What a state

This week’s State of the Union address by European Commission President Juncker contained an admission that the EU faces an existential crisis. As he put it, “it is as if there is almost no intersection between the EU and its national capitals anymore.” Whatever people may think of Juncker – and there are many who do not hold him in high regard – his analysis of what ails Europe was spot on. His comment that “we Europeans can never accept Polish workers being harassed, beaten up or even murdered on the streets of Harlow” was a justified dig at the apparent rise in xenophobia and racism on the streets of Britain in the wake of the EU referendum, where figures show a significant increase of late.

Yet I could not help thinking that his plan of action was an appeal to the high minded ideals which drove the EU forward in better times, with its calls for solidarity and tolerance, rather than any significant change in direction. Whilst I am convinced of the ideals which Juncker espoused, there are many millions who are not, and I am not sure that he devoted enough thought to the issue of why people are not buying into his ideal. Part of the problem stems from the fact that many nations have little time for the political union aspects of the project, and see it more as an economic enterprise. That is certainly true of the Brits and is probably also true of the 13 nations which joined after 2004. And I would argue that economics is the EU’s weak spot.

Even today, the EU spends almost 40% of its budget on agriculture. Admittedly that is a long way short of the 73% in 1985, but it has been a consistent source of annoyance to countries such as the UK which have a much more efficient farming sector than many other EU nations. The good news is that the EU is reducing its real outlays on this sector but I am not convinced that it is an industry which deserves the priority which Juncker gave it in his speech. More worrying is that free movement of labour is a policy whose implications were not fully thought through. It was the issue at the heart of the UK referendum campaign and it is not too far from the surface in countries such as France.

Moreover, the EU has also not fully got to grips with taxation policy. Indeed, it has invested huge amounts of political capital in the single currency project, yet allows individual countries to set their own tax levels without any form of transfer equalisation. This resulted in the bizarre situation whereby Ireland, which had engaged in a form of corporate tax competition, effectively declared insolvency in 2010 and had to rely on other EMU members for a bailout on punitive terms. The madness of EU tax policy was compounded by the European Commission's recent decision to force Apple to pay €13bn of back taxes to the Irish government, which neither asked for nor wants the money. As Juncker put it, “The level of taxation in a country like Ireland is not our issue. Ireland has the sovereign right to set the tax level wherever it wants. But it is not right that one company can evade taxes that could have gone to Irish families and businesses, hospitals and schools.” That is one view. Nigel Farage put it differently: “if you think the EU’s Apple judgement was bad, you ain’t seen nothing yet.  When the EU destroys your corporate tax regime, you will realise, you are better off out of the EU’s failing political union.”

But the EU’s biggest failing is its failure to understand that in its current incarnation, the single currency is fundamentally flawed. According to Juncker, “Being European, for most of us, also means the euro. During the global financial crisis, the euro stayed strong and protected us from even worse instability.” Really? I suspect the Greeks might think differently given that their economy is in not merely suffering a recession but depression. A weaker currency would actually help alleviate some of the strains facing some of the EU nations (fortunately, the ECB recognises this). But Juncker was right about one thing: “Mario Draghi … is making a stronger contribution to jobs and growth than many of our Member States.”

I regret the UK’s decision to leave the EU. But in the face of an existential crisis which is seeing the bloc split into three distinct regions (northern, southern and eastern for ease of geographical exposition), each with its own issues, we are going to need more than warm words to get all members pulling in the right direction.

With friends like these ...

I realise that Brexit-related posts are mounting up on this blog, but the Leavers provide such good ammunition to undermine their own case that it is a subject too hard to resist. The latest gaffe came in the form of recent derogatory comments by Trade Secretary, Liam Fox, who suggested that business leaders do not work hard enough. These are certainly not the most helpful comments ever to come from a government minister – let alone one tasked with boosting UK trade at this sensitive time.

