Just a little respect

The late great Aretha Franklin demanded, and indeed commanded, respect. After a difficult 24 hours during which the EU27 decisively rejected Theresa May’s Chequers plan at the Salzburg summit, the prime minister was only able to demand it. It was not her finest hour! The EU’s rejection should have come as less of a surprise than the British press made out. It was less an “ambush” (as even the normally sober FT described it) and more a failure of the British government to correctly interpret the EU’s stance during the summer months.

Perhaps some EU politicians and officials did give the impression there were things in the Chequers plan that they liked which lulled the British government into a false sense of security. But even at the start of this month there were clear signs that the Irish border problem was not going well. Moreover, as I noted in July (here) the UK was always running a risk by asking for restrictions on the freedom of movement whilst calling for an association agreement which, to all intents and purposes, was a request to remain in the single market (at least for goods). Chequers was a cherry-picking plan par excellence and the UK government knew it. 

The way ahead has now become a lot less certain. European Council President Tusk announced that the “moment of truth” in Brexit talks would come at the EU summit on 18 October, by which time the EU expects to see a credible proposal for the Irish border issue. Recall that the October deadline was supposed to be the point at which the EU and UK would agree on the terms of the post-March 2019 arrangements, which would in turn be put to EU governments and the EU Parliament for ratification. That is now off the agenda. The hope is that an emergency summit in November will be the point at which these details can be thrashed out. But as Tusk noted, only if there is progress next month will the EU even agree to a November summit. Thus, October has become a critical deadline but for the wrong reasons – and failure to make progress here would substantially raise the risk of a disorderly Brexit next March. 

Domestic politics remains a major sticking point. Theresa May will next week have to face the Conservative Party’s annual conference without any support from Brussels and in the knowledge that domestic opposition to her Chequers plan is mounting. It is in this context that we should assess her extraordinary speech this afternoon in which she called for the EU to show more “respect.” The suggestion that “the EU is still only offering us two options” is actually the situation which UK voters faced in June 2016, and the choices are stay or go.

In the PM’s view, “the first option would involve the UK staying in the European Economic Area and a customs union with the EU … [but] that would make a mockery of the referendum we had two years ago.” She’s not often right but she’s wrong again!  Unless we all missed something, the decision to leave the single market and customs union was never on the ballot paper. Indeed, we were promised by many prominent leave supporters that exiting the single market was not an option. This interpretation of the vote is used by Brexiteers to justify their subsequent actions. However, it is –  to be blunt – a lie; fake news of epic proportions. And what is worrying is that this lie is being peddled by the PM. But whilst at first glance the PM appears not to understand the dynamics of the Brexit negotiations, which says a lot about her or those advising her, there is another interpretation. It is an appeal to the hardliners in her party ahead of next week’s conference. Simply put, this was Theresa May pleading for her job! 

The PM’s problem is that having set so much store by Chequers, it is difficult for her to abandon it. The Brexiteers have long opposed the Chequers plan because in their view it does not put sufficient clear water between the UK and the current EU arrangements. This highlights the British government’s dilemma: It cannot put together a plan that simultaneously satisfies both the EU and Leave supporters, and efforts to find a compromise have merely angered both sides. Recent suggestions by prominent Brexiteers that any deal agreed could be unpicked by a future government  or that the UK will not pay its financial obligations if there is no deal have done nothing to bolster the UK’s credibility in Brussels.

It is increasingly obvious that the simplest solution to many of the problems will be to postpone departure from the Customs Union – a policy which never made any economic sense. It will help to reconcile the objectives of reducing trade frictions whilst limiting the free movement of labour and is the only sensible solution to the Irish border problem. As it currently stands, the EU’s solution to the Irish border problem only  involves making provisions for Northern Ireland and not for the UK as a whole, which is (rightly) unacceptable to the UK government as it implies an internal UK customs border. But the UK’s backstop proposal envisages remaining in the Customs Union beyond 2020 (assuming a transition agreement is signed first).

Proposing to remain in the Customs Union would anger the Brexiteers. The question is whether the PM has the backbone to take them on. Only the Brexit ultras support leaving the Customs Union and my guess is that if she were to make this proposal to parliament, she would have the numbers to carry it through. At issue is whether she is prepared to demonstrate the leadership qualities required of a prime minister to make choices in the national, rather than the party, interest. I am not hopeful! 

As for Theresa May’s own position, speculation will mount that she is unlikely to survive too much longer, particularly since Boris Johnson is effectively mounting a leadership challenge via his weekly column in the Daily Telegraph. Consequently, the rhetoric at the party conference next week will sound as hawkish as ever with no talk of compromise. But make no mistake, that will come later – it has to! In any case, it is not clear that a change of leader resolves anything. May remains in post only because nobody else really wants the poisoned chalice. There is thus a good chance that she will remain in office until March but thereafter anything is possible.

But Johnson would be the worst possible candidate to try and negotiate with the EU following Emmanuel Macron’s comments earlier this year that “Nigel Farage and Mr Johnson are responsible for this crime [Brexit]: they sailed the ship into battle and jumped overboard at the moment of crisis.” In the words of one UK official quoted this morning in the FT “Now it’s getting real.”

Choose your enemies wisely

As the Brexit clock ticks closer to March 2019 the UK political landscape is increasingly fissiparous as Theresa May tries to appease both sides of her fractured party whilst managing to satisfy neither.  With regard to Brexit, her main tactic has been to play for time in the hope that something will turn up. But it is increasingly apparent that it has not, and will not, and May is reaching the stage where she will have to demonstrate some proper leadership in order to ensure that the UK gets the deal that it wants. As Simon Nixon pointed out in a recent Wall Street Journal article the PM has embraced a number of contradictory positions and she will have to decide which of them she is going to break. In doing so, the PM will make enemies – it is merely a question of choosing those who cause her the least harm.

