Tactical genius or reckless gambler?

Many moons ago I did wonder whether Theresa May’s plans were an elaborate attempt to strangle Brexit or whether she had become a convert to the Brexit cause. I subsequently concluded that she was determined to deliver Brexit, irrespective of the cost to the economy. Over the last week, I have found myself revisiting the question once again. The PM has basically presented a plan which will put the UK at a significant disadvantage vis-à-vis the EU compared to its current position, with the only alternative being no deal. The “my way or the highway option” is really no option at all, which makes me wonder whether May is a strategic genius trying to manoeuvre the idea of a second referendum back onto the agenda or whether she really means it.

If MPs thought that these really are the only two choices on the table, they clearly have to accept the draft Withdrawal Agreement because the option of a no-deal Brexit is unthinkable. We have been told by Brexit supporters that because the economy remained afloat following the June 2016 referendum, despite suggestions to the contrary, that all will be well on 30 March 2019 even in the event of no deal. I do not share this optimism. The fact that the UK will no longer be a member of EU institutions such as the European Aviation Safety Agency, for example, means that aircraft parts or indeed whole aircraft made in the UK would not have legal clearance to fly in international airspace. Imagine for a minute what that means: Something like 750,000 people who travelled in and out of British airports on March 29 would be unable to do so on March 30. Around 6,660 tonnes of freight will also be grounded. Public frustrations that well up around holiday periods when flights are delayed will have nothing on this.

And that is just air travel. What about the ports? Some simple calculations suggest that 297 lorries arrive at the Port of Dover each hour. Let us assume that half of them travel from the UK to continental Europe and that WTO customs checks require them to be processed at a rate of one per minute. In other words, 60 per hour cross the Channel towards France rather than the current flow of 148. Assuming that each lorry is 15 metres long, within six hours the traffic jam will extend back 8km and it will take 9 hours for lorries joining the queue to get onboard a ferry. After 24 hours the tailback will extend for 32 km and it will take 36 hours to escape. After 3½ days the tailback will extend all the way to London (115km) and it will take more than five days to get across the Channel. Naturally, this is a stylised example but it serves to highlight that, given the extent to which the UK depends on free movement with the EU, even small obstacles can quickly gum up the works.

It is for this reason that economists fear a no-deal Brexit will have big effects on the economy. In practice we can only ever guess at the magnitudes, but some of the analysis I have conducted using a gravity model of trade suggests that losing easy access to the EU single market will incur a one-off reduction of 8% in exports and 5% for imports, implying a reduction of 1.5% in GDP relative to the case where access is maintained. Running the numbers through a structural macro model to assess the feedback effects on the domestic economy produces a loss of output equivalent to anywhere between 3% and 8% of baseline after a five-year period (chart). It might be possible to limit the decline in output to 3% of GDP if the BoE steps in with a huge liquidity injection. But if there is little to no additional monetary support in the event of a no-deal Brexit, as the BoE has recently hinted, I fear that the worst case outcome could materialise. Indeed, the threat to raise interest rates to counter an exchange rate-induced inflationary spike in the no-deal case strikes me as a hollow threat when the rest of the economy is likely to be in such dire straits.

To return to the political calculus, any MP who votes for a no-deal Brexit would have to be crazy given the economic risks. Equally, however, it is clear that the Withdrawal Agreement is such a sub-optimal piece of legislation that I can understand why MPs would want to vote it down. But a second referendum would also be such a hugely divisive tactic (as I pointed out here) that it is difficult to see how this resolves anything in the near-term. Consequently, I still favour an extension of the Article 50 period.  It has the advantage of postponing many of the hard choices (although not indefinitely) and would permit the government to continue testing public opinion.

Of course Theresa May does not publicly favour this option – as she said yesterday, “the British people want this settled.” But she has said many things over the course of the last two years from which she has been forced to backtrack. The Brexit debate is far from over. Like kabuki theatre, it just goes on and on.

Imagine they held a coup and nobody came

Four days ago, amidst much media ballyhoo, the European Research Group began a campaign to launch a motion of no-confidence in Prime Minister Theresa May. All they had to do was get 48 Conservative MPs to sign up and, hey presto, the easiest election call in history. At the time of writing, they hadn't managed to do it. The powerful right-wing backbenchers that the prime minister has spent the last two years trying to appease continue to look like the disenchanted malcontents that they really are. All mouth and no trousers, as they say.

