The Political Economy of Brexit; London Will Adapt.

Everyone is trying to second guess the negotiating strategy of Theresa May, and how the EU will respond. No country should be more concerned about this than Ireland, the only EU country to share a border with the UK. Next week, the Irish government will host an all Ireland civic dialogue.  Political economy considerations have never been more important.

In hindsight Brexit might be conceived as a long-term inevitability, which can be traced back to the structural fault-lines of EU enlargement, and the free movement of peoples into Europe’s largest ‘open’ labour market. Helen Thompson, a professor at Cambridge has suggested as such:

  1. The euro crisis politicized the city of London, which became the default offshore finance centre for euro clearing.
  2. EU enlargement, and then the euro crisis, turned Britain into Europe’s employer of last resort, turning it into an offshore labour market.
  3. This spurred and politicised a latent immigration concern within large swathes of public opinion, and the electorate.
  4. Very quickly, the euro crisis, and the response to it, not least the Fiscal Compact Treaty, exposed the future of Europe as a two tier Union: between the Euro area, and the rest of the EU.
  5. The balance of power (i.e. the rise of Germany) changed and weakened Britain, who were increasingly “outside” the EU process, despite being the employer of last resort for the euro area.

In terms of the political economy of Brexit, the biggest risks don’t really pertain to the city of London (who’s core priority will be to allow some sort of system for the free movement of workers within their sector). The city’s strengths, paradoxically, make it a source of weakness. The Conservative government are confident London’s financial service based economy will adapt. This is much less the case with medium-tech trade and manufacturing (think Nissan and car manufacturing).

For all sectors of Britain’s political economy, a Norway style deal is probably preferable (European Economic Area). Theresa May, and political elites, are not likely to push for this, as it implies complete free movement, and won’t wash electorally. However, Theresa May will want access to tariff free trade, primarily to ensure that the North of England is not badly effected, and that firms such as Nissan in Sunderland don’t pull out and move to Spain. Manufacturing has more to lose than Finance.

This implies that Theresa May will push for a customs union – tariff free – allowing imports for British based manufacturing supply chains. The question then is whether it is a customs union for everything? Theresa May could opt out of agriculture, and then use this as a bargaining card in negotiating other international trade deals, outside the EU.

The question of free movement will be determined by how Teresa May considers Ireland. If she gives priority to maintaining free movement within Ireland (north and south), which I think she will, then this implies there will be no visa controls at the British borders. Hence, it is probable that Theresa May will aim to get a series of sectoral deals – and allow for the free movement of people within sectors, particularly ICT and Finance. This is what ultimately matters for the city of London.

Those most affected within the City of London will be legal services. British lawyers, who predominately rent off the finance sector, will no longer have a hearing on mergers and acquisitions within EU law. But I can’t see Theresa May negotiating a strategy to ensure British lawyers have access to EU courts. What she will want to ensure, on behalf of business and finance elites, is that the city remains a magnet for high-skilled talent. This could be achieved with sectoral deals.

Britain’s main bargaining card is that their consumption-oriented economy, and open labour market, in addition to a high-tech cluster in London, has carried the employment burden of the Eurozone’s labour market woes, in addition to absorbing so much labour from central and eastern Europe. Germany has done little, if anything, to increase domestic demand, to compensate this. So it’s worth asking, absent the liberal-oriented British economy, where will unemployed EU workers go?

 

A dynamic model of financial balances for the United Kingdom

[Attention conservation notice: Rampant self-promotion]

Irish economy readers might be interested in this work. Together with colleagues at the Bank of England we’ve built a model of financial balances for the United Kingdom. The basic question we’re trying to answer is: how can large open economies deal with persistent imbalances now and into the future? This is the first model of its kind for the UK and something we hope to build on in the future. We summarise the findings in this Bank Underground blog.

 

Supply Curves Explained

Numberless ‘experts’ have misunderstood the government’s mortgage deposit subsidy. It’s all about the supply elasticity, as Michael Noonan helpfully explained to the Irish Examiner on Tuesday.

“The economists are saying we should have concentrated on the supply side. When there’s a demand for something, it leads to increased supply. If we can give deposits to people there will be an increased supply. The [building] industry will move to supply the extra demand.

