May's day turns out OK

 

To say that this has been a tumultuous week in UK politics is like saying you can get a good suntan in the Sahara. It is a statement of fact that simply does not do justice to the magnitude of events. At least we did get one meaningful vote – just not the one planned. Following the postponement of the parliamentary vote on the Withdrawal Agreement, we were treated to the spectacle of the civil war within the Conservative Party being fought in the open as rebellious Tory MPs tabled a motion of no confidence in Theresa May. Although her margin of victory was widely viewed as insufficient (200-117), she obtained 63.1% of the vote which is a larger share than in any of the 8 contested ballots in the past 43 years, bar John Major’s 66.3% when he challenged backbench rebels to unseat him in 1995 (chart).

Nonetheless, the impression remains of a prime minister who is in office but not in power. But Brexit is quite simply an undeliverable policy. Worse still, it has been hijacked by various interest groups seeking to further their own interests, all of whom have irreconcilable positions. Brexiteers simply refuse to accept that it is impossible to leave the EU on the terms that they desire, despite all the evidence to the contrary (see here for the journalist James O’Brien’s coruscating denunciation of their views). Remainers don’t always give the impression that they fully took on board the message of the 2016 referendum. Then there are the opportunists in the Labour Party who are simply using the chaos of the current situation to push their call for a general election.

Meanwhile, the world looks on aghast as the extraordinary events in UK politics continue to unfold. It has not been an edifying experience for a nation which prides itself on its constitutional stability and I have lost count of the number of times I have been asked what is going on in your country. I cannot explain it, but it was perhaps best summed up in a letter to The Times yesterday by Robert Blackburn QC, Professor of Constitutional Law at Kings College London, who wrote: “The political class has brought the present crisis over Brexit on itself by continuing to ignore the now urgent need to repair the creaking Victorian infrastructure through which our rulers continue to govern the country ... The use of an ad hoc referendum on a constitutional policy question of immense complexity, with no detailed prior examination and public dissemination of its implications across UK public life … and no parliamentary process for its approval, has exposed to the world the curiosity and embarrassment of a post-imperial unwritten political and governmental structure in turmoil.” In other words, a governmental system that is not fit for purpose.

He concludes that we need to enact the recommendations of a House of Commons Committee which “set out the case for a written codified constitution, one fit for the modern democratic era with a process through which popular deliberation and constitutional change should take place.” At the very least such an approach might act as a pressure vessel to contain the worst instincts of anti-EU populists who have infected the Conservative Party.

But now that the genie is out of the bottle it is difficult to see where we go from here. The leadership election has not resolved anything apart from drawing attention to the kindergarten antics of the inaptly named European Research Group which: (i) hates all European political ideas; (ii) clearly does no research and (iii) is a collection of disparate individuals rather than a coherent group. It is thus likely that we will continue with the plan announced by Theresa May on Tuesday in which parliament will be allowed to vote on the Withdrawal Agreement sometime before 21 January 2019. But in the absence of any significant amendments – and there is no sign that the European Commission is in any mood to reopen negotiations – MPs are likely to reject it.

But whilst nothing good will come out of Brexit, nor is there anything to be gained by calling for a second referendum any time soon let alone withdrawing the Article 50 notice. All three policy options will be hugely divisive, which is why I maintain that an extension to the Article 50 period is the least worst option. One complication which gets little airplay is that an extension of the deadline will cut across the European Parliamentary elections, scheduled for May 2019. It has long been assumed that the UK would be out of the EU by this point and will not be required to send MEPs to Brussels. If the UK is technically still a member of the EU this could cause some problems, though I can envisage a scenario in which the EU and UK arrange a fix whereby the UK is assumed to leave before the end of the parliamentary term and would thus not be required to elect MEPs.

Such a policy will buy time. But how much time will the UK need in order to pull itself together? Probably a lot more than the EU27 is likely to grant. However, I recall suggesting some time ago that one option would be to keep EU associate membership without actually leaving until public opinion has changed sufficiently to suggest that a second referendum is clearly winnable either way, thus decisively confirming or rejecting the Brexit decision. It is more than evident that politicians cannot decide what to do and unless Brussels comes to Westminster’s aid I am struggling to see how else this plays out.

Unless the Conservative Party can sort itself out, however, this issue is likely to periodically erupt every few decades. Thirty years ago, when Labour was in thrall to the left wing of the party, a series of leaders embarked on a modernisation programme which resulted in the expulsion of many of those viewed as extremists. The policy was successful in as much as Labour tacked to the centre ground and laid the groundwork for Tony Blair to claim three successive election victories with handsome majorities. Despite the current vogue for extremist policies, elections are largely won by capturing the centre ground. The Conservatives would do well to have a similar root-and-branch reform and rediscover the brio which allowed them to set the political agenda.