Consider first the group of backbench MPs, led by Jacob Rees-Mogg, who regard themselves as keepers of the Brexit flame. JRM’s latest stunt has been to warn the prime minister that if she goes ahead with her plan to pursue a customs partnership with the EU, his 60-strong faction of MPs will withdraw their support. Rees-Mogg’s objection is that it would “leave us de facto in the customs union and the single market.” For many – including most economists – that is not such a bad idea. But it is (a) legally not true and (b) the EU27 is not very enthusiastic about a plan whereby the UK collects tariffs set by the EU customs union on goods coming into the UK on its behalf. If Rees-Mogg really wants to play a clever game, his best tactic would be to let the EU sink the plan without the need to create waves at home.

But whilst the pro-Brexit lobby is large and vocal, the Conservatives hold 317 seats in parliament. The awkward squad is outnumbered roughly 5-1 by more moderate MPs, some of whom are opposed to Brexit and others who are not willing to go to the barricades on the issue of the customs union. Admittedly, it would take only 48 Conservative MPs (15% of their parliamentary representation) to issue a motion of no-confidence in the leader, so incurring the wrath of Rees-Mogg and his chums would have consequences. But if Theresa May really wants to demonstrate some leadership, perhaps it is now time to face down those who continue to pursue a ruinous Brexit policy. She may not win a leadership contest, because she does not have the wholehearted support of the Remainers, but it seems doubtful that the Brexit ultras would win either. It is time to force the issue. As I have noted previously, Theresa May might have been the least worst option as leader in summer 2016 but it is not clear that she is the right candidate now to deliver the Brexit deal – at least, so long as she is not prepared to challenge her opponents.

That said, whilst it is easy to criticise Theresa May for her caution, we also have to be mindful of the wider backdrop against which she is operating. As the Withdrawal Bill proceeds through the House of Lords, the government has now suffered ten defeats on important legislative matters. The key vote took place on Monday, when peers voted to give parliament a decisive say on the outcome of the final Brexit negotiations rather than simply allowing the government to decide. Of course, this is not set in stone: When the bill goes back to the lower house, MPs will be able to vote on whether to overturn this amendment. However, it triggered much frothing of the mouth in the tabloid press with the Daily Mail accusing “the Remainer elite “ of “fighting a guerrilla war against Brexit using any weapon it can.”

We have come to expect such rabid commentaries from this particular organ over the last couple of years. Clearly, the headline writers do not appear to understand the UK’s constitutional setup in which the House of Lords has no power to block legislation. There again, the paper demonstrated a similar lack of constitutional understanding following the infamous “Enemies of the People” headline when the High Court ruled that parliament should  be given a vote before triggering Article 50. The political editor James Slack either did not realise that the judiciary is separate from government, or more likely, did know and planted a fake news story. This time around, the irony appears to be lost on the Mail that one of the key themes in the whole Brexit debate was about taking back control – British laws decided in the British parliament, and all that – and the House of Lords is giving parliament the opportunity to do just that.

It is precisely because of such vitriolic nonsense that the prime minister has to be very circumspect in how she deals with the Brexit debate. She is simply obeying the Machiavellian dictum to keep your friends close and your enemies closer. But to borrow the old SAS slogan, she who dares wins.

I'll tell you what I want (what I really, really want)

Theresa May’s “big speech” on Friday where she outlined her five point plan for what she wants from Brexit, was supposed to be her Spice Girls moment - telling us what she really, really wants. It would bring the Conservative party together, pacify governments elsewhere in the EU27 and apply some balm to the festering domestic wound caused by the vote to leave the EU. To read various domestic media outlets, you could be forgiven for thinking that it had hit many of its targets. According to the FT "Theresa May warns Eurosceptics to 'face facts'". The Telegraph called it “her most pragmatic Brexit speech to date” and noted “if only [she] had given this speech 13 months ago at Lancaster House.”

Instead, I heard a speech that was long on words but short on content. Guy Verhofstadt got it broadly right in his Twitter feed when he noted that “PM May needed to move beyond vague aspirations. While I welcome the call for a deep & special partnership, this cannot be achieved by putting a few extra cherries on the Brexit cake.” In some ways, the Telegraph was right about one thing – it would have made a far better starting point than her car crash Lancaster House speech in January 2017. But it was not a speech which gives anyone any confidence that at this stage of the Brexit negotiations, the UK government is on track for a Brexit that works for anyone – politically or economically.

The five “tests” were themselves an exercise in irony: (i) “the agreement we reach with the EU must respect the referendum”; (ii) “the new agreement we reach with the EU must endure”; (iii) “it must protect people’s jobs and security"; (iv) “it must be consistent with the kind of country we want to be … a modern, open, outward-looking, tolerant, European democracy”; (v) “it must strengthen our union of nations and our union of people.” In terms of (i), the only thing the electorate voted for in 2016 was to leave the EU – not the customs union nor single market. With regard to (iii), most economists struggle to see how we will be better off and on (iv) I have remarked previously about how the world sees the UK as becoming more, not less insular. But (v) really was a corker: Two areas of the union voted to remain and they are being dragged out of the EU because of the choices of voters elsewhere. Brexit poses the biggest danger to the union in modern times.

May’s statement that “we must bring our country back together” produced this rejoinder from Jolyon Maugham QC, the prominent Remain campaigner: “When your Brexit doesn't deny our children the privileges we enjoyed, we'll listen. When you apologise for calling us "citizens of nowhere", we'll listen. When your policies respect the dignity of our friends, colleagues and partners, we'll listen.”

As I parsed the speech, it was difficult to discern anything new. It was similar in tone to that in Florence last September (albeit way better than the efforts of 2016 and early-2017) though it better reflected the reality that the UK is not going to leave the EU on its own terms. There was nothing of any substance about how to resolve the Irish border problem, although the phrase “we want as frictionless a border as possible” was directly used four times and another twice in a slightly different guise. Nor was any justification provided for the decision to leave the customs union. Another thing that struck me was the mention of introducing processes to differentiate between small and large businesses in Northern Ireland to reduce the administrative burden on smaller companies. So we introduce more admin to reduce the administrative burden? It would be laughable were it not so serious, and none of this would be necessary at all if the UK simply remained in the customs union.