To give you an example: When it was done previously, the first [car] scrappage scheme was introduced by Ruairi Quinn back in the 1990s. The theory then was the motor-car business was on the flat of its back — no cars being sold. So, with the scrappage scheme, people were given money and that money expressed itself in demand for new cars and a lot of new cars were sold. So, when there is demand backed by cash, supply responds and that’s the theory of it.”

So you whistle up some guy in Germany and he ships over 100,000 houses, at yesterday’s price.

Why didn’t I think of this ? Does Philip Lane read the Examiner?

The Nobel Factor

Tomorrow we will know the recipient of the Nobel Prize in Economics. This is not a ‘true’ Nobel, coming some 50 years after Alfred Nobel established the original prizes in physics, medicine, chemistry, literature, and peace. The Swedish Central Bank established the Prize in Economic Sciences in Memory of Alfred Nobel in the late 1960s as a way to counter what it saw as the virulent spread of social democracy across Nordic countries in particular.

The Nobel Factor, a new book by Avner Offer and Gabriel Söderberg, traces the development of the Nobel Prize in economics, which grants authority and ‘Nobel magic’ to economics above other social sciences, and ensures laureates are listened to on every subject. Economics itself is seen as being more scientific, more worthy of the ears of the powerful, as a result of the Nobel prize. The impact of neoclassical economics, the dominant form of economics which emphasises market based interactions above all others on policy makers through teaching and research, is assured because of the Nobel prize.

Offer and Söderberg begin their book with what may well be the best combined explanation, intellectual history, and critique of neoclassical economics and its policy variants I’ve ever read. From there we have a discussion of the social and economic context for the creation of the prize in economic sciences, and an extended discussion of the conflict between free market and social democratic values in the Nordic states in particular. There’s a really interesting series of chapters tracing the evolution of European politics and the individual awards and their subject areas. There’s a great chapter focusing on Assar Lindbeck, a forceful personality and someone who shaped the Prize. 

The story gets a little more complicated once the Prize itself evolves, because it’s not a simple case of rewarding only those who espouse ‘markets are great’ approaches, like Friedman and Hayek. For example in Chapter 7, we learn a lot about empiricists, experimentalists, econometricians and behaviouralists who won the Prize because of their rejection of equilibrium approaches to economics. In Chapter 10, the failure of economics to understand, model, or respond to the growing threats posed by unfettered global capital markets gets a very thorough treatment.

Overall I found the book riveting in that it is written in a deep and scholarly way. I buy the ‘Social Democracy vs Markets’ argument about the genesis of the economics Nobel in the 1960s, but I’m not sure the evolution of the Prize is as clear cut as it could be, after awards to people like Oliver Williamson and Lin Ostrom and Vernon Smith.

The book concludes on a hopeful note. The authors write on page 278:

“To recapture validity, economics has to come down to the ground of argument, evidence, and counterargument, supported by reason and an open mind. In the quest for valid knowledge, for those of Enlightenment disposition, it is well to ignore black boxes, the magic of prizes, and the lure of immutable laws”.

I couldn’t agree more. As intellectual, social, and political history, the Nobel Factor is well worth your time getting stuck into.

My wish for tomorrow’s Prize: Duncan Foley for his work on Public Goods and General Equilibrium, and Charles Manski for his work on just about everything else.

The box below should display the Nobel citation tomorrow around lunchtime.

Ireland ranks poorly in Western Europe in latest WEF competitiveness report

The World Economic Forum (WEF) have released their global competitiveness report. Ireland ranked 23rd, which was one of the lowest in Western Europe. Eleven other countries in Western Europe were ranked higher: Switzerland, Germany, Netherlands, Finland, Sweden, UK, Norway, Denmark, Belgium, France and Austria.

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Inadequate supply of infrastructure was identified as by far the biggest deficiency, and the most problematic factor for doing business. In light of the upcoming budget it’s probably worth noting that all European countries who scored better than Ireland have a higher tax to GDP ratio. Revenue as a percentage of national income is higher in all these countries, which can be probably be taken as a measure of state capacity.

