Hamish McRae: It's the clash of the EU titans: political will vs financial maths. What next?

Economic View

Yes, but what about the economics? The clash in Europe between political will and financial mathematics continues, and Britain last week was caught in the crossfire.

Actually that may be no bad thing.

In political terms it might seem tricky to be in a minority of one in Europe, though it is a situation in which we have found ourselves before and in much more difficult circumstances. But in economic terms there was no alternative. Look at the hard numbers and you can see very quickly why a more distant relationship with Europe may turn out to be in British self-interest. You can also see why Europe very much needs the British market.

Some numbers explain why. The Office for National Statistics produces a study of the country's balance of payments each year, popularly known as the "Pink Book" because of the colour of its cover. Last year's tally is just out. It showed that we have a current-account deficit of a bit less than £40bn. Within that total there was a deficit of nearly £100bn on trade in goods, for we import vastly more physical stuff than we export. But that was offset by a surplus of nearly £60bn in services. The UK remains the second-largest exporter of services in the world, after the US.

That story, that we use a surplus on services to cover much of our deficit in goods, is well-known. Much less well-known is the extent to which the UK has a deficit in its trade with Europe, offset in part by a surplus in trade with the US and Australasia. As you can see from the main graph, Europe sells £66bn more goods and services to the UK than it buys from us. (Germany alone has a surplus of more than €€20bn with the UK.) By contrast, the Americas buy £35bn more from us than they sell to us and, as you can see, we do well with Australia and New Zealand too. So you could say that while Europe matters to us as an export market – of course it does – we matter much more to them.

Now look at earnings from financial services. It depends a bit on how you measure it, whether, say, you include fees earned from London lawyers on international business as well as purely financial earnings, but the headline surplus on trade in financial services is shown in the right-hand graph. As you can see, the City had another bad year last year with the surplus down to "only" £32bn, against a peak of £42bn in 2008. But that is in a bad year, and it is still more than the surplus in 2005 or 2006. The City's surplus covers roughly one-third of the country's trade deficit. So the idea that Germany and France should use the EU to tax this British export industry is as absurd as us getting the EU to put a special tax on, say, the German luxury-car business.

So that is why we are where we are. What happens next?

You should never underrate political will. The fiscal compact that is being developed over the next few months will buy some time – particularly since it will be coupled with some more firepower in the support funds, including cash from the IMF, and, crucially, by the ECB being prepared to help countries fund their deficits, if necessary by printing the money. But this latest summit is the seventh of the eurozone crisis, and, according to Saxo Bank, the 17th financial crisis meeting. There will be many more.

The core problem is not a lack of fiscal discipline that this compact is designed to tackle. Governments all over Europe are already racing to bring in yet more stringent budget packages. A compact might help on a five-year view by helping them to re-establish a reputation for fiscal probity, though cynics would ask why such a compact should succeed where the Stability and Growth Pact failed.

But the problem is that the weaker governments cannot finance deficits at an acceptable rate. The rates they would have to pay, 5.5 to 7 per cent for Italy, would be too high for the countries to bear. (Mind you, looking on the bright side, the yield on Greek debt hit 49 per cent on Friday – form an orderly queue to buy.)

More loans – from the EU, the IMF, the Chinese, whoever – simply postpone the problem, and not for long. Indeed they make the default even larger and more painful when it occurs. As Mervyn King put it, the problem is one of solvency, not liquidity, which is about as close as any central banker could come to admitting that more sovereign defaults are inevitable.

But a default only cuts debts; it does not restore competitiveness. Only devaluation could do that. It may well be that years of austerity will come first but a break-up of the eurozone is a large enough possibility that Europe's firms are already making contingency plans in a way that would have been unthinkable even three months ago.

That leads to the question: would an early realignment of Europe's currencies, either by splitting the eurozone into north and south blocs or by allowing some countries to leave, be such a bad outcome?