To compound the litany of dreadful decisions, May reiterated that the UK would leave the Digital Single Market – the EU's strategy to make it easier for digital businesses to work across borders and which guaranteed things like no roaming charges. And “on financial services, the Chancellor will be setting out next week how financial services can and should be part of a deep and comprehensive partnership.” Only six months too late as banks begin to implement processes to allow them to cope with the business disruption caused by an end to passporting – a process which, once it starts, will not be reversed. With regard to services more generally, “we want to limit the number of barriers that could prevent UK firms from setting up in the EU and vice versa, and agree an appropriate labour mobility  framework.” So there is at least a recognition that non-tariff barriers are a major hindrance for the services sector, so that’s a start, but we have been saying this all along. But scrapping the existing movement of free labour in order to introduce a new set of plans? It all defies logic. As I pointed out in 2015, swapping one set of rules for another means “much of what is currently legislated by the EU would have to be done domestically in the event of Brexit.”

As an economist, I found the speech content-free. But increasingly, it seems to me, the problem is Theresa May herself. As the blogger David Allen Green has pointed out, the PM and her colleagues make speeches whereas the EU issues detailed legal documents. Worse still, May is neither a strong leader nor a good communicator. She can't lead because she is a prisoner of the two factions of her party who want either a hard Brexit or the softest possible and can please neither side as she walks the Brexit tightrope, giving the impression of a leader who is in office but not in power. The PM seems not to understand how to communicate with other EU leaders – her speeches are bland and lack any of the specific detail which her soon-to-be-erstwhile EU partners want to hear. I’m afraid to say that whilst her predecessor David Cameron will go down in history as one of the worst prime ministers in recent history, Theresa May is currently running him close.

Brexit: The (un)civil war continues

It has been clear all along that Brexit has little to do with economics and everything to do with a view which a certain group within the Conservative Party has of the UK and its place in the world. It is also not news that the form of Brexit which this group intends to pursue is not one which large parts of the electorate voted for – even those who voted in favour of leaving the EU. But it is increasingly evident that this is becoming an obstacle to the smooth running of government as the fissures within the Conservative Party threaten to split it apart.

Last week, Boris Johnson again broke ranks with his cabinet colleagues via a series of pre-briefed news articles by calling for additional NHS spending, with newspaper reports suggesting he was pushing for an extra £100m per week (£5bn per year) after Brexit. Recall that Johnson was one of the prime supporters of the claim that the UK would be able to save £350m per week after leaving the EU, a large proportion of which could be channelled towards health spending. Whatever you think of Johnson as a politician, his call for additional NHS spending is well made. According to the OBR’s projections, total health spending is set to decline from 7.2% of GDP in FY 2017-18 to 6.8% by 2019-20. Simply to hold spending constant as a share of GDP implies increasing funding by £166m per week by 2020. But as is often the case with Johnson, there is usually more than meets the eye and the rest of his cabinet colleagues clearly did not think much of his attempts to hijack the political debate.

Meanwhile, Chancellor Philip Hammond is the focus of ire from the Leavers following his speech at the World Economic Forum in which he called for a soft Brexit that would result in only “very modest” changes to the UK’s relationship with the EU. The prime minister has been called upon to sack her Chancellor as concerns mount amongst pro-Leave MPs that the UK is “diluting Brexit” and that it may become an EU “vassal state” during the transition period. This comes at a time when leaked reports prepared for the government suggest that in the absence of a trade deal with the EU, output would be 8% below the pre-referendum baseline over a 15 year horizon. A free trade agreement with the EU – the current favoured option – would result in a 5% decline in output whilst the soft Brexit option (i.e. continued single market membership) would result in a 2% decline in GDP. All of which comes after Brexit Secretary David Davis refused to release impact assessments covering 58 sectors of the economy when requested to by parliament, claiming they did not exist.

All this is, to be sure, a deeply unsatisfactory state of affairs and it highlights the weakness of Theresa May’s position. Despite Boris Johnson’s constant flouting of collective cabinet responsibility, such is the strength of his grassroots support that the prime minister is unable to remove him without jeopardising her own position. If she were to bow to the minority group of hardline MPs calling for Hammond’s departure, the other half of the party would similarly revolt. There is thus mounting concern that there may be a challenge to May’s leadership – a procedure which requires the support of just 48 MPs – although since most Conservatives believe this would hasten their exit from government, this is not anybody’s favoured scenario.

But the Conservatives only have themselves to blame. It was their party that called the referendum, and their government which decided the terms on which they would seek to leave despite being warned of the dangers. Theresa May has compounded the problem by not offering any leadership on the Brexit issue. She has not articulated what she wants from the EU, other than the closest possible relationship, and in the words of FT commentator Philip Stephens, “Mrs May, it is obvious, has no organising vision of the shape of Britain’s post-Brexit relationship with its own continent ... As things stand, history will remember her as an accidental prime minister who foolishly squandered a parliamentary majority in an election she had no need to call — the worst prime minister of modern times with the exception, of course, of her immediate predecessor, David Cameron.”

Former LibDem leader Nick Clegg, also writing in the FT, noted that as it currently stands the proposed transition period which will run beyond the end of the Article 50 period in March 2019, will leave the UK powerless; a member of the EU in all respects but one – the ability to have any say in writing EU legislation. This is very much the position Norway finds itself in now. Why this comes as any surprise to anybody beats me. I pointed out in 2015 that such a Norwegian outcome “would appear to be even less optimal than that which the UK faces today.”

There is increasingly little faith in the government’s ability to square this circle. It clearly appears that Theresa May gambled on the UK’s ability to quickly achieve a deal with the EU without thinking through the implications of what this might entail. In that sense, she is very much in tune with those elements of her party who have spent much of their political career either ignoring or misreading European issues. And now she is their prisoner.

