UK-Europe: Myth and Reality

As featured in this month’s Master Investor Magazine.

As I wrote on the MI website recently (Mr Cameron’s Gamble), we learnt in late October that the Prime Ministers of Finland and Estonia had no idea what Mr Cameron was talking about.

This was not due to a failure to translate Mr Cameron’s speeches into all the major Finno-Ugric languages; but the failure by Mr Cameron to tell these gentlemen what were the issues he wanted to renegotiate ahead of the planned UK-Europe In-Out referendum that is supposed to take place before the end of 2017.

If the Baltic Prime Ministers were in the dark, so were the British public. Eventually, on 09 November, Mr Cameron wrote a letter to Donald Tusk, the Polish President of the European Council setting out four main objectives for his renegotiation of the terms of Britain’s membership of the EU.

The four points of the Dear Donald letter were an exercise in bathos. In essence, Mr Cameron wanted to increase competitiveness in the EU by reducing regulation; to exempt Britain from ever closer union; to restrict migrants’ access to in-work benefits; and to protect Britain and other non-Eurozone EU members from the effects of greater integration within the Eurozone.

While Mr Juncker, the President of the European Commission, sighed that this was all deeply problematic, the Eurosceptics branded Cameron’s demands as unambitious. So if he does get what he wants, those who are not keen on Europe will vote OUT anyway; and if he doesn’t get what he wants, Mr Cameron will vote OUT too. In a speech to the CBI on 09 November, Mr Cameron said: The argument isn’t whether Britain could survive outside the EU; of course it could. The argument is how are we going to be best off…?

David Cameron has set in train a huge political gamble. At question is the future role of the UK in the world – and actually, though the French and Germans do not see it this way, yet – the future of Europe, too.

All because he thought he could steal the Eurosceptics’ thunder. If he were to win on the ticket of renegotiated terms he would give the Tory Europhobe Right nowhere to go and UKIP no reason to live. If the Tories could win back most of UKIP’s nearly four million votes, they would remain in power for a generation.

On 18 November an opinion poll was published asking the expected referendum question: Should the United Kingdom remain a member of the European Union or leave the European Union? 42% of respondents wished to remain IN; 38% wanted OUT and 20% said they were undecided. So this one is wide open. Though I perceive momentum building for an OUT vote.

Le Point in France immediately described Mr Cameron’s demands as chantage – blackmail – and this view on the other side of the Channel is likely to persist. After all, in their eyes, Britain is asking for special treatment by getting derogations – opt-outs – from treaty commitments that successive British governments, including Mrs Thatcher’s, freely entered into. But the fact that the up-market French press has even taken note of Britain’s demands is progress. When Mr Cameron raised the issue of Britain’s renegotiation at a summit in Brussels earlier this year, President Hollande conspicuously used that as a cue for his bathroom break.

On the other hand, Britain has a strong hand to play.

For a start, Britain’s is a big economy – second only to Germany in the EU – which runs a trade deficit with the rest. We are, amongst other things, the largest market for German cars and the biggest consumers, outside France, of Champagne. Would France-Germany wish to jeopardise that? Yet the importance of EU trade to the UK is falling. Goods exported to the EU fell to a record low in April, while exports to other major markets like India and China are growing rapidly. Just 45% of the UK’s exports are now sold to the EU.

Second, Britain is a massive net contributor to EU coffers, the biggest paymaster after Germany. Britain will make a net contribution of £10.4 billion to the EU budget this year, and this is projected to grow by more than £3 billion over the next five years. About 23 of the 28 member states are net recipients of EU funds which is why, of course, they generally do what they are told (though several Eastern European members have put their foot down recently over the compulsory redistribution of migrants). If Britain really were to walk away, EU finances, already creaking, would be plunged into crisis.

So let’s examine each of Mr Cameron’s four gambits.

