Ferry bad news

Companies spend a lot of time these days trying to sell themselves as paternalistic guardians of their employees’ well-being with their mission statements, counselling sessions and monitoring programmes. In truth, it often feels like self-justifying fluff and to those of us who remember when capital and labour were frequently at odds with other, it can sometimes strike a jarring note. Nonetheless, it makes for a vastly superior workplace environment to the red in tooth and claw capitalism espoused by many extreme free-marketeers. For a reminder of the kind of outcomes this model can produce, we do not need to reach back to the go-go days of the 1980s. Earlier this month, P&O Ferries summarily dismissed 800 employees, announcing that it was replacing them with cheaper alternatives, in a message that was as crass as it was insensitive (here for a copy of the video).

This case matters for a number of reasons. The first concerns the legal implications. A second issue is the extent to which it is (or is not) entangled with Brexit. A third issue concerns the nature of employee protection and the economic implications of lax labour laws. Finally it is worth touching on national security issues raised by P&O Ferries’ parent company (note: P&O Cruises is a completely separate company that happens to share the same name).

The legal aspects

Turning first to the legal issues, the Trade Union and Labour Relations (Consolidation) Act 1992 states: “An employer proposing to dismiss as redundant 100 or more employees at one establishment within a period of 90 days or less shall notify the Secretary of State, in writing, of his proposal … at least 45 days before the first of those dismissals takes effect.” On the surface, therefore, P&O Ferries appears to be in direct breach of the law. Indeed, the company’s CEO admitted in testimony to MPs that there was “absolutely no doubt” the company had broken UK employment law. Or has it? It has since come to light that due to a change in the law in 2018 “if the employees concerned are members of the crew of a seagoing vessel which is registered at a port outside Great Britain … The employer shall give the notification required … to the competent authority of the state where the vessel is registered.” Sure enough, eight of the company’s ships are registered abroad, including those which ply the Dover-Calais route.

Legally, therefore, P&O Ferries can argue that they have complied with the letter if not the spirit of the law. An excellent blog post by Darren Newman, an employment lawyer, makes the point that “UK employment law seeks to punish employers who act in breach of it – but does not stop them from doing so. If an employer makes the calculation that the financial consequences of ignoring the law are outweighed by the business benefits of doing so then it is free to go ahead.” Newman points out that this problem has not been confined solely to the UK, and EU efforts at the turn of the century to introduce tougher legislation were blocked by a group of countries including the UK. Nonetheless, the degree of worker protection is far higher in the EU than in the UK and many lawyers believe that the British laws are so weak as to be near useless. Whilst accepting that the degree of labour market rigidity that characterised the 1970s was a primary feature of the British economy’s underperformance during that decade, it is not clear that swinging the pendulum too far in the other direction has improved the position of workers.

Is this anything to do with Brexit?

The short answer is no, at least not directly: The UK’s labour laws have not changed since it left the EU in 2020. That said, by reducing cross-channel freight volumes which pressure P&O’s finances, it did play an indirect role.  It is ironic that the RMT union, which represents maritime workers, advised its members to vote for Brexit in 2016 arguing among other things “it’s a myth that the EU is in favour of workers. In fact the EU is developing a new policy framework to attack trade union rights, collective bargaining, job protections and wages.” In fact, the consultation element of the process, which was so blatantly ignored in this case, was introduced partly in response to EU concerns and highlights the lack of understanding of the EU’s role in large areas of British life prior to the referendum.

Limits of the free market

P&O claims that if it had not taken action to reduce costs the business would have gone under, with the CEO telling a parliamentary committee that he would make the same decision if the same circumstances were to arise. The fact that P&O received £10 million in furlough payments from the British government during the lockdown seems to have slipped his memory. Nobody would suggest that companies do not have a right to make adjustments to turn around a failing business, but by failing to adhere to due process P&O has offended public opinion which may yet rebound on their business fortunes. Ironically, the company’s most recent strategic report contained the priceless gem that “the directors practice a culture of regular engagement with employees … the effect of these measures is an open dialogue across the organisation.”

