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January 13, 2017

May to clarify Brexit strategy next Tuesday

Theresa May will give her long-awaited speech on her Brexit negotiating priorities next Tuesday. Do not expect to hear something you don't know. The strategy is fairly clear from what she has been saying so far. Britain will leave the EU formally two years after the Article 50 trigger. Britain will leave the single market. Britain may stay inside the customs union for a transition period. But, beyond that, Britain wants to have an FTA with the EU. There are still many details that need to be fleshed out - and none of them will in the speech. But this is as much as anybody can be expected to say now, before the negotiations begin and before the Supreme Court delivers its ruling. It is possible that the court may have privately informed the prime minister of the parameters of its upcoming decision to give her time to prepare, but even if that were not the case we do not expect legal obstacles to stall the process - though they may delay it by a few months.

We mostly agree with Martin Wolf's column on what to expect from Brexit, and his assertion that an FTA is unlikely to be agreed within two years, which is why we think temporary membership of the customs union is probably inevitable. We also have to acknowledge that there is the possibility of an exit without a deal, not because the prime minister would be seeking such an outcome, but because of failure to reach an agreement - either between the UK and the EU-27, or among the EU-27. The latter is, of course, outside the control of the British government. We particularly agree with Wolf that sectoral customs unions are not going to be acceptable to the EU, apart from the fact that they are not allowed under WTO rules.

What about the economic consequences? Wolf makes two points. The first is that the costs of Brexit were expected, but are not acted upon. The second is that the loss of value of sterling constitutes a fall in purchasing power that will, over time, reduce real incomes. He acknowledges the possibility that the currency was overvalued before Brexit and that the revaluation, plus the shrinkage of the financial sector, could help rebalance the economy. But the UK's experience has been that a falling exchange rate did nothing of the sort. We agree with him that there will be substantial transition costs as the UK enters a new regime. 

"Investors and other decision makers should therefore not be in much doubt. The direction of travel is sadly clear. To many, that direction remains highly unwelcome. It is not welcome to me. But it is clearly the reality."

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January 13, 2017

What to do with Germany's surplus

We know that Wolfgang Schäuble would be able to report a second consecutive fiscal surplus for 2016, but he has now decided to use parts of it to repay debt rather than just put it into a rainy-day fund which Germany set up when it introduced its constitutional balanced-budget rule. This is an election year, so the use of over €6bn is unsurprisingly controversial. The SPD is talking about a "debt-repayment fetish", while Handelsblatt quotes Schäuble as saying:

"It is not going to do you any harm paying back some debt for once."

The entire German public sector, including states and local authorities, registered a surplus of €19.2bn, or 0.6% of GDP, according to the Federal Statistics Office. Price- and calendar-adjusted GDP rose by 1.8%. Even Germany's largest state, North-Rhine Westphalia, which is about the size of the Netherlands, has achieved a fiscal surplus, which is unheard of. The last time this happened was 1973.

The use of the surplus understandably becomes an election issue, and Sigmar Gabriel wasted no time to demand more investments in road infrastucture and the expansion of the internet network. Jens Spahn, Schäuble's deputy, said the economy is booming, demand is strong, and public revenues are increasing. Even the most left-wing Keynesians should be demanding a fiscal consolidation at this stage.

FAZ writes in a comment that it would be factually and legally difficult to use past surpluses for future spending. There are already capacity constraints for investments, as existing funds are not fully used up. Investment in Germany last year rose by 4%. FAZ argues it would be better to pay the money back to the citizens.

What is the point of a debt repayment at a time when interest rates are zero? We have some sympathy for the argument that it is not that easy to raise investment at a time when existing funds earmarked for investment are not fully used. The German economy has been hitting capacity constraints but, at the very least, the government could have used the money to pay for a one-off tax credit. This would be a more efficient use of funds than debt repayment at a time like this.

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