Bordering on the bizarre

Editorial policy at the Financial Times has taken a strange tack of late. A sensible, sober newspaper has published two opinion pieces in recent weeks illustrating the lack of knowledge displayed by policymakers on matters of real economic importance. Last week’s piece by former German finance minister Wolfgang Schäuble on euro zone fiscal issues was followed by UK Brexit minister David Frost’s call for a rethink of the Northern Ireland protocol (NIP). The latter is part of a government media blitz to convey the message that the NIP has not panned out as expected. It is difficult to buy that view given the warnings which were issued ahead of Brexit.

All this was very predictable

To remind people of what was said at the time the agreement was signed, the deputy leader of the Democratic Unionist Party warned in October 2019 that, “You are really in danger here of causing real problems with the Belfast agreement … and political stability in Northern Ireland.” The charity Fullfact.org reported in December 2019 that Boris Johnson’s claim that there will be “no checks on goods going from GB to NI” was false. They also reported that “it’s not correct, as Mr Johnson said, that if there are any terms of the Withdrawal Agreement that people in Northern Ireland don’t like that they would lapse automatically after four years.” Everything that has happened in recent weeks was thus entirely foreseeable. 

I noted in April that “the contradictions inherent in the Brexit deal regarding Northern Ireland are becoming more evident by the week.” Of all the problems inherent in Brexit, the Northern Irish border issue can be laid directly at the door of Boris Johnson’s government. British MPs simply would not sign up to the “backstop” arrangement negotiated by Theresa May’s government. Johnson’s alternative, which was acceptable to parliament because it prevented the UK from being trapped in the EU’s embrace, imposed a border where previously there was none. Indeed the one thing which the British government has always refused to acknowledge is that there must by definition be a border between UK and EU customs territories. In this case it runs down the middle of the Irish Sea. Anyone who thought otherwise is being disingenuous.

The government adopted a "sign now, deal with it later" approach

According to Frost, “when we agreed this new protocol in 2019, we did so in order to remove the old disastrous “backstop” and to enable Brexit to happen, but to do so in a way that maintained our overriding priority of protecting the Belfast (Good Friday) Agreement and avoiding a hard border.” As to whether it was “disastrous” the Irish government did not think so, nor did Northern Irish nationalist politicians who won more seats than unionist politicians at the 2019 general election. Unfortunately, nobody thought to directly ask the Northern Irish people (who, by the way, voted 56-44 in favour of remaining in the EU in 2016). The protocol was passed through parliament primarily by English Conservative MPs because this was the least objectionable option “to enable Brexit to happen.” 

Frost goes on to say “we underestimated the effect of the protocol on goods movements to Northern Ireland.” Again, I am not sure who is the “we” referred to but the government was warned for years, both before and after the referendum, that imposing frictions to cross-border EU trade would come at a cost. Frost concluded his missive by suggesting that “we agreed … to control certain goods movements within our own country and customs territory. If that situation is not to be totally unsustainable we need to be able to do so in ways which do not disrupt everyday life and which respect everyone’s identity and interests. We continue to work for negotiated solutions which achieve this.” Most rational people believe that the protocol represents just such a negotiated solution and it increasingly looks like the UK government signed on the dotted line simply to get Brexit “done” with the intention of trying to renegotiate the details later.

And now it is paying the price

The international community has little sympathy for the UK’s position. Unsurprisingly, Emmanuel Macron is not to be moved. As he told journalists earlier this week, “We have a protocol. If after six months you say we cannot respect what was negotiated, then that says nothing can be respected. I believe in the weight of a treaty, I believe in taking a serious approach. Nothing is negotiable. Everything is applicable.” More seriously news reports have emerged to suggest that the US government privately rebuked the British for endangering the peace process over the NIP, although both sides have been careful to keep this out of the public domain.