The full report can be read here, and the full listings here.

League of Ireland in the Spotlight

League of Ireland soccer has been in the spotlight recently. Last week, Dundalk arguably achieved the finest result in the league’s near 100 year history, beating Maccabi Tel Aviv 1 – 0 in Group D of the Europa League. (A comparison of the potential financial return of this to date and that of success in domestic competition can be found here).

Moments after the full-time whistle RTE’s PrimeTime (coincidentally) broadcast an interesting report on changes to the structure of underage soccer in Ireland, and the possible implications this will have for both League of Ireland and schoolboy clubs.

International journal Soccer and Society in conjunction with Routledge/Taylor & Francis Online has also commenced publishing a special edition of the journal which focuses on the League of Ireland. The special edition addresses economic, historic and social aspects of the sport in Ireland. The collection of published papers to date can be accessed here .

What should Ireland be looking for?

It was very disturbing to read the following last week:

Agriculture Minister Michael Creed said Ireland will consider a special free trade zone with the UK if Brexit results in a complex UK split from the EU and the Single Market.

It would be legally and technically impossible for one bit of a customs union and Single Market to have such an arrangement with a third party. To achieve such an objective would require our leaving the EU.

And so I was pleased to read this morning that what the Government is actually going to look for is some sort of special status for the North so as to maintain free trade within the island no matter what the British decide. Presumably this would mean the North remaining within the EU’s customs union and/or Single Market, otherwise it won’t work. (Remember: if Britain leaves the EU’s Single Market and customs union without an interim free trade deal with the EU in place, WTO rules require tariffs on trade between Britain and the EU. This can’t be avoided. And that means tariffs on trade between the Republic and Britain. That can’t be avoided either.) I don’t know if such a thing is legally possible under EU law — though as I mentioned earlier the Kingdom of Denmark might offer a possible model — but it does seem like an option worth exploring.

Beware of weasel words however. Jeffrey Donaldson is quoted as saying that

“What we’re really looking for is a special deal for the island of Ireland which enables free movement of goods and people on the island, and preserves the institutions we’ve created under the various agreements,” Mr Donaldson said. “The people we’ll need to convince are the EU.”

Yes, keeping the North inside the EU Single Market or customs union would indeed require this being possible under EU legislation, and it would require both good will and a fair amount of technical work to make it work, if it is even a runner in the first place. (How on earth would agriculture be dealt with, for example?) But the real problem is likely to come from the UK. Mrs May’s speech over the weekend seemed to rule out a special status for Northern Ireland — I thought she was pretty explicit about this. And how would the DUP feel about the logical corollary of such a scheme, namely customs frontiers (and in all likelihood tariffs) between the island of Ireland and Britain?§ The people that we will need to convince, above all, are in London and Belfast. And let’s start by trying to convince them to remain in the customs union, at least as an interim measure, until a free trade deal can be sorted out.

(And let’s not forget: it’s London that is responsible for this mess in the first place. Why on earth did Donaldson’s party support them?)

§ Yes, a border with the Republic promises to be extremely costly for them, but I presume they also export a fair amount to Britain. One way or another, it looks as though they are in big trouble if London decides to leave the Single Market and customs union.

Three Monday Morning Brexit-Speech Thoughts

Three thoughts after reading the UK Prime Minister’s Brexit speech.

  1. This is the opening salvo of a negotiation. Everything needs to be understood (and therefore, deflated) in this context.
  2. In different places in the speech, Mrs May is talking about restricting immigration *and* having unrestricted free trade. This is a nonsense, and it won’t work. Her description of the process also completely underestimates the negotiating power of the EU. For example, Mrs May said she wants to give “British companies the maximum freedom to trade and operate in the single market”, but not at the expense of allowing free movement of workers for these companies or accepting the power of the European Court of Justice. Best of luck with that.
  3. Beyond rallying the troops a bit, and giving a timeline, there’s little in the speech for Ireland, news-wise, apart from what seems like a very firm decision to negotiate as a United Kingdom–meaning our friends up North and in Scotland are in a bit of trouble as there will likely be fewer border-related concessions for them in the context of a ‘hard’ Brexit.