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August 02, 2017

On the importance of a Brexit transition

We have been writing for over a year now that a transitional agreement for Brexit is unavoidable. But we have noted that virtually none of those previously supporting Remain have endorsed it. The reason is straightforward. If you are betting on a second referendum, as many of them still do, the last thing you want is a transitional deal to smooth out the economic impact of Brexit. Only the combination of economic chaos and political crisis has the potential to produce the necessary sequence of events for a reversal: another election followed by a second referendum before March 2019. 

The converse of this argument has been made by John Springford of the CER, who says that Hard Brexiteers should enthusiastically endorse Philip Hammond’s proposal for a transitional phase. He is right. A transitional phase is the only sane way to transition to Brexit without creating chaos, and without endangering Brexit itself. Springford puts forward four arguments why a transitional period makes sense from the perspective of a Brexiteer. A transition is needed because:

  • there will be no FTA ready for provisional application by March 2019;
  • economic chaos before Brexit, and a political crisis, are avoided;
  • it makes it possible to kill the politically unacceptable EEA option for a final deal;
  • it gets the Brexiteers beyond the critical date of March 2019, after which Brexit cannot be reversed. 

We would add one further point. A transitional agreement allows the UK and the EU to reduce the size of the Brexit bill because the UK would simply be paying the equivalent of its budget contributions for as long as the transition lasts, and at least until the end of the current budget period in 2020. As a non-member from 2019, the UK cannot be made liable for commitments made under the new post-2020 financial framework.

Springford discusses, and dismisses, the Brexiteers’ alternative strategy which is too force the EU’s hand by doubling down on the 'better-no-deal-than-a-bad-deal' posiion. His argument is that the UK has more to lose relative to the EU. This is true, but the EU may be politically less tolerant to a loss than the UK, because it has not voted to leave the UK while UK voters have chosen to leave the EU. A recent YouGov survey shows that the hardest of Brexiteers do not care about the economic implications at all, even if they are negative for themselves or their families. The EU would be much more sensitive to a smaller economic effects. We advocated that the best negotiating strategy for the UK would be an honest attempt to seek an agreement with a transitional period, while at the same time making concrete preparations - including even ex-ante legislation - for a no-deal scenario. The purpose of the latter is simply to encourage the EU not to overplay its hand in the negotiations. The political and economic disasters in Greece and Italy are good examples of what happens when you fail to lay down a plan B. We note, however, that the EU has so far exercised restraint, and pulled back from some of the more extreme demands in its original negotiating mandate.

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August 02, 2017

To kill a referendum, starve it

Running a referendum costs money if only to print the ballots, so in addition to constitutional court challenges and the prosecution (or the threat to prosecute) individuals, the Spanish government seeks to prevent the Catalan independence referendum planned for October 1st by starving the project of funds. To this end, the finance ministry will monitor the spending of the Catalan government weekly. According to El País, this was decided after it was detected last June that the Catalan government spent over €6000 from the electoral processes budget line-item. The spending could be legal as the Catalan government runs its own regional parliament elections, but the ministry requested an internal audit report from the Catalan government nonetheless. The Catalan government's internal audit depends on the finance councillor of the Catalan regional government and deputy regional premier. The latter has taken it upon himself to communicate with the Spanish finance ministry on this, and has already filed the first weekly report though he is refusing the ministry's request of access to the names of individual auditors.

The reason the Spanish government can exercise such control over regional spending is twofold. On the one hand there is the budget stability law passed in 2012 after a 2011 constitutional reform to implement the EU's fiscal compact. On the the other hand most Spanish regions including Catalonia lost access to the bond markets and have been rolling over their debt by means of Spanish government loans from a regional liquidity fund or FLA. Except for the Basque Country, which collects its own taxes, most taxes are collected centrally in Spain and then the revenue is distributed to the regions.

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August 02, 2017

How to spot a moron?

The way to spot a moron in an economic debate is when somebody pronounces an end to a crisis because of a cyclical pickup in GDP growth or, worse, because of the result of a sentiment survey. If you did not think that Italian debt was sustainable six months ago, then surely it is still not sustainable today. A couple of quarters of better-than-expected GDP numbers are not going to change that. What would need to happen is a pick-up in potential growth, and an emerging political consensus in favour of an increase in the primary surplus. This may happen, but it has not happened yet. Those who jump to conclusions on the basis of a cyclical recovery demonstrate that they have not grasped the nature of the eurozone crisis.

Carmen Reinhart has a very good comment that underlines this point - that recovery does not equal resolution - and she cites historical evidence. Examples are the Great Depression, the Latin American debt crisis of the 1980s, and Japan which saw several false starts since the 1990s. The eurozone suffers from a large debt overhang from the crisis, both in the private and the public sectors. The current benign environment is due entirely to the extremely low interest rates. The bulk of crisis resolution still lies ahead of us. 

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