Now, right now, is the winter of our discontent

The failure of the political class 

After a relaxing Brexit-free fortnight, UK parliament resumed on Monday and was plunged into a series of constitutional crises related to the apparently never-ending Brexit shenanigans. As one who has followed the twists and turns in this debate from the very start, it is highly frustrating at this point of the proceedings to see that politicians are still treating the most serious economic and political event in British modern history as if it were the subject of an undergraduate debating society.

Just before Christmas The Economist’s Bagehot column published a particularly scathing critique of the UK’s political class. In The Economist’s words “the country’s model of leadership is disintegrating. Britain is governed by a self-involved clique that rewards group membership above competence and self-confidence above expertise.” The article points out that David Cameron “rewarded … pals for losing an unlosable referendum, with peerages [and] knighthoods” whilst the system is “introverted and self-regarding, sending its members straight from university to jobs in the Westminster village.” It goes on to criticise the “new political class [for being ] devoid of self-restraint, precisely because it thinks it owes its position to personal merit rather than the luck of birth.” In another article in the same edition, The Economist calls Theresa May “politically unembarrassable” for remaining in office “despite losing her majority in an election that was considered unlosable.” Jeremy Corbyn, Labour’s leader, “is perhaps more shameless still: in 2016 he refused to budge even after losing a confidence vote among his MPs, on the basis that under Labour’s rules the members pick the leader.” 

Not all politicians deserve to be tarred with the same brush, of course, but when it comes to Brexit too many of them fail to adhere to Mark Twain’s maxim that it is best to keep quiet and be thought a fool than open one’s mouth and remove all doubt.  Take for example the view expressed by the prime minister in December that another referendum “would do irreparable damage to the integrity of our politics.” It will not require another referendum to damage the integrity of the political system: In the minds of many people, MPs are doing a good enough job of that on their own. 

Parliament to the rescue? 

I am not altogether sure whether the Brexit-related events of this week show parliament in a good light or not - only time will tell. To recap, a House of Commons motion was amended by backbench MP (and former Attorney General) Dominic Grieve which will force the government to put forward its Plan B within three days of the Withdrawal Bill being defeated in the parliamentary vote – something which is seen as inevitable next week. Controversy arose because the motion was believed to be unamendable and was only altered thanks to the intervention of the House of Commons Speaker – a move which was deemed unconstitutional by Brexit supporting MPs. But as Grieve pointed out, the previous requirement for the government to present its Plan B 21 days after parliamentary defeat was no longer credible after it wasted four valuable weeks by postponing the vote which should have taken place in December.

There is a huge irony in the complaints of those MPs who deem the actions of the Speaker unconstitutional for he has effectively enhanced parliament’s power over the Brexit process. Those who are serious about taking back control surely have to recognise that parliament is the only sovereign body. Looking back over the past two years, the government’s original plan that only it would manage the Brexit process has been gradually stripped  away piece by piece – recall that in 2016 the government envisaged little role for parliament in the Brexit process which was only reversed following an intervention by the courts.  Of course the full consequences of the Speaker’s decision will only be manifest in the course of time: If a precedent has been set that allows parliamentary motions to be amended in this way, it will reduce the government’s control over the parliamentary process which could have major adverse consequences in future. 

Dealing with the vote 

But that is not a consideration for today. All attention is fixed on next week’s vote on the Withdrawal Agreement which is likely to be rejected – by a substantial margin if current rumours are true. Although the government has not so far countenanced the prospect of defeat, there are signs it is beginning to realise that the game is up. We are thus back to the position of asking what happens next? If Theresa May were not so “politically unembarrassable” she might consider resigning given the extent to which her credibility is bound up in the deal her government has reached with the EU. Somehow I can’t see that happening: The prime minister believes she has a duty to see Brexit through and is too dogged to resign. But a three day window gives the UK too little time to go back to Brussels to try and get some concessions from the EU which will not be granted in any case.

My default position remains that the UK will be forced to extend the Article 50 period. Whilst the EU is likely to grant such a request in order to prevent the chaos that would result from a hard Brexit, it might yet call upon the UK to justify such an action by asking whether it plans a general election or even a second referendum. As abhorrent to the government as the latter option might be, the former is even less palatable since there is a real possibility that the Conservatives’ position would be weakened still further.

