Monday, 31 July 2017

The cost of Brexit

How much will Brexit cost?

The impact of "Hard" Brexit (falling back on WTO rules) was subject to a number of analyses during the Referendum campaign, all predicting a loss to GDP by 2030, e.g. : -6% (HM Treasury); -3.5% (PWC for CBI); -2.2% (Open Europe). George Osborne (former chancellor) has been subsequently widely discredited for the Treasury's overly pessimistic assumptions.

The theory is that a higher volume of trade translates to greater economic efficiency and higher growth. Leaving the EU will bring additional frictional costs to trade, which will tend to reduce the volume of trade and hence reduce economic growth.
  • As Andrew Lilico has noted, the EU Commission's own estimate is that the Single Market has added just 2% GDP on average across EU member states and the UK's gains are probably less than average at around 1%. Nor will leaving the Single Market automatically mean losing these gains.
  • Open Europe have modelled the impact of leaving the Customs Union as resulting in 1-1.2% GDP loss. Most of this impact arises from Rules of Origin cost assumed as 4% of transaction values. Reintroduction of customs controls & declarations will also contribute to increased cost of trade.
  • A "hard" Brexit would also mean an imposition of tariffs. Most tariffs are relatively low and similar cost to Rules of Origin - so in many cases traders will simply opt to pay the tariff. The sectors most impacted will be agriculture (typical tariffs of 40% or more) and finished cars (tariffs of 10%).
Many Remain supporters argue that we simply cannot afford any frictional cost to trade with our largest partner. But a counter argument exists.
    Trade may be simply diverted, either via new trade agreements with third countries or by repatriating supply chains to the UK. The UK car industry has been increasing the percentage of components sourced from the UK since before the EU Referendum. The forecasts for "hard Brexit" tend to be pessimistic about an independent UK's trade prospects.
    The EU does not constitute an open and fair  market. German manufacturing is bolstered by an undervalued currency (the Euro vs the old Deutschmark) and often sets the rules to its own advantage (e.g. Diesel emissions; James Dyson's experience with vacuum cleaner regulations etc). Germany and France seem able to bend the EU's state aid rules, whereas Britain has very little joy with the ECJ. The EU's agriculture policy is famously geared towards French and other continental countries farming industry, to the detriment of Britain's smaller but more efficient farming industry. Britain's key strength is services - but the EU has made little progress in liberalising this sector. Consequently, Britain has an enduring and widening trade deficit with the EU.
    We abandoned our largest trading partner (the Commonwealth) when we joined the EEC in 1973. Trade with the EEC was then less than 20% of our overall exports. Exports to the EU peaked at 60% in 2000, but has been declining ever since, and is currently 40% of all exports (after allowing for Rotterdam, Antwerp & Dublin effects). Even before the Referendum, UK trade has been pivoting towards global markets and away from the EU.
To put these figures into context:
  • Total UK GDP is ~£2tn, UK's annual £10bn net contribution to EU is ~0.5% GDP.
  • The "Brexit bill" the EU want to charge Britain with is alleged to be €100bn / £85bn, i.e. over 4% of GDP.
Freedom of Movement has resulted in 3 million EU citizens in the UK versus 1.2 million UK citizens in the EU - with an associated fiscal imbalance (see link):
  • Many of the British emigrants to Europe, especially Ireland, Italy, Germany, Cyprus, France and Spain, are self-sufficient retirees. In 2013/14 the UK spent £1.4 billion on state pension payments to recipients living elsewhere in the European Union.
  • In 2013/14 the UK paid £580 million to other EEA countries for the treatment of British pensioners in the EEA while it received just £12 million from other EEA countries for the treatment of EEA pensioners in the UK.
  • Figures for benefits claimed by EU migrants are hard to come by. Research by Migration Watch suggest EU migrants tend to have higher claim levels for housing benefits, tax credits and child benefits, but lower levels for unemployment and sickness benefits, compared with UK citizens. The UK Government spent £140bn on benefits (excluding pensions) in 2015 - a substantial amount of which will have gone to the 3 million EU migrants who form about 4.5% of the UK population.
It is hardly an understatement to state there has been a continual attempt to overstate the economic cost associated with leaving the EU. George Osborne's Treasury forecast of 6% loss of GDP is excessively pessimistic, especially considering UK exports to the EU only account for just over 9% of GDP. The more balanced estimates of GDP impact from PWC and Open Europe are actually less than the Brexit bill the EU propose to charge Britain. Moreover, these forecasts suggest only a diminished rate of growth - not  recession or depression. There are also potential fiscal gains from being free of UK contributions to the EU and benefits payments to EU migrants.

This is obviously a simplistic analysis. Many will complain that non-tariff barriers may have a devastating impact, although I've looked at these in detail and it seems to me that these concerns are also being overplayed. This scenario assumes the EU would effectively declare a trade war, which at the same time would damage their own traders and economy, as well as damaging their international reputation.

