In the pre-dawn hours last Friday, Europe was hit by a political and economic earthquake that reshaped the continent, knocking Britain off the continental shelf and pushing it farther into the North Sea. Europe, allegedly, is no longer one.
The earthquake was triggered by Britain's historic veto of a new European Union treaty that would have enforced fiscal discipline, and eventually fiscal unity, among all 27 EU countries, Britain among them. British Prime Minister David Cameron delivered his resounding "No" because he was unable to secure the safeguards he wanted for his country's vital financial services industry.
Since that dramatic moment at the EU summit in Brussels, politicians and commentators across Europe have pronounced Britain's move disastrous, that it has lost its seat at the European negotiating table, and that retaliation from Europe will damage Britain's economy. On Tuesday, European Commission president Jose Manuel Barroso joined Mr. Cameron's critics, saying that the Prime Minister's demand "was a risk to the integrity of the internal market" that made compromise "impossible." All of the EU countries, save Britain, will now create their own fiscal pact, leaving Britain isolated.
But Britain's move is geared to protecting its national interest, and predictions of economic hardship on the fringes of the EU remain far from proven. And distancing itself from the euro zone – the 17 EU countries that share the euro – may prove beneficial, given its declining fortunes as the debt-crisis juggernaut flattens one country after another.
Britain's financial services industry was behind the Britain-Europe rupture. Although the banks were the source of enormous pain – Royal Bank of Scotland PLC and other major players were partly or almost entirely nationalized in the 2008-09 financial crisis – their presumed revival would go a long way toward restoring Britain's lost fortunes.
The industry, according to TheCityUK trade group, contributed £124-billion ($198-million) to British gross domestic product in 2009 (and that was a down year), equivalent to 10 per cent of overall GDP. It had 1.6 million employees. There is no doubt London vies with New York as the world's leading financial centre, and in some areas (international initial public offerings, for instance) surpasses it. Mr. Cameron's argument is that another barrage of European-inspired financial regulations, notably the transactions tax championed by French president Nicolas Sarkozy, would damage its most valuable industry.
Andrew Smithers, founder of the London investment firm Smithers & Co., said any other European country with a world-scale industry would have done the same. It would be unimaginable, he said, for France to dismantle the Common Agricultural Policy given the prominence of farming in the national economy and psyche. "The EU has to be sensitive to these things," he said.
Britain could face retaliation from the France, Germany and the other EU countries that supported the new fiscal pact. But how serious is that threat? With recession looming in large swathes of Europe, more trade is essential. Europe is unlikely to cut off Britain, and Britain is unlikely to leave the EU – another prediction made by some commentators this week. That's because about 40 per cent of its trade is with other EU countries (Britain's weak spot is trade with high-growth Asia).
On Tuesday, Britain showed that its exports are rebounding. According to the Office of National Statistics, exports of goods rose to a record £26.5-billion in October, while imports fell, narrowing Britain's trade deficit by the biggest amount since 1998.
Exports are up in part because sterling is down. Countries with their own currencies have a huge advantage over those in the euro zone, which is ruled by a one-size-fit-all monetary policy. Britain can print money and inflate or deflate sterling's value. Countries without their own currency have no such flexibility. Deprived of their ability to print money, hard-hit countries such as Greece, Ireland and Portugal are going through a painful internal devaluation that is crunching growth and eliminating jobs.
It's almost impossible for a country with its own currency to go broke or stay in deep recession for a long time. Note that Standard & Poor's has put all of the triple-A rated euro zone countries, including France and Germany, on notice that their ratings might be cut.
Britain has a lot of problems. Unemployment is rising. In October, the jobless rate hit 8.1 per cent, the highest in 17 years, and could go higher as the euro zone stumbles into recession. Its budget deficit, forecast at 8.2 per cent in 2012, is twice as high as Italy's. Inflation is running uncomfortably high, at more than double the Bank of England's 2 per cent target (though it's coming down somewhat).
And now, it is, allegedly, a pariah state in the EU, suggesting that retaliatory measures – yet to be defined – could damage its fortunes even more. But Britain is not leaving the EU. It had no choice but to protect its financial services industry. Every country in the EU, including Britain, has better things to do than worry about who is inside and who is outside the European tent. Fixing their economies has to be their priority.