To say that the government is between a rock and a hard place is an understatement. I recently came across an article in the Daily Telegraph suggesting that the situation facing Britain 40 years ago during the Winter of Discontent was far worse than the position we find ourselves in today. It isn’t! Like the Conservative government today, the then-Labour government was a prisoner of factions within its own party. But unlike 40 years ago when the Labour Party was fraying at the edges in the same way that the Tories are now, the government was still coherent. It also faced credible political opposition in the form of Margaret Thatcher who took office soon after. The scars of 1978-79 thus healed relatively quickly and although this period gets regurgitated from time to time, most people dismiss it fairly quickly. I fear this will not be the case with Brexit. To quote Shakespeare, “NOW is the winter of our discontent.”

Some thoughts on the 2019 outlook

It is with some trepidation that we look ahead to 2019. There are indications that economic activity is slowing and markets are selling off as they adjust to changed circumstances, which is reason enough to be concerned. But the overriding concern is politics with Donald Trump applying his policy of unfiltered Tweeting rather than rational engagement, on issues ranging from China and North Korea to veiled threats about the position of Fed Chair Powell. Brexit continues to demonstrate why political decisions are too important to be left to politicians and the European elections in May will give voters another chance to demonstrate their support for populists who continue to undermine the rules-based system on which we depend.

Starting first with the economics, it is unlikely that we will see recessions in any of the world’s major economies this year (hard-Brexit considerations in the UK notwithstanding). Both the US and euro zone are projected to lose some momentum this year, with growth rates around 2.5% and 1.4% respectively roughly around 0.5 percentage points lower than in 2018. That is far from a bad outcome if realised, although some of the data around the turn of the year suggest that the slowdown may be a bit more abrupt than we thought a few weeks ago.

But the US cycle in particular looks long in the tooth: So long as the US does not fall into recession before July, it will surpass the 120 month upswing between March 1991 and March 2001 as the longest on record. But the strength of each successive upswing is weaker than the previous one and policy makers continue to fret about the weakness of productivity growth, which is the key driver of living standards, compared to previous cycles. Another puzzle for policymakers is the absence of inflation, and I doubt that inflationary concerns will justify monetary tightening in 2019. But I maintain my view that interest rates that were set in order to deal with economic conditions a decade ago are not appropriate for today’s environment. The Fed was right to raise rates since late-2015 which at least gives it some monetary ammunition to deploy in the event that the economy turns down – room for manoeuvre that neither the ECB nor BoE have.

Against this backdrop, why are markets so jittery? I have long maintained that a large part of the correction reflects a repricing after investors pushed asset valuations too far on the back of loose monetary policy and recovering growth prospects. In the course of the first nine months of last year, investors continued to force US equities higher despite the fact that the Fed was clearly engaged in monetary tightening, buoyed by the fact that cuts in corporate tax cuts were giving earnings a one-off boost. Reality finally began to take hold during the autumn but what surprised me was that many market commentators were surprised.

Regular readers may know that I track Robert Shiller’s 10-year trailing P/E for the S&P500 as a measure of the extent to which markets are out of line. Last month it dipped below 30 for the first time since summer 2017 (the post-1950 average is 19.4). On the basis of current data, the S&P500 would have to fall by another 10% just to return the P/E index to 25. This would put the S&P500 around 2270, representing a 23% decline from the September 2018 peak and only around 3% below the pre-Christmas flash crash low. Making stock market predictions tends to make fools of us all, but I would not be surprised to see US equities making a 10% downward correction during the course of this year. Whether we go lower depends very much on the outlook for 2020. I am not hopeful.

Politics remains the big concern for markets. Dealing with the easy one first, I do not believe that the UK will be allowed to crash out of the EU without a safety net in place so my prediction Is that there will be no no-deal Brexit (probability 80%). Note that the probability is not 100% – such has been the lack of economic rationality during the whole Brexit process that there are major tail risks and the events of December 2018 give little confidence that the UK knows precisely what it wants and, more worryingly, how to achieve it.

A more difficult question is what will happen in the US-China trade dispute. As a (usually) rational individual, I find it difficult to understand why the US would want to ratchet up the pressure. Admittedly, the trade dispute is hurting China but this week’s announcement by Apple that slowing Chinese revenues will hurt profits is an indication that the process is also beginning to impact on the US. My guess is that some of the tension will ease in 2019 once Trump is satisfied that China has taken some pain. But as one who has habitually underestimated Trump’s unwillingness to play by normal rules, I may be accused of being too sanguine. However, one prediction I will make is that impeachment proceedings will not be initiated against Trump as Democrats realise that the process will be politically counterproductive.

