of Maastricht and the creation of the EU, which in turn led to a strengthened European Parliament and a common defense policy. In 1999, the EU was further strengthened by the creation of the European Monetary Union (EMU), in which member nations pooled their economic resources to create a common currency, the euro. By 2007, there were 27 member states in the EU, 12 of which participated in the EMU.

Growing Stress and Strain

The financial crises of 2007-08 and 2010-12 almost spelled the end of the EMU, when fundamental rules of economic management enshrined in various treaties of the EU were circumvented or broken outright in order to bail out failing EMU member nations. These moves came with either the wholesale Eurozone bailout of Greece, or the lesser bailouts of Italy, Portugal and Spain. Given the lack of a legitimate, central government authority overseeing the EMU, the European Central Bank (ECB) emerged as a sort of shadow government, exercising monetary control. Given the circumstances, the ECB became a proxy of those EMU governments that favored relaxed fiscal and monetary policy, such as Italy and France, over those who favored more rigid financial controls such as Germany. The result was ECB policies that put a premium on keeping the EMU membership intact, even if it meant violating the very functions of fiscal and economic management that made the EMU viable to begin with. It also drove a wedge between Europe’s two major economic powers, France and Germany, with France supporting looser financial policies that were ultimately paid for by Germany, putting strain on its working class and by extension the German political system.

Brexit will throw a monkey wrench into an already-overstressed set of relationships among the ECB, the EMU and the member nations. While the UK was not a member of the EMU, it has been a member of the EU and has participated in its development. The anticipated “no-deal” British exit from the EU will result in lower economic growth and output in both the UK and the EU. More importantly, Brexit will also significantly alter the political power structure of the EU, both in terms of those nations which, like the UK, had opted to remain outside the EMU, and those that comprise the EMU. The presence of the UK among those countries opting out of the euro gave them a collective voice at the EU table, given the size of the British economy and the role the UK played in formulating EU economic policy. With the UK gone, these nations will be weakened, and in search of new alliances. Here one can expect the opt-outs to gravitate toward Germany, which has pursued more market-friendly policies like those of the British.

Any alliance between the remaining opt-outs and Germany will be viewed as a threat by France and the other members of the EMU, which are dependent upon the German economic engine to keep the euro afloat. The willingness of the ECB to continue the loose monetary policies it is currently pursuing as a means of stimulating the economies of debt-ridden EMU nations depends directly on Germany’s willingness to sacrifice the savings of its citizens to underwrite this indirect bailout. Grumbling among German bankers about ECB policies has in turn put pressure on German politicians regarding their continued willingness to sacrifice German economic health at the altar of EMU viability. While Germany’s chancellor, Angela Merkel, has indicated that she will not interfere with the independence of the ECB, the same assurances cannot be made about her chosen successor, Annegret Kramp-Karrenbauer, when Merkel’s term expires in 2021.

Meanwhile, France is already irritated at Germany for its perceived failure to commit to a eurozone stabilization fund to ease the impact of future economic troubles. The existence of such a fund would help sustain the economic policies of the French in the chaos generated by a “no-deal” Brexit. The same, however, cannot be said of German parsimony. The ECB has been trying to balance the need for economic stimulus with the desires of German investors who drive the German 10-year bond market, which serves as the benchmark for the 19 nations who comprise the eurozone. A “no-deal” Brexit could pull the ECB in two incompatible directions, trying to implement discretionary policies to support weaker EU economies while simultaneously holding a tighter line financially as advocated by stronger economies, especially Germany. This conflict in policy priorities will come to a head in the kind of economic recession that Brexit is expected to trigger. The financial tension between France and Germany will be exposed, and if neither side is willing to capitulate to the other, the days of the EMU may be numbered.

European unity was built upon the questionable belief that deep historical differences can be papered over through economic integration. The postwar period necessitated economic revitalization in Europe, which in turn provided room for the kind of political maneuvering necessary to bridge these historical differences through common economic policies and transnational institutions. But World War II ended 75 years ago, and the old national differences and prejudices long embedded in Europe are re-emerging with a vengeance. While this does not mean that European nations will return to warfare to resolve their disputes, it does mean that the Franco-German political-economic duopoly that has held Europe together during the postwar period will fracture. Europe then will find itself pulled in different directions by the gravitational forces of these two incompatible, competing economic models, creating a bipolar, or even multipolar Europe that may be incapable of sustaining a singular economic union. Brunnermeier’s notion of a “Rhine Divide” has proven prescient, helped along by the pressures being brought to bear on a shaky European economic structure by an anticipated “no-deal” Brexit.

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