The rusting of the iron lady

Twelve months ago to the day, Theresa May stood up in Lancaster House in London and outlined the nature of the future relationship she was seeking with the EU. As I wrote at the time “anyone looking for any great insight as to how the UK will be able to achieve the objectives she set out will have been disappointed. Mrs May in effect gave a wish list of what she wants for the UK, but the nature of the deal itself will depend on the compromise which can be achieved with the EU. And on that front, we will have to await the EU’s opening play to assess how realistic her goals are.“ 

One failed election campaign later, which has severely weakened the prime minister’s political clout, the UK remains deadlocked in negotiations with an EU27 which has maintained an impressively coherent stance, despite attempts by the UK to sow division. The UK has also fallen into line with EU27 demands on its three main negotiation points (the rights of EU citizens, the Irish border question and the Brexit bill). Twelve months ago, the UK government was also awaiting the Supreme Court ruling on whether parliament would be allowed a vote on the triggering of Article 50. In the event, it was – despite the government’s initial position that this was not necessary. The EU Withdrawal Bill, which is now in the process of going through parliament, has also been watered down with parliament to be given a vote on the final terms of the EU deal in yet another concession to MPs.

Indeed, looking back over the past year it is clear that the government has been forced to give way on a number of areas. Theresa May initially believed that the government could simply transcribe all EU law onto the UK statue book, and strike out those parts of the legislation it did not like, before agreeing an exit deal with the EU without any parliamentary oversight. She also told us in September 2016 that she would not give a “running commentary” on Brexit negotiations. But thanks to a rearguard action by many MPs, parliament now has a chance to scrutinise the Brexit deal whilst the House of Commons Library has published on the state of negotiations after each round of Brexit talks. This, of course, is precisely what should happen. After all, one of the key Brexit selling points was that the UK parliament should oversee UK laws (though strangely enough, the likes of the Daily Mail always kicked up huge objections any time the government’s authoritarian Brexit approach was challenged). 

With numerous pro-Leave campaigners expressing regrets about how issues have been handled since the referendum, most notably the surprise suggestion by Nigel Farage that he would not necessarily be opposed to a second plebiscite, it does make you wonder how events will unfold over the next twelve months. As I noted last week, a second referendum is unlikely anytime soon. However, it is likely that a compromise agreement will be reached which postpones the final exit decision until end-2020, thus giving industry – including the so-far neglected financial services sector – more time to prepare for an uncertain future. 

The government itself is in a precarious position, and survives in office only with the support of a confidence and supply agreement with the Democratic Unionists. In more normal times, it is hard to imagine Theresa May holding onto her position since she has proved, as The Economist wrote last week, to be anything but a safe pair of hands whilst “her biggest problem is more fundamental: she doesn’t have any ideas.” But she maintains the support of the Conservative party because she is the least divisive candidate in a party which is split down the middle on Brexit and which is paranoid that a change of leader would open the door to the opposition Labour party. The gossip regarding May’s survival chances continues to swirl and I have no idea whether she will still be in office in a year’s time. But over the next twelve months, we can look forward to the crossing of more red lines as the process of aligning the “will of the people” with the needs of the economy continues.

They still don't get it

It has been pretty evident to anyone with even a passing interest in the subject that the Brexit negotiations are not going as planned. The closeness of the referendum result in June 2016 reflected a country that was split down the middle on the issue of EU membership, and in the subsequent 16 months the Conservative Party has all but torn itself apart. Theresa May’s attempts to placate the hard Brexit faction within her own party has resulted in a series of clumsy soundbites (“Brexit means Brexit” and “no deal is better than a bad deal”) which fail to cover up the fact that the government does not have a plan – or at least not one that is acceptable to the EU27 and the two factions within the Conservative Party.

This has been compounded by an election which robbed the PM of whatever authority she had, and as a result the EU27 is loath to accommodate any demands the UK might make for fear that she will not be able to deliver at home. With more than a quarter of the negotiation period mandated under the Article 50 process having ebbed away, the UK is no further forward than in March. If a scriptwriter had come up a parody of all that is wrong with modern politics, they would have struggled to come up with a story as bizarre as the one which is unfolding before us.

There are those who continue to believe that the EU needs the UK more than vice versa. Indeed, a group of Brexit supporters has written an open letter to Theresa May demanding that she commit the UK to trading under WTO rules in the event that no deal with the EU27 is forthcoming because “no deal on trade is better than a deal which locks the UK into the European regulatory system and takes opportunities off the table.” Moreover, “it has become increasingly clear that the European Commission is deliberately deferring discussions on the UK’s future trading relationship with the EU27 post-Brexit. The EU is taking this approach because they do not believe that the UK would be prepared to go to WTO rules for our trading relationship with them.”

Owen Paterson MP argued in a radio interview this morning (here starting at 1:09:10) that the EU27 has “simply not taken up [Theresa May’s] generosity to discuss a future trading relationship” following her Florence speech and it is time to take an alternative approach. In Paterson’s view, this would give business “certainty” as to the post-Article 50 trading arrangements. He also repeated the canard that it is “massively” in the EU27 interests to do a deal on trade because “they run a huge surplus” with the UK. Paterson argued that a fallback to WTO rules would allow the UK (and I emphasise that I am quoting verbatim from the interview) to “immediately be able to grab the advantages of leaving the single market, leaving the customs union and doing trade deals around the world [and] sorting out our own regulation.” Yes, you did read correctly that leaving the single market is somehow an advantage.

