No-one is above the law

Since early 2016 the well of public debate has become increasingly poisoned by rising levels of mendacity. It had been occurring before that, of course, but the Brexit referendum campaign brought out the worst in the political class with both sides – but especially the Leavers – making increasingly outrageous claims. One of the lasting consequences of the referendum is that public figures have realised that since there are no sanctions for lying in public debate, this tactic can be repeatedly applied. At some point, however, the lies begin to catch up with you. This week marked such a point with the government apparently intent on trashing its international reputation with its blatant willingness to break international law in order to secure the Brexit deal it wants. 

What happened? 

Earlier this week the UK government presented the Internal Market Bill (IMB) which, as a government minister admitted to parliament, would “break international law in a very specific and limited way.” That is a bit like saying a criminal charged with theft could claim that since they were not charged with murder, they breached only a limited part of the law in a specific way. The legal profession was quick to point out that the Attorney General’s defence of this action was “risible”. The shadow Attorney General noted: “The rule of law is not pick and mix, with acceptable laws chosen by the home secretary or an adviser in Number 10.” Such was the strength of feeling within the civil service that the head of the UK government’s legal department resigned. Clearly this action flies in the face of the image that the UK has tried to project for decades that it stands for the rule of law, and has prompted warnings from three former leaders of the Conservative Party that it threatens to undermine the UK’s standing on the world stage. So why has the government taken such a stance? 

What is the government trying to do? 

The government’s biggest concern is that the Withdrawal Agreement, drawn up by the UK and EU in October 2019 and passed into British law in January 2020, draws a border between Britain and the island of Ireland which runs down the middle of the Irish Sea. This has significant legal and economic consequences. One of those consequences is the treatment of state aid which underpins the enforcement of the European single market. In the Northern Ireland Protocol of the Withdrawal Agreement, Article 10 makes it very plain that “the provisions of Union law [relating to state aid rules] shall apply to the United Kingdom.” In other words, the limits on state aid which were in force when the UK was a member of the EU will also apply in the event that the Withdrawal Agreement comes into effect.

In the IMB legislation presented this week, the Bill states that “Regulations … may (among other things) make provisions – (a) about the interpretation of Article 10; (b) disapplying, or modifying the effect of Article 10”. Clause 45 of the IMB goes on to say the provisions in the bill “have effect notwithstanding any relevant international or domestic law with which they may be incompatible or inconsistent.” In other words the government has given itself carte blanche to take actions which are unlawful. This is not “a very specific and limited” breach of the law. The government intends to drive a coach and horses through it.

What is the point of such action? 

A number of well-placed sources have reported that the UK has taken specific exception to state aid rules because it wishes to provide support to the tech industry as the economy repositions for the digital age. Ironically, the UK has traditionally been opposed to state aid to support particular industries. According to the EU’s State Aid Scoreboard the UK share of state aid spending in 2018 was 0.34% of GDP versus an EU average of 0.76%. It could thus double its support and not be out of line with the rest of the EU. Without knowing exactly who in government is pushing the idea, we know that Dominic Cummings, Boris Johnson’s key adviser, is passionate about all things tech. According to Cummings: "Countries that were late to industrialisation were owned/coerced by those early (to it) ... The same will happen to countries without trillion dollar tech companies over the next 20 years." 

But the UK’s efforts to back industrial winners over the last 70 years have been abysmal. British Leyland, the former state-owned car giant, was a microcosm of all that was wrong with state-backed capitalism: Management which did not know how to manage organising a labour force which did not want to work to produce cars for a public which did not want to buy them. Previous efforts to back tech companies include ICL, formed in 1968 to create a British computer industry that could compete with major world manufacturers like IBM - an experience that did not end well. ICL was sold to Fujitsu in 1990. Nor did the Conservative government raise any eyebrows when ARM was sold to Softbank in 2016. In any case, for all the noises about generating tech titans to compete on the world market, the UK will not be able to develop one if it is unable to sell into the European market. And that is precisely what will happen if the current spat results in no trade deal between the UK and EU. 

Implications 

It is worth noting that the agreement which Theresa May’s government reached with the EU did not envisage a border in the middle of the Irish Sea. In her words to parliament, “no UK Prime Minister could ever agree to” such a plan. Her government therefore reached an agreement with the EU which created a UK-wide ‘single customs territory’, avoiding the need for customs checks between Great Britain and Northern Ireland although the province maintained regulatory alignment with the EU. But Northern Irish politicians objected because it would have introduced differences in regulation between Northern Ireland and the rest of the UK, even though a majority of the population were in favour. Hardline Brexiteers (including Johnson) objected because it would have meant the UK remaining in a customs territory with the EU, removing the UK’s ability to vary its tariffs. Therefore the plan which the Johnson government signed up to allowed the UK to vary tariffs but in return reintroduced the sea border. 