Plus ça change ...

Whilst the focus on this sceptred isle has been very much on the shenanigans of Brexit, the rest of the continent is focused on its own troubles. The most prominent issue, which has captured newspaper headlines across the continent, is the wave of public unrest in France where the gilets jaunes have been demonstrating against higher fuel taxes in particular and the rising cost of living in general. 

This reflects concerns expressed around the world that “the system” is not working for the average voter and that more of the same just won’t do. This in turn reflects a complex series of issues which have come together all at the same time to create a Gordian Knot of such complexity that no politician can reasonably be expected to resolve them. Environmental challenges, technological change and a shift in the geopolitical tectonic plates are big enough challenges on their own. Trying to deal with their implications at a time when we are still recovering from the biggest recession in 80 years magnifies their impact.

Looking more closely at the French government’s plan to raise fuel taxes, the French electorate appears to be as concerned as anyone about the problem of global warming and climate change, if opinion polling data are any guide. It is not unreasonable, therefore, for the government to conclude that consumers will appreciate that they have to pay more if they wish to continue emitting greenhouse gases in the process of burning fossil fuel. But they are not having it: Having been squeezed for so long, French voters just see this as another attack on their living standards.

Indeed, this demonstrates the problem of getting consumers to buy into the social changes which will inevitably have to come, and highlights the challenges for policy makers who have to wean the electorate away from certain types of behaviour. This requires an adjustment that people are not prepared to make – at least not now. However, history shows that although democratic societies frequently resist big changes at first, only to subsequently accept they are inevitable, this often occurs only after considerable social unrest, as anyone who lived through the Thatcher era in the UK will attest.

But there is another issue at work in France. Outside observers (such as me) look at the current French situation and realise we have been here before. The reform agenda set out by prime minister Alain Juppé in 1995 met with huge resistance and the general strike it provoked only ended when the retirement reform plan, which amongst other things eliminated the rights of railway workers to retire aged 55, was dropped. These strikes, which were the biggest public demonstrations since 1968, were repeated in 2010 when the government was again forced to modify its plans to reform public pensions. Given this experience, the initial reaction of the Macron government is understandable: Do what previous governments have done and suspend the tax changes in a bid to cool public unrest.

However, Macron has now gone much further than this. He appeared on TV on Monday promising to take the concerns of rural and suburban France more seriously, offering higher payments to pensioners and a rise in the minimum wage, all of which amount to additional outlays around €10bn. Having originally planned a budget deficit of 2.8% of GDP in 2019 – which is higher than the much-contested Italian plan – the budget minister now admits that in the absence of offsetting measures, the deficit will rise to 3.4%.

There are a couple of problems with this strategy. On the one hand, the French government has now done what many of its predecessors have done by kicking the can further down the road rather than engaging in the structural reform that Macron knows is required. This will only invite further protests when the government has to revisit the problems again, but the challenges in future will not get any easier. In addition, it gives cover to Italy’s position and will stiffen its resolve not to back down in the face of the European Commission’s fiscal concerns. Given that the EC has already started excessive deficit procedures against Italy, how does it intend to deal with France?

Against that, we could argue that European countries are once again rediscovering the joys of fiscal policy after years of wearing the hair shirt. But whilst across the euro zone as a whole the cyclically-adjusted budget deficit has averaged 1.3% of GDP over the period 2012-2017 (chart) and Germany has averaged a surplus of 0.5%, France has run a cyclically-adjusted deficit of 3.1% (versus just 1% in Italy). France is certainly less well placed than other EMU countries to provide a fiscal stimulus. 

Another casualty of this policy approach will be Macron’s attempt to move Europe forward. Admittedly his fine words last year were exactly what Europe needed to hear as he attempted to prevent the EU from ossifying as the messy compromise into which it had evolved. But his words did not get a particularly good hearing on the other side of the Rhine. Given the German fixation with keeping deficits down, it is unlikely that his stock in Berlin will have risen.

Whilst there is nothing wrong with judiciously using fiscal policy to nudge the economy forward when circumstances demand, the French – and the Italians – are increasing their fiscal deficits to buy off the electorate. And it may even work for a while - after all it is voters' money. But hard choices sometimes have to be made. I have long argued that the UK has overdone the degree of austerity and I understand why Macron made his choices. But I cannot help feeling that somewhere down the line this might be a policy that backfires.

