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December 19, 2016

Inside the customs union, outside the single market

Looking at it dispassionately it appears to us that - even six months after the UK referendum - the two sides still pretend as though they are campaigning. We presume that the long wait until the trigger of Article 50 is making people nervous on both sides. But in reality some of the fog is lifting. The UK is now seeking a transitional agreement. And over the weekend some of the contours of that agreement have become visible. Liam Fox, the international trade secretary, said it would involve continued membership of the customs union (which is not the same as membership of the single market). During that period of unknown duration, the UK and the EU would hope to negotiate a free trade agreement. Fox was looking at the EU/Turkey trade agreement as a model for the transitional period. That agreement theoretically allows Turkey to strike third-country trade agreements, but in practice the EU has the right to annul them. We would assume that Britain would be negotiating FTA's during the period of the transitional period, for implementation at the end of it. 

Membership of the customs union without membership of the single market makes sense as a transitional agreement, as it would give everybody a bit more time to prepare. Manufacturing companies in particular cannot plan on a shorter notice. 

While the contours of such a sequence appear logical, the devil is in the details, and the process could still come unstuck. The FT reports this morning that the EU will insist on settling the terms of the divorce before agreeing any transitional agreements. There is, of course, the issue of what newspapers call the divorce bill. There is an unofficial number of €60bn, and the Daily Telegraph has identified the "monster hardliner" close to the Commission president - no prizes for guessing who - wanting to sabotage the entire Brexit process. 

But sequencing is an issue, and it is possible that the negotiations may get stuck at some point. Simon Nixon makes the following observation in the Wall Street Journal this morning.

"The U.K. government therefore faces a paradox: Its threat to walk away from an Article 50 divorce is only credible if it starts preparing for the hardest of Brexits—and, in doing so, incurs the very costs it is trying to avoid. Yet if it can’t credibly make this threat, its leverage is minimal. Resolving this paradox will be a formidable test of Mrs. May’s negotiating skills and political leadership."

But what about the other side? Do we really think that the EU wants to pursue a hard Brexit without a deal if the risk is that the UK would deport over a million citizens from eastern Europe - almost 1m from Poland alone - most of whom would presumably go to Germany? There were already reports of the UK blocking progress in the international fight against tax evasion at the G20 level. Neither the UK nor the EU can really afford a hard Brexit, and we think it is pretty pointless to estimate who can afford it less. If, say, Michel Barnier thinks he has the stronger negotiating position, and lets the process drive to a wall, just wait from the reaction from Germany as we approach B-day. It is far easier for a single government to maintain unity, than for the EU-27.

Chris Giles has an excellent analysis in the FT, in which he looks at the economic impact of both tariff and non-tariff barriers, and concludes that it may not be all that large. The tariff barriers are on average only 2.3% - though with significant variations. Non-tariff barriers are more important. But he qualifies even that statement. When the UK leaves the EU, the products will still have have the Conformité Européenne attached to them. And 80% of the standards are voluntary. What the UK, however, cannot do is enter into a trade agreement with the US and recognise US regulation as compliant while remaining in the customs union. We agree with Giles' conclusion that 

"there is no obvious solution that satisfies all the UK’s goals of simple and cheap regulations, easy trading relationships with the EU, deals with non-EU countries and full sovereignty over regulations."

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December 19, 2016

Back to the future in Italy

There are few countries in the world where grown-ups have a tendency to talk about the pros and cons of electoral systems as much as Italy. The country has been through pretty much every system, from totally proportional to first-past-the-post, and back again. It is the sign of a confused mind to always reiterate the same arguments, and this is what is happening right now. Matteo Renzi wants the country to go back to an electoral law known as the Mattarellum, named after the current president Sergio Mattarella who proposed a new electoral law in the early 1990s. Two governments of Silvio Berlusconi and one administration of Romano Prodi were elected under this law. It is a mixed system - predominantly first past the post, with a proportional element. But, as Corriere della Sera points out, it is not easy to get back to this old law, as it worked at a time when Italian politics was bipolar which is no longer the case.

Renzi addressed a party congress yesterday, trying to rally the troops and prepare the party for new elections at some point between April and June, based on the Mattarellum. Stefano Folli notes in his comment in La Repubblica that Renzi is once again going for the maximum risk. He didn't even bother to take the time to analyse in detail what really happened on December 4 when he lost the referendum. Folli is sceptical that this is a wise course of action. He writes that Renzi has a rather superficial understanding of the No vote, blaming the loss on a failure to communicate effectively, and especially a failure to use the internet properly. He writes there is a bit more to Renzi's analysis, but not a lot. What happened on December 4 is that Italy went in one direction while the leader went in another. Renzi looks like the politicians caricatured by Berthold Brecht, who want to change the people.

We agree with Folli's scepticism about Renzi. The Italians have rejected their leader, and doubling down is about the worse thing he can do right now. His party would be well advised to select another leader before the vote. We know that a new electoral law has become necessary after the referendum result, and we see benefits in a harmonised system for the chamber and the Senate. But since a new system has just been introduced for the chamber, it would be easiest to extend this to the Senate rather than going back to a completely different system on the grounds that one political party sees a potential advantage (the history of gerrymandering in Italy is not very encouraging for those who do it).