According to Fox, at what he thought was an off-the-record drinks party, “this country is not the free-trading nation it once was. We have become too lazy, and too fat on our successes in previous generations … Companies who could be contributing to our national prosperity - but choose not to because it might be too difficult or too time-consuming or because they can't play golf on a Friday afternoon - we've got to be saying to them if you want to share in the prosperity of our country you have a duty to contribute to the prosperity of our country.”

Businesses can be accused of many things but I would never level a charge of laziness. As for “too lazy and too fat”, British businesses are operating in one of the most competitive markets in Europe, with the OECD pointing out that labour market regulation is the lowest in the EU and product market deregulation is second only to the Netherlands. Successful businesses in the UK have to work very hard to be successful against that backdrop. Not surprisingly the comments did not go down too well with large parts of the business community. Richard Reed, founder of Innocent Smoothies and a leading figure in the Remain campaign, hit back by saying that Fox had “never done a day’s work in business in his life” and “How dare he talk down a country that he has damaged?”

Indeed, with Fox having been a prominent Brexit campaigner, at odds with large swathes of the business community, his remarks threaten to undermine relations between business and certain elements of government. The comments were not supported by 10 Downing Street. Nor indeed were David Davis’s comments last week suggesting that it is “very improbable” that the UK will remain a member of the EU single market.  I still have not worked out whether government ministers are deliberately talking at cross purposes or whether it is all part of Theresa May’s master plan to undermine the credibility of pro-Brexit MPs.

Furthermore, Fox’s comments highlight a gross fallacy at the heart of the Brexit campaign. Recall that many Leavers argued that it was the EU’s bureaucracy that was holding back the UK. But now that the post-EU future may not be as easy to negotiate as many of them argued, there appears to be an attempt to pin the blame on corporate UK as the Leavers get their retaliation in first. I have long pointed out that it would always be difficult to secure the trade deals with the rest of the world that the Leavers promised. This view was reiterated last week by Sir Andrew Cahn, former chief executive of UK Trade and Investment, who pointed out that Fox’s claims the UK would have a network of deals in place by the time it left the EU were “highly unrealistic.” Sir Andrew noted that “trade deals are unsentimental instruments of real world economic and political reality. The more economic weight you have the better deal you get.” In the grand scheme of things the UK is a small to medium-sized open economy. Any trade deals we do get will thus be on terms which are favourable to the bigger players such as the EU, the US and China.

The letters page of The Times yesterday was full of comments regarding Fox’s remarks, noting variously that “Dr Fox’s comments on exporters would carry more weight if the government’s policies backed them … Not only were Dr Fox’s comments ill-considered, they were unhelpful … I have spent my life exporting British-made products [and] I am incensed by his ill-chosen remarks … his support of Brexit has not done exporters any favours. Dr Fox needs to offer constructive help to the business world.“ That is the voice of business. With friends like Fox, who needs enemies?

Another one bites the dust

The news today that David Cameron is to stand down with immediate effect as an MP probably should not surprise me. He gambled on the Brexit vote, lost, stood down as prime minister and has nothing left to achieve in domestic political terms. But I was immediately transported back to his final day as PM on 13 July when he was asked by former Chancellor Ken Clarke, now a backbench MP, whether he will “still be an active participant in this House as it faces a large number of problems over the next few years?” Cameron replied, “I will watch these exchanges from the Back Benches.” So we’ll take that as a “yes” then?

However, as James Kirkup pointed out in the Telegraph, “he fought the EU referendum campaign promising not to quit if he lost, then quit when he lost.” In fact, Kirkup’s article sums up pretty well, I thought, the issues surrounding Cameron’s premiership. “Flouncing out of Parliament in this way is so telling: it speaks to something fundamental about Mr Cameron's character and his approach to politics: a lack of seriousness, the absence of real commitment.  Yes, he wanted the job and yes he put the hours in, to the cost of his family. But he would never die in a ditch for his political beliefs … It was always enough to get by, to do just enough to get the top grade and do better than the rest [although] Mr Cameron's just-good-enough performance was, in fact, pretty good, and probably better than any of the others who might have done his job at the time. Yet that lack of commitment, the sense that he never anything more than a gentleman amateur trying his hand at governing out of a combination of duty, boredom and vanity will stay with him when the histories are written.”