Europe will likely to continue grinding along in low gear. The economy has lost momentum and EMU members increasingly have to deal with domestic political issues. I would not like to offer odds on Angela Merkel remaining as German Chancellor, given that she has already announced her departure. But September will mark the halfway point of her final term in office and it might be deemed a good time to hand over the reins.

One change we know is happening for sure is that Mario Draghi will end his eight-year term as ECB President. The smart money suggests that he will be succeeded by former Bank of Finland governor, Erkki Liikanen. I have no strong opinions on the matter but I suspect whoever it is, it won’t be Bundesbank President Jens Weidmann whose stock with southern European nations is not high. Also this year, we can look forward to the announcement of who will succeed Mark Carney as BoE Governor, as he is scheduled to depart in January 2020. Whenever anyone asks me, I say the BoE need look no further than FCA Chief Executive Andrew Bailey. But given that Carney has already twice extended his tenure, who knows whether he might do so again?

We all know that there are no certainties in life. But I hope I am right about my Brexit call above all others. Because if I am wrong, my blog posts around early April might become less frequent as I am forced to forage for the food that we used to import.

2018 in review

As we look back at 2018, many of the bigger trends which I anticipated a year ago did indeed pan out. There were a few unanticipated surprises, of course: It would not be quite the same if there were not. To summarise the year as succinctly as possible, global growth held up although fears of a slowdown began to materialise late in the year; markets had a rocky year and politics dominated the agenda. 

As I noted in early January, markets at the start of the year were entering late-cycle territory with many investors describing themselves as “reluctant bulls.” My recommendation at the start of the year was to reduce the degree of risk exposure, primarily because I expected volatility to pick up, but I still expected equity markets to end the year up 5-10%. I was right about the volatility but wrong about the trend in equities, although I was right to believe that equities could not continue to rally as they had done in previous years. The equity option volatility trend reflects a change in investor attitude towards risk and there was a sharp spike in February and a less elevated but still strong upward movement towards the end of the year. I have long believed that markets were under-pricing risk and 2018 was the year that a reassessment took place. Many of those who were reluctant bulls a year ago are now outright bears, and with hindsight I should have had the courage of my convictions to call for the market correction that I feared might happen.

The reasons for the investor reassessment are many and varied. My main concern a year ago was I believed equities to be overvalued: Based on the Shiller ten-year trailing P/E metric I still believe they are. Cracks in the tech universe were another factor: Tech stocks continued to fly high until late in the year but I did warn that “a market which is so dependent on tech stocks is clearly vulnerable to a shift in sentiment.” And so it proved when the FAANG stocks started to give up their gains around October. This is partly the result of product dependency fears, with concerns that demand for Apple products is slowing, and cyclical factors as growth concerns mount. I also noted that the Fed’s quantitative tightening policy, whereby it continued to reduce its balance sheet, at a time when interest rates were rising indicated that “more air is being taken out of the monetary balloon than at any time in the past decade.” There is no doubt that US monetary support for equity markets has been steadily withdrawn over the past 12 months.

But undoubtedly the biggest factor influencing markets was the outbreak of a trade war between the US and China – something which happened more suddenly than I anticipated because I thought that President Trump’s bark was worse than his bite. Although the G20 summit in December appeared to take some heat out of the US-China trade dispute, many of the issues which prompted the dispute in the first place remain unresolved. In what appears to have been a truce in trade hostilities, China made some trade concessions that prompted the US to hold off from raising tariffs on a wider range of goods. But China continues to skirt around the fact that the expropriation of copyright technology as a precondition for foreign firms to do business in the domestic Chinese market remains a live issue. To the extent that the trade ceasefire is conditional on eliminating this problem, we cannot say that trade concerns will not resurface in 2019.

Perhaps one of the biggest issues exposed by the trade war is that the rules-based architecture on which global prosperity has been based is threatened in a way we have not seen in many decades. The WTO exists as part of the institutional framework to prevent trade frictions from escalating, with 38 disputes brought before it this year alone. Unfortunately, the Trump administration is sceptical that the WTO will act in favour of the US and it continues to block appointments to the WTO’s Appellate Body which has been reduced from seven members to three. With the terms of two members set to expire in December 2019, this would reduce the Appellate Body below its necessary quorum unless new members are appointed and would mean that the WTO is no longer able to arbitrate in trade disputes. For the record, an analysis of WTO cases brought against China[1] indicate that “there are no cases where China has simply ignored rulings against it” – in contrast to the US which “has not complied with the WTO ruling in the cotton subsidies complaint brought by Brazil.” Bias? What bias?