Many of the more deluded on the Brexit spectrum cannot bring themselves to admit that there are big costs associated with their signature policy and continue with the narrative that the NIP was somehow “imposed on the UK by Brussels at the moment of our greatest weakness” (I will leave it to you to decide whether it is fortunate or unfortunate that it is behind a paywall. Ironically the same author extolled the virtues of the NIP less than two years ago). It beggars belief that the British government finds itself in such a position. Johnson promised “an oven ready deal” just 18 months ago which was meant to lead us to the sunny uplands. Instead we find that the deal does not do what it said on Johnson’s tin. To add insult to injury, Frost is not an elected politician – he is an unelected (recently ennobled) member of the House of Lords. The British government has thus appointed an unelected trade novice to oversee trade policy. Brexit is not yet at the stage of devouring its own children but the pot may be about to be readied.

A wider problem is that if the government has treated major issues such as trade policy in such a cavalier fashion, can it be trusted on other issues? As the OECD put it, “trust is the foundation upon which the legitimacy of public institutions is built and is crucial for maintaining social cohesion.” So far there has not been any significant loss of domestic trust with Johnson’s act continuing to play well at home but the UK’s reputation in international dealings is not exactly being burnished by recent events.

The EU is not blameless either but the UK government must shoulder the blame

This is not to say that the EU is entirely blameless. Its actions regarding the NIP reflect a tendency to hide political problems behind technical issues, arguing that the purity of the single market must be protected at all costs. This intransigence is what caused the Swiss to recently walk away from seven years of negotiations to achieve a framework deal with the EU to replace the patchwork of deals currently in place. Of course, one of the great ironies of the current situation is that Brexiteers always argued that the EU was an excessively bureaucratic institution that the UK was well advised to leave whereas the truth was that as a member, the UK was shielded from the worst of it.

We can debate the extent to which the EU needs to change its policy towards its neighbours – and this argument is not without merit. However, the recent spat demonstrates that the UK government’s casual approach to legal details over the past five years does have consequences. I have made it clear for many years that there is no such thing as British exceptionalism, which appears to be the leitmotif of many hardline Brexiteers. As it is, the Northern Irish problem, serious as it is, affects a relatively small proportion of the UK population. Over time, a larger proportion of the population may begin to become aware of the damage that Brexit has inflicted upon them. Only then might we start to have the debate we should have been having five years ago about the price of the policy.

The jury is still out

The topic of Brexit has figured prominently on this blog over the last five years but in recent months I have resisted the temptation to look at it, primarily because there was not enough information to make an informed assessment of how much impact it was having on the economy. But more than 100 days after the UK left the safety net provided by the EU transitional arrangements, and with key data for the first two months of the year now in, it may be time to look once again at where we stand.

Trade: The story is still unfolding

It was always to be expected that trade would take a significant hit in early-2021 following the late signing of the EU deal on 24 December 2020 which meant that companies had little time to adapt to the new trade rules. Accordingly, the collapse in trade with the EU in January came as no surprise, with exports falling by 42% and imports by 30%. The question was always how quickly it would rebound in February. This week’s trade data release provided us with an answer. UK exports to the EU in February jumped by 47% versus January whilst imports increased 8%. In other words, a large proportion – but not all – of the January export collapse has been reversed but imports remain well short. Nonetheless, exports are still around 7% below levels prevailing in the second half of 2020 whereas imports are running almost 15% lower.

But this does not provide a definitive answer to the trade impact. There was clear evidence of stockpiling in late 2020 which means that companies may be running down inventories before picking up imports again. This may be one reason why imports from the EU have not rebounded very quickly. It is notable, however, that there was a sharp jump in imports from non-EU countries in February (+26%) which may be a first indication of import substitution away from EU sources although we should be wary of over-interpreting one month’s worth of data. We should also bear in mind that although full border controls have applied on British goods going to the EU since 1 January, goods coming in the other direction have benefited from a grace period.  The UK originally planned to impose regulatory checks from 1 April but recently announced it would now only do so from October 2021 in recognition of the fact that customs systems and port infrastructure are still not ready. Accordingly, we may not be able to determine the full trade impact of Brexit on UK trade flows until the end of the year. 