In some ways, perhaps, Cameron was a throwback to an earlier political age, the era of the gentleman amateur. And at a time when we criticise our politicians for being too professional and for not having had experience outside politics before entering parliament, it may seem hypocritical to criticise Cameron for not being cut from this cloth. But running away from a problem of his own making really takes the biscuit. It is one thing to quit as PM but then to disappear from politics altogether because he does not want to be seen as a “distraction” simply does not wash. In his view “leaving parliament is the right thing to do.” In what way, exactly? Although Johnson, Gove and Farage were the arsonists in chief who set the Brexit fire alight, let’s not forget that it was Cameron who supplied them with the matches. This was a problem of his creation and he owes it to the country he claims to love to help fix it.

As Cameron heads for the political exit, questions will continue to be raised about his political legacy. But in order to answer this question forces us to ask what he stood for in the first place. He came to office in 2010 promising to detoxify the Conservative brand. Arguably, he made matters worse. After conceding in 2006 that the party had alienated voters by "banging on" about Europe, he reaped the whirlwind with his Brexit promise. Promises to build a “Big Society,” designed to “generate, develop and showcase new ideas to help people to come together in their neighbourhoods to do good things” were quietly dropped. His Chancellor’s austerity policy, which Cameron failed to rein in, did the Tories more harm than good and efforts to devolve regional government are being scaled back by Theresa May’s government.

As I have suggested previously – and as James Kirkup’s article indicates – Cameron at his best was a very effective political performer. But he was always a more effective tactician than strategist and once the tactics on the EU referendum went wrong, the game was up. Prior to the 2009 election, former BoE Governor Mervyn King privately criticised Cameron and George Osborne for their lack of experience and tendency to think about issues only in terms of their electoral impact. As both men fade into political history, it is hard not to think that Cameron’s government will go down as one in which the winning of small victories was more important than getting the bigger picture right. Following his Bloomberg speech in January 2013 I concluded that it was difficult to avoid the view that Cameron was playing fast and loose with the national interest for uncertain political gains. For that, he deserves to be judged harshly.

2001: The dawn of a new revolution?

Fifteen years ago today terrorists flew two aircraft into the World Trade Center in New York, and the world has never been the same since. Although the US economy and stock market had been weakening for some time – for example, it took the NBER until November 2001 to determine that the US economy slid into recession in March 2001 – it truly marked, in my view, the point at which the 1990s boom could be said to have ended. Although on the surface the economy recovered relatively quickly, the event proved to be a traumatic national event which saw the US unleash its military might on the Middle East and profoundly changed American politics in ways which are still being felt today.

It was around the same time that we began to take much more notice of the rise of Chinese economic power. Whilst it would be wrong to suggest that the shift away from the unipolar economic world of the 1990s began this day fifteen years ago, it is easy to understand why this parallel might be drawn. Despite the efforts of Barack Obama to heal many of the wounds which were created by 9/11, Donald Trump has tapped into a surge of anger regarding the decline of the US. There is no doubt that the relative position of the US has diminished as China has ascended: In 2001, the US economy was eight times the size of China measured in simple dollar terms. By 2015 it was only 60% larger. In PPP terms, the IMF reckons that the Chinese economy is now larger than the US. However, this is a very different thing to saying that the US is in decline:  After all, the dollar value of US output has increased by 69% since 2001.

But the ordinary working man and woman have felt the squeeze. Median US household income in 2014 was reported just below $54,000, having peaked at $57,843 in 2009. Thus the purchasing power of the average household has declined by around 7% since the end of the 1990s, and in inflation-adjusted terms, this decline is even bigger. This is attributed partly to falling household size – after all, if you only have to support one person rather than two, then life has got rather better rather than worse.  It is also partly due to a rise in the number of low-skilled immigrants who populate the lower end of the income scale. But there is little doubt that in the US – as in most other parts of the industrialised world – the majority of the working population does not feel as though they have benefited from the recovery which is apparent in the headline economic statistics such as GDP or unemployment.

