One of my expectations directly after the Brexit referendum was that Germany would ultimately come to the aid of the UK because of its trading interests. I admit that this prediction looked a bit shaky in the light of the robust negotiating position taken up by Angela Merkel, the German chancellor. But it was the right call. As we approach the December crunch date in the first round of Brexit talks, Germany's language has softened notably.
I always thought it was unrealistic to expect that German companies would have nothing to say if faced with the possibility of a sudden and brutal cut in supply chains. In 2016, Germany ran a trade surplus with the UK of €50.4 billion – 1.6 per cent of German gross domestic product – the single-largest bilateral trade surplus with any country.
Constructive
But there is another reason for Germany’s more constructive attitude, one that did not exist a year ago. Ms Merkel is about to negotiate one of the most expensive coalition agreements in German history.
The outgoing government has amassed a moderately large fiscal surplus, which Ms Merkel will need to use to satisfy the special interests of her future coalition partners, the Free Democrats and the Greens.
I have heard estimates of a fiscal expansion of more than 1 per cent of GDP, though this is clearly the outer limit of what is possible under the debt ceiling in the German constitution. The closer the coalition goes to that limit, the less fiscal space there will be for any German largesse in the EU.
This looming financial squeeze informs Germany’s position on Brexit in rather specific ways. Germany clearly wants to avoid a breakdown in the Brexit talks. A no-deal Brexit would cause an existential crisis in the EU since neither Germany nor France would be willing to plug the gap. But while Germany wants a deal, it does not want to be short-changed by the UK, either.
Profit
Germany does not seek to profit from the UK's withdrawal but is right to insist on a cost-neutral Brexit. If and when Theresa May, the UK prime minister, provides the necessary clarity on finances, I see no reason why the EU should refuse to take the Brexit negotiations into the second phase, consisting of talks about the transition period and the future trading regime.
The second phase of the Brexit negotiations will be a lot tougher than the first. I am relatively confident that the various transitional legal issues can be sorted, but the permanent trade agreement will be very complex.
I read with interest a story last week, according to which the German foreign ministry has prepared a four-page memo on the outlines of a future trade and co-operation deal. The paper seeks far more than a tariff-free zone for manufactured goods. It proposes co-operation on foreign and security policy, on terrorism, and on a number of selected service industries, including airlines. Finance was notably absent.
This is not an official document. Ms Merkel’s own position may be different. But a country in the middle of Europe with an exceedingly large current account surplus can ill-afford the chaos of a cliff-edge Brexit. Economic and security interests interact – hence the involvement of the foreign ministry.
Clarity
What the UK government does not see with sufficient clarity yet is that any such comprehensive association agreement would come at a price. I do not see the EU agreeing to free movement of airlines or nuclear materials without free movement of people.
This brings us back to immigration, the issue at the heart of the Brexit talks. If the UK restricts the movement of EU citizens into Britain, it is hard to see how a trade agreement can extend much beyond free tariffs on manufactured goods.
Even if the UK were to agree to free movement, I cannot see the EU accepting financial services in a trade agreement. Mrs May has chosen a Brexit without membership of the single market and the customs union. That choice determines the outer scope of the future relationship.
I see no chance that the City of London will retain its current level of access to the European market – though there may be deals for certain sub-categories of financial services.
It was never an optimal arrangement that the euro zone’s main financial centre was outside its borders. This is the one area where euro nations see an obvious advantage as a result of Brexit. They will not easily give this up.
What makes me moderately optimistic that the EU and the UK will end up with a broad co-operation agreement is the current trend in net UK immigration, which has been falling fast.
By the time the trade talks reach the critical point, both sides may conclude that the price of a compromise is worth paying. The UK needs to avoid a cliff edge in 2021 or 2022. Germany does not want to lose the €50 billion. Accidents are always possible at any stage. But what matters the most is that interests are aligned.