For anyone in government to argue that they did not understand the implications of the plan is disingenuous. This was a plan the Johnson government negotiated and signed up to in October 2019; sold to the electorate during the election campaign (“Our deal is the only one on the table. It is signed, sealed and ready”) and was passed by a majority of 331 to 231 in the House of Commons on 9 January. Johnson owns this – there is no getting away from that fact. So why undertake such a stupid act? 

Perhaps one of the objectives is to prompt the EU to walk away from negotiations, thereby delivering the no-deal Brexit which some in government appear to want. With the EU rather than the British government withdrawing, the government could then blame the adverse economic fallout on the EU. But the experienced EU negotiators are smarter than to fall for that trick and have instead called for the UK to withdraw its plans to override the Withdrawal Agreement by end-September or potentially face a legal challenge. The US has also applied pressure with Nancy Pelosi, speaker of the House of Representatives, warning that if “Brexit undermines the Good Friday accord, there will be absolutely no chance of a US-UK trade agreement passing the Congress.” The Johnson government is thus looking ever more diplomatically friendless. Going ahead with a policy which jeopardises a trade deal with both the EU and the US would be the height of stupidity.

As to how all this ends, the next few days will tell. The IMB may fail to pass the House of Commons if sufficient MPs rebel against the government. It may be blocked in the Lords where by convention manifesto commitments are not blocked (the Salisbury Convention), but a policy which contravenes promises made to the electorate is likely to promote significant resistance. It may even be passed into law! However, I maintain that there is still a Brexit deal to be done but the limits of what the EU will tolerate are being tested. Whatever happens, this is a government which is rapidly losing the trust of large parts of the electorate as well as unsettling the international diplomatic community. At a time when it is drawing up new measures to combat the spread of Covid-19, it would do well to remember that they will only be successful if people comply with the law. And as last year’s legal challenge made clear, even the government is not above the law.

Perfidious Albion

As the eighth round of post-January talks between the UK and EU gets underway this week, the newspapers are today abuzz with rumours that the British government is about to renege on the Northern Ireland protocol, signed alongside the EU Withdrawal Agreement only last year. Specifically, the FT reports that it plans to “‘eliminate the legal force of parts of the withdrawal agreement’ in areas including state aid and Northern Ireland customs.” Such a move would constitute a breach of international law and jeopardize any attempt to ensure a trade deal can be reached between the two sides before year-end. This would dramatically raise the risk of a no-deal Brexit on 31 December. Politically it is a big deal: It threatens to become a major economic issue.

Up to now I have taken the view that despite all the bluster, the UK will eventually sign a trade deal – however suboptimal compared to current arrangements – simply to allow Boris Johnson to say that the deal he promised has been achieved. However, the suggestion the government is prepared to renege on previous commitments implies that the risks to this view have taken a quantum leap higher. Recall that during the election campaign 10 months ago, Johnson promised that the deal was oven-ready. It turns out that it was merely half-baked.

What might the motivation be for taking such a stance? It could simply be a negotiating tactic: a mad dog strategy to convince the EU that the UK is crazy enough to do anything in order to force more concessions. Indeed I have learned to be wary of stories which the government plants in the press – even sources as reputable as the FT – because it has a habit of leaking stories to suit its own purposes. Or it could be that the UK really wants to avoid a hard border between Northern Ireland and the mainland, which as it currently stands would run through the Irish Sea (recall Johnson’s mid-August quote that “There will be no border down the Irish Sea – over my dead body”). The problem with this, of course, is that the alternative would be to impose a hard border between the Irish Republic and the North. Interestingly, although both the UK and EU are committed to upholding the 1998 Good Friday Agreement, the Agreement itself says very little about a physical border: The only place in which it alludes to infrastructure at the border is in the section on security (there should be a "removal of security installations").

Only this weekend Johnson sounded relaxed about the prospect of no-deal suggesting that it would be a “good outcome for the UK.” I hardly need repeat my long standing view that nothing could be further from the truth. All the economic evidence suggests otherwise (here and here for example). Nor does the electorate appear to buy into the idea with survey evidence continuing to show a lack of enthusiasm for Brexit, let alone the no-deal version that the government is edging towards (chart). This may in part be due to an erosion of trust in the government following a series of high profile missteps in the course of this year with latest polling data showing a sharp fall in the government’s approval rating.