One factor which has contributed to this apparent slowdown is the deceleration in productivity growth. Back in 2001 the talk was of a productivity revolution, triggered by advances in ICT. Today, we worry that these advances are about to supplant labour rather than complement it. As Paul Krugman once remarked, “productivity isn't everything, but in the long run it is almost everything.” Over history, rising productivity has gone hand-in-hand with rising living standards and if it is not growing particularly rapidly, it should come as no surprise that our living standards are not progressing at the same rate as they once did. Economists continue to debate why this should be the case. It could be that many of the advances in productivity are simply not being captured properly in the data (I’ll come back to that another day) or, as Robert Gordon was pointing out back in 2001, many of our recent technological innovations do not offer the same boost to productivity as those in the past.

Either way, the last fifteen years have seen significant economic changes. These are partly the result of geo-political changes but perhaps more importantly they reflect socio-economic shifts. We may not have known it at the time, but perhaps the years around the turn of the century marked the start of a third industrial revolution driven by the dawn of the digital age. It took 60-80 years starting around 1760 for the first revolution to fully make its presence felt, whilst the period 1860-90 arguably marked the duration of the second. On the basis of past trends, we may thus only be halfway through the transition period of the third industrial revolution. For Stanley Kubrick, 2001 was the year of a space odyssey. For Americans, it marked the first significant attack on the US mainland. For future historians, it may yet go down as the start of a new era in world economics.

It’s dusk in the second age of reason …

… is a line from Ian McEwan’s latest novel “Nutshell.” As a description of the depressing state of public debate on many of the key contemporary economic and political issues, I find it very apt. Apparently I am not the only one. ‘Enough Said: What’s Gone Wrong With the Language of Politics?’ is a book by Mark Thompson, the former director-general of the BBC, in which he analyses the current state of political discourse and the way in which we conduct our debates on issues of great public importance (click here for The Guardian’s review or here for the FT’s take on it).

One of the points which Thompson makes is that the public is no longer prepared to take the word of experts on a wide range of issues, preferring instead to rely on views distilled from the vast realms of cyberspace. He argues very cogently that far from creating a forum for open discourse, the internet has instead allowed individuals to seek out like-minded people with the result that they preach to the converted and engage in closed rather than open discussions. Moreover, the constant search for clicks has resulted in ever more shallow debate and, as Andrew Rawnsley put it, “political discourse in which there is no longer any presumption of good faith between opponents.” (The irony of making these points on a personal blog has not escaped me).

It is this environment which has allowed the likes of Donald Trump to flourish – a man whose latest outburst against Mexican immigrants ("We will build a great wall along the southern border. And Mexico will pay for the wall, 100 percent. They don't know it yet, but they're going pay for the wall”) has allowed him to narrow the polling gap with Hillary Clinton. He is even ahead in the latest CNN poll. It is this environment which allowed Michael Gove during the Brexit campaign to get away with saying “people in this country have had enough of experts” and to dismiss warnings of the economic consequences of Brexit by comparing the doomsayers with German scientists in the 1930s who were paid by the government to denounce Albert Einstein (at least he did not use the word “Nazi”).

All this is just a fancy way of saying that we hear what we want to hear, and in that sense it is not exactly a new phenomenon. But bad things tend to happen when politicians fail to engage in sensible discussions. Looking at it from a policy angle, an environment in which politicians left management of the economic cycle to central banks whilst trying to persuade electorates of their fiscal rectitude contributed to the damaging round of fiscal tightening which was implemented across Europe starting around 2010. In the euro zone in particular, it was considered heresy to even talk about any form of fiscal easing. Central banks may also be considered part of the problem, since they agreed to loosen the monetary stance as governments tightened fiscal policy and thereby encouraged governments to go further than they may have otherwise (though that might seem a harsh judgement).  