I am not sure which alternative reality Paterson (and other signatories to the letter, including former Chancellor Nigel Lawson) are inhabiting but it is not one that most economists recognise. When 47% of UK exports go to the EU whilst 16% of EU27 exports go to the UK, it should be pretty obvious where the balance of power lies – and the EU27 knows it. As for giving clarity about future trading relationships by committing to WTO rules, it would effectively give business the green light to think about alternatives to investing in the UK. Moreover, on the assumption that the UK imposes most-favoured-nation tariffs on imports from the EU, the Resolution Foundation reckons that the basket of goods which makes up 40% of consumption would rise in price by 2.7% which will hit the poorest households most hard. And of course the WTO approach has little to say about how to deal with services where non-tariff barriers are more important. Such an approach would clearly signal to banks that the government is not serious about trying to arrange a transition deal, which would hasten efforts to move business to other parts of the EU – a process which is already underway.

Of course, none of this is new. These arguments were made in the run-up to the referendum by Brexiteers who believe in the primacy of free trade without acknowledging that the EU has other objectives and no incentive to play ball. It is a sad indictment of the whole debate that the Leavers continue to make the same hollow arguments. However, the evidence is mounting that there is an economic cost. Why, for example, don’t our incomes stretch as far as they once did? It’s mainly because the currency markets have taken a negative view of the UK’s post-Brexit economic prospects and have forced down the value of the pound, resulting in higher inflation and a real income squeeze. It may not have been the economic disaster that was feared in summer 2016, but whilst we may not have dropped the frog in a pan of boiling water it is in the pot and the heat is being turned up.

Those people who want Brexit at any price are blind to the consequences of their actions. But equally, they fear that the UK will not leave the EU as planned because they underestimated the complexities of doing so and will be trapped in the exit lounge for longer than they desire. But even if a transitional period is eventually granted which will give the UK an extra two years to finalise a deal, it will not be long enough. As Joachim Lang, managing director of the BDI, Germany’s chief business group told the FT, “it’s unrealistic to expect that we could renegotiate rules within two years that evolved over the 40 years of Britain’s EU membership.”

Theresa May will be told at today’s summit in Brussels that “insufficient progress” has been made during the first phase of Brexit negotiations and that the UK will not be rewarded with the start of any discussions on trade. Brexit supporters are fearful because if no such deal is forthcoming, their lies during the campaign will be found out. Many of us would be only too happy to see them drive off the much-feared cliff edge – we just don’t want to go down with them.

Theresa and Florence

Theresa May's speech in Florence yesterday was supposed to be the big one – a chance to articulate what Britain wants from Brexit. Perhaps because it was so hyped up in advance it failed to live up to expectations. For my money, it was a grade C: Not absolutely terrible, but nowhere near good enough. Journalists have convinced themselves that they heard the PM promising to stay in the EU for a two-year transition period and the promise to pay into the budget during that period. I heard her asking the EU27 for a transition period and no mention of any figures.

As for the speech itself, it was long on waffle and short on content. To be sure, it was less strident than her dreadful performance to the Tory faithful last October and the Lancaster House speech in January. But it contained many of the same appeals for unity: "If we were to ... be divided, the only beneficiaries would be those who reject our values and oppose our interests." So we should all get behind Brexit because otherwise you don't share "our" values? As for the "concrete progress on many important issues" during the negotiation period, this amounted to a recognition that "there are unique issues to consider when it comes to Northern Ireland." As Michel Barnier noted in his response, that does not amount to providing any solutions. There was one jaw-dropping phrase which acts as a reminder why the PM managed to alienate large chunks of the electorate in June: "throughout its membership, the United Kingdom has never totally felt at home being in the European Union." The PM may speak for many in the Conservative Party, but she clearly does not speak for the near-half of those voters who took a totally different view 15 months ago.

However she was more emollient on the granting of rights to EU citizens in the UK and there was a recognition that the ECJ judgements should still be taken into account by British courts. Although the PM suggested that neither EEA membership nor a Canadian style free trade agreement are appropriate for a future relationship, May did not outline what sort of relationship she does want. EEA membership was ruled out because it "would mean the UK having to adopt ... EU rules ... over which, in future, we will have little influence and no vote." Meanwhile, an FTA is a far less beneficial arrangement than the UK enjoys now. Of course, many of us have been pointing this out all along. Everything that was wrong with the speech was summed up in the PM's phrase "We can do so much better than this." Unfortunately she neglected to explain how.

With regard to the transition period, it seemed to be apologetically sneaked into the speech near the end: "a period of implementation would be in our mutual interest. That is why I am proposing that there should be such a period after the UK leaves the EU." Substitute “proposing” for “asking” and we are closer to the mark. As the PM noted, this "can be agreed under Article 50." However, that is true only if there is unanimous agreement amongst the EU27. And that is not guaranteed. So far as budget commitments are concerned, the PM said “the UK will honour commitments we have made during the period of our membership.” Whether that covers contributions during a transition period or a nod to the exit bill is unclear to me. What it most certainly was not was a commitment to pay a figure of €20bn, as many journalists have assumed.

The Daily Mail didn't like it. "May is accused of BETRAYING referendum by effectively keeping Britain in EU until 2021 as she climbs down on citizens' rights and borders with €20bn bung for Brussels in bid to revive Brexit talks." The rating agencies didn't like it either with Moody’s downgrading the UK’s credit rating by one notch to Aa2 – two below the AAA rating it enjoyed for 35 years until 2013.

Both are wrong in their assessment but it is a reflection of the rock and a hard place dilemma facing the government. The Daily Mail appeals to the hard Brexit end of the spectrum but the reality is that the head bangers who wish to see Brexit at all costs fail to see the damage that it will cause. Or don’t care. Either way, the PM could not possibly repeat the same message as she did before triggering Article 50 as she has fewer cards to play and even less authority to call the shots. That said, the hard Brexiteers in her cabinet probably prevented her from being more conciliatory than perhaps she would have liked, and Boris Johnson’s intervention last weekend may have played a role here.

