British Prime Minister, David Cameron, makes a speech on Europe at the offices of Bloomberg in the City of London this morning.
© FT

In conversations with senior European officials I keep hearing one revealing argument: if Britain votes to leave the EU and if this is seen as a success, other member states might want to follow suit. And this danger must be nipped in the bud.

Such thinking reveals an implicit acknowledgment that Brexit might work economically. Specifically, those who make this case worry that a successful Brexit would rob pro-Europeans of what they think is their strongest argument: fear of the unknown. The recent swing in the opinion polls towards Leave suggests that the fear campaign employed by the Remain camp is not working. If Project Fear, as the campaign to remain in the EU has been dubbed, fails visibly in the UK, it cannot be deployed elsewhere. Pro-Europeans would then be forced to make a positive case for the EU, something many of them find hard to do. Brexit could thus unleash a domino effect in which one state after another might decide to follow Britain out the door.

And so a successful Brexit must be prevented at all costs. In France, some officials have advocated a punitive response against the UK — or at least a clean break from all EU treaties, including the single market. They oppose any soft departure deals that give the UK preferential access to the world’s biggest free trade area.

Is the premise of a mild economic impact realistic? If so, should other EU members retaliate to set an example? My answer is: “probably yes” and “certainly no”. There will be economic consequences to Brexit, but I believe that these would not be as dramatic as the Remain campaign suggests. And no, the other EU members should not retaliate. It would harm them more than the UK.

I know that the UK Treasury, the Bank of England, the OECD club of rich nations and the International Monetary Fund have all produced studies purporting to show a severe economic impact of Brexit. The problem is that these studies rest on rather specific assumptions about future trade patterns and, more importantly, about how the economy adjusts in the long run — all of which are highly speculative and almost certainly wrong. And the British economy would eventually adjust to this new regime, just as it adjusted to the single market when it began more than 20 years ago.

Macroeconomic modelling has many useful roles. But it is an abuse of the methodology and the underlying mathematical assumptions to pretend that one can gauge the long-term economic consequences of an unknown political decision. There are, of course, a number of specific negative economic effects, but also offsetting ones. The pound could devalue and lead to a lowering of Britain’s large current account deficit. House prices might fall, but this could also be a good thing. And if the City of London loses some business, that would not necessarily be bad for the economy as a whole. Economic theory tells us that the wealth of a country ultimately depends on its skills, resources, and the quality of its policies. It is hard to see how Brexit would change that — unless you think that the UK is turning into some version of North Korea.

In the short term, Brexit would have a negative economic impact. It would be a sudden regime change, and those can cause frictional losses. But it would be madness to let considerations about short-term economic costs get in the way of a decision about the country’s long-run strategic position in Europe.

The premise of those concerns about the political impact of Brexit elsewhere is thus correct. So how should the others react? Should they aim to drive up the transitional economic costs for Britain to discourage others from following suit? This would be irresponsible and counterproductive. For one, the EU has a trade surplus with the UK. More importantly, the EU is already busy losing its soft power reputation in its morally abject refugee deal with Turkey. If the EU then started to penalise a member state for leaving, it would take on the reputation of a nasty regime.

There is a German saying that one should not seek to delay travellers on their journey. My advice would be let the British go in peace, offer them a good deal and to think strategically. The EU still needs Britain in many policy areas. And who knows, Britain might decide to return to the EU in the future.

If Remain wins, I would expect the other EU governments to honour the deal with David Cameron, UK prime minister. Under no circumstance should the EU accept a treaty change that allows the UK to absolve itself from ever-closer union. That would render absurd the whole idea of a European Union. Given the lack of appetite for treaty change, especially in France, I do not see any danger of that happening.

But whatever the referendum’s outcome, the chances of the UK playing an active role in shaping Europe’s future are minimal.

Letters in response to this column:

UK has been absolved from ever-closer union / From Simon Brocklebank-Fowler

Remain camp should emphasise the good reasons for staying / From David R Cameron

UK will have to reinvent trade policy / From Jean-Claude Piris

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