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EU of Nations must stick together

Trump wants the EU to break up while May offers a vision of tax nihilism

The beginning of 2017 doesn’t look good for the European Union. But things are at least becoming clearer. In light of attacks from both the US and the UK, the choice between unity and disintegration is registering for Europeans. This is a good thing. Disintegration would result in accelerated poverty and maybe even war, so unity seems like the easy choice. However, tougher decisions lie ahead as unity will be difficult to protect since the EU is facing its own contradictions.

In the last few weeks the EU has had to face two unprecedented attacks. The first is the iconoclastic declaration by an American President that he is expecting more European countries to leave the EU and that it will be a good thing, notwithstanding the risks to worldwide peace. This came along with a direct attack on the role of Germany in Europe. This announcement was preceded by the news that Trump would fast track an exhaustive free-trade agreement with the UK.

The second attack came from Theresa May. On 17 January, she announced that the UK will go the route of ‘hard Brexit’. She confirms that UK will carry out fiscal dumping by cutting corporate taxes if it doesn’t get access to the single European market.

During the Christmas holidays, news surfaced in the UK media that its Queen favoured Brexit, presumably because it would allow the UK to refocus on the Commonwealth. This illustrates to what extent, even at the highest levels, the English never really wanted the EU… and have kept their colonial mindset. Seccessiontist moves from the UK vindicate Charles de Gaulle who always opposed UK membership on the grounds that the UK would never be enthusiastic members. But it is a shame that after 43 years, the EU had not been better at winning over English and Welsh hearts and minds.

Threat to post-war order

Tectonic shifts

Donald Trump’s declaration is a direct affront to the very post-war order that the US helped to foster. Despite all her words of friendship with the EU, let’s be clear: Theresa May’s declaration was a message of economic war to her neighbours. On 18 January, the cover of The Times couldn’t have been more explicit: “May to EU: Give Us Fair Deal or You’ll Be Crushed”. The implied threat is that the UK could turn into a tax haven by lowering corporate tax and regulation to lure as many multinationals as possible away from the EU. This threat is credible: London already has many tools to attract high-powered business away from the continent. All of this points to a new direction in the current world disorder: a stronger Anglo-Saxon axis. Of course this axis has always existed: it is the ‘special relationship’. For years new Foreign Secretaries in Britain visited the US before any European countries. But recent developments have only strengthened this relationship.

The directions the UK and the US have taken make things much clearer for Europeans in 2017. With an assertive Russia in the East, the risks of an isolationist and erratic America in the West, an ascendant China and the protectionism that would follow the implosion of the EU, disintegration would almost certainly lead to poverty and even war. So naturally, Europeans should choose to stick together.

Regarding negotiations with the UK, the choices are easy too, at least on paper. With the EU, the English at least want to have their cake and eat it too. Theresa May’s premise is that the EU is desperate for access to the UK market because the UK is the fifth economic power in the world. But this is partly because France and Italy are so weak. While Sweden, Denmark, the Netherlands and Germany have done so well in international markets, it is baffling to hear that the UK thinks EU membership has held it back. May plainly puts the blame for UK failures on the backs of others. The UK has a number of its own problems holding it back, including the fact that it has no industrial policy. In addition, UK internet, telecom, road and train infrastructure is sub-standard; healthcare is on the point of collapsing; the regions are emptying out to London; many economic sectors are uncompetitive and the ones that are competitive overlap with those in America. The irony is that in the end, the UK’s weaknesses and new direction may well backfire on Brexit voters or at least on the least advantaged – and angriest – in the UK. It is clear that the slightest concession in the name of economic interests would create a precedent that would lead more members to leave the EU. The UK tax-haven threat is only credible if UK-based firms get free access to the single market. If they did not, none would choose to invest in the UK to trade with the EU. And EU companies and countries can work even harder to become innovation hubs that would mitigate any advantage of being based in the UK. It is slightly reassuring that the President of the German Industrial Association recently declared that German industrialists will not lobby their government to make concessions to protect their access to the UK market. But in practice, since European politicians have always bowed to Britain, I am not sure we can count on firmness.

Are the populists on to something?

But it would be foolish automatically to dismiss the new positions in London and Washington, even if they are both arrogant. They highlight an uncomfortable truth for the European political establishment, and the tough choices that lie ahead for the EU if it wants to survive. The difficult choices are about how we will stick together.

