EU’S BREXIT PROVOCATIONS

One for all, and all for one! UK now turns to Five Eyes, an alliance comprising Australia, Canada, New Zealand, the United Kingdom, and the United States. These countries are bound by English language, common culture, freedom, and the best standards of living on Earth.

German business associations are calling on the EU Commission to end its Brexit provocations. An unorderly Brexit would entail enormous costs for the German economy, the President of the German Chambers of Industry and Commerce (DIHK) warned; therefore an amicable Brexit agreement with London must be reached. The Federation of German Industries (BDI) expressed a similar view. The head of the EU’s Commission’s recent audacious financial demands and deliberate indiscretions have stirred massive resentment in the United Kingdom and were rightfully considered an attempt to influence Britain’s upcoming parliamentary elections. Observers attribute these indiscretions to EU Commissioner Jean-Claude Juncker’s German Chief of Staff, Martin Selmayr (CDU), who is currently playing a key role in the Commission’s Brexit negotiations’ preparations. The German Chancellery is now calling for restraint in view of the severe damage a hard Brexit could entail for the German economy.

Though it is hard to predict how a bargaining game involving strong emotions as well as economics will play out, we can offer some conjectures about what will happen. These conjectures are mostly based on what we have called the law of distance — the observation that the interactions between two countries are proportional to their sizes (GDPs) and inversely proportional to the distance between them.

Distance, in this sense, is not just physical distance but also cultural distance (e.g., whether two countries have different/similar official languages) and administrative distance (e.g., the absence or presence of a historical colony-colonizer link between the two). The law of distance has been associated with some of the most robust results in international economics, which is why it underpinned the UK Treasury’s generally well-regarded analysis, a year ago, of the long-term consequences of Brexit.

German businesses are complaining about the EU Commission’s recent provocations: On the one hand, the deliberate indiscretions concerning confidential talks on April 26 in London between the British Prime Minister, Theresa May, the President of the EU Commission, Jean-Claude Juncker, and their respective closest collaborators in preparation of Brexit negotiations. The alleged contents of the talks were leaked to a German newspaper, which published a detailed report, spiked with assessments, presenting the British government as blind to reality, uncompromising and disunited.[1] Juncker’s statements, reproduced in the report, are rightfully regarded in Britain as an attempt to tarnish Theresa May’s conservative government and thereby reinforce EU-oriented forces, particularly among the Liberal Democrats and segments of the Labour Party during the election campaign – apparently to no avail: The obvious attempt to interfere in the country’s internal affairs has stirred massive resentment in the United Kingdom. In last week’s local elections in various parts of the country, all pro-EU parties, except the Welsh Plaid Cymru, lost mandates, whereas the conservative party made substantial gains. In spite of the significance of particularities in local elections, this is regarded as an expression of the wide approval for May’s political course.

Outside EU, the world is UK’s oyster, and the Commonwealth remains that precious pearl within. UK might be able to gain more from a free hand in negotiating with the Commonwealth — former British Empire states such as Canada, Australia, India, and South Africa — than it might lose in terms of limited access to EU. The GDP of the rest of the Commonwealth is only 55% as large as that of the rest of EU.

UK has a common official language (English) with 91% of the rest of the Commonwealth (on a GDP-weighted basis) and a colony-colonizer link with 99%, versus only 2% on both factors with the rest of EU. Based on estimates that a common language normally boosts trade by 2.2x and that a colony-colonizer link has a multiplier effect of 2.5x, the joint effect of the two (5.5x) in boosting market potential in the Commonwealth is substantial.  UK on its own has the leverage to achieve better terms with the Commonwealth countries than it currently enjoys with the EU. Consider that Britain accounts for only 16% of EU GDP.

Moreover, the tenor of the relationship between the UK and the EU is not good: Compare Britons insisting that the UK could exit without paying a brass farthing versus the EU’s claims for £50 billion or more. Consider the combative personalities of some of the key negotiators. Add in the consideration that Brexit, even if accomplished with a maximum rather than minimum of goodwill, will hurt Britain’s trade with EU for purely technical reasons, and it seems safe to predict that there will be a deterioration of trading relationships with Britain’s largest natural market; the only question is to what extent.

Given that relatively safe prediction, the natural next question is which industries and companies are likely to be hurt the most and therefore face the greatest need to reconsider their current operating models. Brexit is likely to change the most is the administrative distance between the UK and its former partners in EU. This suggests that industries with a high degree of sensitivity to administrative distance are likely to be affected the most — unless, of course, the provisions under which UK-based operations can access EU markets happen to be eased the most for them.

London has taken note of the special role Germany is playing in this affair. The indiscretions were published in a German newspaper and were probably leaked by the German EU official Martin Selmayr, a member of the CDU. Selmayr is Commission President Juncker’s Chief of Staff, and, according to reports, he is closely allied with Chancellery Minister Peter Altmeier. He is considered to be Juncker’s most important prompter, having a “tight grip” on the Commission, according to observers. (german-foreign-policy.com reported.[2]) He also holds a prominent position in the Brexit negotiations: Last October, Juncker mandated him to conduct regular preliminary talks on the Brexit negotiations with London. In the meantime, Selmayr has repeatedly announced that “Brexit will never become a success,”[3] thereby following Berlin’s suggestion that the Brexit could possibly have a deterrent effect on EU critics in other member countries. Selmayr is suspected of having leaked the recent indiscretions, because they contained also those parts of the confidential talks in London, in which only he and Juncker had participated on behalf of the EU. Michel Barnier, the chief Brexit negotiator, and his deputy, Sabine Weyand, joined the talks only later on April 26. Alongside Selmayr, trade expert Weyand is the second German in a decisive procedural position in the Brexit negotiations.