The company has admitted that it will pay the replacements for the sacked workers a rate less than the British minimum wage, offering just £5.50 per hour compared to a rate of £6.83 for those aged 18-20 rising to £9.50 for those aged over 23 (this at a time of the biggest squeeze on living standards in decades). This action comes just a few months after the government blocked efforts by the opposition to introduce legislation preventing firing and rehiring following a similar tactic by British Gas last year, claiming that legislation was not the appropriate way to tackle the problem. A series of articles by the FT journalist Sarah O’Connor (here and here) highlighted similar disregard for the law in the UK clothing industry. Such was the resonance of her analysis that she was invited to testify before a parliamentary committee which made a series of recommendations, all of which were rejected by the government. It does not exactly give the impression of a government that cares.

Ironically, the empirical evidence from the economics literature suggests that minimum wages have little adverse impact on aggregate employment although their existence does have a small impact on profitability. There are some upsides associated with the presence of a minimum wage, notably it can lead to an increase in productivity by reducing worker turnover and increasing the incentive to invest in labour saving technology. If a company believes that slashing wages so far below the legal minimum is necessary to return to profitability, there is a lot more wrong with the business than its cost structure.

Does it serve the national interest?

One aspect of this case that has gone unremarked are the complications of contracting out vital parts of the infrastructure to the private sector. Cross channel ferry links constitute a vital element of the UK supply chain, with Dover handling 14% of UK merchandise trade prior to 2020. P&O Ferries is owned by DP World – the same company that in 2006 was barred from taking control of six US seaports on national security grounds. There is nothing necessarily wrong per se in allowing DP World to have a significant degree of control over the cross channel link, but the fact that it operates very close to the limits of employment law does raises questions about its probity. To add insult to injury, DP World is in line for £50 million of taxpayer support for its role in setting up freeports. Following recent concerns about the degree of Russian influence in areas of British public life, this case raises further questions about whether the UK government conducts sufficient due diligence when contracting out areas of national interest.

The case highlights the limits of untrammelled free markets, demonstrating that the absence of constraints can result in very bad social outcomes. It also highlights the weaknesses in employment law where employee protection is a lot weaker than often appreciated. A government that has taken a laissez faire attitude towards actions of the private sector in the past may believe that P&O has gone a step too far – the electorate seems to think so.

Pleasing nobody

In its assessment of Chancellor Rishi Sunak’s Spring Statement (as the March fiscal set piece event is now known), the OBR pointed out that the first quarter of the 21^st century has seen the economy subject to a number of unprecedented shocks of which the war in Ukraine is just the latest. Each shock appears to be worse than the last but with inflation expected to head towards 40-year highs, the economic fallout from the Covid pandemic and the Ukraine war have combined to produce a hit to living standards, the likes of which many people have not seen in their working lifetime. In the course of March 2020, Sunak unveiled a package of measures appropriate to the scale of the problems facing the economy. His efforts in March 2022 were a woefully inadequate response to current problems, managing to be both ineffectual and badly targeted.

The nature of the cost of living squeeze

Last year Sunak announced that he was freezing income tax thresholds at 2021-22 levels until 2025-26. This would be bad enough if inflation was running at or slightly above the 2% target but with CPI inflation set to average more than 7% this year – the fastest pace in almost 40 years – a lot more people are likely to find themselves dragged into the higher income tax bracket if wages follow suit. Last September, Sunak also announced that he planned to raise National Insurance Contributions from April 2022 which I argued at the time was an unnecessary risk when the economy was only just recovering from a severe recession. Most worryingly, domestic energy bills are set to rise by over 50% from next month with the prospect of further big hikes in October. Altogether this combination of events is helping to stoke what many commentators are calling the UK’s biggest cost of living crisis in decades, with low paid workers set to pay the biggest price.

Sunak’s response was risible. He announced a temporary 5p per litre cut in motor fuel duty which (a) sends the wrong signal for a government which likes to talk up its green credentials and (b) does nothing to help the least well off who are more likely to spend money heating their homes than running a car. If the Chancellor was serious about helping this group he could have announced a temporary suspension of VAT on domestic fuel bills and thereby use one of the few additional policy levers derived from Brexit (EU rules require setting VAT on domestic fuel at a minimum of 5%).

