The United Kingdom and the European Union both stand to benefit if they cooperate rather than compete with each other in bargaining over the terms of the U.K.’s exit from the EU, Professor John C. Coffee Jr. of Columbia Law School argues in an analysis that relies on simple game theory concepts.
The alternative–retaliation that results in economic rivalry would cause both sides to suffer, argues Coffee, the Adolf A. Berle Professor of Law and director of Columbia Law School’s Center on Corporate Governance, in a paper that assesses how the EU might respond to both Brexit and the nationalism espoused by President Donald Trump.
The most desirable deal for both sides in the Brexit negotiations would be what Coffee terms a “continuing transition” that might last five years or longer and should induce the parties to cooperate more permanently.
As Coffee envisions it, the U.K. would continue to honor the rules and costs of the single market in return for Brussels’s continuing to allow clearing of euro-denominated financial transactions to remain in London, which dominates the market.
“This is not a long-term solution, but it’s a start,” Coffee writes in the 20-page paper to be presented on Sept. 1 as a keynote address at a meeting in Paris arranged by the Laboratory for Excellence in Financial Regulation (LaBex ReFi), an arm of the French Ministry of the Treasury. “Each side gains something, and with each additional year, this arrangement begins to resemble an iterated game in which no one defects over several periods.”
That’s not to suggest either side would agree to it, he notes. “To be sure, Brexit becomes more symbolic than substantive during this transition, and the U.K.’s current ministers appear divided on whether they will accept such an arrangement,” says Coffee, who puts the odds of such a compromise at no better than even.
Countering conventional wisdom
As Coffee sees it, the ability of the Brexit talks to produce an acceptable deal will turn on the ability of the parties to curb private interests that seek to profit from positions that favor their special interests. These so-called rent-seekers—as exemplified by European companies and cities that aim to siphon off some of the dominance the U.K. enjoys in financial markets—seek to exploit indignation the public on both sides feels about perceived abuses to lobby negotiators to stake out positions that boost the rent-seekers’ profits.
But retaliation by the EU against the U.K. over Brexit likely would lead to counter-retaliation by the U.K. and spark a trade war, a prospect that, as Coffee chronicles, would harm consumers on both sides and undermine financial stability. Ironically, he says, the only winners would be neither London nor Paris, but New York (to which much trading would retreat).
That’s especially true if the volleying leads the U.K.—free from oversight by the EU—to compete against the latter by slashing taxes on foreign companies and reducing financial regulations with the aim of creating a lightly regulated tax haven to induce companies to remain in London, as the U.K. government has threatened.
“This would attract companies back to the U.K., but could lead in time to another financial crisis on the scale of 2008,” Coffee predicts.
The most rational goal, he concludes, is a “divorce under which both parties cohabit—a very European outcome.”
Posted on August 31, 2017