The action by Moody’s was frankly a joke. I am reminded of the words of Paul de Grauwe who in 2009 posed the question “How can these agencies, which were systematically wrong in the past, have any credibility in whatever risk analysis they make?” According to Moody’s “the outlook for the UK's public finances has weakened significantly since the negative outlook on the Aa1 rating was assigned.” Just as a reminder, since Moody’s downgraded the UK from AAA in February 2013 the UK’s public deficit has fallen from 7.2% of GDP to 2.3%. On the basis of the evidence for the first five months of fiscal 2017-18, the UK deficit is running slightly below the corresponding period in 2016-17. And as one of the more pessimistic longer-term forecasters of UK public finances, I still reckon it is possible to bring it below 2% on a five-year horizon.

Furthermore, the rating agencies consistently fail to account for the fact that the UK issues debt in its own currency. There is virtually no default risk. Admittedly the political risk is higher but we don’t need a ratings agency to tell us that. If investors get cold feet, they will simply stop buying. In any case only 25% of gilts are held by foreign investors – demand amongst domestic pension funds remains high and they will continue to buy in order to match their long-term assets and liabilities.

In summary, therefore, the Florence speech was a disappointment. But hemmed in by the needs of business and those who want Brexit at any cost, the PM was always on a hiding to nothing. However, it does nothing to change the economics. If anything, a longer transition period to Brexit should be seen as a positive – if the EU 27 agrees. In that light, the actions of Moody’s should be dismissed as the irrelevance that it clearly is.

Dial it down

The rhetoric over the Brexit divorce has gone up by a few notches in the course of recent days. Leaked accounts of last week’s dinner engagement between Theresa May and Jean-Claude Juncker were splashed all over the German press at the weekend. Subsequently, the FT has calculated that the upfront cost of departure is likely to be in the region of €100bn whilst Theresa May today made the extraordinary allegation that “some in Brussels” did not want Brexit to succeed. It might be wise at this point to dial down the rhetoric before things get out of hand.

Dealing first with the politics (I know it’s dull but this whole debate is driven by it), there is little doubt that the European Commission was responsible for the leaks to the Frankfurter Allgemeine Zeitung. The details were too precise to be made up, and it is clearly designed to rattle the UK’s political cage in order to remind the government that it will not get everything it wants during the Brexit negotiations (if indeed, it gets anything at all). It is not very edifying but that’s politics for you.

As for Theresa May’s statement, she is right – except it is probably more accurate to say that “no-one in Brussels” wants Brexit to succeed. Why would they? We have known all along that the EU has no incentive to make life easy for anyone who wants to leave: If Brexit is a success the whole basis of the EU is threatened. If the EU is serious about holding together in the absence of the UK’s departure, of course it wants to see Brexit fail – to suggest otherwise is an act of incredible naïveté. The suggestion that there is any meddling in the election was, however, a step too far. In any case, this unnecessary election is all about the UK’s bargaining position regarding Brexit, so the PM’s comments were a bit rich.

Which brings us to the issue of divorce costs. I have referenced the work of the FT’s Alex Barker before, and I am indebted to his analysis of the data for an insight into where the EU’s increased bill comes from. Previously, the bill was estimated at around €70bn – a figure which included numerous questionable items. The extra €30bn is even more controversial, largely due to the demand for contributions to commitments planned for 2019 and 2020, which occur after the UK has already left the EU and which is estimated to cost between €10bn and €15bn. The EU is also believed to be demanding an upfront payment of €12bn to cover contingent liabilities rather than stumping up at the point when they arise. Finally, France and Germany are also believed to be doubtful that the UK has any entitlement to the EU’s assets – a move which is calculated to wind up the UK government.

It should be stated at the outset that the €100bn is a gross figure. If the UK is paying its full share of the budget beyond 2019, it will be entitled to its normal rebate. Once we add in farm subsidies and other items, it is expected that the final figure will be around the €65bn mark. Of course, like any good dealmaker, the EU is bound to start with a high figure in the knowledge that it will be beaten down, but the higher you bid the more chance of  getting a figure close to what you believe to be reasonable. The ratcheting up of pressure was likely also partly triggered by the recent UK government belief that it can legally walk away without paying anything at all, and this is the EU’s way of letting the UK know it is not in a strong negotiating position. After all, the UK will not get any form of trade deal if it refuses to pay anything (which, of course, the UK knows). More problematic still is that Michel Barnier, the EU’s chief negotiator, will not put a final bill on Brexit until the negotiations are complete – he simply wants the UK to agree on the methodology.

All told, this puts the UK in a difficult spot. David Davis, the UK’s chief negotiator, will not sign up to such a deal – and for once I have some sympathy. The UK will already be asked to contribute to the unattributed parts of the budget which have not been allocated on an accruals basis (the so-called reste à liquider payments), whose provenance is dubious. To deny the UK any claim on EU assets is morally indefensible, particularly since the UK is such a big net contributor to the EU budget. But to pay for budget commitments beyond the time the UK leaves is a red line. It’s like being charged in a restaurant for a meal you already don’t want to eat, but then you are being asked to pay for the next customer’s food as well.

The whole day has been one of high octane posing. As I have said before, there are deals to be done but if both sides continue to antagonise the other, the prospect of successfully concluding one will diminish. My advice would be to turn down the noise – no trade deal is ever concluded with anything other than a cool head.

Out of the blue

Today’s announcement by Theresa May that she intends to call an election in the UK for 8 June was an Easter surprise that nobody anticipated. From a political perspective, there are many good reasons why the PM would wish to hold an election now. First, the timing is propitious: The economy has withstood the Brexit shock better than most people expected, and although consumers are now being squeezed by the sterling-induced rise in inflation, with the result that real wage growth is now at its slowest since 2014, it has not yet gone on long enough to be really noticeable. It thus makes sense for her to hold an election before the bad news starts to kick in. Although the election was not originally scheduled to take place before 2020, there is a risk that in three years’ time, the economic fallout from Brexit would start to make its presence felt, which could be politically damaging.