But it is not only trade issues that have rattled markets. There is a growing trend towards economic nationalism evident throughout global politics which is leading to concerns that we have passed the high water mark of globalisation. Trump’s America First policy is a clear manifestation of this, as is Brexit. Indeed, perhaps one of the key trends to emerge in 2018 was the sense of drift in political leadership. I have talked at length about the political failures of Brexit, and I have serious reservations that politicians will see the light in the next three months which will avoid a hard Brexit having spent the past 30 months behaving irrationally. But French and German politicians are also facing increased pressure from an electorate which does not like what is on offer, whilst Italy’s populist policies have drawn the ire of the European Commission. This lack of leadership and inability to rise above local concerns to see the bigger picture is one of the biggest threats to the economy and markets as we look ahead to 2019.

In terms of some of my other 2018 predictions, I didn’t do altogether badly. Bitcoin prices collapsed, as I suspected they would; there was no war on the Korean peninsula and Donald Trump was not impeached. I was also right that Italy would not win the World Cup (though that was more to do with the fact they did not qualify for the finals). But when I did do the analysis in mid-year and tipped Germany to win, I did so only on the basis that the 18% probability assigned to their victory chances implied an 82% they would fail to win. Those are the sort of predictions I like – ones which can be both right and wrong at the same time. Happy New Year.

[1] Bacchus et al (2018) ‘Disciplining China’s Trade Practices at the WTO’, Policy Analysis 856, Cato Institute

Forecasting the UK: How did we do?

At this time of year journalists like to look back at how forecasters did over the past twelve months. One of the comparisons I follow most keenly is that compiled by David Smith in the Sunday Times, even though I have some reservations about the methodology (here for the full article if you can get past the paywall). Smith makes the point that those making UK forecasts in 2018 did pretty well. But what has struck me most in recent weeks is not so much that many forecasters did well in their assessment of UK growth in 2018, but how consistent the consensus has been for the past two years regarding the impact of Brexit on the economy.

Each month the Treasury invites contributors to make projections for a wide variety of indicators for the current and following years, with the forecast horizon rolled over in February of each year. The first projections for 2017 were thus published in February 2016. Prior to the EU referendum the consensus was that GDP growth last year would come in at 2.1%. After a brief wobble in the summer and autumn of 2016, when the consensus dipped to 0.7%, forecasters quickly adjusted their forecasts upwards when it became clear that the economy was not falling off a cliff. Nonetheless, growth last year came in at 1.7% - a good 0.4 percentage points below pre-referendum estimates.

The first projections for 2018 were published in February 2017. What is remarkable is that over the last 22 months the projection for 2018 growth has barely changed, and although we only have data for the first 10 months of the year we have enough to be confident that it will come out close to 1.3% for 2018 as a whole. As a rough guide to assess the extent to which forecasts have changed, I used the Treasury’s database of consensus forecasts to measure the consensus projection for growth in December of each year versus the initial estimate for the year in question, made in February of the previous year. For example, in February 2017 the consensus forecast for 2018 UK GDP growth was 1.4%, implying a 0.1 percentage point deviation from (expected) outturn.

We can run this analysis all the way back to 1988. The evidence indicates that the 22-month accuracy of UK forecast projections for 2018 was the second lowest in 31 years, beaten only by 2015 which turned out to be spot on. Of course, forecasts can bounce around throughout the forecast horizon as short-term indicators give additional information. Indeed, the consensus forecasts for 2015 rose during 2014 and early 2015, only to fall back again to where they first started. One measure of forecast stability is the standard deviation of monthly forecasts, and on this basis projections for 2018 have shown the lowest degree of variation in the 31 years of available data (chart).