But although the language of economic policy has up to now appeared restrained and rational, a divergence between words and deeds has been growing for some time. George Osborne’s efforts at expansionary fiscal contraction were a gesture in futility designed to persuade us that economic pain today would mean better living standards tomorrow. But now even the language of policy is becoming more strained as central bankers continue to try and persuade us there is more that they can do to help ease our current economic predicament, when in reality policy has run out of road. So on Thursday, when ECB President Mario Draghi stands before the assembled representatives of the press, an honest and open assessment of the current policy environment would see him throwing up his hands and saying, “We’ve done all we can on the monetary side, and in any case we’re sick of taking the brickbats for our attempts to try and keep the euro zone together. From now on, it’s up to the governments of monetary union members to try something.” It may not be popular but it would at least convince me that the age of reason is not dead.

Skirmishes in the Brexit phoney war

It is increasingly evident that Theresa May’s July comment that “Brexit means Brexit” was simply a device to buy some time over the summer in order to allow some heat to go out of the fractious debate. Today’s return of parliament following the summer recess marks the point at which the government has to get down to some hard thinking about how it wants to implement any sort of plan.

Today’s domestic highlight was the speech by Brexit minister David Davis outlining the government’s position on Brexit. I use the word “position” because plan is too grandiose a word to describe what we know so far. The key message from Davis was that it is “very improbable” that the UK will remain a member of the EU single market. This comes a day after the US and Japanese governments warned PM May, in China for the G20 summit, of the consequences of Brexit for trade and investment. The US indicated that securing a trade deal would not be a priority for the US, which is seeking to conclude negotiations with the far larger EU, whilst the Japanese government issued a 15-page report outlining the problems which Brexit could cause for Japanese firms. It pointed out that “a number of Japanese businesses, invited by the Government in  some  cases,  have  invested  actively  to  the  UK,  which  was  seen  to  be   a  gateway  to  Europe.” In other words, you invited us in and took the money we brought but you have changed the rules of the game. The thrust of the document was a plea for business conditions to remain broadly as they are now, otherwise “this could force Japanese companies to reconsider their business activities.”

It is, of course, still very early days, but the events of the weekend highlight what many us pointed out all along: first, that changing the economic rules will have consequences for UK jobs and, second,  that the rest of the world was not necessarily going to jump at the chance to negotiate a special deal with the UK. If you can do a trade deal with a market of 500 million people, it is likely to yield far bigger benefits than negotiating one with 65 million. All this throws Davis’s comments into stark relief and highlights the rock and hard place dilemma facing the government. In order to make a success of not taking part in the single market, the UK has to secure trading relationships with non-EU nations – a process which has not got off to a good start. If it proves difficult to build these relationships, the government will find that it is in its best interests to maintain closer ties with those EU countries which it just spurned than many people might find desirable.

A curious element of PM May’s speeches in China was that she ruled out the adoption of a points-based system to manage immigration flows, despite the fact that this was a key element of the Leave camp’s plan, and left her open to the charge of backsliding (though she never advocated it, so that charge seems rather spurious). She argued that they are not an effective means of controlling migrant inflows. I am less sure about that – as a means of controlling absolute inflows they have their uses. But they do have other shortcomings, as even the Australian government admits. For one thing, many of those coming in on such schemes often tend to be under-employed which drives them down the value chain to compete for unskilled jobs, and for another they allow government to dictate labour supply rather than the needs of employers.

But by torpedoing one of the key planks of a policy advocated by Boris Johnson and Nigel Farage, PM May is sending a signal that some of the simple ideas put forward by the Leavers will not be implemented. Maybe this is clever politicking designed to restrict the Brexiteer’s options in a bid to expose some of the fallacies inherent in the case for leaving the EU. It will certainly make life harder for David Davis as he puts together his plan to take the UK to the next level. However, much that we have heard so far tells us only what the government is opposed to, not what it is in favour of. Brexit may indeed mean Brexit. But it may also end up being a slogan designed to hold the Conservative party together in much the same way as David Cameron’s pledge to hold a referendum in the first place.