However, this episode raises two major issues. On the domestic front, it is unclear in whose name a no-deal Brexit is being conducted. The Johnson government might believe that its whopping election victory last December gave it the green light to pursue the form of Brexit which its more hardline proponents have always advocated, involving independence at any price from the EU. That is a very risky calculation. The fact that many voters held their nose when voting for Johnson since the alternative was to vote for Jeremy Corbyn suggests that support for the government’s position may be less deep-rooted than supposed. Moreover, with the UK suffering the biggest contraction in Q2 GDP of all the world’s industrialised economies, it is evident that the economy faces significant economic headwinds. There may be some elements in government that believe they can hide the consequences of a hard Brexit behind the smokescreen of a Covid-induced recession but it would be a major political gamble to assume that the electorate will not see through the ruse.

The second issue is the international dimension of the government’s threat. Issuing threats to your main trading partner during the course of tense negotiations when they hold all the economic aces borders on lunacy. Michel Barnier has already expressed irritation that the UK has wasted time over the summer. In his words: “Too often this week it felt as if we were going backwards more than forwards … I simply do not understand why we are wasting valuable time.” The problem remains the same as ever: The UK simply does not understand (or refuses to do so) the EU’s position on the conditions for access to the single market. This is not to say the EU is blameless. The fact that it treats the UK differently to Canada in terms of access to the EU market is a genuine source of UK irritation. Nonetheless, with positions hardening in a number of EU capitals, the risk of miscalculation is mounting. If the EU simply refuses to budge – and it would have every right to do so, given that the UK is prepared to tear up agreements to which is a signatory – the prospect of a no-deal Brexit becomes more real.

In addition, as I have pointed out before, the tectonic plates of globalisation are shifting. The UK is not alone in wanting to follow a policy of economic nationalism and it does not have the clout on its own to secure the trade deals it wants with the partners of its choice. And even if it were, the latest threatened actions by the Johnson government do not paint it as a reliable partner in international agreements, which will raise the risk premium baked into sterling denominated assets.

What to make of it all? I am inclined to see the UK’s latest threat as an increasingly desperate negotiating ploy by a government which (a) does not have the experience to conduct complex trade negotiations and (b) is finding it far harder to deliver on its promises than it believed. You do not have to be a great poker player to realise that the UK has a weak hand and is bluffing. The EU knows it, but I am not sure that the UK knows that the EU knows. Whatever one’s views on Brexit, this is not the way to conduct trade negotiations and even if the UK does get some of what it wants, the Johnson government’s dwindling reserves of goodwill are almost exhausted. It does not pay to make enemies of your friends for in the words of country singer Merle Haggard, “Someday you're goin' to need your friends again.”

The pros and cons of returning to the office

Governments face one of their biggest economic dilemmas of recent times: How quickly should they withdraw the support provided to the economy during the Covid-19 crisis in order to minimise the hit to public finances, in the knowledge that this risks derailing the nascent recovery? However there are big question marks as to whether they should even be thinking on such lines in the current climate. Indeed, the French government last week launched a €100bn (4% of GDP) plan to boost investment in green energy and transport and support industrial innovation to help the economy recover from the recession. In recent days, governments in Austria, France and Germany have announced plans to extend their labour market support programmes to prevent a big rise in unemployment as activity levels prove insufficient to support pre-recession levels of employment.

It is against this backdrop that the start of the new school year in the UK has prompted a debate about how to get employees back to their workplaces after more than five months working from home (WFH) or on furlough. A month ago, a survey by Morgan Stanley suggested that UK workers were slower to return to their offices than in other European countries. According to the survey evidence, only 34% of white-collar employees had gone back to work compared to a European average of 68% (in France and Italy these figures were 83% and 76% respectively). More recent evidence suggests that British workers are now returning to the workplace, with the ONS reporting that 50% worked exclusively in the workplace in the last week of August compared with 30% in June.

Nonetheless, the data indicate that British workers lag behind their continental counterparts in this respect. Google mobility trends data (chart) bear out the view that between May and July fewer British workers had returned to their offices than in other European countries (the recent dips in Spain, Italy and France represent a holiday effect rather than a Covid-19 effect). This is sharply highlighted in the residential data where UK home footfall remains higher than elsewhere, implying a greater degree of home working.