To add insult to injury, Sunak announced that from April 2024 he intends to reduce the basic rate of income tax from 20% to 19%, thereby increasing the wedge between the taxation of earned and unearned income. The economic rationale for this is questionable and such is the uncertainty surrounding the economic outlook it may not even be affordable. It was also a blatantly political move, designed to burnish Sunak’s leadership credentials and his party’s standing ahead of an election in 2024, allowing him to continue making the claim that his is the party of low taxation. This is, of course, not true. According to the OBR, the overall tax burden is set to rise from 33% of GDP in 2019-20 to 36.3% by 2026-27 – its highest level since the late 1940s.

The OBR goes on to point out that “net tax cuts announced in this Spring Statement offset around a sixth of the net tax rises introduced by this Chancellor since he took over the role in February 2020, and just over a quarter of the personal tax rises he announced last year.” The FT’s putdown of Sunak’s credentials was funny, damning and accurate: “Sunak is a low-tax Chancellor, in the same way that people who play air guitar in their bedrooms are rock stars. He tried his best. He cut fuel taxes by 5p per litre, which means that, when your house is flooded by climate change, it’ll be cheaper to drive far away from it.”

The bigger economic picture

There is a lot of very good analysis on the state of the economy and what the spring statement implies and I will not repeat it here. The OBR’s mighty tome is the original source for a lot of the analysis (here) and the Resolution Foundation also produces an excellent synthesis (here). However a few issues do bear highlighting. The OBR’s analysis makes the point that “real household disposable incomes per person fall by 2.2 per cent in 2022-23, the largest fall in a single financial year since ONS records began in 1956-57.” It also highlights that in the wake of the decision to leave the EU, the UK “appears to have become a less trade intensive economy, with trade as a share of GDP falling 12 per cent since 2019, two and a half times more than in any other G7 country” (chart below).

Obviously governments cannot be held responsible for exogenous shocks which hit the economy but they do bear responsibility for the manner in which they deal with them. In this regard Sunak’s package of measures falls far short of what is required. Those on benefits face a particularly savage cut in real incomes, with benefits rising by 3.1% as inflation heads above 8%, compared with expected average weekly wage increases of 5.3%. As the IFS has pointed out, the current method for uprating benefits does not work when inflation is high and variable (chart below). A wider point made by the commentator Chris Dillow is that our current system derives its legitimacy from supporting all members of society. Ignoring the poorest undermines that legitimacy. That said, the Tories have hit the poorest voters hardest for more than a decade without any adverse consequences at the ballot box.

When it comes to trade, the government bears full responsibility for the adverse impact. By leaving the EU Single Market, the OBR maintains that the UK will suffer an output loss more than double that of the pandemic. At a time when living standards are under enough strain, the boiled frog problem of Brexit will place a significant additional burden on the economy. This matters because in a little-publicised report, the Government Actuary’s department has calculated that from the 2040s, the National Insurance Fund will be insufficient to maintain projected state pension payouts. Therefore we will either need faster growth, higher tax rates or lower pension payouts to ensure that the fund remains in balance. As an aside, it was notable that one of the measures announced yesterday was an alignment of the starting thresholds for income tax and NICs. How long before the government phases out employee NICs and folds them into income taxes (a subject I covered here)?

Last word

Sunak prides himself on his Thatcherite approach to fiscal management believing in an “ethical” mission to halt the expansion of the state, minimise taxes and restore fiscal self-discipline. I have long criticised politicians who treat state budgets like household finances and Sunak, who is an otherwise intelligent man, appears to have fallen into this trap. Within two years, the current budget balance is projected to return to surplus and overall public borrowing to fall below 2% of GDP. It may well be that the Chancellor will have to use some of these resources to provide extra help to the poorest in society. When even traditional supporters such as the Daily Telegraph balk at the lack of support, you had better believe more needs to be done.