They may get the requisite 48 signatures one of these days. But the fact that it is taking them so long to do so weakens their case to be speaking for a large element of the Conservative Party. And the longer this drags on, the weaker they look. In some ways, their fate is beginning to look like that of Islamic State, which was a formidable terrorist organisation that occupied territory held by sovereign governments before being gradually pushed out by the well-organised forces ranged against them. IS are still dangerous but they are a shadow of their former selves. Without wishing to accuse the ERG of terrorism, they have infiltrated large parts of the Conservative Party and have occupied the political agenda by winning the 2016 referendum. However, as the inconvenient economic facts close in on them, they are fighting a losing battle to stay relevant. They are losing ground, and they know it. Even Theresa May is not scared of them anymore. The ERG has lost its power to intimidate and the PM is prepared to battle on her terms. 

The ERG is losing because it has never accepted the reality of Brexit. Over recent weeks prominent Leave-supporting MPs have made some ridiculous statements which have undermined their credibility and do make you wonder whether they are looking at the issues in the same way as other rational people. Take, for example, former Brexit Secretary Dominic Raab’s comment that “I hadn’t understood the full extent of this but … we’re particularly reliant on the Dover-Calais crossing.” This is the port through which a lorry passes every 12 seconds of the day and through which 17% of UK merchandise trade flows. Or take Nadine Dorries’ comment that Theresa May’s deal with the EU gives us “No voice; no votes; no MEPs; no Commissioner.” Seriously? And just to prove that the inability to face up to reality knows no party bounds, when faced with a quote by EU President Juncker that the UK will not get a deal that is as advantageous as EU membership, Jeremy Corbyn responded “Well that was his view. We have a different one.” 

Brexiteers may have won the 2016 referendum but they never knew how to deliver Brexit. It is not as if they have not had plenty of opportunities: Two Brexit Secretaries and a Foreign Secretary, all with influence over the relationship with the EU and all have walked out. They will undoubtedly continue to intervene from the backbenches but they have four months to pull a non-existent rabbit from an invisible hat and nobody believes they can do it. 

This does not mean that the Withdrawal Agreement will necessarily pass through parliament. Too many people oppose it for different reasons. I am thus increasingly of the view that extending the Article 50 deadline is the best option and sure enough, Michel Barnier yesterday proposed extending Britain’s transition period out of the EU until end-2022. Naturally it will cost more – another €10bn is the figure being put about, which is broadly the same as the UK’s current net contribution. So that's OK then: Pay the same and have no say over the rules. 

What is particularly irritating is that it was so blindingly obvious that this was going to happen, yet politicians blindly led us to the edge of the cliff despite being told they were on the wrong track. We told you that the EU would extract a quid pro quo as the UK left. We told you that the UK would lose any say over the rules whilst still paying into the budget. And we warned you that it was virtually impossible to take back control in a globalised world. For those MPs who still think they can negotiate the impossible deal, I have a bridge to sell you.

DExEU's Midnight Runners

Today has been another one of the momentous days in British politics which appear to have become all too frequent as a result of Brexit. Yesterday’s cabinet meeting was an ominous sign that all that was not well: Whilst the Withdrawal Agreement is a large document, and was always going to take a long time to digest, it was evident that a five hour meeting hinted at major disagreements. And so it proved when Brexit Secretary Dominic Raab tendered his resignation this morning.

This comes just four months after the previous incumbent, David Davis, resigned when it became clear he could not support the Chequers Plan. To misquote Oscar Wilde, to lose one Brexit Secretary is unfortunate but to lose two is careless. To be charitable, the job of Brexit Secretary is a thankless task for a Leaver when the process is being controlled by the prime minister’s office. But it is also an indication of how difficult it is to deliver the kind of EU departure that would satisfy Brexit supporters. In addition to Raab and Davis, we should not forget that junior minister Steve Baker, another prominent Brexit supporter, also left DExEU in July to form the trio we should name DExEU’s Midnight Runners. As was the case in the wake of the referendum in summer 2016, it is another example of how Brexit supporters tend to run away from the mess they have created. And when they have been given ministerial responsibility, they have not exactly covered themselves in glory with Boris Johnson widely regarded as one of the worst Foreign Secretaries of all time.

