When David Cameron presented his demands for a renegotiation of Britain’s relationship with the EU to Donald Tusk, the debate in British media focused on the question of how far the prime minister had “caved in”. The current demands to limit welfare claims from EU migrants were seen as a retreat from former Tory positions which were aimed at a much broader restriction of both in-work and out-of-work benefits for migrants.
Consequently, commentators were quick to conclude that now chances for an agreement between Britain and the EU have increased, as supposedly the other of Mr. Cameron’s demands (safeguards for non-euro members; focus on competitiveness; exclusion of Britain from a goal of an “ever closer union”) were much less controversial.
Yet, this conclusion might be overly optimistic – and not only for the political reasons my colleague Almut Möller outlined last week. In fact, this conclusion fails to understand the economic logic of the interaction of the single market and the eurozone. While at first sight, protecting the single markets for those who are not in the euro might sound uncontroversial, upon closer inspection, it is something that Paris and Berlin cannot agree to – at least not if they want to get over the still lingering euro crisis for good.
In 2012, in the midst of the euro-crisis, we argued in an ECFR policy brief that the euro-crisis would leave the single markets either reduced in depth or in reduced geographical scope. Our argument then was: to save the euro, more integration is necessary. Yet, this integration might be unacceptable for some of the euro-outs. Hence, either the euro would break or some euro-outs would start to reassess their costs and benefits from EU membership, eventually leaving the EU.
This point still holds true as before: While the eurozone has moved forward towards much more integration, it is not completed yet. Most economists agree that even more integration will be necessary to make the common currency work without falling back into crisis. On top of the list is the banking union. The common resolution framework and the banking union’s common resolution fund have not been tested. The common resolution fund is laughingly small. Most experts say that at least a common deposit insurance is necessary. In order to make the whole framework really crisis-proof, more bank regulation will be necessary which might further crack the single market along the outside borders of the eurozone.
One example: It is conceivable that the eurozone decides that government bonds in the future should be backed by bank equity and taken into account when computing capital adequacy ratios and this is a demand which is widely discussed. After all, the euro crisis has shown that eurozone bonds are not risk-free: As none of the eurozone countries has control over their own central bank, at some point a country might be forced to default (as has happened in Greece). From a prudential regulation point of view, it is thus only logical to ask banks to hold capital to be prepared for such losses.
This argument does not hold for Britain: As the country still has its own central bank and its parliament can always require the Bank of England to print money to service the country’s sterling debt, UK gilts are actually free of default risk. Hence, for Britain, it makes sense not to have gilts backed by equity capital. Of course, there then might be the risk of inflation, but in contrast to an outright default, this does not endanger bank stability.
Yet, a regulation that forces eurozone banks to back their holdings of government bonds with equity capital, but allows British banks to not do so (and hence would increase costs to eurozonezone banks, but not to British banks) would clearly be inacceptable to the financial sectors in the eurozone and thus also to the national governments there. So, here, only two solutions are conceivable, both not acceptable to Britain: Either such a rule is introduced for the EU as a whole (which would increase costs for British banks alongside with eurozone banks) or eurozone banks need to be protected against British competition in other ways.
This is just one example how British interests in protecting the integrity of the single market of 28 countries and the eurozone’s wish to move forward with more integration might clash.
Giving Britain (and other euro outs) a right to veto such regulations would mean that Berlin and Paris will not be able to move towards completing the monetary union. This should be unacceptable to any German or French government which takes the task to protect its own country seriously.
Cameron here should remember that for the eurozone governments, the stability of the eurozone is more than a politically important, yet economically marginal question of having to pay or not to pay a few billions to migrants from other EU countries through a national welfare system. For the eurozone countries, stabilising the euro zone is politically as economically an existential question, as estimates of the economic costs of a violent break-up of the currency union go into the thousands of billions of euros.
It seems that no one in Berlin (or Paris) has yet decided how much to hand to Mr. Cameron to keep Britain inside the EU. And while it is true that Merkel in principle wants the UK to remain in the eurozone, she certainly does not want to keep it at any costs. Preventing necessary reforms of the eurozone might as well be too high a cost for her.
David Cameron has once before underestimated the determination of his EU colleagues to reform the eurozone. When the eurozone pushed for the fiscal compact in late 2011 and Mr. Cameron asked for concessions for the City in exchange for agreeing to the pact (which would not have applied to Britain anyway), the other EU countries did not linger for long, but just signed the compact as a multilateral treaty outside the European treaties, leaving Britain sidelined.
He should be well advised not to make this error again. For Britain, the stakes in this gamble today are much higher than in 2011.
The European Council on Foreign Relations does not take collective positions. ECFR publications only represent the views of its individual authors.