Pieces in the puzzle

Just as the fall of the Berlin Wall in 1989 kick started the wave of globalisation, so the Russian invasion of Ukraine threatens to throw the process into reverse. Whereas its rise was initially a slow process which only seeped into the wider consciousness around the turn of the century, the reversal of globalisation is likely to take the form of a screeching U-turn as the west reassesses its security and economic needs. Whether or not the fighting in Ukraine quickly comes to an end, it is clear that Russia under its current government will remain an untrustworthy geopolitical partner which will require governments to reassess their political alliances. This in turn will have consequences for the shape of the global economy.

Assessing China’s position

The role of China will be particularly fascinating. Prior to 2008 it was hoped that China would align more closely with the west as rising prosperity convinced the government that opening up the economy would be in its best interests. That has proved a forlorn hope. An ever stronger China has continued to plough its own political and economic furrow with ambitions of usurping the US to become the dominant Asian power. It is ultimately likely to achieve that goal one way or another. At issue is the timing and the extent to which this transition occurs peacefully or otherwise.

It was therefore particularly interesting to hear suggestions that Russia has asked China for financial and logistical support for its invasion of Ukraine which further complicate the geopolitical mix. Whether China will agree to do this remains unclear. Last month, Russia and China extended the 2001 Sino-Russian Treaty of Friendship for another five years which commits China to support Russia “in its policies on the issue of defending the national unity and territorial integrity of the Russian Federation.” It also states that “when a situation arises in which one of the contracting parties deems that peace is being threatened and undermined or its security interests are involved or when it is confronted with the threat of aggression, the contracting parties shall immediately hold contacts and consultations in order to eliminate such threats.” Clearly, the ties between the two are very strong although it is questionable whether China expected Russia to launch its invasion which runs counter to its interests.

A particularly interesting article by Hu Wei, vice-chairman of the Public Policy Research Centre of the Counsellor’s Office of the State Council, suggests that China’s alignment with Russia could cause more problems than it solves. The thrust of the text is that if the conflict were to spiral, with NATO becoming involved, Russia cannot win by military means which would raise US influence on the global stage and leave China more isolated. He suggests that “China cannot be tied to Putin and needs to be cut off as soon as possible … Being in the same boat with Putin will impact China should he lose power. Unless Putin can secure victory with China’s backing, a prospect which looks bleak at the moment, China does not have the clout to back Russia.” It is important to stress that this does not reflect government policy and the fact that it was submitted to the Chinese-language edition of the US-China Perception Monitor and translated into English suggests it was designed for a western audience.

The official Chinese position views the world in zero-sum terms: What is good for the US must be bad for China (although the Trump administration was guilty of the same mindset). It does not have to be this way and rather than issuing threats about how the US would react – wielding the big stick would likely prove counterproductive, especially since China is aware of the consequences – a better approach may be to highlight the benefits of the cooperation which China claims to value. Whilst we should not expect China to publicly oppose Russia’s actions, at the UN or elsewhere, it has more potential than any other external force to act as a restraining influence.  

China is also aware that it runs significant reputational risk if it aligns itself with Russia and has more to lose than to gain if the west does decide to loosen economic ties. Moreover, Russia’s actions will cause problems for one of China’s signature economic policies – the Belt and Road Initiative. The BRI is designed to create a land route across central Asia, linking China to consumer markets in western Europe and raw material producers across Europe and Asia. War in eastern Europe will disrupt the supply of commodities to China and elsewhere, particularly in the event of a protracted conflict. It is thus in China’s economic interests that the war in Ukraine is swiftly resolved.

Big questions for Europe

From a European perspective, the western alliance has come together far more quickly and in a more unified fashion than we have seen for many years. The EU’s actions are a reminder that it has its roots in a project designed to ensure that the continent would not revisit the ravages of the first half of the twentieth century – a point that was lost on large parts of the UK electorate during the Brexit referendum. With the spectre of conflict once again at the EU’s border, the nature of the union is likely to change. The commitment to raising defence spending will mean more expansionary fiscal policies across Europe. During the Cold War, European economies routinely spent around 3% of GDP on defence. Recent figures suggest that this has slipped to around 1.5%. In order to boost outlays will mean either higher taxes or an increase in debt issuance (and this is before we discuss the costs of dealing with the refugee crisis).