On EU immigration, Mr Cameron has changed his tune over the last year. Freedom of movement is a sacrosanct pillar of the EU – he realised that there is no way Britain would be able to permit French hedge fund managers to enter the country and yet to bar Slovakian farm hands. So he doesn’t want to limit the flow per se, as Theresa May, Home Secretary, signalled that she wanted to do in her speech to the Tory Party Conference in October. He just wants to limit the right of new immigrants to claim benefits, especially Tax Credits which top up incomes for the low-paid. That way, only people who are genuinely seeking work will come to the UK from Europe.

On 09 November, Downing Street released figures suggesting that 43% of all new EU migrants receive UK benefits – that’s 224,000 out of 526,000 new arrivals over the last four years who receive Tax Credits, Housing Benefit and other welfare handouts. Tax Credits claimed averaged out at £5,000 per family, costing the government an estimated £530 million in 2013[i]. What Mr Cameron wants is a four-year moratorium on all benefits for all new EU migrants.

Yet the issue of paying benefits to newly arrived EU migrants could have been addressed without any agonising treaty change at all. Virtually all EU members style their own welfare systems as contributory – meaning that citizens get paid out in accordance with what they have paid in. The UK system is, in essence, contributory, in so far as, since the advent of the Welfare State under the post-WWII Labour Government (1945-51) benefits are notionally a function of citizens’ National Insurance Contributions (NICs). Even after the new arrangements coming into force next year, your State Retirement Pension will be determined by how much NICs you will have paid. But our system is now described as universal because, as the welfare state has expanded, new discretionary benefits like Housing Benefit and Tax Credits have not been linked to cumulative payments of NICs. Mr Cameron could decree tomorrow, if he wished, by secondary legislation that only people who have paid NICs for four years are entitled to such benefits. And there would be no reason to submit himself to the indignity of a wrangle with Brussels.

This would mean, however, that Britain would have to ban British-born workers from such benefits until having worked for four years. The House of Lords, the Bishops amongst them, where the Tories are in a minority, would probably oppose this just as they opposed Mr Osborne’s proposed cut in Tax Credits. But that has absolutely nothing to do with Brussels.

When I told a French municipal councillor recently that Polish people in the UK claim Child Benefit for children who still reside in Poland, he laughed. That could never happen in France, he said.

On the thorny question of freedom of movement, it will not have escaped readers’ notice that several Schengen area countries, as I write, most prominently France, have re-imposed border controls in view of first, the refugee crisis and second, the IS terrorist attacks in Paris. There is currently a lot of talk in the French press of ditching Schengen altogether. Apparently, EU countries have the right to close their borders in “emergencies”. If net EU migration exceeds a specified level, why couldn’t Britain just declare a state of emergency and close its borders?

On regulation, Mr Cameron opines that there should be less of it. Generally speaking, that is. And yet, the anecdotal evidence is that the UK parliament is quite adept at imposing regulation on the country without help from Brussels. If you speak to Euro hacks, Britain is notorious for implementing EU directives rapidly and unsympathetically, while further south, national parliaments get round to the job in a much more leisured way.

Furthermore, the UK has a record of signing up to measures blithely without fighting its corner. Take the so-called “tampon tax”. In the UK, female sanitary products carry the minimum 5% rate of VAT whereas men’s razors are zero-rated. They are classified as a “non-essential luxury”. Yet there is no VAT on female sanitary products in Ireland – because the Irish simply would not accept it, and they gained an opt-out.

Britain actually enjoyed an opt-out from all European social and employment legislation until that opt-out was surrendered for ideological reasons in the early days of the Blair government.

The Scottish Parliament and the Welsh Assembly have learnt a few tricks about regulation too. In fact, the more levels of government you have the more regulation you will get, since politicians have a tendency to manufacture reactive legislation: that is what they do. Someone gets bitten by a dog: The Dangerous Dogs’ Act, 1997. You might even think this is all right and proper; or you might think it is pointless red tape. But it has precious little to do with Brussels.