 

If nothing else, this rather refutes the claim by Steve Baker MP, who noted earlier this year  that he was unable “to name an accurate forecast, and I think they are always wrong.” Where forecasts do tend to go look shaky is when the economy is subjected to an unanticipated shock. A good example of this is the recession of 2008-09 which was entirely unforeseen when the first 2009 forecasts were published in February 2008, with the result that the consensus was forced to downgrade sharply. A similar, although less sharp, correction was evident during the recession of 1990-91. Whilst the economy was not subject to a shock in 2018, the forecasts have to be seen against a backdrop of high post-referendum uncertainty – it has not been a “normal” year.

One of the great ironies of the 2018 comparisons, which are based on projections submitted to the Treasury in January 2018, is that Patrick Minford’s Liverpool Macroeconomic Research (LMR) outfit[1] finished at the bottom of Smith’s rankings. You may recall that Minford is one of the leading lights in the pro-Brexit group Economists for Free Trade which produced its Alternative Brexit Analysis earlier this year which suggested: “All those who attempt to forecast the UK’s long-term future must bear the burden of having their endeavours frequently proved wrong … This isn’t a matter of misforecasting the GDP or inflation figures by the odd percentage point or two. We all do that all the time. Rather, the record is making some serious errors of judgement about some of the key issues before the country.” There is a delicious irony in this statement: Most economists believe that pro-Brexit groups are making serious errors of judgement about the economic impact of Brexit and as a consequence their forecasts are way off target.

The level of uncertainty surrounding next year’s forecasts is even greater and I will deal with that another time. Suffice to say, however, if there is a hard Brexit the consensus forecast for growth of 1.5% is likely to prove an over-estimate. For the record, LMR is forecasting growth of 1.9% next year. It is not impossible, but only if the cliff edge Brexit is avoided.

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[1] Mrs Rosemary Irene Minford has more than 75% of the company’s voting rights which of itself is not an issue. But Mrs Minford’s date of birth is given as May 1943 which happens to be Patrick’s d-o-b. Elsewhere in the filings Mrs Minford’s d-o-b is given as January 1946. I am not sure whether this reflects laxity on the part of Companies House or is another example of Minford playing fast and loose with facts. See this link for more detail https://beta.companieshouse.gov.uk/company/01645294

Not seeing is believing

Last week the world was abuzz with the story of how Gatwick Airport had been closed due to sightings of a drone dangerously close to the runway. Cue social media outrage that something must be done. Get the military in to shoot them down! I even read how Dutch airports are training eagles to take out rogue drones. The general tone, even from the more sober elements of the media, was that the government’s credibility was somehow damaged. All pretty depressing stuff.

So imagine my surprise that it now transpires no one in authority has actually seen the drone in question. According to the police, there was “always a possibility that there may not have been any genuine drone activity in the first place.” There were no pictures or video of the drone incursions into the airspace around Gatwick; there was “no available footage and [officers] are relying on witness accounts.” I was not one of those affected by the disruption and my sympathies go out to those that were. But you have to see the funny side, particularly at this time of year.

After all, we tell our children that a portly gentleman dressed in red manages to park a sleigh driven by nine reindeer onto the roof of our house, drops down the chimney and delivers unsolicited presents. Strangely we never hear him. Nine reindeer on the roof! Coming down a chimney! And although he is such a great house breaker, he never takes anything away. Indeed, he leaves stuff behind! No wonder we celebrate at Christmas: the guy is a phenomenon.

Santa Claus is testimony to the power of belief. As children we are willing to suspend our critical faculties because the payoff is so good that it pays to be a believer. It gets harder to suspend our critical faculties as we get older but people are still able to do it. After all, if it weren’t for the belief in an invisible Deity, we would not be celebrating Christmas. But Santa Claus today has competition in the form of Amazon, which is able to deliver goods to virtually anywhere in the world. Better still, they operate all year round whereas the man in red operates on one day only. There again, I would rather have Santa dropping down my chimney than Jeff Bezos.

The power of ideas is one of the most powerful of human forces. So let’s not knock those who thought they saw a drone at Gatwick last week. Maybe they did. Maybe they did not. Or maybe this was Santa doing a bit of drone testing in order to keep up with the competition. After all, reindeer are expensive costing around USD 2000 per year in upkeep. That’s a decent outlay when you are a pensioner working one day a year for free and who gives stuff away.

Increasingly we have to suspend our disbelief at the events unfolding around us. So I’m going to give the benefit of the doubt to those who thought they saw a drone at Gatwick last week. Just because you can't see it, doesn't mean it wasn't there - after all, they laughed at Einstein. It just remains for me to wish you and yours a Merry Christmas and may you continue to travel safely in 2019.