But it is not just Brexiteers who object to the Withdrawal Agreement, as Theresa May’s session to parliament indicated this morning. Many MPs will vote against the EU agreement for a variety of reasons – perhaps because they are opposed to the terms of the deal, or simply because they oppose Brexit. Or, in the case of the opposition Labour Party, because the leadership sees this as an opportunity to force a general election. Despite the mounting opposition, Theresa May is doggedly determined to put the Withdrawal Agreement to parliament. And as I noted yesterday, it can still pass depending on the number of Conservative dissenters. But the risks are rising.

The first problem is the position of the prime minister herself. Jacob Rees-Mogg was the first MP to send a letter of no confidence in the PM to the backbench 1922 Committee and up to 12 others have confirmed they have followed suit. Recall that it will take 48 such letters to trigger a leadership contest. JRM has no chance of becoming leader himself and of the others known to have sent letters, the likes of Brexiteers Steve Baker, Nadine Dorries and Andrew Bridgen have as much chance of becoming PM as I do of winning the Nobel Prize for physics. Indeed, the latter two characters belong to the category of politician characterised by Irish journalist Fintan O’Toole as “the genuine hallmarked, unadulterated, slack-jawed, open-mouthed, village idiot variety.” As O’Toole pointed out “the Brexiteer MP Nadine Dorries admitted in effect that she didn’t know what a customs union is. Her comrade Andrew Bridgen said last month: ‘As an English person, I do have the right to go over to Ireland and I believe that I can ask for a passport. Can’t I?’” (Don’t believe it? Listen here.)

Whatever the PM’s personal position, we now have to reckon with the real possibility that the Withdrawal Agreement may not pass through parliament. What happens if it does not? The first recourse would be to go back to Brussels and secure a minor concession on the pretext of being able to put the bill before parliament for a second time. If that fails then Theresa May is in real trouble. The sensible strategy at that point would be to extend the duration of the Article 50 process, which is possible if there is unanimity on all sides. But May explicitly ruled out that option this morning (again).  So either she reneges on her commitment or is forced to resign whilst another Conservative prime minister is installed who is prepared to extend the Article 50 period. Politicians at this stage appear more likely to ask for an extension than push for a second referendum. In any case, given that time is short, it is likely that an extended Article 50 period is a prerequisite to enable a “people’s vote” because it almost certainly cannot now take place before 29 March 2019.

None of this will satisfy the “slack-jawed, open-mouthed, village idiot” brigade which believes that no deal is better than compromise. But they are losing ground in the war to deliver their form of Brexit. A poll conducted today by Sky News suggests that whilst only 14% of respondents support the prime minister’s deal, 54% would prefer no Brexit versus just 32% for a no deal outcome. We know how reliable polls can be, but this is not a one-off result. And whilst Theresa May gets a pretty low approval rating of just 31% in  terms of those most trusted to lead the country through the Brexit process, she still leads Jeremy Corbyn and is well ahead of Boris Johnson and JRM.

For politicians who set so much store by delivering the “will of the people” it seems that many of them have lost touch with it. The electorate is becoming fed up with the political posturing and any politician prepared to gamble with the country’s economic future ought to think twice, for the electorate may yet wreak its revenge.

Trying to seal the deal

It has been a rough ride and one which at times did not look like it would ever be achieved, but the UK and EU have finally agreed a draft divorce treaty which sets out the bare bones of what will happen on 29 March 2019 (all 585 pages of it here). Naturally, this is not the end game: An awful lot of effort has been expended just so the UK can get to the start line for the marathon talks with the EU that lie ahead. But at least the UK has been able to agree a relationship that does not imply a hard border in Ireland, thus satisfying one of the EU’s key requirements and offers a glimmer of hope that a hard Brexit can be avoided.

The draft agreement involves a UK-wide customs backstop, thus removing the need for a customs border within the UK – which is the approach I have advocated all along. However, the EU has insisted that Northern Ireland remains in a deeper customs and regulatory relationship with the EU, which has so angered the DUP.  It is hard to digest the full implications of the document, given its dense legal language, and undoubtedly more details will emerge. But at a first glance, the UK will not be able to unilaterally end the backstop arrangement with Northern Ireland – the EU has a veto. The document also states “the institutions, bodies, offices, and agencies of the Union shall in relation to the United Kingdom, and natural and legal persons residing or established in the territory of the United Kingdom, have the powers conferred upon them by Union law. In particular, the Court of Justice of the European Union shall have jurisdiction as provided for in the Treaties in this respect.” In other words, the UK has to play by the rules established by the ECJ. 

