Posted: 20 Nov. 2017 8 min. read

Decision time for the EU (and it’s not about Brexit)

What is the biggest question facing the European Union?

Brexit is the obvious candidate. The secession of a member state is an almost unimagined contingency. But for all the historic significance of Brexit the future direction of the EU itself is, for my money, a more important question.

The UK was a relatively late entrant to the EU, joining in 1973. By dint of a UK tendency to see the EU as a free trade area, not a nascent federal union, along with ‘opt outs’, notably from the Single Currency and the border-free Schengen Area, the UK has occupied a somewhat semi-detached position in the EU

This status was confirmed by Mr Cameron winning a final opt out, last February, to the EU’s founding aim of an ‘ever closer union’.

With the UK heading for the door, the question is what ‘ever closer union’ means for the remaining 27 member states.

European integration has proceeded unevenly since 1957. The 1990s and early 2000s saw breakneck progress towards closer union. In 1992 the European Economic Union became the European Union, underscoring a more political and federal shift in direction. A year later the launch of the single market created a true free trade area for goods. Internal border controls between most member states were abolished through the 1990s and the decade ended with the launch of the single currency. By the eve of the financial crisis in 2007 free movement of labour had become a reality and the former communist states of central and eastern Europe had joined the EU.

It has been different in the last ten years. Holding the EU together, not integration, has been the priority. But to do so member states have ceded sovereignty in a number of areas - signing up to tougher rules on budget deficits, financing funds to counter debt crises and to bail out failing banks and transferring supervisory power over large banks from national governments to the European Central Bank. It’s pretty dry stuff, but it represents a further move in the direction of a more integrated EU.

The crisis also exposed divisions between member states, highlighting how a larger EU was also a more diverse one. The euro area debt and banking crises pitched Germany and the northern European member states against southern and peripheral European countries. Parties of the far right failed to achieve decisive breakthroughs in elections in Germany, France and the Netherlands this year, but they remain potent forces. In Central and Eastern Europe the tone has become markedly more nationalistic and hostile to immigration.

As for the future direction of the EU the options range from carrying on as now, and trying to make existing institutions work better to, at the other end of the spectrum, driving towards a United States of Europe.

History suggests that the most durable unions, such as the USA, eventually become fiscal unions, ones where a central authority exercises a high degree of control over taxation, borrowing and government spending. But the necessary diminution of national control to achieve a fiscal union is proving contentious in the EU.

Proposals to issue common EU bonds, or ‘Eurobonds’, have met resistance. Countries with low borrowing costs, such as Germany, tend to see Eurobonds as German lending its credibility to more indebted European countries to raise money on the cheap. In the process it would expose Germany to new risks and raise its cost of borrowing.

Germany has also blocked the establishment of a euro-wide insurance scheme to protect bank deposits. Germany worries that its stronger, more stable banks will end up propping up weaker banks elsewhere in the EU.

Germany’s mantra is ‘risk reduction should precede risk sharing’ – and that member states should demonstrate that they can control their own budgets and borrowing before there are further steps towards integration. Having prioritised strong public finances for decades Germany is loath to lend its support to nations which appear unable to follow its lead.

A larger, more diverse EU, means that the days of all nations proceeding as one are probably over, and arguably have been for at least a decade.  The fact that a number of nations, including Sweden and Poland, are outside the euro area shows that the EU is already moving at different speeds. In a recent speech Emmanuel Macron, a staunch pro-European, said that the EU would increasingly be multi-speed, with member states going ahead in some areas unimpeded by the refusal, or lack of readiness, of others to join. That a French President would promote a policy once derisively called “Europe à la carte” by some in France testifies to the profound change that has occurred.

As membership of the EU has increased, it has become more diverse. The governments of the EU range from the nominally socialist in Portugal to right wing and nationalist in Hungary. The gap in national income between the richest and poorest EU member state has risen ten-fold since 1981. A widening gap between the richest and poorest nations raises the cost of a fiscal union to richer nations. The willingness of EU nations to share risks and pool sovereignty varies by issue, but there are limits. On budgets and banks richer countries are wary of shouldering risk in poorer countries where rules, budget discipline and solvency are more fragile. Germany took the lead in accepting refugees in 2015 only to find that some EU member states were unwilling to share the burden.

Next month, the EU will hold its first summit of heads of state and government since July 2015. Its task will be to set a course for the next chapter in the development of the EU. German politics may well add complexity to proceedings.

The decision Europe’s leaders make will be vital to the future of the EU. The European dream lives on, and has powerful support. But it is likely to progress through looser coalitions and alliances, not, as its founders intended, through an “as one” drive towards a United States of Europe.

The population of the UK is 65 million, that of the remaining 27 EU nations 450 million. Brexit is important, but it should not obscure the future of an alliance of close to half a billion people.

PS: One of our readers, Hilary Cooper from The Finance Foundation, got in touch with us following last week’s Monday Briefing on the global decline of cash usage. Her research for the think tank found that the UK’s older population, those aged 80 and over, have a strong attachment to cash as a secure and tangible way of making payments and keeping track of their spending. The research also found that some are heavily dependent on cash as they struggle to use financial technology such as internet banking and ATMs, either due to physical constraints or security concerns. This is yet another argument for the importance of cash to prevent financial exclusion. Although younger generations who are familiar with current technology will enter this age group (expected to reach five million by 2030), it is important to remember the speed at which technology itself is changing.

PPS: Analysis by the Resolution Foundation shows that for UK households with below average incomes, annual housing costs were typically £714 higher in 2015-16 than they were in 2007-08. By contrast, those on above average incomes enjoyed cuts in housing expenses of £271 over the same period. The data highlights the contrast between homeowners who’ve benefited from reduced mortgage interest payments after the BoE slashed rates during the financial crisis and those that are renting whose payments have risen each year.

Key contact

Ian Stewart

Ian Stewart

Partner and Chief UK Economist

Ian Stewart is a Partner and Chief Economist at Deloitte where he advises Boards and companies on macroeconomics. Ian devised the Deloitte Survey of Chief Financial Officers and writes a popular weekly economics blog, the Monday Briefing. His previous roles include Chief Economist for Europe at Merrill Lynch, Head of Economics in the Conservative Research Department and Special Adviser to the Secretary of State for Work and Pensions. Ian was educated at the London School of Economics.