The British government is currently advocating that workers return to their offices as it seeks to get the economy on a more solid footing. We should acknowledge that large numbers of workers were unable to work from home in the first place, with essential staff continuing to travel to their place of work throughout the pandemic. But of those who were able to work from home, the bigger question is whether they need to return to their offices. After all, many of us manage quite happily with an internet connection which allows us to do our jobs whilst remaining connected with the outside world. Whilst accepting that it is not to everyone’s taste, since a lot of people require the buzz of interaction with their colleagues, the idea that white collar workers need to be in the office to do their jobs is increasingly anachronistic. That said, there are positive externalities associated with workplace clustering so it is premature to conclude that office working is finished.

Consider the evidence

The demand by the head of the civil service that 80% of civil servants should be back at their desks at least once a week by the end of September needs a stronger economic rationalisation. According to Sir Mark Sedwill (who is technically the outgoing head, as he was effectively sacked by the government in June) “getting more people back into work in a Covid-secure way will improve the public services we deliver.” That is a bland statement which may or may not be true. But the limited evidence available on the benefits of WFH suggests that there are many upsides. 

A reputable study conducted on Chinese travel agency workers in 2014 and published in the Quarterly Journal of Economics (if Nick Bloom has his name attached to it, it’s worth taking seriously) found that “home working led to a 13% performance increase, of which 9% was from working more minutes per shift and 4% from more calls per minute. Home workers also reported improved work satisfaction, and their attrition rate halved.” The study went on to point out that: “The overall impact of WFH was striking. The firm improved total factor productivity by between 20% to 30% and saved about $2,000 a year per employee WFH. About two thirds of this improvement came from the reduction in office space and the rest from improved employee performance and reduced turnover.”

So why the rush to get people back to their offices? On the one hand, those businesses which depend on passing trade in crowded city centres are struggling. The proliferation of sandwich bars, coffee shops and pubs in our city centres rely on the lunchtime or evening crowd for their revenue and nobody wants to see our town centres becoming more hollowed out than they already are. But as Sarah O’Connor recently pointed out in the FT “Britain’s economic geography was under strain even before coronavirus. Good-quality jobs had grown ever more concentrated in London and a few other big cities like Manchester. That didn’t work for the rest of the country, and it didn’t work particularly well for the city dwellers either.” Her argument is that crowded city centres lead to spiralling accommodation costs, which is a particular problem for the low-paid, and those seeking to avoid them move further out and thus face long commutes on overcrowded (and expensive) public transport.

If we accept this view, one consequence of the pandemic will be to allow us to rethink the world of work and how we use our city centres. Assuming that at some point the social distancing measures are relaxed, businesses will need less expensive city centre real estate which will reduce costs. There will be losers, of course: property developers for one, and companies which rely on passing traffic for another. As noted above, however, this does not mean that there is no need for office working. Aside from the social aspects, office working does promote a greater delineation between work and leisure time; it allows the creation of more robust networks via face-to-face interaction; it creates a sense of belonging, which is important to company attempts to create a corporate culture, and it is a more efficient way of passing on experience as staff of different levels of seniority mix together. It is thus possible to imagine a world in which workers will be encouraged to spend some, if not all, of their working time in the office. The era of hot desking may be at hand (though not under current Covid restrictions).

Ultimately, how the world of work develops will depend on the needs of companies and their employees. It is possible to imagine a world in which the Covid crisis has accelerated a move away from the 9 to 5 drudgery although long-term predictions of working practices are fraught with uncertainty. Back in 1930, the economist John Maynard Keynes predicted that technological change and productivity improvements would eventually lead to a 15-hour workweek. Despite significant productivity gains over the past few decades, on average we work more than double (and in some cases treble) that. Nonetheless, if governments are so keen to allow market forces to operate, maybe they should let private sector companies figure out what works best for them and not impose 20^th century working practices on a 21^st century workforce.

A new monetary paradigm

Last week marked a big event in central banking history and economists will look back at Jay Powell’s speech on 27 August as the point at which the parameters of the three decade experiment with inflation targeting were changed. Central banks have tended to adopt a numerical target for inflation, usually centred around 2%, but in recent years inflation has undershot this target. A variety of reasons have been put forward for this. Many central bankers will argue that the adoption of inflation targeting was one of the factors which squeezed the high inflation of the 1970s and 1980s out of the economy. However, we can also add a number of exogenous factors such as the opening up of China as the workshop of the world, the end of the Cold War and more flexible labour markets.