But nonetheless, a "big picture" or "bottom line" view of Brexit like this is useful for perspective. Brexit, even on the basis of worst-case “hard Brexit” forecasts, is not the apocalypse. Pivoting to a global trading when free from EU control both mitigates the impact on EU trade and is an entirely necessary process, given the pre-existing trend of UK trade and the fact that 90% of global growth in coming decades will be outside the EU (as the EU commission itself admits).

Friday, 28 July 2017

Beware the Remain long game

I've heard a number of Leave voters asking why a transition period is necessary. Well, when Remain campaigners said Britain is still a sovereign and independent country and Nick Clegg dubiously claimed that only 7% of UK law was EU in origin - they were wrong. Disentangling from the EU is complex precisely because so much governance has been ceded to Brussels.

Businesses (on both sides of the Channel) will need to prepare for Brexit. Leaving the Customs Union will mean customs declarations and additional administrative burdens for exports & imports. Leaving the Single Market will require use of an importer (or suitably qualified responsible person for some sectors). As Michel Barnier has said, Businesses should use the Article 50 period up until March 2019 as their transition period.

But the additional burden on customs authorities and ports, requires new IT systems, technology and infrastructure investment and may need more time to implement. EU Regulatory agencies, systems and agreements will be lost. Leaving the EU also means leaving the Euratom treaty which currently governs plutonium for power stations, isotopes for medical devices and so forth. The EU Open Skies agreement is crucial to our aviation industry and aviation safety is governed by the European Aviation Safety Agency (EASA). There are a myriad of arrangements to be replaced.

 In fact, the Prime Ministers Lancaster House speech in January this year made clear the need for a "phased process of implementation" - transition by another name.

The reason why many Leave voters question the need for transition is because they sense that delays to Brexit may be used to eventually reverse or abort Brexit. Unfortunately, Remain supporters are only too eager to seize such an opportunity. Ian Dunt, possibly the most miserablist anti-Brexit voice, made this clear in an article of his:
Earlier this week, Wolfgang Munchau wrote in the FT suggesting hard-core EU supporters would be best served arguing for a lengthy transition.
Munchau's description of an association agreement as a model for EU's relationship for peripheral european countries is a familiar one. Many such ideas have been proposed since the Euro crisis begain in 2009. Lord David Owen published a book on EU reform of ("Europe Restructured") this nature. It can sound seductively attractive - the idea of a core of European nations pushing on with political integration while other nations have a looser relationship based on trade and security co-operation.

Two arch-federalists, Guy Verhofstadt and Andrew Duff, have proposed a new form of EU membership termed "associate membership". A draft of the next proposed EU treaty includes the idea of associate membership. Unfortunately, they describe associate membership as a parking space for those countries not yet ready for full integration. Notably, Lord Owen supported Leave in the EU Referendum because he concluded that Brussels were hell-bent on integration at any price - there is no prospect of reform.

It should also be noted that the EU intends that associate membership should replace the EEA agreement in time. The EU can quit the EEA agreement with 1 year's notice, offering associate membership as the replacement arrangement to the EFTA states. The idea of EFTA EEA as a safe haven from the ratchet of EU political integration ratchet simply does not stack up.

So while I believe there are pragmatic reasons for a transition or phased implementation, there are key conditions that must apply. It must be strictly time limited, probably to a maximum of 3 years. EFTA EEA membership is not suitable for such a short-term arrangement. Instead, elements of current EU membership should be phased out over the transition period. The destination (a CETA+ FTA) must be described in sufficient outline within the Article 50 exit agreement before transition commences.

Remain are clearly playing a long game: delaying tactics,  pronouncements that Brexit is all too complex, eventually engineer EU associate membership. It seems that the EU are also playing the same game - delaying any discussion of future relationship, threats to stall the talks and so on. To counter this, the UK Government must stick to the approach laid out in the Lancaster House speech. Which includes saying No if the EU insist on playing the long game.

Wednesday, 26 July 2017

EFTA EEA is a destination, not a transition

Is EFTA EEA suitable as an interim of transitional solution ?

The idea of using EFTA EEA as a post-Brexit transitional or interim arrangement pre-supposes we can seamlessly leave the EU and adopt EFTA EEA membership to retain Single Market membership.

During the EU Referendum campaign, I believed the UK could simply reverse the process followed when Austria, Sweden and Finland switched from EFTA EEA membership to EU membership in 1995 - seamlessly maintaining their single market membership. The EEA agreement was not even amended to reflect their change of status until 2003.

Unfortunately, it seems this view is wrong.