Second, although the PM has previously said that the current government would serve its full term until 2020 it is pretty obvious that the manifesto commitments made in 2015 are constraining her room for manoeuvre. As I have pointed out previously (here) the election promise not to “raise VAT, National Insurance contributions or Income Tax" was a howler, which backfired in March when Philip Hammond was forced to rescind his planned increase in National Insurance Contributions for the self-employed following a backbench revolt. Oddly, the same backbenchers did not show any discontent when the commitment to remain in the EU single market was reneged upon (“We say: yes to the Single Market”). It is thus clear that the government realises the manifesto commitments are no longer appropriate in a post-Brexit Britain (so look out for a rise in self-employed NICs in the November Budget).

Third, the Labour Party is down and out. Jeremy Corbyn’s approval ratings are subterranean with three big pollsters giving him a net rating of between -36 and -41 (here). The Conservatives are ahead by 20 points in the polls, but prior to last year’s EU referendum the lead was only 5 points. I would conclude that Corbyn’s failure to speak out in favour of the near half of voters who rejected Brexit, and his decision to go along with the Conservatives’ Brexit timetable, has cost his party dearly. The bottom line appears to be that the Conservatives will win by a landslide with pollsters pointing to a parliamentary majority in excess of 100 seats, compared to 17 today.

As for UKIP, who cares? They appear to be a busted flush with their sole MP having quit the party last month and the party foundering in the absence of the charismatic Nigel Farage. Indeed, a party which existed only to force the UK out of the EU no longer has a raison d’etre. However, they could still damage Labour efforts to win seats in the English north and midlands by siphoning votes away, which can only help the Conservatives. Meanwhile, the Lib Dems are not expected to improve on their poor 2015 showing and the Scottish Nationalists will retain their lockout north of the border.

All this leaves me rather uneasy. The Fixed-Term Parliaments Act 2011 was designed to force governments to serve their full five year term and prevent them from choosing the timing of an election to suit their own purposes. Only twice since 1951 has a government called an election so early in its parliamentary term (1966 and 1974), and on those occasions the majority was either unworkably small (1966, when it was down to 4 seats) or the government was in a minority (1974). We have to go back to 1923 for the last time a government with a workable majority called an election so early. Following the 1922 election which gave the Conservatives a comfortable majority, the prime minister wanted to secure a mandate for tariff reform, which his government supported. In the event its 74 seat majority was wiped out in 1923 allowing Labour to form its first ever government (with support from the Liberals). So beware the lessons of history.

As it happens, sterling ended higher today as (in the FT’s words) “investors bet the prime minister would use the vote to neutralise Tory Eurosceptics and deliver a soft Brexit.” I am not sure it will necessarily turn out like this. Janan Ganesh, also writing in today’s FT, pointed out that the prime minister is not so much bending with the wind to appease the right-wing backbench Conservative MPs as much as she is a conviction politician on a mission. If you buy that version of events, then if the PM is able to secure a much wider parliamentary majority (as is pretty likely), she will then have a mandate to do pretty much whatever she wishes. And as the blog at Another Angry Voice points out (albeit in fairly intemperate language, here and here)  Theresa May has a lot in common with the right-wing of her party. This concerns me because it suggests that far from facing down the Eurosceptics, there is a risk she will be happy to deliver the Brexit-at-any-cost policy which so many of them want.

One thing is for sure: We should never underestimate the prime minister and she certainly does not come across as the type to be pushed around by anyone – especially by those within her own party. As Ganesh pointed out, we should not be fooled by the fact that “on Easter Sunday, one of the least pious societies in the world heard an explicitly Christian message from its prime minister.” As the old joke goes, she may be the clergyman’s daughter, but you couldn’t put anything pastor.

Is it just me?

Sometimes you just have to admit that you are out of tune with the Zeitgeist. Having endured Theresa May’s speech yesterday when she set out her vision for a post-Brexit Britain, it seems that there is little point in engaging in rational debate. After all, nobody else seems to be interested. Donald Trump won an election in this fashion; Boris Johnson went from being the ex-Mayor of London to UK Foreign Secretary via a Brexit campaign and Vladimir Putin invaded a sovereign state – the common denominator being that all of them spun a web of lies and deceit in order to ensure that the debate was conducted on their terms rather than the awkward reality which we used to call facts. They say you can fool some of the people all of the time, and all of the people some of the time. But in our post-truth world, it feels like mainstream politicians are trying to fool all of the people all of the time.

When the PM opened yesterday’s speech with the line “A little over 6 months ago, the British people voted for change. They voted to shape a brighter future for our country. They voted to leave the European Union and embrace the world,” I had to pinch myself to ensure that I was not dreaming of the occasion when the electorate overwhelmingly rejected EU membership. When May noted that "after all the division and discord, the country is coming together," I wondered whether she had bothered to consult with Scottish MPs who clearly do not share the same desire to exit the EU. 

As she went on to outline that one of the reasons why British citizens have a problem with EU bureaucracy is that “supranational institutions as strong as those created by the European Union sit very uneasily in relation to our political history and way of life,” I realised I had it all wrong. Clearly, the fact that the UK has one of the most centralised governments in Europe is a figment of my imagination. The European Economy Discussion Paper published by Charles Wyplosz in 2015 (here) citing research which showed that UK sub-central government spending as a share of total public outlays is (along with the Netherlands) the lowest in the EU, is obviously fake news.

And then it really went downhill. The UK government intends to leave the Single Market in an action which I can only describe as one of economic self-harm. But that’s OK because “we will take back control of our laws and bring an end to the jurisdiction of the European Court of Justice.” That would be the same ECJ which ruled in favour of the UK in 2012 when the ECB tried to ensure that the clearing of all euro denominated transactions should take place in the euro zone, rather than in the London financial market. May must have forgotten the court’s ruling that “the ECB lacks the competence necessary to regulate the activity of securities clearing systems as its competence is limited to payment systems alone.” A small oversight, I’m sure.