Northern Ireland: Contradictions unresolved

However, the contradictions inherent in the Brexit deal regarding Northern Ireland are becoming more evident by the week. During the Brexit negotiations both the UK and EU made it clear that they wanted to adhere to the Good Friday Agreement and avoid the imposition of a hard border in Ireland. But the UK’s decision to leave the EU single market meant it was inevitable there would have to be a border somewhere. Theresa May rejected the option of a border between GB and the EU running through the Irish Sea as unacceptable since it would effectively slice Northern Ireland away from mainland Britain. Unfortunately, the deal that her government agreed with the EU was not acceptable to the British parliament since the UK would have remained in a common customs territory with the EU until such times as alternative arrangements could be made. Many Conservative MPs (including Boris Johnson) refused to back this plan arguing that it would indefinitely bind the UK and the EU together since the UK would be unable to unilaterally break away.

Boris Johnson’s government subsequently renegotiated the Northern Ireland Protocol (NIP) leading to an agreement whereby the whole of the UK left the EU Customs Union, but Northern Ireland adopted EU Single Market regulations on goods and thus remained an entry point into the EU market. Whilst this avoided the imposition of a border on the island of Ireland it did introduce one in the Irish Sea, despite the fact that Johnson said last summer that such an outcome would only occur "over my dead body."

There has been a considerable amount of political fallout in recent weeks, highlighted by a significant degree of violence on the streets of Belfast. This has been attributed in large part to dissatisfaction within the loyalist community towards the provisions of the NIP as it fears a permanent separation from the mainland. It was always the case that the May government’s deal was the least-worst option since it preserved the integrity of the UK and minimised the frictions in cross border trade. It was opposed for ideological reasons by large parts of the Conservative Party which wanted a clean break from the EU. Ironically, MPs from the DUP, who between 2017 and 2019 provided parliamentary support to the minority Tory government, also voted against it. Their fear was that if Northern Ireland remained bound by single market regulations (as May’s plan envisaged) this would eventually lead to the imposition of an Irish Sea border. They also voted against the Johnson government’s plan for precisely the same reasons but following the 2019 election they were no longer in a position to demand concessions from the Conservatives and they ended up with the outcome they had feared. The people of Northern Ireland have been let down by their politicians.

There have recently been efforts to rewrite the history of the Northern Irish border problem. An article in the Daily Telegraph earlier this week was headed “Northern Ireland is paying the price for Theresa May's negotiating blunders” whilst an article published in the Daily Mail blamed the “spiteful” EU. None of this stands up to scrutiny. The problems stem from the construction of the deal signed by the UK government which has spent five years attempting to resolve the unresolvable of where to locate the border without actually putting one in place. Not that this matters to the electorate on the mainland where the majority of those believing the Brexit vote was a mistake has narrowed in recent weeks (chart 2). However this is heavily influenced by the EU’s poor performance on the vaccine rollout and will undoubtedly change again in the months ahead. Nor is it a cause for concern to Westminster politicians who, as I noted in 2019, knowingly sold the DUP down the river.

An ongoing process

I have long pointed out that Johnson’s 2019 election slogan to “get Brexit done” was disingenuous and that the process of normalising relationships between the UK and EU would take considerable time. Accordingly, the UK and EU are currently engaged in discussions on how to resolve the problems in Northern Ireland. Negotiations are also still ongoing with regard to the future of financial services although on 26 March the Treasury did confirm that technical discussions on the text of the promised Memorandum of Understanding have successfully concluded.

But it is simply too early to tell what effect Brexit is having on the UK economy which continues to suffer under the fallout from the Covid-induced collapse. According to research by John Springford at the CER, trade in February was 5% below what might have been expected had the UK not left the single market. Knowing what I do about the method he used to make this calculation we should treat this with a pinch of salt, but it does sound plausible. Nonetheless, businesses are reporting that the main challenge for companies exporting and importing is the increased administrative burden. This confirms my view that the business impact will be a boiled frog problem – it will take time for firms to realise just how much damage has been done. They will naturally adjust and probably even get used to the inconvenience but compared with the counterfactual of pre-Brexit admin, the costs to the overall economy will mount up over time.