EU27 ministers are scheduled to meet next week and are unlikely to raise any serious objections. All being well, it is possible that the UK government and the EU27 will hold a summit on 25 November to ratify the agreement. And then the fun starts. Any deal has also to be ratified by the UK parliament and various politicians and media commentators have spent the last 24 hours telling us how difficult it will be to get this done. Indeed, Theresa May’s negotiation efforts continue to unite hard-core Leavers, who believe that the plan as currently envisaged will turn the UK into a “vassal state”, and Remainers who believe the deal is so much less favourable than current arrangements that the only way to proceed is via a second referendum (a “people’s vote”). 

Let’s start with the voting arithmetic to assess whether it can pass through parliament. By my reckoning, there are 638 MPs eligible to vote (650 MPs in total, less 7 Sinn Fein MPs who have not taken up their seats; the Speaker of the House and his three deputies, who by convention do not cast a vote, and one MP is suspended). This means ratification requires 320 votes. We know that anywhere between 40 and 80 Conservative MPs are likely to vote in principle against any agreement with the EU (let’s round that up to 100 to account for other malcontents). The Labour leadership will almost certainly try to use the Brexit vote as an attempt to force a general election, though not all will necessarily follow. Assume, therefore, that 200 of 257 Labour MPs vote against the deal. What about the rest? The 9 DUP members appear minded to vote against, as do 4 from Plaid Cymru. If the 12 Lib Dems and 35 Scottish Nationalists also withhold their support, it is dead in the water. Even if each of the 7 independents supports the government’s position, the plan would be defeated by 360 votes to 278. However, if the Conservative dissidents can be limited to 55 or less, the plan has a fighting chance.

A more pertinent question is why would anyone vote against the agreement? Obviously, up to 80 Conservatives are irredeemable hardliners who have no interest in reaching an accommodation with the EU. The DUP objects to the prospect of differing EU customs relationships for Northern Ireland and the rest of the UK. But what is in it for Labour? The party leadership clearly wants to put pressure on the government and force an election but a large bloc of Labour MPs oppose Brexit on principle and are thus unlikely to vote for a policy which entails leaving the EU, despite the fact that their leaders are pro-Brexit. Thus, MPs from the same party can be expected to vote against the government for different reasons but the end result is still the same. In a similar vein, the SNP and Lib Dems are also opposed to Brexit and will vote against legislation that enables it. But gambling on the prospect of a second referendum, in the event that the government’s efforts to find a compromise have failed, would be an exceptionally risky strategy. We simply do not know what will happen if the agreement is rejected in Westminster.

For all the sound and fury, I cannot envisage that the UK will be able to improve on the current deal. It is far from perfect: Financial services are clearly not going to get any preferential treatment which from a professional perspective is not good news. And as I have long pointed out, an arrangement in which the UK is a rule-taker is massively sub-optimal compared to the status quo. But it is perhaps the closest economic relationship that the UK can possibly achieve if it wants (foolishly) to curb the free movement of labour. Agreement is all about compromise – as the journalist Paul Waugh put it, this is the Rolling Stones solution (“you can’t always get what you want / but if you try sometimes / you might find you get what you need”). It remains to be seen how much compromising MPs are prepared to undertake.

More to the point, pro-Brexit supporters have never been honest with the electorate about the choices that leaving the EU entails. Jacob Rees-Mogg and his cronies simply cannot obtain a better deal than any compromise offered by the EU. Brexiteers claiming that the UK has capitulated to Brussels are, to be blunt, barking mad. I have more sympathy with hard-core Remainers but short of halting the Article 50 process, which will give the UK more breathing space to decide how it wants to proceed, voting down the compromise agreement risks a no-deal outcome. As the IMF pointed out today, a no-deal Brexit could be expected to cost around 6% of GDP in the long-term versus the no-Brexit baseline (figures which accord with my own simulation exercises).

Much as I do not want the UK to leave the EU, I fear the motives of those who would vote against the agreement even more. It would almost certainly spell the end of Theresa May’s career, and whilst many might say that is no bad thing, who in their right mind would want to take on the poisoned chalice that is the PM’s role? And if it leads to a new election, it is likely to result in another hung parliament as the electorate punishes those parties which used the Brexit process for their own political gain. There are bad deals and there are bad deals. If the UK really must leave the EU, then the terms set out today appear to be the least-worst option. As bad as the terms are, the alternatives are far worse.