What the UK have been saying for a while, without being listened to, is that continuing on the same federalist track will drive the EU into a wall. The EU has been much too casual and naïve in the way its institutions are disconnected from citizens. It suffers from a lack of inspirational leadership. It has had a hard time dealing with European differences and identities, and regrettably the Euro and Schengen, its two sacred cows, are economically crushing tens of millions of EU citizens and putting hundreds of millions at risk to terrorist attacks. What Donald Trump is saying is that this federalist track is increasingly Germanic. Both governments are referring to the elephant in the room in Europe so why are we shocked? I’m afraid it is not because Mr. Trump is wrong about the role of France and Italy in our precarious European situation!

Germany is now the dominant nation in the EU. Of course, Germany courageously engaged in bold structural reforms under the Schröder government while many other countries including France and Italy did not. But its strengths and the growing competitive gap with many others has fostered a neo-mercantilist trade policy at the expense of its neighbours. And without independent monetary policies, the growing competitive gap with Germany is now almost impossible to close for many European states. The alternative is ‘internal devaluation’ i.e. significant cuts in the wages and standards of living of millions of European citizens. This fuels the growth of inequality between the haves and have-nots even under the European project. This also fuels the growing wave of populism across Europe. The Euro straightjacket will kill the EU in the end if faster growth does not kick in. But German fiscal orthodoxy imposed on its neighbours perpetuates the stagnation. People in the UK were horrified by German intransigence towards Greece in the summer of 2015. That also played a role in the Brexit vote. The refugee crisis didn’t help though the ultimate blame for that lies with the US and the UK which unnecessarily destabilised the Middle East against the wishes of Germany, France and Russia in 2003. That is why the UK’s refusal to welcome refugees is so hypocritical. Illustrating its growing unilateral stance, Germany’s decision to welcome millions of refugees has generated a crisis for many of its neighbours and exposed the inability of Europe to properly control its outer borders. Further public disillusion is unfolding, especially with the ongoing threat of terrorism. It is increasingly clear that the borderless Schengen area, allows terror groups to move around the continent with ease.

Trouble in France and Italy

Pitfalls

Moreover Germany is not the only culprit. The EU used to work well when powers were balanced, i.e. when France was an equal partner and Italy was more dynamic. This is no longer the case, and the departure of the UK further accentuates the lack of balance. With a succession of inept governments, France has gone from bad to worse in the past thirty years. Entrenched in what I would call a “parasite economy,” a system where roughly 60% of the French work hard to subsidise the other 40% who survive thanks to the State, everybody is desperately clinging to their own privileges and the country is now economically and socially ossified. The business elite has totally failed to change the course of things and to win over the heart of French people. Citizens are no longer protected in their daily lives and Paris has become a city under siege. The comparison with 1789 is worrying. If the incoming government does not start to turn this situation around after May, the spectre of civil war in France is increasingly real in the next five years.

In a similar vein, Italy has lost its élan. And it is unable to reform just like in the past. But the difference now is that it no longer has monetary policy to fall back on. Because of intense off-shoring to low-cost countries, most Italian firms have also lost their ‘made in Italy’ quality advantage.

What the tough choices are about

To protect the EU and stick together, tough choices are increasingly urgent. Which EU model do we want? Do we want more of the same, i.e. a more federal EU disconnect with its citizens’ hearts and realities and which might ultimately collapse, or the return to a looser but more sustainable federation, a Europe of Nations that safeguards the essentials of the EU (free trade and investment; extensive military, cultural and legal cooperation) by giving Member States much more freedom? I believe European politicians will choose more of the same, especially since the UK no longer stands in their way. But I predict that further dangerous cracks in the EU’s foundation will appear in 2017 and beyond.

Mainstream European politicians would be wise to trade their rigid ideology for more pragmatic common sense and to start listening to their constituents. As a great supporter and beneficiary of the EU, I really hope they will steer clear of the extremes that are gripping the UK and the US which would destroy the EU and our values.

Business leaders who benefit from the EU should make it a priority to protect the EU’s interest. They should refrain from lobbying in favour of the UK in the upcoming Brexit-related negotiations. They should resist playing tax games. They should accelerate public-private partnerships to advance science, education and innovation in the industries of the future so that Europe remains competitive enough to make UK threats irrelevant. They also need to become closer to average citizens and make the case for the EU. Annual and CSR reports are not doing the trick!

Stéphane J. G. Girod is Professor of Strategy and International Business at IMD.