Whatever the reason, there is a strong case for suggesting that the current regime which emerged in the wake of the high inflation of the 1970s and 1980s is no longer appropriate. For one thing, as currently practiced, inflation targeting contains an inbuilt asymmetry since central banks are more likely to react to inflation overshoots rather than undershoots for fear of being seen as soft on inflation, despite the fact that the target usually allows for some leeway around the central case. But we find ourselves today in an environment in which economies have taken the biggest hit in at least 90 years and inflation concerns are rapidly being put on the back burner as policy makers start to concern themselves with issues such as unemployment. Accordingly, the Fed announced last week that it will in future target maximum employment and “following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” In effect, it will adopt a medium-term price level target – something many economists have devoted time to thinking about over the past decade.

This has a number of important implications for monetary policy in future. For one thing it effectively means that the Fed will be less likely to pre-emptively tighten policy in response to a perceived inflation pickup after a period of below-target inflation. At a time when real economy concerns are paramount this makes a lot of sense. But questions arise as to what the Fed means by the two parts of the phrase “inflation moderately above 2 percent” and “for some time?” Much of the early discussion about price targets tended to focus on short-term deviations of inflation from the target. Thus if an exogenous shock results in inflation averaging 1% over a year, inflation can run at 3% the following year in order that it averages 2% over the whole period. But if inflation averages 1% over a 10-year period, this would require a 3% rate over the next ten years in order to get the long-run average inflation rate back to 2% (chart). In such a case is 3% “moderately above 2%?” And does a ten year period represent “some time” or does this represent a whole different paradigm?

As I argued in this post once we start to tolerate higher inflation the concept of price stability begins to become eroded. There is thus a concern that the price level targeting regime could result in inflation expectations becoming de-anchored. We might not worry about this any time soon but it is a discussion which will doubtless be taking place within the Fed. That said, at a time when government debt levels have gone through the roof in many countries, no government is going to complain about a little bit more inflation if it helps to alleviate the debt burden.

One of the less discussed aspects of the change was that on the rules versus discretion spectrum, which has been a feature of monetary policy over recent decades, the Fed’s policy announcement is very much a step in the direction of discretion. It ascribes a greater weight to “the shortfalls of employment from its maximum level” where the Fed freely admits that “the maximum level of employment is a broad-based and inclusive goal that is not directly measurable and changes over time.” Full employment has always been a nebulous target, but it is about to become even more so and runs the risk of being whatever the Fed believes it to be in order to satisfy its current policy stance. For markets which have become used to interpreting mechanistic rules, this implies a rather more opaque central bank than we have become used to. It also suggests an enhanced role for forward guidance which is likely to become even more important as a policy tool.

Another important aspect of the new policy is that the central bank will be even less concerned in future with trying to fine tune the economy via monetary policy, since shortfalls imply a persistent deviation from the nebulous concept of maximum employment whereas deviations imply cyclical divergences. Whilst the Fed’s moves make a lot of sense from an inflation perspective, it also fits with the new realities of the post-Covid economy in which central banks will have to play their part in dealing with the resulting economic scarring. By explicitly committing to keeping rates low(er) for longer, the Fed is perhaps taking the first steps along the path towards financial repression. 

However, it is important to be aware of some of the downsides. For one thing a policy of targeting price levels implies the potential for short-term inflation volatility if economic agents are not sufficiently forward looking and base their inflation expectations on extrapolation of current rates out into the future rather than the longer term goal of ensuring that price levels will eventually return to target. In addition, the standard objection in the literature is that there is likely to be greater output volatility under a price level targeting regime as the central bank does not attempt to moderate cyclical swings as frequently.

Nonetheless, it is likely that other central banks will eventually follow in the Fed’s footsteps and adopt a version of an average price level target with a focus on the real economy. However, it is unlikely to find much favour in the euro zone where the focus on short-term price stability remains paramount. But as Martin Sandbu points out in the FT the ECB has “treated its own legal mandate far too narrowly … There is a widespread misperception that the ECB is treaty-bound to the single duty of ensuring price stability … But beyond this, the ECB has a legal obligation to ‘support the [EU’s] general economic policies’” (a point I have made repeatedly in the case of the BoE). The ECB may not be a slave to monetary policy fashions but it is not the Bundesbank and has proved itself pretty flexible in its monetary dealings in the past. It just might take a while to get there.