Thinking out of the box

Some months ago I came across a book entitled Radical Markets: Uprooting capitalism and Democracy for a Just Society by Eric Posner and Glen Weyl which proposes that in order to organise markets for the good of everyone, we should be less concerned about curbing market power than giving them free rein to operate. Given that one of the motivations for this blog in the first place was to highlight that markets do not always deliver optimal social outcomes, in contrast to much of the conventional thinking amongst policymakers, the ideas in this book caught my eye. Admittedly, most of them are bonkers and will never be implemented, but at the very least the authors force us to look more closely at the ills within our current economic system. On the basis that if you can diagnose the problems you might be able to find a cure, this is a useful service.

One of Posner and Weyl’s key ideas is that property rights confer a monopoly status that prevents markets from operating properly.  Take the example of land: A landowner can extract a very high price from someone who wants to put the plot to a more productive use. They pose the question whether it is socially just that the landowner can extract rent at the expense of wider society. Their solution to this problem is brilliantly ingenious, albeit impractical. All members of society assign a value to each and every asset that they own and are taxed on the basis of their declared wealth. But the twist is that if someone offers to buy the asset at the value which the owner declares, they are legally obliged to sell it.

In a world of perfect information, asset holders would be able to value their assets at a sufficiently low price to minimise their tax bill but high enough to deter potential buyers. But because we do not inhabit such a world many asset holders will overvalue their assets, in which case society benefits from the additional tax revenue that results. Similarly, many will undervalue their assets which will allow wealth to be redistributed throughout the economy. As an intellectual thought experiment, I was very much taken by the idea. Obviously it would never work in practice because the ultra-rich would simply acquire the assets of the less well-off and we would end up with more concentrated ownership of wealth. But at a time when there is evidence of increased industrial concentration, with a smaller number of firms accounting for a rising proportion of sales in most economic sectors (think Amazon or Apple), this is brave attempt to force the concentration problem onto the agenda.

The authors also propose solutions to the problem inherent in democratic systems whereby the rights of minorities have to be protected, but equally minority interest groups cannot be allowed to block the progress of a wider agenda. Posner and Weyl use the area of environmental regulation as an example but we might even apply it to the Brexit problem, where the actions of the DUP and the ERG have thwarted plans to move things forward. Posner and Weyl’s solution is to abandon the principle of one person one vote and instead give individuals a fixed supply of credits which means that if they expend them on one issue, their blocking power in other areas is correspondingly reduced. In the authors’ words, “a vote can tell you only whether a person prefers one outcome to another, but not how much the person prefers the outcome … we need a way of determining whether the intense preferences of the minority outweigh the weak preferences of the majority.”

On a day when the UK government has issued its immigration White Paper which I found a profoundly depressing and economically illiterate document, based as it is on pulling up the drawbridge, it should come as no surprise that Posner and Weyl weigh into this subject. Their analysis on this area is pretty weak but it boils down to the idea that citizens should be allowed to sell a visa to an immigrant  worker, to whom they provide financial support until such times as the immigrant is able to stand on their own two feet. The rationale is that society benefits from the additional income which flows from immigration, though I struggle to see why those who are not prepared to sponsor immigrant workers should be allowed to free-ride on the additionally generated income.

But mad as many of the proposals are, and unlikely as they are to be implemented, the authors at least have a go at identifying many of the problems which have exercised voters across the western world. The question of whether society could or should accept the undermining of individual property is more troublesome. However, many of the cases highlighted in the book demonstrate that in theory, individuals can better express their preferences by giving up their rights. In a year when The Economist has called for the liberal agenda of free trade and free markets to be redefined in a bid to enhance living standards, the book is suitably thought provoking.

As a final thought, until 1917 just four major countries permitted universal suffrage and it was not until 1971 that all cantons in an enlightened country such as Switzerland allowed women to vote. What was once unthinkable is now commonplace. Just because we cannot imagine how some of Posner and Weyl’s solutions might operate does not mean that they should be dismissed out of hand.

Negotiating with the EU: A practical guide

Following Theresa May’s abortive efforts to persuade the EU to change its mind with regard to offering some form of Brexit concessions, and as the Italian government’s spat with the European Commission continues, it seems like an opportune moment to reflect on how to negotiate with the EU. Based on a recent article by the Neue Zürcher Zeitung, which looked at the lessons Switzerland could take away from its EU negotiations, I set out a framework for the likes of Poland and Hungary, who might soon find themselves on the wrong end of the Commission’s wrath, based on the past experiences of Greece, Italy and the UK. 

