EU-UK Trade Will Continue Because Germany Needs It To

By: John_Mauldin

BY JACOB SHAPIRO : British Prime Minister Theresa May has signed a letter officially invoking Article 50. That starts the process of the United Kingdom's withdrawal from the European Union.

Almost a year has passed since 52% of British voters opted to leave the EU. But the process for separation has now been initiated. The next issue is how to understand what will happen during the two years of UK-EU negotiations that lie ahead.

Three important observations should be kept in mind.

• First, the British economy did not collapse because of Brexit, nor will it.
• Second, the UK has significant leverage in upcoming negotiations with the EU. This is because the EU needs a relationship with the UK more than the UK needs the EU.
• Third, the formal triggering of Article 50 opens a Pandora’s box of problems in the United Kingdom itself.

Doomsday Forecasts Didn’t Come True

The anticipated demise of the UK’s economy post-Brexit turned out to be greatly exaggerated. There was no shortage of doomsday forecasts circulating in the lead-up to last June’s vote.

It’s true that in the weeks after Brexit the British pound lost 10% of its value. But none of the doom forecasted by the government of former Prime Minister David Cameron materialized.

In fact, the UK’s GDP growth in the fourth quarter of 2016 was 0.7%. That exceeded expectations and was higher than the three previous quarters.

None of this is to say that Britain’s Brexit experience will be without negative consequences. But those challenges will be surmountable.

In many ways, Britain’s trade position was already changing even before the Brexit referendum. The histrionics leading up to the vote had less to do with reality than attempting to scare British voters into choosing to remain.

These overstatements failed to sway British voters. They also had the effect of drawing even more attention to Britain’s “carrying on” after Brexit.

The UK’s Leverage Against the EU

Other countries reconsidering their place in the EU not only see a member leaving the union, but also one that faces few of the negative effects that many asserted without sufficient evidence.

Much of the media coverage will now turn to upcoming two-year negotiations between the UK and the EU. This entails negotiations not between London and Brussels, but rather London and Berlin, where the EU’s real power resides.

Both will take strong positions. Many will use various statements and leaks from these negotiations to show how badly Britain will be affected. They’ll say the forecast for doom was not wrong… just early.

The important thing to remember is that the UK is not without significant leverage in negotiations with Germany.

In 2015, about 32% of British exports went to the EU. About 10% of British exports went to Germany. Neither of those figures is insignificant. But two things must be kept in mind. First, exports make up about 27% of the UK’s GDP.

Second, the largest single export destination for Britain that year was the US, at 15%. Britain also can look to the former Commonwealth countries to increase trade if necessary.

Germany’s Dependence on Trade with the UK

By comparison, exports make up just under 47% of Germany’s GDP. Germany has relied on increased trade with the US and the UK to offset sluggish growth in the EU and declines with China.

What that means is that the EU (and Germany in particular) needs a cooperative trading relationship with the UK This is not a zero-sum game in which Germany can bring the UK to its knees and scare EU countries into avoiding a reconsideration of their own relationships with the EU.

The optics of the EU attempting to punish the UK for exercising its legal right to withdraw would not play well. The EU is already being ignored by many of its member states. That includes France on budget deficit rules, Italy on bank bailout rules, and Hungary and Poland on migration rules.

The negotiation will be tough, and both sides will likely have to make compromises. Trade will proceed—perhaps not exactly as before, but without systemic collapse on either side.

Scottish Independence: The Biggest Threat for the UK

The real and most dangerous consequence of all this for the UK has less to do with the EU than with the UK’s future as a united kingdom. Scotland’s parliament has already voted in favor of another referendum on Scottish independence.

Similar overtones are resonating out of Northern Ireland.

Many dismiss Scottish independence as fantasy for two key reasons, and there is merit in this diagnosis. First, except for a brief period immediately after Brexit, polls on Scottish independence have remained slightly opposed to independence, hovering at 55–45% against.

Polls must be taken with a grain of salt, even accepting that referendum results in 2014 are a reliable data point. Still, that opinion polls have remained consistent is notable.

Second, the economic viability of an independent Scotland is unclear at best. This is especially true since the EU has made it clear it would not welcome Scotland with open arms. The EU fears the precedent it would set for other breakaway regions in EU member states.

Dismissing these desires in Scotland or Northern Ireland misses the point. It means, at least in Scotland’s case, that almost half of the population wants independence. It may not be enough to win a referendum. But it is still a sizable share of the population.

What Is the United Kingdom?

Brexit has renewed an old question: What is the United Kingdom? The answer is a group of different nations whose fates can theoretically be separated by choice. The fact that they have been joined together for centuries is less remarkable than the fact that even after centuries, the feelings of national difference remain potent.

In a world where multinational institutions are under general stress, the potential for a change of opinion cannot be ruled out. After all, the Cameron government thought it had the Brexit vote in the bag.

The consequences of overconfidence when the outcome is uncertain can be unexpected. This is an issue not just for the UK, but also for other states in Europe, such as Spain or even Germany. The UK may be a forerunner in more than one way.

Meanwhile, lurking behind all of this is the continued reorganization of Europe (and the world) around national interests.

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