The conventional view, mouthed by every mainstream politician and most economists is that a eurozone break-up would be a disaster. All sorts of calculations have been made about Europe losing 10 per cent, 20 per cent, whatever, of its GDP. Intuitively this feels wrong. Experience of other currency-zone break-ups suggests there would be short-term costs, but there would also be longer-term benefits. The break-up of the rouble zone in the early 1990s after the Soviet Union collapse did lead to massive disruption across Eastern Europe before output recovered. But the structure of those economies had to be transformed; it was not just that they had an uncompetitive exchange rate. The gradual break-up of the sterling area brought clear benefits to the countries that left, including, probably, Ireland. (Ireland did devalue in 1979 when it broke its sterling link, but initially only by about 5 per cent.)

What is beyond doubt is that we are heading further into unknown territory. There may well be a couple of weeks of relative calm as markets digest what Europe is doing, or trying to do. But come the New Year the challenges will mount again. Can Italy and Spain raise money from the markets on acceptable terms? And if not, what will emerge from the next crisis summit – and the ones to follow?

Turkey is a terrific success story, so maybe it's not so bad on Europe's fringes

So what is life like on the fringe of Europe, if that is where we might be a-heading? A visit to Istanbul last week was profoundly uplifting – and not just because it is such a stunning city in a stunning location. From an economic perspective Turkey has been a huge success story. Growth this year is expected to decline to, wait for it, 7.5 per cent, after 9 per cent in 2010. The economy is slowing and will undoubtedly be further hit by the eurozone crisis, with estimates of between 5 per cent and 2 per cent growth next year. Unemployment, while too high at 9.2 per cent, is still below the eurozone average, and most impressive of all, government debt has been stable at around 50 per cent of GDP right through the recession. In 2001 it was over 100 per cent of GDP – amazing what decent growth coupled with devaluation can do.

Turkey has other advantages aside from currency flexibility, in particular a young and increasingly well-educated workforce. Back in the 1960s fertility rates were around six babies per mother, the same as India, and that cohort is of course still in the workforce. Now the fertility rate has fallen to a little above replacement rate, 2.1 babies per mother – still higher than anywhere in the EU, and the flow of young graduates is great for ambitious businesses.

Population growth and the potential for further productivity increases mean that the economy is projected by the Goldman Sachs Brics model to become the 12th-largest in the world by 2030. Turkey should by then have an economy about the size of Italy's, though its larger population will still have lower living standards than people in Western Europe.

There are, inevitably, social and political tensions, and no one should minimise those. But from an economic perspective Turkey is a massive success story, an example to the EU, and a great place to escape the pre-Christmas blues of Britain.

Arts & Entertainment
A stranger calls: Martin Freeman in ‘Fargo’
tvReview: New 10-part series brims with characters and stories

Arts & Entertainment
Shaun Evans as Endeavour interviews a prisoner as he tries to get to the bottom of a police cover up
Review: Second series comes to close with startling tale of police corruption and child abuse
Sport
Raheem Sterling and Luis Suarez celebrate during Liverpool's game with Norwich
football Another hurdle is out of the way for Brendan Rodgers' side
Arts & Entertainment
Charlotte Brontë, the English novelist, poet and the eldest of the three Bronte sisters who lived into adulthood, has been celebrated with a Google Doodle depicting her most famous novel, Jane Eyre.
arts + ents "Reader, they doodled her".

VIDEO
Arts & Entertainment
Schwarzenegger winning Mr. Universe 1969
arts + entsCan you guess the celebrity from these British Pathe News clips?
News
Portrait of Queen Elizabeth-II by David Bailey which has been released to mark her 88th birthday
peoplePortrait released to mark monarch's 88th birthday
Arts & Entertainment
The star of the sitcom ‘Miranda’ is hugely popular with mainstream audiences
TVMiranda Hart lined up for ‘Generation Game’ revival
Life & Style
The writer, Gerda Saunders, with her mother, who also suffered with dementia before her death
healthGerda Saunders on the most formidable effect of her dementia
Sport
Manchester United manager David Moyes looks on during his side's defeat to Everton
footballBaines and Mirallas score against United as Everton keep alive hopes of a top-four finish
Sport
Tour de France 2014Sir Rodney Walker on organising the UK stages of this year’s race
Arts & Entertainment
Jessica Brown Findlay as Mary Yellan in ‘Jamaica Inn’
TVJessica Brown Findlay on playing the spirited heroine of Jamaica Inn
News
YouTube clocks up more than a billion users a month
mediaEuropean rival Dailymotion certainly thinks so
Arts & Entertainment
The original design with Charles' face clearly visible, which is on display around the capital
arts + ents
Arts & Entertainment
‘Self-Portrait Worshipping Christ’ (c943-57) by St Dunstan
books How British artists perfected the art of the self-portrait
News
People
News
Sir Cliff Richard is to release his hundredth album at age 72
PEOPLE
Have you tried new the Independent Digital Edition iPad app?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Database Team Lead ( Leadership, Sybase, Computer Science)

