Can Merkel’s Germany manage a good Brexit deal for all?

There is still some uncertainty in London about the role Germany and Angela Merkel will play in Brexit negotiations after the German elections on September 24. For Germany, clearly, the weight of the “market-friendly/liberal” block in the EU (whose current core members include the UK, the Netherlands, Sweden, Denmark and Estonia) will decline, potentially making the EU less market-friendly. The EU budget would also have to do without UK financial contributions.

But the real political risk is that Brexit could set a new and awkward precedent. It could trigger chain reactions, such as a backlash against any notion of an “ever closer union”, even where this makes obvious sense, as in the areas of defense, foreign policy, defending the external boundaries of the EU, and certain aspects of environmental policy. Brexit could also encourage national exit movements elsewhere.

The Czech Republic, Hungary, Poland and Slovakia have been critical of Germany’s migrant policy. Voters in Spain, Portugal, Greece and Ireland have recently also supported political parties of a more radical outlook that have gained support as voters turn away from the old political establishment.

Although a British withdrawal from the EU wouldn’t turn Germany into a hegemon, it could somehow isolate the most powerful member of the Union. It could increase the perception of German dominance and with it add pressure to form coalitions to counterbalance its power. Paradoxically, therefore, Germany could actually become weaker – that is, less able to get what it wants – in an EU without the UK. Meanwhile, expectations of Germany would probably increase further.

The UK is Germany’s third largest export partner with €90 billion in sales last year. The country’s nominal exports to the UK increased by 50% between 2010 and 2015. No less than 7.5% of all German goods exports were sold to Britain in 2015, a large number given that the UK does not purchase many machine tools or other heavy products of the sort Germany also specializes in, unlike emerging economies.

With subdued domestic demand, Germany and the EU depend on trade-induced moderate growth including close trading relations with Britain. Nine EU countries send at least 5% of their total exports to the UK. In 2015, Germany’s trade surplus with the UK alone was a staggering €51 billion, about 20.5% of Germany’s entire trade surplus.

Against this backdrop, the structure of German industry helps explain why Berlin is not, and has never been, really interested in developing a single market in services. Germany’s economy is focused on the export of goods rather than services, which is why the single market works particularly well for them.

The topic of the EU budget is particularly relevant to Germany as the EU-27 also needs to work out how the absence of Britain’s net contribution of €7 billion to its budget can be compensated for by 2019. Net recipients of the EU budget will call on Germany to pay more in the future.

Germany’s role in shaping the agreement between the UK and EU will be crucial. While different coalition partners after Sunday’s election may tip the balance in favour or against the UK, ultimately it’s unlikely to shift the general direction of Brexit negotiations significantly, unless there is a major upset.

In the UK, after its election in June 2017, there is probably no House of Commons majority for Theresa May’s version of a “hard” Brexit. The UK-EU must agree on the status of UK and EU citizens, Northern Ireland and the divorce bill for leaving the EU before they even discuss any trade deal. There is a view that the UK has not done the ground work for the trade negotiations. This UK government has come under more concerted attack domestically. Merkel, EU governments and institutions are almost bemused by the lack of preparation shown by the May government.

Despite the fact that the UK does not use the euro, Brexit will have important implications for the European Monetary Union’s future. The UK’s significant financial sector and the loss of its budgetary contributions will lead to numerous EU reforms in the wake of its exit. Germany will lead the EU in taking advantage of this. Germany and the EU will be mindful of the benefits that London’s financial markets have provided in the past and will not make Brexit unnecessarily disruptive. After the initial shock, Merkel and the German political and business elite have come to realize that the EU should use post-Brexit reforms as an opportunity to strengthen the Eurozone and make it more robust against future crises.

The UK and the EU appear to be in two completely different worlds: the UK only wants to talk about trade deals; the EU about divorce bills, citizens’ rights and the Northern Ireland border. The slower the progress, the more tense the negotiations. The UK has been accused of being unprepared and not knowing what it wants, the EU of inflexibility and blackmail. Cooler heads in London and Berlin do not want a “hard” Brexit which looks like the more likely outcome. Given the confusion and disagreements about what a final post-Brexit deal with the EU might look like, there has been increased focus on a potential transitional arrangement. Merkel will want to address these problems after she is re-elected. She will want to provide breathing space for the UK and avoid a damaging Brexit for Germany and the EU. It is essential for the UK and EU that there is minimal disruption to banking and financial services. Although it was telling that Brexit was not discussed in the latest election debate between Merkel and her Social Democratic Party (SPD) opponent Martin Schultz.

The UK often overestimates its ability to win support from Germany. In recent years, there have been a number of occasions where the UK believed it had German support, but it turned out not to be the case. For example, the UK thought it had the support of Germany in the negotiations on the Fiscal Pact as well as the appointment of Jean-Claude Juncker as Commission President. On both occasions, Germany decided to change its position and leave the UK isolated. Also during the pre-referendum negotiations Germany was not willing to give the UK government certain concessions on labor mobility, which would have helped them to present a convincing case to the UK electorate to remain in the EU.

The UK government should therefore not rely too much on being able to gain support from the new Merkel German government for its demands. Merkel’s political interest in keeping the EU-27 together outweighs any interest the German car industry or any other industry has in the British market.