Why the EU27 should not punish the UK for leaving

Matthew Sinclair // 30.06.2016

There has been some talk of the rest of the EU attempting to punish the UK for leaving. The idea is that the institutions need to deter other exits and will accept some additional economic costs in return for imposing a visibly bad deal on the UK.

The means to do that might be to take advantage of desperation for a deal in the UK to insist on a settlement that limits market access for London financial services, for example. Some Member States would hope that some activity might be relocated to their jurisdiction as a result.

The economic impacts of such a strategy would be dismal. Frankfurt or Paris are not going to replace London as an international financial centre, they do not have the scale or wider competitiveness, and an attack on the UK is more likely to see activity relocate to New York or an East Asian financial hub.

Corporations in the EU27 would suffer a serious blow to their competitiveness as the quality-adjusted cost of financial intermediation which every major business depends on increased.

Of course, that does not mean it will not happen. EU27 governments might conclude the political stakes are high enough it is worth the economic risks. The project is at stake. I think that would be a mistake though. Punishment would be counterproductive in its own terms.

Four factors in particular should give EU27 governments pause:

1. It could cause a new asymmetric shock, exacerbating the internal stresses in the Eurozone. Economic crises are inherently unpredictable. Who knows what might tip Greece, or Spain or even Italy over into a fresh crisis? Throwing additional spanners in the gears of the European financial system is a good way to worsen the odds.

2. The visible difference between the impact in the UK and EU27 will not necessarily be the one intended. It is possible, for example, that you might create a stagnation in the UK but a panic in one or more Member States, where the political situation is more fragile. Even if the overall economic impact is greater in the UK, you might still create a scenario which looks to voters like exit was the right option.

3. It would undermine the spirit of the European project. Brexit, the Eurozone crisis and the Schengen crisis have all combined to weaken the spirit of optimism that characterises the EU at its best. Many Europeans still feel warmly about the institution and associate it with peace and modernity (it is an institution Member States choose to remain a part of, not one they are scared to leave). The UK leaving can be presented as a sad, but not entirely unpredictable, result of long-standing differences in institutions (and its particular status as a non-member of the Eurozone or Schengen). It does not have to call the nature of the project into question, but a protracted battle with the UK might.

4. Nations with particularly strong trading relationships with the UK would be put in a very awkward position. Does anyone want to force Ireland, for example, to choose between its second largest trading partner (after the US) and its EU membership? There is no need to force that choice at all, but a punishing deal might do so, particularly if the conflict escalated.

There are enormous obstacles to other Member States following the UK course. An overreaction to the UK leaving is more likely to hurt than help wider EU stability.

Matthew Sinclair is Head of Economics at Westbourne Communications.

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