Ever Closer Union? No thank you, says Mr Cameron. This is an argument about nothing at all. Politicians spin phrases to bolster solidarity. And this was framed, after all, in the aftermath of the slaughter of WWII. For a country which opted out of the Schengen Agreement and then the Eurozone, it doesn’t count for much. Does Mr Cameron really require an amendment to the Treaty of Maastricht to the effect that all countries aspire to Ever Closer Union except for the United Kingdom? Precisely what would that achieve?

Finally, Mr Cameron wants a guarantee that the Eurozone will not act against the interests of those EU members who retain their national currencies. (That’s the UK, Sweden and Denmark, though Denmark has pegged the Danske Kronor to the Euro anyway. Forget Poland, Croatia et al –they don’t even know what they want).

Now we get to the real problem. It’s one thing to be a member of a common trading area of 28 states, where tariffs and rules are harmonised. It’s another thing to be a member of a common trading area where 18 of those states have a single currency and where, by reason of the internal (and irreconcilable) disharmonies amongst the 18, the entire 28 are periodically de-stabilised, even though there are 10 states which do not participate in the single currency. (Historically, this is simply unprecedented).

When the EU adopted the Euro on 01 January 2002, it effectively became a federation of states whose mutual interests were entwined for evermore. You’ve only got to consider the Greek tragedy – about which I’ve written elsewhere – to see that even though the Euro has condemned Greece to penury, the Greeks themselves can see no way out of the Cretan labyrinth.

A successful monetary union requires, as we now know, not only a common monetary policy, but common banking supervision and capital adequacy regulation. Furthermore, it requires a substantially uniform fiscal policy (aka taxes), universal labour market regulation and almost continuous governmental intervention in the money markets in the event of any disequilibrium. In other words, Ever Closer Union.

On this side of the channel we forget that the Euro was not conceived by economists at all; but rather by politicians. As I explained in a recent piece on the MI website (The Secret History of the Euro’s Birth) the Euro came about as a direct result of the collapse of the Berlin Wall. In a remarkable book, Mitterrand: A Study in Ambiguity, Philip Short reveals that, as late as November 1989, Francois Mitterrand was warning the German foreign minister that the consequences of German reunification could be yet another European war against Germany. The same month, the Soviet leader, Mikhail Gorbachev told Mitterrand that, if German reunification went ahead, he would be toppled by a military coup.

In these extraordinary historical circumstances Mitterrand saw an irreversible common currency as a way of anchoring a unified Germany of 80 million people into Europe, and of spreading Germany’s prosperity across the continent. This currency would not just be shared by France and Germany but by all the EEC (as it was then called).

In a historic secret meeting with the German Chancellor, Helmut Kohl, in the spring of 1990, Mitterrand offered a deal. France would not stand in the way of German reunification if Kohl and the German political class committed, irrevocably, to give up the mighty Deutsche Mark and to replace it with a European common currency.

German reunification then became a dead certainty as soon as Kohl decreed that the Deutsche Mark could be exchanged for the hitherto unconvertible Ostmark at a rate of one-to-one, in July 1990. East Germans queued at banks to unload their useless Ostmarks.

At the Maastricht summit (December 1991 – the same month that the Soviet Union disintegrated) Europe agreed that the new European Central Bank (ECB) would be located in Frankfurt, and that its first president would be a Frenchman.

At Maastricht, John Major, the British Prime Minister, came away with an opt-out for Britain on the single currency project. He explains in his memoirs that, while he could see the merits of the scheme, he was persuaded that the European economies were just too divergent to impose a one-size-fits-all single currency straight-jacket.

Unlike the French and the Germans, the British saw the issue as an economic one, rather than a political one. In part, this reflects the differing intellectual and philosophical traditions of Franco-German and Anglo-Saxon thought. The Franco-German tradition starts with the ultimate goal; while the Anglo-Saxon is empirical (it identifies the practical problems you will encounter in trying to get there). Indeed, much of the problem has been that Anglo-Saxons do think differently – and have radically different legal systems.

