Moody and petulant

Over the course of recent months I have expressed concerns at the quality of governance, particularly in the UK, and nothing that has happened recently has prompted a change of view. If anything, quite the opposite. These concerns were picked up by the ratings agency Moody’s following Friday’s decision to downgrade the UK’s sovereign credit rating by another notch to Aa3, citing the “fractious policy environment.” As a rule I do not set much store by the macro views of ratings agencies, largely because they tell us what we already know. More importantly their raison d’être is to assess the likelihood of default, and whatever else might be wrong with the UK it is less likely to default than any euro zone country because it issues debt in a currency it controls whereas euro zone countries do not. That said, we should take the comments on governance seriously.

According to Moody’s, the UK’s failure “to manage change in a predictable and confidence-building manner is evident with respect to the UK’s approach to Brexit, in its inability to achieve an outcome which meaningfully replicates the benefits of EU membership and in its approach to implementing the agreement reached with the EU to date.” It went on to add that “Even if there is a trade deal between the UK and EU by the end of 2020, it will likely be narrow in scope, and therefore the UK’s exit from the EU will … continue to put downward pressure on private investment and economic growth.” Anyone who has read anything I have written on this subject will know that this has long been my view, so on the one hand I ask myself what took them so long to catch up, although on the other it is nice to be vindicated. 

The great bluff revisited 

It is no coincidence that this downgrade took place on the day the British government announced that the UK should prepare for EU trading arrangements “that are more like Australia’s, based on simple principles of global free trade.” In other words, a no-deal Brexit. But as Simon Hix of the LSE pointed out in a Tweet, “Australia has a range of agreements with the EU. No Deal is more like an ‘Afghanistan style deal’.” Anyone who thinks that a no-deal Brexit is a good outcome has not been paying attention. Indeed back in 2017 the then-trade secretary Liam Fox argued that securing a trade deal with the EU would be the “easiest in human history” and only last year Boris Johnson promised the electorate that he had “an oven ready deal”.  There are doubtless some who still believe that leaving the EU at any price is worthwhile but mainstream politicians have gone rather quiet on this front and a no-deal Brexit is welcomed only by those who don’t know any better.

For all my reservations about Johnson and his suitability for the highest office, I do not believe he is a stupid man (even though he often acts like one). Accordingly I still maintain that this action represents the highest stakes yet in a campaign of brinkmanship that has characterised the whole negotiating process. But what is a cause for concern is that Johnson’s statement risks triggering a miscalculation which makes a no-deal Brexit outcome more likely. After all, the EU only has to take him at his word and end negotiations and the whole edifice comes crashing down around the UK’s ears. As if to illustrate this, media reports suggest that the UK’s decision to break off talks are the result of a misunderstanding. This followed the EU’s decision to delete from the statement issued after last week's summit a pledge to intensify negotiations. According to the EU, this was designed to reduce the pressure on Michel Barnier to find a breakthrough in the discussions. The British side saw it as unwillingness on the EU’s part to make concessions. 

France and fisheries 

Matters have not been helped by comments by the French government. Having inflamed tensions by suggesting that UK has a choice between accepting the EU’s conditions or getting no deal at all, Emmanuel Macron reminded us that “The British, no matter what was said to them during the referendum campaign, need the European single market … They are much more dependent on us than we are on them.” Whilst this is not news to anyone it does nothing to assuage the hardliners in the British government who refuse to accept they are the weaker partners in the negotiations.

Fisheries remain one of the key sticking points. For the French, Dutch and Belgian fishing industries based in Channel ports, access to UK territorial waters is vital to their continued survival and the French government has increasingly adopted a hard line on this issue. It does seem a remarkably trivial issue over which to scupper a trade deal but this is the strange world of Brexit where rationality long since departed the stage. The German government has reportedly tried to intercede in order to persuade the French government to soften its position but apparently has had little impact so far. It may require some deft diplomacy on the part of the EU to take matters forward, as my reading of the German position is that they see little point in allowing negotiations to fail over a fishing dispute.

Quite why fisheries occupy such a totemic place in the Brexit debate has always escaped me since they account for less than 0.1% of UK GDP. But for those who care about these things they are a symbol of the EU’s encroachment on the ability to set domestic policy. The setting of quota limits in Brussels has coincided with a decline in the British fishing industry over the past 40 years. But the industry would have struggled anyway due to the fact that overfishing would have reduced the catch. Nonetheless, blaming the EU is a convenient narrative. Interestingly, one of my colleagues, who I should point out is an ardent Remainer, recently suggested to me that he had some sympathy for the position of the Brexiteers. As he pointed out, there seems little point in taking back control of your sovereignty if you are forced to concede access to French fishermen. But this is to miss the point. The British are seeking tariff free access to the wider European market and have to give something back in return. In my view, fishing concessions have such a small aggregate economic impact that it is a price worth paying to ensure the continued survival of the car industry. 

Domestic politics will force the UK to do a deal 

A no-deal Brexit is unlikely to play well at home.  On the one hand the survey evidence suggests, for what it is worth, that a rising proportion of those surveyed believe that the decision to leave the EU was wrong (see chart below). Even more significantly, like other European countries, the UK is suffering from a sharp rise in Covid infection rates. Not only is the government’s handling of the Covid crisis causing significant domestic political tension but the prospect of additional lockdown measures will place an additional burden on the economy, with current policies setting us up for a big rise in unemployment. Some simulation analysis I conducted in 2018 suggested that a no-deal Brexit could result in a 1.5% decline in GDP in the first quarter after leaving the EU. Adding the Covid burden on top of this would result in economic outcomes that would almost certainly hit the Conservatives at the ballot box by the time of the next election. A rational government would surely not want to take that risk.

The fact that the EU plans to continue talks with the UK next week suggests that a deal can be salvaged in the coming weeks. My long held view is that the UK has no interest in walking away without one. But the atmosphere of mistrust on both sides might act as an obstacle to progress and there is always a risk that at some point the EU may call the UK’s bluff. However, with both sides having narrowed their differences on many other issues (aside from fisheries) it is likely that they will try to keep negotiating lines open. On the basis that in EU negotiations “nothing is agreed until everything is agreed” they may yet surprise us.