Prof. Clemens Fuest: Hard Brexit leads to a blame game

It worsens political relations between the UK and the EU, making future cooperation more difficult

Prof. Clemens Fuest

Political and economic factors interact. From a purely economic point of view it is difficult to understand and manage things like Brexit or the migration crisis. Populist policies are economically harmful, yet they sometimes receive political support, says Prof. Clemens Fuest, President of the Munich-based ifo Institute for Economic Research, in an interview with Europost.

- Prof Fuest, would you explain why does the EU resemble more and more the Habsburg Empire towards its end, as said in the Report 2019 of the EEAG on the European economy that you recently presented?

- We observe that a growing number of EU Member States increasingly focus on what they perceive as their national interest and show little enthusiasm for cooperation with their European partners. This is short sighted and may endanger the EU. Brexit is an example, in Hungary and Italy we see similar tendencies. Brexit absorbs a lot of energy and time, and it will diminish the size of the EU and the internal market. For the first time in history a country leaves the EU, and it is a very large country which stands for almost a fifth of the EU's economy.

- How strong do the uncertainties that are coming from outside affect the European economy, and what about the internal factors?

- US trade policy is an example of a destabilising factor coming from outside Europe. Brexit and the conflict about Italy's fiscal and economic policy are important internal factor which create uncertainty. The fact that the Eurozone does not have the institutions required to make it sufficiently stable is another weakness that needs to be addressed.

- The cooling of the economy trend that was predicted to be very visible this year, what signals does it give?

- The cooling of the economy is driven by the industrial sector. This reflects growing protectionism and uncertainty about Brexit. Nevertheless, employment is still growing in Europe. This is a stabilising effect.

- Why, 10 days after the release of the report, did ifo Institute cut its growth forecast for Germany for 2019 from 1.1% to 0.6%, while raising it for 2020?

- The incoming economic data shows that the weakness in the German economy is deepening. An important factor driving this is the growing likelihood of a hard Brexit and the looming US tariffs on cars. The difficulties of the car industry related to the new emissions tests will last longer than expected, but we expect them to be overcome by 2020. This explains why we are more optimistic regarding 2020.

- What are actually the threats if there is a hard Brexit?

- In the short term economic exchange would be disrupted. In the medium to long term there is a risk that a hard Brexit leads to a blame game and worsens political relations between the UK and the EU, making future cooperation more difficult.

- You are mentioning anti-immigration nationalists when you raise the issue of European divergence or convergence. Why do you see the need to incorporate a political element in an economic analysis and forecasting study?

- Political and economic factors interact. From a purely economic point of view it is difficult to understand and manage things like Brexit or the migration crisis. Populist policies are economically harmful, yet they sometimes receive political support.

- Which EU countries are coping better with the changes urged by external influences?

- These are often smaller countries. Countries like Denmark, Sweden, Finland and the Netherlands have had to confront economic crises in the past and they were able to adjust and recover. Larger countries often find it more difficult to carry out necessary reforms. A possible explanation is that large countries can afford to react more slowly and therefore wait too long before they adjust. If they do, the positive effect of reforms may take longer before they are felt. It may also be more difficult to find political agreement on reforms. Also, a lot depends on the ability of countries to share the costs of adjustment.

- Looking outward, what is the impact of the rise of China for the European economy?

- In the first decades, Europe has primarily felt the rise of Chine through trade. Chinese imports have made new and cheap consumption goods available to the European economies. But these imports have also forced European companies to adjust. Jobs have been lost in firms competing with Chinese imports. At the same time, new jobs have been created in firms which export to China. Overall, this growth of trade is an advantage for Europe. But gains and losses are divided unequally across countries, regions and sectors.

- To what extent can the looming trade war with the US deepen the economic difficulties for the EU countries?

- In general, the looming trade war creates uncertainty. Up to now, only few new tariffs have been introduced, so the damage is limited. But the US currently considers 25% tariffs on cars. If these tariffs are introduced, the EU will have to retaliate. Analysis of the ifo Institute shows that car tariffs may reduce car exports from Germany to the US by 50%. The loss in value added for Germany would be seven billion euros. Other European countries are less exposed to the car industry, but many will suffer. A trade war with the US would deepen the current economic slowdown.

- Bulgaria already announced that it is preparing to apply for ERM-2 this year, and Croatia also expressed interest. In your view, how can adopting the euro in the next 3-4 years affect these countries' economies?

- A lot will depend on the exchange rate at which they will enter the Eurozone. Entering the Eurozone with an overvalued currency is dangerous because correcting this through reductions of prices and wages is difficult. Countries need to increase their ability to adjust. They should also be aware that they are entering a currency union with institutions that are in need of reform. The growing number of countries will make reforms more and more difficult.

- Do you see some risk for the rest of the Eurozone if in a few years these countries join the single currency area?

- It is key that the new Member States pursue solid and sound economic and fiscal policies, so that they can prosper in the Eurozone. If they fail to do that, the likelihood of a crisis is larger compared to a situation where they would still have their own currency. The biggest risk is for the new members themselves, less for the rest of the Eurozone.

 

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Prof. Dr. Dr. h.c. Clemens Fuest is President of the Munich-based ifo Institute for Economic Research, Professor of Economics and Public Finance at the Ludwig Maximilian University of Munich, Director of the Centre for Economic Studies (CES) and Executive Director of CESifo GmbH. He is a member of the Academic Advisory Board of the German Federal Ministry of Finance and of the European Academy of Sciences and Arts and of the German National Academy of Science and Engineering.

Before he was appointed as ifo President, Professor Fuest was President of the Centre for European Economic Research (ZEW) in Mannheim and Professor of Economics at the University of Mannheim. From 2008 to 2013, he was Professor of Business Taxation and Research Director of the Centre for Business Taxation at the University of Oxford.

His research focuses on the implications of globalisation and European integration for tax policy, the impact of taxes on firm behaviour, and the debt crisis in the Eurozone. He has published widely in international scientific journals and he is author and editor of various books. A month ago, Professor Fuest presented in Brussels the Report 2019 of the EEAG Research Group on the European economy.

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