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How Brexit might spark a European Union 2.0

Luc Vallée is chief strategist of Laurentian Bank Securities and former chief economist of Canada Economic Development.

Britain's Brexit vote came as a shock. But after the initial disbelief, the dust settled surprisingly quickly. Within three weeks of the vote, Britain had a new Prime Minister and cabinet. Markets anticipated that it would remain business as usual, at least for a while, and so swiftly recovered. Yet questions remain about the longer-term implications for both Britain and Europe.

In a situation that could be likened to a disgruntled employee leaving a job to express a grievance, the quitter is the primary loser. Bizarrely, though, this quitter has yet to announce when and if it will actually leave – indeed, it has indicated that no such announcement will happen for six months.

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Moreover, after that, the quitter will retain a minimum two-year option over his previous employment agreement. While partners would prefer a swifter departure, they remain powerless to lay the quitter off. If this sounds like French labour relations, it also exposes the flaws of the European Union.

While Britain currently remains in the EU, the uncertainty surrounding its impending departure will undoubtedly have negative consequences as foreign businesses already seem reluctant to invest in Britain. The threat of the end will linger, while trust may falter in the meantime, further affecting business and political relationships. Moreover, British consumers, businesses and governments will need to tighten their belts as their financial outlook deteriorates. Brexit is also affecting Britain's EU partners, as the presumed benefits of membership are only likely to weaken over time, at least until a new arrangement can be reached to accommodate all parties.

Any renewed arrangement would have to be acceptable to all EU members. It potentially also could have to be extended to all of them, creating more delays and tremendous hurdles to reaching a deal – first, with the European Union apparatus and, then, with the bloc's various political jurisdictions.

Britain's political and economic clout within Europe gives it leverage to push for such a solution, but this is absolutely no guarantee that an acceptable solution can be found, or that the crisis won't percolate to other players, jeopardizing the EU's very existence. At the same time, such an agreement could definitely provide a new impetus to the European Union.

What exactly are Britain's grievances? And can they be addressed to form the basis of a new EU partnership? Unsurprisingly, the answers are rooted in politics and help to explain why the Remain camp could not successfully promote its platform using just economic facts and statistics. Brexiters' complaints mostly fall in two categories: free movement of labour and EU encroachment on British sovereignty.

To understand why these issues matter, just envisage what might have happened to the North American free-trade agreement if it had mandated the free mobility of labour throughout the United States, Canada and Mexico, as well as a North American parliament and court reigning supreme over the U.S. Congress and its judiciary. It wouldn't have mattered that Canada and Mexico together had less than half than its 246 million inhabitants in 1989, or that the United States was built on a tradition of immigration. For Americans, these conditions would have been non-starters.

To understand British apprehension, recall that Britain is a country of 65 million, opened to a continent of more than 500 million people from vastly diverse cultures that is also currently facing a Middle Eastern migrant crisis. The results of the referendum are a reminder that Brexit was more about what is politically acceptable to British citizens than anything else.

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In the end, voters expressed their preference and desire that Britain might be able to recover some of its lost sovereignty. They chose to ignore economic arguments made by their opponents. We should expect that Brexit negotiations also revolve around the same issues, whether or not the new arrangement is economically optimal.

It was also of little comfort to British voters that most Europeans consider Britain a land of opportunity. Contrast the situation with that of Norway, another rich country often viewed as a post-Brexit model for Britain. Although Norway is not an EU member, it benefits from free trade with Europe and accepts the free movement of workers.

However, Norway is a country of five million, further from the European continent, with a colder climate and a rather undiversified economy. It is thus not difficult to understand why Norwegians could perceive labour mobility as an opportunity rather than a threat.

Going forward, if common ground is to be found, it will pass through institutional recognition that the judicial supremacy of the EU and labour mobility are not always practical or politically adequate. Giving domestic judiciaries more flexibility in establishing local laws and regulations might yield a much less elegant, and undoubtedly much more difficult to oversee, EU framework. But it would likely reduce the irritants that are seen as obstacles to building a stronger and more unified Europe.

Nobody here is talking about letting member countries adopt their own human-rights charters, but rather consenting that Europe yields to domestic courts some power over the free movement of EU residents seeking work and social benefits outside their country of origin. Giving member countries some leeway in selecting who has the right to permanently reside within their borders would also likely provide more flexibility in managing economic cycles.

Moreover, OECD research shows that giving local authorities more discretion over policy implementation tends to be more effective in promoting growth. Such flexible framework is thought to provide local stakeholders with motivation to participate more actively in the social and economic development of their regions.

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Extending such an arrangement to all member countries and subjecting it to intense scrutiny would obviously prolong uncertainty and potentially threaten the union's survival. But an EU 2.0 might be exactly what the doctor ordered. The alternative, failing to recognize that the experience of the past few years provided valuable lessons going forward, is not an option.

The author's opinions do not reflect the position of the Laurentian Bank, nor that of the government of Canada.

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