In a historical perspective, the British, or more particularly the English, have displayed a long-standing antipathy to currency unions. When King James VI of Scotland assumed the throne of England in 1603 as James I, he wished to unite the currencies of the two nations over which he reigned. But the English parliament refused. It was not until the parliaments of both countries were fused, in 1707, that the Scottish Pound (Pound Scots to purists) was replaced by the Pound Sterling (at an exchange rate of twelve to one). Moreover, while the French maintained a single currency throughout the French Empire in colonial times, the British Empire never imposed a single currency, preferring for each jurisdiction to maintain its own. So a traveller moving from British India to British East Africa would be required to change rupees into shillings.

Clearly, the roots of these attitudes run deep. In any case, the British have never shared what our French and German neighbours call the European ideal. This is a collection of notions around the fundamental righteousness – moral supremacy – of European integration, which consciously rejects the narrow nationalisms of the past. This is alien to the British who see the EU as a set of arrangements with admittedly generally like-minded and culturally similar neighbours. In fact the British don’t really feel European at all. As Churchill said, if we had to choose between Europe and the open sea, we would choose the open sea.

At Maastricht, though, the die was cast. The timetable for the European currency was set and the Exchange Rate Mechanism (ERM), which Britain had joined in the last month of Mrs Thatcher’s premiership, was given the role of stabilising European currencies ahead of the momentous day when all exchange rates would be fixed for good. The following year, however, on Black Wednesday (16 September 1992) Sterling was spat out of the ERM by an FX market that refused to believe that the Bank of England would be able to maintain the Pound at Deutsche Marks 2.95. Sterling fell, in a furious day of trading, to DM 2.30. This was a searing experience which changed the British mind-set forever. It also destroyed the Tories’ reputation for economic competence, and opened the way for New Labour.

As Euroland evolved, two types of EU members emerged: the Eurozone and the Non-Eurozone EU. Most non-Eurozone countries still aspire to join the Eurozone (Croatia, Latvia etc.). The Hungarians and the Poles are more circumspect. The ever-outsides (the UK, Sweden, Czech Republic) are now regarded by the Eurozone as the awkward squad.

And then the British found fault with the management of the single currency, especially after the Financial Crisis.

Germany has been running a current account surplus which now amounts to over 8% of GDP. German exports have risen from 29% of GDP in 1999 to 51% in 2013. That is entirely admirable; but where Germany runs surpluses, its trading partners will run deficits. In a floating currency system, that would not be a problem as the currencies of deficit counties would depreciate. In a fixed currency system, that is not possible. Instead, the deficits accumulate as debt.

Structural reform is barely even under discussion. Furthermore, the Euroland banking sector remains inefficient and undercapitalised. As a consequence of all this, the Eurozone has lurched from one financial crisis to another on its periphery – and its woes are clearly far from over. So long as unsustainable deficits persist, there will be bailouts. Who will pay for them?

On one reading of the Maastricht Treaty, the UK is still obliged to join the single currency by 2020. No one believes now that that will happen – the world, and Europe, have moved on. So there will have to be at least one treaty change anyway!

The OUTs in the forthcoming UK referendum are not just ignorant xenophobes, as they are sometimes portrayed in European media. The British are unhappy because they are shackled to an unstable system which was not of their devising (and which they warned against).

So if those renegotiated terms turned out to be a damp squib the British people may not give Mr Cameron the answer that he hopes to receive. And if Mr Cameron failed to get concessions, it would be bizarre if he then decided to lead the OUT campaign. Moreover, even if he gets all he wants, some cabinet members (Mrs May and Mr Duncan-Smith?) are still likely to join the OUT campaign; so cabinet collective responsibility will be suspended.