A void where the government used to be

Just when you think you have seen it all in the Brexit debate, we always find something interesting around the corner. Brexit Secretary Stephen Barclay said yesterday: "The vote is going ahead and that's because it's a good deal and it's the only deal." This morning, Downing Street was telling us that the “meaningful vote” that parliament had been promised on the terms of the Brexit deal was definitely going ahead. This afternoon, the prime minister informed us: “We will … defer the vote scheduled for tomorrow.”

Obviously, the fact that there was a snowball-in-hell’s chance of the deal being ratified would have put the prime minister in an impossible position and called what is left of her authority into question. On only three occasions in the last 100 years has a government been defeated by more than 100 votes and it is pretty easy to construct a scenario in which the Withdrawal Agreement would have been rejected by a majority of around 125. Recall that the 139 vote defeat suffered by Tony Blair’s government in 2003 on the question of involvement in the Iraq War arguably marked the beginning of the end for the prime minister as his authority began to leach away. Theresa May is in a far weaker position and it is questionable whether she would survive such a crushing blow. May’s future, however, is a subject for another day. At issue is where does the UK go from here? 

The PM has made it clear that she intends to meet with other EU leaders to discuss the concerns surrounding the backstop which threatens to leave the UK permanently tied to the EU. However, it is difficult to imagine any circumstances in which the EU will make any concessions. The Commission’s view is likely to be something along the lines of “we gave you a reasonable deal which you can take or leave as you see fit. In any case, you haven’t voted on it yet. Come back and see us when you have.” So May could be forced to put the Withdrawal Agreement to a parliamentary vote, and of course it will be heavily rejected. In this case the prime minister goes to Brussels to repeat her request and the EU27 merely repeats the first part of its answer.

Under these circumstances, the UK would have no option but to request an extension to the Article 50 process. The question is how the UK would then use the extra time made available? Probably the first option it would pursue is a Norway Plus arrangement in which the UK joins EFTA and applies to join the EEA (an option only available to EFTA or EU members). Whilst this would minimise the economic costs, the UK would still be subject to the four freedoms of goods, services, capital and labour. In essence it would be a rule-taker. Indeed, as I noted six years ago in response to the FT’s year-ahead 2013 questionnaire “Anyone with notions that we can negotiate a Swiss or Norwegian-style existence on the fringes of the EU is dreaming. Such an existence would still mean that we are subject to large parts of EU legislation but without any power to change it – something which the euro sceptics would like even less than the system they have now.”

What is worrying is that many politicians still don’t understand this point and they have had six whole years to think about it and a whole lot of information put in front of them to demonstrate it. Maybe, just maybe, they will eventually get it in which case the UK would be mad to pursue such a course of action. I suspect that the other alternatives involve either a general election or – and whisper it quietly – a second EU referendum. An election does not do anything to resolve the Brexit question and should be viewed as a side effect of the current political impasse rather than an attempt to resolve it. With regard to a second referendum, I agree with the PM when she says “if you want a second referendum to overturn the result of the first, be honest that this risks dividing the country again” (as I hope I made clear here). But if politicians cannot agree what form of Brexit they want, they may have no choice but to put the question back to the people.

The reason we might end up in this position is primarily due to the fact the government failed to manage the process. The referendum result was never legally binding but May did all she could to make it sound like it was. She was far too late to face down the Brexit ultras who promised unicorns and cakes and indeed pandered to their prejudices (remember “citizens of nowhere” and “queue jumpers”). Perhaps most damningly, the referendum was treated as a winner-take-all outcome in which the near-half of voters who opposed Brexit were completely marginalised. For those who express sympathy with the PM for the near-impossibility of her task, remember that she made it far harder for herself than it needed to be.

I would not like to predict the outcome of a second referendum (I wouldn’t even like to predict the question on the ballot paper). But if it is a choice of “Remain” or “Accept the current deal” the likelihood is that the UK might not even leave the EU (some polling data here, for what it is worth). Further support for this option comes from today’s ECJ ruling that the UK can unilaterally rescind its Article 50 notification, for it suggests that the EU is giving the UK room for manoeuvre if it changes its mind on Brexit.

Nothing that has happened today has helped markets, with sterling falling to its lowest since April 2017. Although markets fear that today’s events have raised the likelihood that the UK will leave the EU without a deal, I don’t buy it. Nonetheless, there is major uncertainty regarding the nature of the UK’s future relationship with the EU which has put sterling under great pressure and 3-month GBP option volatility is on a par with what we saw around the time of the 2016 referendum (chart). Like nature, markets abhor a vacuum and today’s decision to withdraw the parliamentary vote has exposed a major void where the government used to be.

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.