No economy is an island: why Britain's finances now depend on Europe

Weak growth in Europe turned Britain into a safety deposit box, but that may soon change.

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If you believe Mark Rutte, the prime minister of the Netherlands, the Brexit vote has plunged Britain into chaos. The UK, he concluded a few days after the referendum, “has collapsed politically, ­monetarily, constitutionally and economically”. In terms of politics or the constitution, he may well be correct. But monetarily and economically, this view is wrong (or at least incomplete) in one crucial respect. It fails to see that no country’s economic fate is determined unilaterally. What happens next elsewhere – and in the eurozone especially – will be just as important as what happens in the UK.

Money and people have flowed to Britain from continental Europe over the past half-decade. The most cursory glance at the employment roster of any hospital in the country, or at a graph of London house prices, will show you that. The tabloids love lurid stories about Russian oligarchs and Chinese princelings waging bidding wars for Knightsbridge penthouses. Yet the truth is that Spaniards, Italians and Greeks have almost certainly been a much larger and more influential constituency.

This reminds us of something important about the UK’s post-financial-crisis boom and its status as a location for investment and a safe haven for savings – and, in particular, about London’s coronation as the first city of Europe. It is not Britain’s uniquely sound economic policy framework or its stellar growth rate that has sucked in Europe’s best and brightest and hoovered up a lot of European capital. In the UK, relative to economic history, recent growth has been quite weak. Rather, Britain’s post-crisis attractions have owed much to the way that the eurozone has been stuck in a near-depression.

In international finance, everything is relative. So although it is true that one of the crucial factors determining our economic future will be whether the next government can safeguard the UK’s reputation as a sound place to live, to litigate and to invest, another is what the competition will have to offer. And, given the eurozone’s lacklustre performance over the past few years, it is possible – perhaps inevitable – that the competition is about to get a lot tougher.

That may sound like a brave statement, given the consensus that the Brexit vote has pitched the EU into an existential crisis. It is true that the three most important eurozone countries face a succession of tough trials over the next 18 months. The first and most dangerous is the Italian constitutional referendum, to be held no later than 6 November.
The details of the issue at stake – whether to concentrate more power in Italy’s lower house of parliament – are, in a sense, not that important. Given the rising popularity of the anti-establishment Five Star Movement, the vote will, in effect, be on a motion of no confidence in the government.

Unfortunately, confidence is not running high. Italy’s performance since the crisis has been dismal, with GDP still roughly 8 per cent lower than at its peak. A tentative recovery began in 2015, only for the bad debts heaped up since 2008 to overwhelm the country’s banks again this year. The government has tried to intervene but Brussels has nixed the idea. It is hardly the ideal backdrop to Prime Minister Matteo Renzi’s referendum campaign; in such circumstances, there is much potential for a protest vote. The Five Star Movement, an unknown quantity in terms of national government, appears well positioned to carry the popular vote in a subsequent general election.

The next important staging post for the eurozone will be the French presidential election in spring. Marine Le Pen, the anti-EU and anti-euro leader of the Front ­National, is a close second in the polls. The Brexit vote has given her party’s platform some credibility: what previously seemed to be little more than the fantasy of cranks has become a reality across the Channel.

Finally, there are the German federal ­elections in September or October 2017. German politics has so far proved more hostile to anti-euro parties – understandably, for the country that has benefited most from the single currency. Nevertheless, even in Germany, the Eurosceptic ­Alternative für Deutschland party is notching up double digits in opinion polls. Only a definitive pro-euro mandate will secure the eurozone’s future.

It all adds up to a year and a half of living dangerously for the eurozone. Renzi may lose his referendum; Le Pen may triumph in France; even in Germany, support for the euro may ebb. If so, the drama of Brexit will come to look like small beer. The UK may retain its attractiveness as a safety deposit box for southern Europe. But the gravitational pull of a eurozone in crisis will be a far more powerful and negative force.

Yet those whose fortunes have waxed with the UK economy over the past half-decade should also think carefully about other possibilities. What if Italy does devise a way to cure its banks and Renzi wins his vote? What if Le Pen, like her father before her, falls at the final hurdle? What if Germany’s adaptable electoral system once again proves capable of accommodating and co-opting the more extreme views from the ends of the spectrum?

Then the wheel of fortune may turn. The UK will be past the peak of its housing and business cycles; the eurozone will at last be on the up. Eurozone investors who snapped up UK property in 2011 will revisit the valuation of real estate across the continent and ask themselves why they shouldn’t sell their flat in London and buy two in Rome instead. The tide of capital will reverse – and the tide of people, too.

The UK faces a changed environment after the Brexit vote yet it is how the cards fall in the eurozone, not in the UK, which will probably make the biggest difference. However things turn out, it is likely to be the end of Britain’s post-crisis economic model. That might be no bad thing. 

Felix Martin is a macroeconomist, bond trader and the author of Money: the Unauthorised Biography

This article appears in the 21 July 2016 issue of the New Statesman, The English Revolt