Much of the heat and passion has gone out of the Brexit debate. Now it is up to its proponents to demonstrate that it will improve the lives of those in whose name the whole exercise was conducted. We might have to wait a long time!

Border disorder

It has been a tumultuous week in the world of British politics as the political establishment tears itself apart over the issue of Brexit. With just 29 days to go, Boris Johnson reiterated at today’s keynote speech to the Conservative Party conference that the UK is "coming out of the EU on October 31, come what may." There is only one way that this can be achieved and it requires the UK and EU to agree a deal that will enable the transitional arrangement to come into force which will prevent a no-deal Brexit. For all the ongoing excitable talk in the press, no doubt whipped up by Conservative sources, that the government is prepared to leave without a deal, do not forget that to do so would be a breach of the law. Parliament has already ruled out this option and having lost one legal battle, Johnson would not relish the prospect of MPs once again resorting to the courts to force him to comply.

If ever there was a time for ignoring press chatter and speculation, now is that time. Ahead of Johnson’s speech, there were stories suggesting that the government would unveil its strategy to deal with the Irish border problem, and present it to the EU as a “take it or leave it” option. That was not what we got. The rhetoric was far more conciliatory as the government presented a plan which allows for regulatory alignment between Northern Ireland and the Republic for a limited period of time. But it is what happens once the transition period ends that is far more problematic.

At that point, Northern Ireland will leave the EU customs union and revert to being part of the UK customs union. However, the North will be fully aligned with the EU for the purposes of the agri-food business and “in addition, Northern Ireland would also align with all relevant EU rules relating to the placing on the market of manufactured goods.” This effectively means the creation of two borders: A regulatory border between Britain and Northern Ireland for manufactured goods and agri-food products but a customs border between the North and the Republic.

Moreover, the British government has reiterated its position that “no customs controls necessary to ensure compliance with the UK and EU customs regimes will take place at or near the border.” Instead, they will rely on “continuing close cooperation between UK and Irish authorities” with movements across borders notified using a declaration process, utilising processes such as the trusted trader scheme which the EU has already rejected as unworkable. None of this sounds to me like a solution that the EU can buy into – it is all a bit vague. And from the EU’s perspective it gets worse. The UK has proposed that every four years, the Northern Irish electorate will get a chance to have its say on the regime to ensure that it is still satisfied with the arrangements. But “if consent is withheld, the arrangements will not enter into force or will lapse … after one year, and arrangements will default to existing rules.” This is clearly not the permanent solution to the border problem that the EU is seeking. In its current form, I would be highly surprised if the EU accepts it. Indeed, chief EU negotiator Michel Barnier was reportedly scathing of Johnson's Irish border plan, describing it as "a trap".

The best way to view the proposal is as a starting point for discussion. But it all seems a bit late although that seems to be the only way that anything gets done in these negotiations. Clearly the EU does not want to reject it outright since this would effectively scupper any chance of a deal at the summit in two weeks’ time. The question is then how much are the British prepared to bend to accommodate the EU’s requirements (and vice versa)? And where does it leave the Democratic Unionist Party? After all, they were the ones who objected to a customs border between Northern Ireland and the mainland yet that is exactly what they have now signed up to.

But Johnson is now entering the most critical phrase. His mantra “let’s get Brexit done”, for which read "leave the EU on 31 October", rings increasingly hollow. It is 100% certain that Brexit will not be “done” by the end of this month even if the UK leaves the EU. The October deadline represents a staging post which would at best mark the start of negotiations regarding the nature of the UK’s long-term relationship with the EU. As a third country with much less bargaining power than the EU, the UK will be in a much weaker position than it is now and negotiations will be a lot tougher than anything seen so far. As a consequence, the economic uncertainty that has held back business investment over the past three years is likely to persist – a point made by MPC member Michael Saunders in a speech last week.