1) Know what you are trying to achieve 

The British clearly failed on this score. The referendum result merely expressed a wish to leave the EU, not how it should be implemented. Nine months after the referendum, the UK invoked the two year Article 50 procedure without any clear objective in mind other than to leave the EU. Without having done any preparatory work beforehand the British started their negotiations from a position of weakness and things never got any better. As a consequence, the British have spent more time arguing amongst themselves than engaging constructively with the EU. Last week, when Theresa May went back to Brussels to plead for more concessions in order to raise the chances of the Withdrawal Agreement passing through parliament, she was repeatedly asked to specify what she wanted. And she could not do so.

2) Everyone has their own domestic policies 

Many of those members who get into difficulties with the EU often find that they ignore the domestic sensibilities of other members. When faced with the Troika’s proposals to allocate more funds to Greece in the summer of 2015, the Greek government called a referendum in which the Troika’s terms were rejected by a majority of 61% to 39%. But EU member governments were having none of it and offered liquidity on the same terms, which the Greek government was subsequently humiliatingly forced to accept. The tactic employed in parts of the Greek press of portraying Angela Merkel in terms of a previous, less enlightened, German Chancellor clearly did not play well in Germany and hardened the resolve of the EU. The UK finds itself with similar difficulties: It cannot continue to ask for exemptions from the EU rules that everyone else has to abide by. At some point, someone is going to cry foul. 

3) Don’t paint your red lines too deeply 

One reason why Theresa May finds herself in her current position is that she set red lines on issues such as immigration, ECJ involvement and leaving the customs union without accounting for the consequences of her actions. As a result when faced with the draft Withdrawal Agreement, both Leavers and Remainers can rightly argue that she has not reached an agreement that anyone can sign up to because the PM has been forced to compromise so much. The Italians find themselves in a similar position today. Having refused to countenance any cuts to outlays, the European Commission instituted excessive deficit proceedings in an action that was totally avoidable. If nothing else, the EU is built on compromises and it is normally possible to find some form of accommodation – so long as you don’t paint yourself in a corner to start with. 

4) Don’t mess with the family 

It was (rightly) argued long before the Brexit referendum that the EU had no interest in giving a generous deal to the UK. Its primary interest was to defend the interests of its members and ensure that no country could leave on favourable terms in case others decided that they also wanted to depart. The EU27 have thus closed ranks and spoken with one voice regarding the terms on which the UK could leave. Like any family, the EU is quite capable of quarrels – even feuds – but when the chips are down it usually pulls together. Ironically, Britain has never really felt like one of the family. It was twice refused membership in the 1960s thanks to President de Gaulle’s view that the UK was a Trojan horse for US interests and would undermine the vision that many members shared for the EU. De Gaulle may not have been wholly right but he was not totally wrong either and sometimes the UK has felt more like a lodger than a full family member. 

5) Might is right 

It is unfortunately one of the rules of life that larger and more powerful nations dictate terms to the smaller ones.  This is not new: Larger tribes have been pushing the smaller ones around since ancient times, but at least the EU is underpinned by a series of rules that afford some rights to the smaller members. However, the Greeks learned to their cost in 2015 that it was impossible for a nation of 11 million people to go against an economic superpower of 314 million, particularly when their case is relatively weak. Greece reckoned that ultimately the EU would cave in and offer more favourable terms but the Germans, particularly Finance Minister Wolfgang Schäuble, were adamant that the only choice Greece faced was take the terms or leave. They took the terms! The Irish can tell a similar story about how they were forced to accept the terms of the EU bailout, which many claim even now was primarily designed to support the EU banking system rather than Ireland. So when the UK goes into the conference chamber as one government facing 27 others, with Germany and France arraigned on the other side of the table, you don’t have a strong negotiating position.

The UK, like Greece before it, has failed to understand the basis of its negotiating position vis-à-vis the EU which goes a long way towards explaining its current predicament. However, many of these pitfalls were avoidable and it speaks volumes that the British tried to placate domestic opinion rather than that of its EU negotiating partners. I would like to think that Polish and Hungarian officials have taken these lessons on board as they brace for heightened tensions with Brussels. But somehow I have my doubts.