Robin Niblett
Director, Chatham House

A little over a month since David Cameron's speech promising Britons a referendum on Europe, the UK is already on a roller coaster ride in its relations with the rest of the EU. The February 8 deal on the EU budget for 2014-2020 was presented as a victory for the British government. This week, the government was dealt a body blow as other EU member states overruled it and accepted the European Parliament’s proposal of a bonus cap for European bankers.

The first question being asked after the bonus debacle is whether Cameron's referendum decision has diminished UK influence in EU decision-making. Herman Von Rompuy, president of the European Council, issued Britain a warning last week when he asked, 'How do you convince a room full of people when you keep your hand on the door handle?'

But reversing the proposal to cap bankers' bonuses would have been hard to stop under any circumstances. No government wants to fight the bankers’ corner publicly in today's climate. 

The more important question is whether the bonus issue is emblematic of a deeper problem for the British Prime Minister. Can he be confident that other European governments will support his agenda to make the EU more competitive in the future?

Crafting a UK agenda for the EU

A core argument in Cameron's January speech on the EU, was that he wants to help reform the EU to enable it to succeed in delivering jobs and prosperity in an increasingly competitive world. An EU that values international competitiveness is one in which the UK people should vote to remain. An EU that seeks to pull up the drawbridge and try to detach itself from the global economy is not.

The debate on the future of Europe's economic competitiveness brings together the most important issues on which Cameron wants progress or reform in the EU ahead of taking his country to a referendum. These include extending the Single Market to business services, striking new trade deals with the US and Japan, delivering a more efficient and integrated European energy market, and allowing national governments more control over employment law and regional development spending. This agenda also appeals to many EU political and business leaders.

The prime minister has made a relatively good start in pushing forward his competitiveness agenda. He has avoided demanding repatriation of any EU powers at this stage. Instead, he has joined forces with Angela Merkel to control EU spending and to help launch negotiations to create a transatlantic trade and investment partnership.

Financial markets as the exception?

But competitiveness in financial services presents a far more difficult challenge. London is the EU's financial centre and its principal connector to global financial markets. For example, London handles more euro foreign-exchange transactions than the rest of the euro area combined, 40 per cent of the global total. It is largely up to the UK, therefore, to ensure that EU banks do not slip into the global second tier, leaving large US and – someday perhaps – Chinese banks to deliver globally integrated services to European and other multinational companies.

Lying outside the eurozone, however, and with no near-term prospect of joining, the UK has to fight that much harder for its interests in the single EU financial market. Unlike in the UK, most policy-makers on the continent are more interested in designing financial regulations that will stabilize the euro than they are in ensuring the global competitiveness of the EU financial sector. And, unlike the EU budget, the UK and Germany rarely see eye to eye on financial regulation, leaving Britain in a more lonely position.

Making a stand

The easy solution would be for the British government to throw in the towel now on bank bonuses. The UK has already secured most of what it wanted in the overall Capital Requirements Directive to which the bonus cap has been appended. But, if the government believes that the way the cap has been designed will have serious negative consequences for the international competitiveness of British and other European banks, as well as for the City of London, it should continue to make its case in the weeks ahead, during the important negotiations on how to implement the cap.

And, if the UK government does not get the reassurances it needs, then George Osborne has the option to take the issue back to the finance ministers' level and challenge his EU counterparts to outvote the UK, with the risk that they might be outvoted on one of their own core interests in the future.

The government cannot afford to back down on the bonus question for political expediency. To do so may confirm the suspicion of some in the EU that it is more beholden to its domestic political gallery than to its principles for a more competitive Europe. In which case, why should EU members compromise on other aspects of the UK's reform and competitiveness agenda later?