July 14, 2016
Meet Her Majesty's Principal Secretary of State for Leaving the European Union
On day one for the new British prime minister, what interested us most of all was her appointment to the newly created Brexit ministry. The official job title is Secretary of State for Leaving the European Union. This position will be taken by the veteran Tory eurosceptic David Davis, who favours an extreme form of Brexit - one where Britain and the EU have a series of trade deals. Davis has actually set out in writing how he wants to proceed, and while we think this is utterly bonkers, we are at least glad to see that somebody has actually put together what appears to be a strategy.
The strategy consists of two planks, the first is to spend a few months fleshing out the negotiating strategy in some detail, and to trigger Article 50 only after consulting with the Scots in particular, but no later than Christmas. The second plank is to immediately start negotiations on bilateral trade agreements with third countries. He notes that Korea managed to get a trade deal negotiated in less than twelve months, and says it is much easier for countries to do this than for trading blocks like the EU. This is what he had to say on single market access.
"The ideal outcome, (and in my view the most likely, after a lot of wrangling) is continued tariff-free access. Once the European nations realise that we are not going to budge on control of our borders, they will want to talk, in their own interest. There may be some complexities about rules of origin and narrowly-based regulatory compliance for exports into the EU, but that is all manageable. But what if it they are irrational, as so many Remain-supporting commentators asserted they would be in the run up to the referendum?"
Then he answers the hypothetical question if these alien Europeans are not rational. Here is the answer of what he will do:
"In that eventuality, people seem to forget that the British government will be in receipt of over £2 billion of levies on EU cars alone. There is nothing to stop us supporting our indigenous car industry to make it more competitive if we so chose. WTO rules would not allow us to explicitly offset the levies charged, but we could do a great deal to support the industry if we wanted to. Research support, investment tax breaks, lower vehicle taxes – there are a whole range of possibilities to protect the industry, and if need be, the consumer. Such a package would naturally be designed to favour British consumers and British industry. Which of course is another reason that the EU will not force this outcome, particularly if we publicise it heavily in a pre-negotiation White Paper."
So to be clear, he is not seeking WTO access on exit - but a series of bilateral trade deals, and he is willing to jump out of the EU without an agreement. In other words, Britain's negotiating position will be: we will toughen this out. It is in your interest to trade with us just as it is in our interest to trade with you.
In her inaugural address, May restated her commitment to take Britain out of the EU, but this will prove to be an administratively more formidable task than Davis suggested. Alan Beattie offers a very useful article highlighting the technical obstacles that lie ahead for the UK before it can negotiate trade agreements with the EU and third countries. The first obstacle is that the UK will need to negotiate a separate WTO membership, which will take several years, given the need for all WTO member states to agree. The shortest way would be for the UK to copy and paste the EU's existing schedules. This will be easier done for traded goods than for services or agricultural products. While the various schedules are being negotiated and agreed, the UK's legal status as a trading nation will be undetermined. Even if the politics is positive, the process will still take many years to complete.
This accords with our own view that Davis' strategy is unrealistic, and that the UK will need to negotiate a transitional EEA-type agreement with the EU during which its WTO status and a bilateral FTA with the EU as a whole are negotiated. We would assume that this status would last for at least four years, possibly longer. We will not see full Brexit until the latter part of the next parliament - though legally Britain's EU status will cease at the end of the two-year period after Article 50 is triggered.
Of the other appointments made by Theresa May, the most surprising one was Boris Johnson to the job of foreign secretary, and Liam Fox to the role of international trade secretary. Both will also directly and indirectly be involved in the Brexit process - Fox will oversee the third-country trade negotiations. Johnson, Davis and Fox are all eurosceptics. We assume that Johnson must be glad that he does not have to spend his time talking tariffs with Jean-Claude Juncker. Philip Hammond, the former foreign secretary, is the new chancellor. And George Osborne is out.
In her inaugural address, May positioned herself as a prime minister of the centre. In this sense, the comparison with Angela Merkel is justified. In her rather impressive inaugural speech she said that she will stand for social justice, and an end to inequality and privilege. She praised David Cameron for moving the Tory party to the centre ground of politics, but she left no doubt that she intends to go much further in that direction. Now that the centre-right of the Labour Party has essentially disappeared from the political scene following what looks like a failed coup attempt against Jeremy Corbyn, there is a giant space for centrist policies, that May intends to fill. The appointment of Davies shows that May will be tough on Brexit, but soft on social and economic policies. An intriguing new mix. The chances of our favoured Norway option have faded significantly.
Another reason for that is the desolate state of the Labour Party. The Labour leadership contest saw another candidate entering the fray: Owen Smith, a former shadow cabinet member on the left of the party. He entered the fray safe in the knowledge that Andrea Eagle, who is on the right of the party, has no chance in winning the contest against Jeremy Corbyn. As leader, Corbyn has managed to get on the ballot automatically. The widespread expectation is that Corbyn will win the vote. The Blairites are furious. David Aaronovitch writes in the Times that, with Corbyn, there is no chance Labour will ever get back to power. What surprises us, however, is how well the Labour Party is holding up in the polls despite this existential crisis. Under Corbyn it is doing a lot better than the SPD in Germany. And there may be another lesson from Germany. If the main centre-right party is centrist, the centre-left party cannot also be centrist. While Corbyn is deeply unpopular, we doubt very much that Labour can get more votes if it shifts back to the right.
Our twitter feed is still full of bitter Remainers who just can't get over the fact that they lost - clinging to the hope that some miracle might undo the whole thing. Quite a few of them are economists. Tim Harford has a thoughtful article about the economics profession, and finds that its representatives have fallen prey to the common error of mixing up what they want to happen with what they expect to happen. This is also known as confirmation bias. As an example he lists the betting markets, which had Remain ahead even in the weeks when Leave was leading in the polls. What's more, there is no sign of an end to confirmation bias. Remainers now see the catastrophe they predicted, while Leave voters are either more optimistic about the economy or ready to blame Remainers for talking down the country. Both sides easily dismiss evidence contrary to their existing views.
And, finally, we noted an article in Frankfurter Allgemeine according to which 600,000 Brits were planning to leave the UK for another EU country, and up to 10m are at least open to the idea. This information is based on a poll. Another example of the facts of Brexit being created on the ground.
We think Davies is either delusional or still in campaign mode. There will be no talks with the EU before he triggers Art 50, and he won't be able to conclude bilateral trade deals outside the framework of the WTO. These are not details. We suppose that the Sir Humphreys will fine-tune this strategy to the extent that not much of it will see the light of day. If not, there is a real potential for a violent rupture.