Although the Conservative government believes that it will be possible to reunite the country once it has dragged Brexit over the line, I continue to have my doubts. A no-deal Brexit will exacerbate, rather than heal, divisions and the damage to the UK as a business location may already have been done – a view I heard expressed at a business forum I attended yesterday. Brexit long ago stopped being about the economics and simply became the toughest battlefront in what now has to be seen as a culture war. But the economics matters – ultimately it will determine whether Brexit is deemed a success. I am not holding my breath.

Snatching defeat from the jaws of victory

Brexit has been the dominant theme of this blog for the past 30 months. It was not meant to be this way, but it is a measure of the fact that the political forces impacting on economic decision making have dominated the agenda of policy makers and investors. Nationalism has become one of the biggest political and economic challenges of our time and has found expression across the whole of Europe, not to mention the US.

Brexit is merely the tip of this nationalist iceberg. Indeed, the fact we have spent 30 months discussing what form it should take means we have spent more time debating the issue after the referendum than we ever did beforehand. If we think back 30 months before the referendum, we are transported back to the innocent days of early-2014 when the debate was dominated by the aftermath of the euro zone debt crisis, the extent to which the global economy was recovering and how rapidly interest rates would be normalised (for the record, I expected UK Bank Rate to be at 3% by now).

But now it is crunch time with the vote on the Withdrawal Agreement due next Tuesday. MPs are widely expected to reject it, which means that much of the negotiations and effort put into this debate are likely to count for nothing. If the last 30 months have taught us anything it is that there are no simple answers to complex questions – a point that Mark Carney repeatedly made in testimony before the Treasury Committee this week when pressed to explain some of the issues in simpler terms.

I was also struck by an excellent Twitter thread by Seamus Nevin, head of  policy research at the Institute of Directors, who made a comparison between the situation facing Theresa May’s government today and that facing the Irish independence movement in 1921 when a smaller entity made a bid for independence from a larger body. As he pointed out, it is ironic that Northern Ireland loomed large during both campaigns. Back then, of course, the north was the industrial powerhouse which was cut out from the rest of the island. Today the roles are reversed, with the Republic a much stronger economic force than Northern Ireland.

To quote Nevin: “The Anglo Irish Treaty fell far short of the Irish separatists’ demands for full sovereignty. The Treaty Michael Collins negotiated meant Ireland would not be fully independent but a ‘self-governing dominion of the United Kingdom’ … Leavers wanted the north to exit on the same terms as the rest of the country. Business interests argued that leaving the customs union would cause great damage to northern Irish industry. Just as the UK is finding now, leaving a customs union is not without political difficulty. The deal, reached after long and hard rounds of talks, was imperfect … But as Collins argued back then to his frustrated and disappointed party colleagues, the deal ‘gives us freedom, not the ultimate freedom that all nations desire, but the freedom to achieve it.’”

This latter point goes to the heart of the Brexit problem. Leavers want a perfect Brexit which gives the UK all of the economic upsides but with the added benefits of controlling its own borders free from interference from the ECJ. As I am bored of repeating, but it cannot be stressed enough, this is a fantasy that can never be realised. The deal on the table is probably the best that the UK can expect to achieve. As Nevin puts it, Theresa May has to “convince her colleagues that to reject the negotiated agreement risks jeopardising the very thing the Brexit leavers, like their Irish separatist predecessors, have fought so hard to achieve: freedom from that neighbouring union.” If Brexiteers reject this deal, they may just have kissed goodbye to their chances of achieving any form of Brexit.

In the event that parliament rejects the Withdrawal Agreement, MPs will then take over the Brexit process and it is widely assumed that they will do whatever it takes to avoid a no-deal outcome. This will likely involve a form of accommodation with the EU that precludes the Brexit ultras from being able to achieve the degree of independence they have fought so long to achieve. If they want any form of independence from the EU, it might be better for them to accept an imperfect Brexit than none at all. Of course, the UK gains very little independence from the current deal, as the release of the government’s legal advice this week made clear.

Nonetheless, it would be the bitterest irony for the likes of Boris Johnson, David Davis and Jacob Rees-Mogg that they won the referendum against the odds but then threw away their best chance of victory (or at least a draw) at the last minute by pushing for a better outcome.