Austerity matters

I happened to dip into a TV programme the other day that looked at the life of a school over the course of an academic year (here for anyone able to view it). Aside from shining a light on the increasing pressure which teachers face in the wake of significant social change, what was particularly striking was the financial burden under which schools are constrained to operate. It really highlighted the extent to which eight years of fiscal squeeze are now cutting into the bone of public services now that the fat and muscle have been stripped away.

One of the teachers expressed particular concern at the extent to which pastoral care has been hard hit. Pupils were reported to have demonstrated rising levels of misbehaviour and anxiety, and there is increasing concern that schools simply do not have the resources to cope with the stresses that these issues pose to the smooth running of the school. Since I was at school, more years ago than I am prepared to admit, the pressure on students to pass exams has increased exponentially and not surprisingly a much greater support network is required to help them cope. If it is not there, the well-being of the students is not being supported in the way that it once was with adverse consequences for performance.

As an aside, it is notable the extent to which performance is very much at the heart of the education system today. One teacher openly admitted that his prospects for a pay rise depend on generating a certain level of performance from pupils in their exams. This in turn creates a series of perverse incentives whereby certain pupils may be steered away from particular subjects for fear that their exam performance drags down the school average. Indeed, there are many stories of schools which refuse to teach certain subjects for fear that they will drag down the overall performance. This is particularly the case for subjects where the marking is subjective. One example is the teaching of literature, where the marking system is so variable across geographical locations that schools cannot be sure of the outcome.

But it is the cost squeeze on the education system that is the biggest problem. Despite claims in the budget two weeks  ago that the age of austerity is over, the Department of Education’s capital outlays will fall by 20% over the next two years though this offset by a rise in current spending. According to analysis by the Institute for Fiscal Studies whilst total spending per child is 42% higher than it was 20 years ago, much of the increase has been spent on the most severe cases. Almost half of the £8.6bn children’s services budget in England is now spent on 73,000 children in the care system, leaving the rest to cover another 11.7 million. Spending per head on the most vulnerable children is more than 100 times that spent on the rest. Small wonder that teachers in “normal” schools feel hard done by.

It is not just the education system that is struggling to keep its head above water. A report three weeks ago from the House of Commons Home Affairs Committee highlighted the strains on the police force as a result of a persistent budgetary squeeze. For example, the time taken to charge an offence rose by 25% between March 2016 and March 2018. The Committee concluded that the current system that determines police funding is “not fit for purpose” and requires radical reform, including reduction in the reliance on Council Tax receipts (a local property-based tax) and must recognise “the true cost of policing.”

A recent series of reports by the Times journalists Rachel Sylvester and Alice Thomson (summarised here) highlights the extent of the rise in poverty over recent years which has raised the numbers of working poor. When even The Times is pointing out the extent to which people trapped in the welfare system are being left behind, you know there is a problem. As Sylvester points out “the education system has made matters worse because the focus on test results has fuelled a rise in exclusions as schools ease out pupils who might bring down their league table rankings.” And as is now being recognised, one of the biggest problems with the current system is that Universal Credit, which is being patchily rolled out across the country, only pays out in arrears whereas previously applicants were entitled to benefits immediately. Consequently, those with little to no savings who are entitled to benefit (a large proportion of them), find that their problems are not over once they are accepted for Universal Credit.

Even though the government has promised that “austerity is finally coming to an end” it will take a long time to undo much of the damage caused by eight years of slashing the public sector. For one thing, the economy is growing more slowly than in the past – partly due to secular factors, which I will deal with another time, but in recent years as a consequence of Brexit-related uncertainty. Consequently, the government cannot simply turn on the spending taps. As a society, we need a proper debate about the levels of taxation required to fund the level of public services we demand. But Brexit itself has absorbed so much of the government’s own time and energy for the last two years – and is likely to continue to do so for some time to come – that it has taken its eye off the ball on social policy.

I do not wish to sound like a broken record on either fiscal policy or Brexit but they happen to be two important policy areas where the government has failed to cover itself in glory. As I pointed out in my previous post government efforts a century ago to slash the public sector exacerbated many of the economy’s underlying weaknesses. Given this historical lesson, the increasing headwinds now facing the economy suggest that a little bit less austerity would go a long way.