Moreover, the UK will obtain the benefit of being able to control immigration. Hoorah, I hear you cry. The woman who failed to control immigration when she was Home Secretary will be given the opportunity to do so at the expense of the UK’s economic self-interest. It is evident that the PM is happy to trade off access to the Single Market against the ability to control our borders. And if someone can enlighten me as to what the benefits of this are, please feel free to leave a comment.

As if this were not enough, the prime minister urged the EU to accommodate the UK’s demands wishes because not to do so would be “an act of calamitous self-harm … Britain would not – indeed we could not – accept such an approach. I am equally clear that no deal for Britain is better than a bad deal for Britain.” This was translated by the headline in The Times this morning as “Give us a fair deal or you’ll be crushed”, and by the Daily Mail as “Steel of the new Iron Lady” as memories of the blessed Margaret were rekindled (here if you must).

But as the eminently sensible Rachel Sylvester pointed out in The Times yesterday, May is looking at a still image of the EU when in reality it is a moving picture. She has “a two-dimensional view of the EU negotiations but she risks being skewered by her own inflexibility” as the debate regarding immigration changes across the continent. Sylvester also quoted one senior businessman who said, “They are living in a fool’s paradise. There’s still a belief that the Europeans will blink, that they need us more than they need them, and I don’t believe that for a second.”

I wrote in a note yesterday that May’s speech does not constitute a plan: It is a wish list. It is an opening gambit in a poker game where the UK does not hold many good cards. Worse, the hand is being played by a bunch of bluffers. When it comes to the crunch, the UK negotiating team will have to step up to the big league where they will learn when to fold and when to hold. Meantime, the economy (i.e. the voters) will pay the price for such arrogance. But what do I know? I am clearly thinking in the old ways and we should never let the facts get in the way of a good story.

May for March

Yesterday’s speech by PM Theresa May, which outlined that the UK will begin the Article 50 proceedings no later than March 2017, left me feeling rather uneasy. It was a speech straight out of Conservative Campaign Headquarters casting, designed to give a reassuring feeling to the assembled masses at the party’s conference, but short on substance. There was a lot to be concerned about: Her statement that “The referendum result was clear” was a case in point. No one denies that the Leavers won the referendum, but it was by less than four percentage points. It was not at all “clear”, as the Leavers would agree had the result gone the other way. And unlike a parliamentary election, where you get a chance within five years to change the outcome, that is not possible on this occasion. So if there is to be a Brexit, it is absolutely vital to get it right, and I have many reservations that the government is going about it the right way. 

The prime minister also made it clear that “it is not up to the House of Commons to invoke Article Fifty, and it is not up to the House of Lords. It is up to the Government to trigger Article Fifty and the Government alone.” There are many lawyers who would dispute that, and indeed next week the High Court is due to give a ruling on this issue. May accused those who sought to challenge the referendum result of “not standing up for democracy, they’re trying to subvert it. They’re not trying to get Brexit right, they’re trying to kill it by delaying it. They are insulting the intelligence of the British people.” Some might say in response that a Leave campaign which blatantly lied about issues such as the cost of EU membership, and how the money saved could be used to fund the NHS, brought the process of democracy into disrepute in the first place. And whilst we’re at it, prime minister, your mandate as leader of the Conservative party was obtained with far fewer votes than Jeremy Corbyn when he won the Labour leadership contest. A little bit more humility regarding the nature of democracy would not go amiss. 

Even dangerous Daniel Hannan has admitted that the referendum result was so narrow that it is necessary to ensure that a peaceful coexistence can be maintained between the sides. We got no sense of inclusivity from PM May yesterday: Had she not (allegedly) been a Remain supporter, I could have sworn that we were listening to the victory speech of a prominent Brexiteer. The general tone of the speech suggested that the UK is on course for a ”hard” Brexit, a notion which May rejected: “there is no such thing as a choice between “soft Brexit” and “hard Brexit”. This line of argument … is simply a false dichotomy. And it is one that is too often propagated by people who, I am afraid to say, have still not accepted the result of the referendum … I know some people ask about the “trade-off” between controlling immigration and trading with Europe. But that is the wrong way of looking at things.” Again, we will have to agree to differ on that one. There clearly is a form of trade off, and to pretend otherwise is simply to ignore what other EU nations are telling us. 

The prime minister’s grasp of the economic realities of Brexit was, in my view, rather shaky. She suggested that “the referendum … was a vote for Britain to stand tall, to believe in ourselves, to forge an ambitious and optimistic new role in the world … And there is already abundant evidence that we will be able to do just that. Important foreign businesses – like Siemens and Apple – have committed to long-term investments in this country. With the Japanese purchase of ARM for £24 billion, we have seen the biggest-ever Asian investment in Britain. Countries including Canada, China, India, Mexico, Singapore and South Korea have already told us they would welcome talks on future free trade agreements. And we have already agreed to start scoping discussions on trade agreements with Australia and New Zealand.” 

Where do we start? How about the fact that the sale of ARM means that the intellectual capital, and the profits which flow from it, are no longer UK owned? Or that Nissan is delaying new investment in its Sunderland plant until the UK has concluded Brexit negotiations with the EU? Or that Australia has said that any trade deal will also have to wait until after the UK-EU deal is concluded? Or that there was no mention of any deal with the US?

However, May’s speech was of a piece with a lot of the statements out of Westminster in recent weeks. As one EU diplomat suggested, “she seems to be saying that regaining sovereignty is so valuable, she is willing to pay a price in terms of economic disruption.” Missing from the speech was any sense that this is a two way bargaining exercise. If the EU refuses to negotiate with the UK before Article 50 is triggered, and its demands are immediately rejected by a French or German government which is deeply involved in its own election campaign, the whole strategy falls apart. Moreover, once Article 50 is triggered, the UK loses any influence over the EU. The best we can say about the prime minister’s speech is that it was designed for domestic consumption only. It’s naïve to think that our EU partners are going to roll over and play ball and I suspect that this sunny optimism will not last beyond the first contact with Realpolitik.