Negotiable: Harrington Starr: Database Team Lead ( Leadership, Sybase, Compute...

C#.NET Delphi SQL Developer (C#,DELPHI,SQL)

£40000 - £50000 per annum + Bonus+Benefits+Package: Harrington Starr: C#.NET D...

VB.NET SQL Junior-Mid Level Developer (VB.NET,SQL,Excellent com

£25000 - £35000 per annum + Bonus+Benefits+Package: Harrington Starr: VB.NET S...

Trade Support, Application Support, Operations Analyst, CRM MS

£45000 - £55000 per annum + Bonus and Benefits: Harrington Starr: Trade Suppor...

Day In a Page

Rubin ‘Hurricane’ Carter: The man who could have been champion of the world - and the Bob Dylan song that immortalised him

The man who could have been champion of the world

Rubin ‘Hurricane’ Carter and the Bob Dylan song that immortalised him
Didn’t she do well?

Didn’t she do well?

Miranda Hart lined up for ‘Generation Game’ revival
The Middle East we must confront in the future will be a Mafiastan ruled by money

The Middle East we must confront in the future will be a Mafiastan ruled by money

In Iraq, mafiosi already run almost the entire oil output of the south of the country
Before they were famous

Before they were famous

Can you guess the celebrity from these British Pathe News clips?
Martin Freeman’s casting in Fargo is genius

Martin Freeman’s casting in Fargo is a stroke of genius

Series is brimming with characters and stories all its own
How I brokered a peace deal with Robert Mugabe: Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC

How I brokered a peace deal with Robert Mugabe

Roy Agyemang reveals the delicate diplomacy needed to get Zimbabwe’s President to sit down with the BBC
Video of British Muslims dancing to Pharrell Williams's hit Happy attacked as 'sinful'

British Muslims's Happy video attacked as 'sinful'

The four-minute clip by Honesty Policy has had more than 300,000 hits on YouTube
Church of England-raised Michael Williams describes the unexpected joys in learning about his family's Jewish faith

Michael Williams: Do as I do, not as I pray

Church of England-raised Williams describes the unexpected joys in learning about his family's Jewish faith
A History of the First World War in 100 moments: A visit to the Front Line by the Prime Minister's wife

A History of the First World War in 100 moments

A visit to the Front Line by the Prime Minister's wife
Comedian Jenny Collier: 'Sexism I experienced on stand-up circuit should be extinct'

Jenny Collier: 'Sexism on stand-up circuit should be extinct'

The comedian's appearance at a show on the eve of International Women's Day was cancelled because they had "too many women" on the bill
Cannes Film Festival: Ken Loach and Mike Leigh to fight it out for the Palme d'Or

Cannes Film Festival

Ken Loach and Mike Leigh to fight it out for the Palme d'Or
The concept album makes surprise top ten return with neolithic opus from Jethro Tull's Ian Anderson

The concept album makes surprise top ten return

Neolithic opus from Jethro Tull's Ian Anderson is unexpected success
Lichen is the surprise new ingredient on fine-dining menus, thanks to our love of Scandinavian and Indian cuisines

Lichen is surprise new ingredient on fine-dining menus

Emily Jupp discovers how it can give a unique, smoky flavour to our cooking
10 best baking books

10 best baking books

Planning a spot of baking this bank holiday weekend? From old favourites to new releases, here’s ten cookbooks for you
Jury still out on Manchester City boss Manuel Pellegrini

Jury still out on Pellegrini

Draw with Sunderland raises questions over Manchester City manager's ability to motivate and unify his players