In addition the rush to diversify away from Russian energy sources will impact on living standards for many years to come as the relative cost of energy remains elevated. This may also have implications for the EU’s green agenda. Whilst there are increased incentives to diversify away from hydrocarbon fuels, it will be difficult to make the sudden switch to renewables. Consequently, many EU countries may be forced to extend the lifetime of coal-fired power stations, rather than using gas as a transition fuel until such times as renewable sources come online.

Across the continent, governments are likely to be far more engaged in economic management than has been the case for many years, which they will justify on national security grounds. As this post from the Breugel think tank pointed out, the private sector may have responsibility for the generation and distribution of energy but has no responsibility for ensuring security of supply nor for ensuring that consumers have access to energy. The private sector may also be unwilling to carry the costs of replenishing supplies at current prices, for fear of huge losses in the event that oil and gas prices fall. All of this suggests that significant fiscal intervention may be required to guarantee energy supply.

Europe has perhaps been too complacent about the risks emerging from the geopolitical sphere in recent years, partly because it has had to cope with the aftershocks of the Greek debt crisis and Brexit. However, it has acted remarkably swiftly in the last three weeks as latest events highlight that the time for complacency is over. In the wake of the 2008 crash, hopes were expressed that we could return to the old world order. The pandemic and the war in Ukraine suggest that we are likely to return to a geopolitical order more reminiscent of 1985 than 2005.

The price of war

As the war in Ukraine unfolds and the harrowing scenes of death and displacement fill our TV screens on a daily basis, questions are increasingly being raised as to what is the end-game. Far from this being a Russian invasion with a swift conclusion, it could turn out to be a protracted conflict as Russia becomes bogged down in Ukraine. Without claiming to be an expert on Russian policy, there is plenty of good material out there which allows us to draw some conclusions as to how proceedings might unfold. One thing is evident: A range of different outcomes are possible and it is unwise to identify a single outcome at this stage of the proceedings.

Major military operations often take considerable time to conclude – for example, it took US forces one month to take Baghdad after launching its Iraq invasion in 2003. However, the Iraq invasion was planned as a slow and methodical affair: The Russian invasion of Ukraine appears from the outside to have miscalculated the strength of opposition. This runs the risk that ever more desperate measures will be taken to hasten the conclusion and increases the longer-term risks, both for Russia and the west.

How much pressure does Putin face at home?

Looking at the issue from Putin’s perspective, it is now an established fact that he sees Ukraine as part of a “greater Russia.” Having committed substantial resources and having put his domestic reputation on the line in order to take the country by force, the likelihood of him backing down before completing his objective is lower than a further escalation of Russia’s military effort. There have been suggestions that the sanctions against Russia will help to undermine Putin’s position as the oligarchy rises up against him. But a Twitter thread by Professor Olga Chyzh suggests this may be a naïve hope. Chyzh points out that they owe their wealth and position to Putin and if he goes, they do too. In her view, “the oligarchs are simply managers delegated with over-seeing day-to-day activities … Putin’s oligarchs have no political power whatsoever. Their domain is strictly economic.” She further notes that whilst the oligarchs may wield the economic power, it is the siloviki (strongmen) who wield the muscle capable of overthrowing Putin but since their interests are aligned with his, they have no incentive to bring him down.

However, Putin is not invulnerable. As a very informative article in Foreign Affairs, published last year, noted: “because of the compromises he has had to make to consolidate his personal control over the state, Putin’s tools for balancing the competing goals of rewarding elites who might otherwise conspire against him and appeasing the public are becoming less and less effective.” This suggests that sanctions may be effective. However, they will take a very long time to achieve their objective and are likely to do so only by making life for ordinary citizens intolerably hard.

The manpower cost of Ukrainian expansion

In the meantime, in the absence of a ceasefire – which currently looks unlikely – the war in Ukraine is set to continue. It is possible that Ukraine may be able to hold out long enough for Russia to opt for a face-saving exit strategy. That does not look to be on the cards at present, although we should never say never. Russia might instead decide to cut its losses and conquer only the territory to the east of the Dnieper River, claiming this was the goal all along. Alternatively it may double down its efforts and push through to the western border which will prove to be a long haul. Either way, having taken the territory it will prove economically and militarily ruinous to hold it.