1) The UK is a party to the EEA agreement by virtue of its EU membership. When the UK leaves the EU it will lose access to all third party trade agreements negotiated by the EU - including the EEA agreement. This is the position taken on legal advice by the UK government as well as by the EU. The UK would have to apply to rejoin EFTA EEA.

2) Some had argued that the "velvet divorce" of Czechoslovakia provides grounds for "presumption of continuity" for the UK to retain access to the EU's third country trade agreements, quoting the Vienna Convention on Succession of States. As much as we may think of the EU as being a super-state, it is not yet recognoised as such in international law. Britain is leaving a Customs Union - we will not be a successor state, the velvet divorce precedent does not apply.

3) When Austria, Sweden and Finland switched from EFTA EEA to EU membership, it was their EU accession treaty which confirmed the change of status, including how their payments and other obligations would change as a result. These accession treaties required a unanimous ratification process.

4) The EU has made clear that the UK is unable to negotiate with any third parties until the Article 50 process has completed. So EFTA membership, which requires unanimous agreement of all EFTA states, cannot be agreed during Article 50.

5) Similarly, the EU has stated that a future UK-EU trading relationship cannot be agreed during Article 50 - be it EEA or bespoke FTA.

6) Re-joining EEA will require a unanimous ratification process because it covers areas not deemed exclusive competence of the EU - leading to the the possibility of a Wallonia veto (as happened with ratification of CETA). This is not a quick process.

Some argue that the EU could be more flexible in allowing the UK to join EFTA EEA, waiving the restrictions of Article 50 and requirement for unanimous ratification. But the EU is characteristically legalistic, regularly proclaims how it is a rules-based organisation and would surely be reluctant to set a precedent for Britain. The EU did boast of breaking its treaties when the Euro crisis first unfolded, so it will break its own rules when it is an urgent matter of self-preservation. Accommodating a British entry into EFTA EEA during Article 50 would either suggest the EU's hand is a lot weaker than they claim - or I'd be very suspicious as to their motives.

But dont just take my word for it. Peter North, (the junior member of the Flexcit family business), now recognises this reality and confirms what I had concluded last autumn:

Ironically, Flexcit's initial proposition back in 2014 was that the 2 year deadline of Article 50 meant that an off-the-shelf interim solution was needed - namely EFTA EEA. Now we have team Flexcit arguing we need 5 years to join EFTA EEA - suggesting we will need the EU to grant the UK a transitional period (by essentially extending current membership of the Single Market and potentially customs union) before we can even get to EFTA EEA.

This all confirms what a lot of people have said for a long time (and I took a while to see) - those proposing an EFTA EEA solution are proposing it as a destination - not an interim or transition.

Tuesday, 25 July 2017

The EU has always been about Political Union

I saw a tweet today which revisited an old familiar theme. The claim that we have been lied to for decades by our politicians that the aim of the EU was always ever closer union - leading to a political union and a single European state.

A Remain supporting EU-phile shot back with a Daily Mail editorial from the 1970's. Her point being it was crystal clear what the intent of the then EEC was.

It is true to say that the aim of the EEC/EU was always ever-closer union. It is in the text of the 1957 Treaty of Rome that founded the EEC. A study of the "Father of Europe" Jean Monnet will also fully illuminate this intent. The "economic" case for EEC/EU was always a cover for the real intent of full political union.

It is also undeniable that UK politicians have always sought to deny this - to hide an uncomfortable truth from the British public. On our succession to the EEC in 1973, Prime Minister Edward Heath sought to reassure the British public by denying we would sacrifice independence & sovereignty. In 2016, we had Prime Minister David Cameron stating that we wanted to avoid ever closer political union. Cameron's "piece of paper" he brought back from Brussels with its claimed opt-out from ever closer union was widely ridiculed. The experience of 40+ years meant this empty reassurance rang hollow.

You can argue that the British public in the 1970's should have known the true intent of the EEC. There were enough clues around. But the fact is, most people saw it as most of the politicians sold it - it was an economic project, not a political one. The British public did not willing and knowingly consent to political union.

Had our politicians in the 1960's and 1970's been more honest with the public and sold the dream of ever-closer union, the history of the last 40+ years would have been very different. Either Britain would have gone into the EEC with its eyes wide open or more likely the British would have rejected the idea of sacrificing independence and sovereignty. Either way, decades of argument with Europe would have been avoided. Roy Jenkins got this right in 1999:

Finally, there is a key passage in that 1975 Daily Mail editorial which we should pay attention to. "Political Union will not come until we - and the French and the Germans - are ready for it." A study of UK politics of the last 40+ years tells you we have never been ready for political union. The EU Referendum confirmed that we are not ready now. The EU is ready for political union and will press on regardless. This more than anything else should tell us that a parting of the ways is inevitable and is best for both parties. The option of returning to an ambivalent, half-hearted membership of the EU is gone. The status quo ante no longer exists. It really is time to move on and embrace our independent future.