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December 19, 2016

The lessons from Fillon's first gaffe

Eric Le Boucher drew three lessons from the U-turn by François Fillon over his health reform. The first is that, while those who voted for Fillon may want to see radical reforms, nobody wants to pay for them. They all see themselves as the beneficiaries of those reforms, leaving the bill to others. Once a reform becomes concrete, so does the opposition to it. The health reform is just the first example. One may have concluded that by choosing Fillon, the French are in for some serious reforms. But in fact they are not ready yet. The second lesson concerns the shallow reporting by the media. As long as there is an obsession with the personality of the presidential candidates, there will be no proper in-depth discussion of their programme. And the third lesson is that all these reform promises do not take into account the difficulty of actually delivering reform. After going through the mill of social, legal and financial procedures these reforms might well fall short of its intended purpose. The state seems sometimes powerless and the effect might well be the opposite of what was intended: it fractures society and deprives it of the intended benefits of the reform. Le Boucher says what needs to happen is, first, to build a consensus over what needs to be done. Once strategic lines have been defined, the implementation should be delegated to a decentralised governance system. The immediate lessons for presidential candidates: don’t give out a reform programme that is super-detailed but untested. Emmanuel Macron is right to staying with the big political themes. This is a battle between grand political options, not about the details of reforms.

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December 19, 2016

Montebourg - a bit of everything

Arnaud Montebourg, in an interview with Le Parisien, revealed parts of his programme which he said is at the heart of a different left. For this he takes a bit from everything - referring to the modern socialist lines represented by Dominique Strauss-Kahn and Jean-Pierre Chevènement - but also taking inspiration from Gaullists, Republicans and Greens. The best way to please everybody is not to upset anybody, comments Marianne. If he were to become president, the first thing Montebourg would want to do is to propose a new Republic giving citizens more rights. Concretely, he wants to halve the number of parliamentarians, introduce 10%-20% proportionality into the legislative elections, and introduce citizens into the Senate, one per Département. He said France needs to take back control of its administration. In his usual firebrand rhetoric, Montebourg insisted on the supremacy of people over administration, lashing out against Brussels in particular. And he uses polemics against the other candidates in the primaries, saying that they are not having no real programme at all, except for Benoît Hammon's legalisation of cannabis. It is still early in the game, and we expect the candidates to get more concrete with their programmes in January, after the Christmas break.

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December 19, 2016

The Maastricht error

Caroline de Gruyter has a pessimistic column about the functioning of the EU, motivated by the cases of the Ukraine association agreement and the CETA treaty with Canada, both of which were halted by a single parliament's opposition (the Netherlands, and the Belgian region of Wallonia, respectively). She traces this to a design flaw of the Maastricht treaty: the joint responsibility of the EU and the member states for issues such as the euro, Schengen, foreign policy, and border control. This was born of the desire to progress on European integration beyond the internal market, trade and agriculture - all exclusive EU competences - at a time when the member states were not fully ready to cede sovereignty on fiscal policy or foreign and security policy. But in the early 1990s the EU member states were aware of the need to tackle issues such as climate change, migration, terrorism, or digitisation. The problem, as illustrated by the Ukraine association agreement, is that this doesn't work. And the CETA case shows the dynamic of re-nationalisation is even polluting trade, which used to be an undisputed exclusive EU competence. De Gruyter concludes with the suggestion that the EU should focus on what the member states allow it to do well, and stop trying to do things half-way in other areas.

It seems to us that the EU project must have looked very different to the EEC of 12 member states that adopted the Maastricht treaty. The institutional structure has clearly not been able to accommodate the expansion to 15, then 25, 27 and finally 28, and now even founding members such as Belgium and the Netherlands find themselves at odds with the EU's strategic direction.

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December 19, 2016

If Paul Romer is right...

Whether an academic theory is right or wrong, good or bad, is not usually of importance to the wider public. But as Wolfgang Münchau argues, the New Keynesian economic framework is in a different category because its models have become the workhorse of central banks, governments, and international institutions. This the theoretical framework behind independent central banks, explicit inflation targets, and independent fiscal councils. The validity of all of this would appear to be in doubt if Paul Romer is right in his criticisms of modern macro, a discipline he said that had been regressing over the last quarter century. Our macroeconomic policy framework is premised on the notion that these theories are correct. But the theory is clearly at odds with our experience of a financial crisis that has left a permanent impact on economic output and the price level - something that was not supposed to happen. Münchau says central bank independence can be defended, but it is not a no-brainer; and, when policy does have a long-run impact on output, then it surely cannot be left to experts. 

Münchau's point is that if the liberal establishment he is part of does not challenge the New Keynesian policies and institutions, the populists will, and will do so brutally. But Münchau remains sceptical that the liberal establishment has what it takes to do this. Too many vested interests are at stake. The macroeconomic establishment did not challenge the prevailing orthodoxy after the financial crisis, and preferred to protect their own interests, having invested heavily into these frameworks. The most likely course is therefore a populist rupture - the antithesis to the current frameworks - and an age in which the role of macroeconomists will be much diminished.

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