The IN-OUT question is not a binary choice. To vote IN entails a preference for the status quo plus or minus whatever revisions to existing treaties Mr Cameron can obtain. A vote for OUT, on the other hand, would be just the beginning of a process of disengagement from Europe. The British government, possibly under Mr Cameron’s successor (since that might be a good moment for him to spend more time with his family) would then begin a process of negotiating the precise terms of Britain’s withdrawal.

We would not only have to negotiate with Brussels but also, since trade policy has been the province of the EU for the last 40 years or more, with all of our other trading partners at the same time. While it seems rational that some kind of free-trade agreement could be achieved between a detached Britain and the EU (would the Germans really risk our imposing tariffs on their cars?) this might be contingent on what deals we strike with the US, China and the rest. This would therefore be a game of multi-dimensional chess in which all outcomes – positive and negative – were possible. We simply cannot be certain what would lie on the other side of this Rubicon.

So, to paraphrase the great Donald Rumsfeld, the choice is between a known unknown and an unknown unknown. If the British people were to vote OUT, there would surely have to be a second referendum on the final terms of Britain’s withdrawal from the EU in which, in their infinite wisdom, they might vote NO. This state of confusion and uncertainty might endure for years. Notoriously, financial markets abhor uncertainty.

Meanwhile, Ms. Sturgeon and her hordes would play havoc with the Union. Even though, if Britain could regain control of her fisheries, Scotland might benefit most. The political settlement in Northern Ireland could be plunged into crisis. We can be sure that any perception of weakness or vacillation by a Tory government would be mercilessly exploited by their enemies. Mr Corbyn, who is agnostic on Europe (he believes, deep-down, that it is a con-trick played on the working class by international capital) could well profit.

Yet the die-hard Eurosceptics will argue that these risks are nonetheless worth taking. Ultimately, they will say, to regain control of our national sovereignty, borders and trade policy and to forego our hefty membership fees will be worth any costs of separation.

I wrote in last month’s MI magazine about how India faces the future with confidence. As does China. Both those great countries have a spring in their step. This cannot be said of Europe where the medium-term economic outlook is gloomy. Quite apart from Europe’s sclerotic growth record, unemployment and its governments’ unsustainable burdens of debt, the continent’s demographics are negative. Germany’s population will soon be falling as rapidly as Japan’s. Deflation has already entered the frame. We are conjoined with a continent in decline.

If Britain could join Switzerland and Norway as members of the European Economic Area, we could retreat to the side-lines. But we would still have to contribute to European coffers and abide by EU regulations. There would still be free flow of labour and capital, so Tory Eurosceptics and UKIP supporters would not be satisfied. Unless we decided to do something bolder; and much riskier.

At the end of WWII, Churchill rebuffed overtures by the Australian prime minister to forge closer economic ties between the Antipodes and the Mother Country. Britain could have created a free trade area throughout the white Commonwealth that would have anticipated the Trans-Pacific Partnership (the TPP, which was finally drafted on 05 October after seven years of negotiations). Instead, weary and broke at the end of the War, Britain let things drift.

Having absented themselves from negotiations leading up to the Treaty of Rome (1957), at which the EEC was founded, the British then sought to join the EEC in the 1960s. Only to be rebuffed by the French. We are now paying the price for an extraordinary lack of strategic planning during the twilight of empire. During this referendum debate we ought to take stock of our mistakes.

If you haven’t worked out how I’m going to vote in the referendum, that’s because, having thought about the subject all my adult life, I still don’t know either. But if cultural Europhiles like me can now even contemplate voting OUT, I suspect the outcome is heading that way.

The timetable will inevitably recede as negotiations seize up. If I were a betting man I’d put my money on a narrow OUT vote in early 2017, with a turnout of less than 60%.

I wish that Mr Cameron hadn’t forced me to make this tortured decision. But when I make my mind up, I’ll let you know.

[i] The Times, 10 November 2015, page 1, Almost half of migrants from EU are on benefits.