Alongside this indiscretion, the most recent hike in the amount Brussels is demanding that London pay for its exit from the EU is being met with resentment in Great Britain. Even the 60 billion euros, mentioned a while back must be seen – to put it mildly – as an unrealistically exorbitant starting point for the negotiations. Last week, the commission increased the amount even further, to €100 billion, according to which, two years after its exit, the United Kingdom is to pay, for example, agricultural subsidies for other EU countries, as well as EU administrative costs, alongside co-financing both the European Central Bank (ECB) and the refugee agreement with Turkey. On the other hand, London would not be able to lay any claims to its share of the EU’s assets.[4] Observers suppose that these unorthodox demands have been ultimately raised to increase pressure on London’s government and lower its re-election possibilities in favor of EU-oriented forces – until now, to no avail.

Instead, Brussels’ provocations are now leading to public complaints from the German economy. Britain is its third largest sales market for the highly export-dependent German industry and its second largest foreign investment site. At a time when business with important business partners is suffering – due to sanctions (Russia) or political tensions (Turkey), when trade with its most important ally, the United States, has become unreliable with the recent change of government and its number one sales market – the Euro zone – remains deeply embedded in a crisis, German business associations are adamantly refusing to take on any more risks.[5] “Now, it is important not to smash any more porcelain during the talks,” warns Dieter Kempf, President of the Federation of German Industries (BDI), in reference to Brexit negotiations. “Reason and pragmatism” must be the guidelines for “both” negotiating partners.[6] One should not forget “that the Brexit will come at high costs, also for the German economy,” warned Eric Schweitzer, President of the German Chambers of Industry and Commerce (DIHK). An unorderly Brexit, in which merely WTO standards apply between the EU-27 and Great Britain, trade between Great Britain and the EU would engender trade tariffs of around twelve billion euros. Because of the extensive exports to the United Kingdom, this “would engender an enormous additional strain, also on German enterprises.”[7]

Correlated indicators of administrative sensitivity include industries that are subject to high levels of regulation, produce staples or entitlement goods or services, are large employers or suppliers to the government, include national champions, are construed as vital to national security, control natural resources, or require large, irreversible, geographically specific investments. Other markers of industry sensitivity to Brexit include high levels of scale economies that need to be amortized over international regional markets, rather than just by national markets; high levels of trade-dependence on either the export or the import side; and belonging to the service sector.

At the company level, there are some additional attributes that seem likely to be associated with high degrees of exposure to Brexit. Companies with particularly high levels of export or import-dependency in relation to their competitors are likely to be hardest hit. Small firms that aren’t yet exporters or importers are also likely to be hurt more, at least in terms of a narrowing of their opportunity sets: Such firms typically look nearby for their first international transactions. And even where products or services aren’t flowing across borders, companies that use Britain, particularly London, as their regional headquarters for serving all of Europe (e.g., many U.S. multinationals) are likely to need to reconsider basing that role there — as may, for that matter, companies that use London as their global headquarters, especially if most of their business is outside UK.

The British companies that may have private reasons to cheer are those focused on UK that are trying to hold off regional or even global competitors at home. Which is a reminder of the importance of granularity in forming such assessments — not all companies within the same industry, let alone all industries, will be affected in the same way. Similarly, in terms of what is to be done, once again, the appropriate response will be predicated on the specifics of a company’s situation.

Over the weekend, the first calls for restraint had been heard in Berlin because of complaints from within business circles, and the fact that the EU provocations seem to be backfiring in the United Kingdom. Chancellor Angela Merkel made known that she is “upset” about Commission President Juncker, because “his failed Brexit dinner” has only made the climate worse between Brussels and London.[8] The German MEP Ingeborg Grässle (CDU), chair of the European Parliament’s budgetary control committee, criticized Juncker in the name of the European Parliament. “It is time that the EU Commission presents a bill comprehensible for everyone,” she demanded in view of the sum London has to pay for the Brexit. “We want to maintain good relations with the British.” The most recent demands – a good example of the EU Commission’s dealing – are “completely exaggerated.”[9]

NOTES

[1] Thomas Gutschker: Das desaströse Brexit-Dinner. http://www.faz.net 01.05.2017.
[2] See Eine nie dagewesene Machtkonzentration.
[3] Florian Eder, David M. Herszenhorn: Brexit will never be a success: Juncker’s top aide. http://www.politico.eu 05.05.2017.
[4] Hendrick Kafsack: Ich will mein Geld zurück. Frankfurter Allgemeine Zeitung 04.05.2017.
[5] See A Dangerous Game and Auf brüchigem Boden.
[6] BDI fordert Pragmatismus im Brexit-Poker. http://www.handelsblatt.com 06.05.2017.
[7] DIHK warnt vor hohen Brexit-Kosten. http://www.dihk.de 04.05.2017.
[8] Merkel verärgert über Juncker nach Brexit-Dinner. http://www.spiegel.de 06.05.2017.
[9] Andre Tauber: Wie hoch ist der britische Anteil am EU-Vermögen? http://www.welt.de 07.05.2017.

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