It was twenty years ago today ...

It dawned on me this morning that it is twenty years since I packed myself off to Germany to start a new job. Two whole decades! As I reflect on where the time has gone, and why English football is in an even worse state than it was then, I am struck by how much simpler the world economy appeared back in 1996. The world's economic power was concentrated in Europe and the US, which meant that keeping track of the fundamental issues driving markets was a relatively simple task. European monetary union remained an aspiration for policymakers whose aim was to meet the qualification targets for entry into the single currency. Central and eastern European economies were still adjusting to the post-Communist world and were early converts to go-go capitalism which promised a massive rise in living standards. In Japan, we were awaiting a recovery following the bursting of the bubble economy in 1990, whilst southern and eastern Asian economies were regarded as a dynamic, but very unsophisticated.

How times have changed. Two market booms and busts later – the most recent being the most far-reaching since the Great Depression – the position of the US as a kick-ass superpower has changed. It is still the strongest military power in the world but its economic supremacy is no longer unchallenged. European monetary union did happen as promised, but as recent events have shown, it is far from a one-way ticket to prosperity. Many of the smaller nations in southern and central Europe are struggling under the weight of the massive rise in debt accumulated during the boom; we are still awaiting a solid Japanese recovery following 25 years of stagnation and Russia looks more like the old Soviet Union than the engaged partner the west hoped it would become. But the biggest change has been in the perception of Asia, particularly China, which is reclaiming its historical importance as a big player on the world stage.

Of all the events which have taken place over the past two decades, perhaps the most emblematic was the Lehman’s bankruptcy of 2008 which marked a seismic shift in the western world. This signalled an end to the fantasy world of debt-fuelled prosperity and the dawn of a day of reckoning. No longer would we be able to build our monetary Tower of Babel all the way to Heaven (to use Jens Weidmann’s analogy). We would have to be content with a smaller place with fewer floors (or should that be flaws?). As it turned out, the foundations  of our tower were pretty rotten and even now we are still digging them out, trying to construct a more sustainable structure.

In retrospect, we should have foreseen many of the problems which hit us, but most of us did not. As Martin Wolf noted in his book, “The Shifts and the Shocks”, we “lacked the imagination to anticipate a meltdown of the Western financial system.” Perhaps that is because we had created a system which had proved pretty robust to all that had been thrown at it and we simply became complacent. But an additional reason is that we failed to understand the significance of the change in the world economic order. Ben Bernanke argued as far back as 2005 that excess saving in surplus countries such as China was a contributory factor to the boom which preceded the western bust. It is not the whole story, but it indicates that the changed dynamics of the global system meant that western economies were potentially subject to forces which they had not been designed to withstand.

So whilst it may be overstretching it to argue that the 200 year dominance over the world economy enjoyed by the west is at an end, I have long believed that the high water mark of western capitalism was reached in summer 2007. As that particular tide begins to ebb, it will become ever more apparent how important the Asian economies will be to the global economic order. The US and Europe will no longer be in a position to decide for the rest of the world.

I noted some years ago that against this backdrop, Europe will have to be more outward looking; more open to hearing the voice of the electorate in order to shape its liberal democracy to cope with the demands of a 21st century world. Policymakers will have a key role to play in this debate, balancing the need to impose adjustment against the resistance of the electorate to the radical changes which are needed. The signs are not looking propitious. The stresses imposed by the euro zone debt crisis have exposed fault lines in the design of the single currency whilst the threat of Brexit may be the thin end of a wedge which exacerbates European divisions as populism rises up the political agenda.

We can be certain only that the old certainties no longer hold and for that reason it is pointless to try and predict what will happen in the next twenty years. Suffice to say that western policymakers have a lot of work to do to ensure that we will be in a position where we can feel as positive about our future in 2036 as we were in 1996. I would like to be optimistic about where Europe is headed. But until such times as we rediscover our sense of purpose, I suspect the years ahead will be politically and economically challenging.