In looking at the economics of occupation I am indebted to work by the economist John Llewellyn, conducted when he was working at Lehman’s in 2004 (available here). A study of the numerical requirements for a successful occupying force concluded that “no post-WWII occupation of a country has been successful at a force ratio of less than 20 troops per thousand head of population. And indeed some occupations … failed notwithstanding a force ratio of nearly 40.” This implies at the very least Russia would have to commit almost 900,000 personnel in order to have a chance of successfully occupying the whole of Ukraine. With an army comprised of one million active personnel and two million in reserve, this would require committing almost one-third of the available numbers to the task. Even if it were to occupy only the eastern half, Russia would still have to commit around 400,000 personnel which would be a considerable drain on resources.

Assessing the financial costs

Then there is the financial cost. The US is estimated to have spent $8 trillion in its 20-year “war on terror”, including its invasions and occupations of Afghanistan and Iraq. Even if Russia were to spend 5% of this amount, it would still require outlays of $400 billion – roughly seven years of Russian military spending – and this at a time when the economy will be under severe pressure as a result of global sanctions. Prior to the war, Russia could tap into $630bn of foreign exchange reserves. That amount has been roughly halved after western nations announced sanctions preventing access to any reserves held on their territory. Consequently reserves now amount to around 10 months of import coverage.

Despite the imposition of sanctions, however, oil and gas are exempt and European countries continue to buy Russian energy. German Chancellor Scholz stated yesterday that: “Supplying Europe with energy for heat generation, mobility, electricity supply and industry cannot be secured in any other way at the moment. It is therefore of essential importance for the provision of public services and the daily lives of our citizens.” Even though Urals crude is trading at a $25 discount to Brent, it is still around $100/bbl. On the basis that Russia exports around 4.5 million barrels per day to Europe, that amounts to $13.5bn per month in oil revenues alone. Similarly, Europe currently imports 32% of its gas from Russia (Russia met 40% of consumption needs in 2021). Last week, the think tank Bruegel calculated that at then-current market prices, the daily value of gas imports was around $755 million, or almost $22bn per month. If the world is serious about imposing sanctions, a reduction in hydrocarbon imports from Russia is essential otherwise the revenues will be used to further conduct the war.

The EU is working on a plan to cut Russian gas imports by two-thirds over the next twelve months, which is double the amount proposed by the IEA’s 10-point plan announced last week. Frans Timmermans, who leads the European Commission’s work on the European Green Deal, reckons that near-term savings could be made by cutting energy use, filling up gas storage in 2022 and finding new sources of supply, with the EU already in discussions with the likes of Egypt, Qatar, Australia and the US. If this can be realised, the flow of funds into Russia will dry up very quickly and reduce Putin’s capacity to pursue his war.

Weaning the EU off Russian energy imports will come at a significant economic cost. A paper published yesterday[1] attempted to measure the costs to Germany of ceasing to import energy from Russia. The authors conclude that “the effects are likely to be substantial but manageable. In the short run, a stop of Russian energy imports would lead to a GDP decline in a range between 0.5% and 3% (cf. the GDP decline in 2020 during the pandemic was 4.5%).” This is a big economic price to pay. But the moral price of continuing to fund Putin’s activities may be even higher.

Last word

Aside from the grief and heartache it causes, war is also an expensive economic enterprise. Even if Putin achieves his objective of conquering Ukraine, Russia will struggle to hold onto the territory unless it significantly raises its military commitment. But as the west cuts ties with Russia, leaving it increasingly economically isolated, Putin may not have to the resources to achieve this. Quite how a cornered Putin then reacts depends on whether the west allows him a face-saving way out and how his people react. It is not going to be pretty.

---

[1] Bachmann, R., D. Baqaee, C. Bayer, M. Kuhn, A. Löschel, B. Moll, A. Peichl, K. Pittel and M. Schularick (2022) ‘What if? The economic effects for Germany of a stop of energy imports from Russia’, ECONtribute Policy Brief No. 028