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November 02, 2017

The Impact of Brexit

The big news in the UK has been last night's resignation of Michael Fallon as defence secretary. He is the first prominent victim of a sprawling sex-abuse scandal that affects both of the large parties. The question on our mind is whether any of this will impact the fine balance of power in the British parliament. As of yet, we don't think so. The pro-Remain Fallon is unlikely to turn into a Brexit rebel. The sleaze scandals during the Major administration in the 1990s may have contributed to the Labour victory in 1997, but the Major government lasted a full term.

The other big news is that the House of Commons managed to force the government to publish the impact assessments of Brexit. We think it is never a good idea to hide information. We also have no doubt that the impact assessments - based on economic models - will almost surely be negative, but probably with a greater nuance than the politically motivated previous studies by the Treasury or the Bank of England. 

Those who can't wait to read those, and see their worst fears confirmed, might find solace in a similar exercise just published by the European Parliament. This is useful as a compilation of the various impact studies that have already been undertaken. What is good about this report is that it is not of the foam-in-the-mouth variety, and it hedges its bets. What struck us about those impact assessments is that the the overall numbers are relatively small. The worst-case scenario in one of the studies is still a much more benign scenario that the eurozone crisis, for example. There can be no doubt that a hard Brexit without a transition would constitute a mighty economy shock. But a negotiated settlement with a transition period will reduce the frictional costs and, most importantly, it will give time for new economic activity to emerge. This adaptation is the kind of stuff that's not included in any of the models. It is also hugely important, which is why one should not get obsessed with these impacts assessments. They are simply too static. But they still provide some useful information that we think should be out in the open.

We highlight two impact assessments, from two different studies, coming to different conclusions about the size of the shock. But they agree on the importance of the trading regime to be adopted. And they agree that the impact will be stronger for the UK than for other countries. Here they are.

Source: Roja-Romagosa (2016). BLU (Belgium and Luxembourg); CCM (Croatia, Cyprus and Malta); BAL (Baltic countries).

Other than the UK, the most affected country is, of course, Ireland. Two other countries that can expect a large impact are Malta and Cyprus - we presume because of their financial sectors. Geographical proximity also plays a role. The fact that the impact on Germany is relatively small should not be misread. Germany has a massive trade surplus with the UK, constituting some 1.6% of GDP. 

In this context we also noted an article in FAZ, which reflects a new seriousness about Brexit in the German debate. Until very recently, it was common among German reporters and commentators to dismiss Brexit as a cry for help that will ultimately be frustrated one way or another. There is now an acceptance that Brexit will actually happen, and that it might affect Germany in a negative way. The article cites an estimate that the adoption of the WTO trading regime would reduce German exports to the UK by one third, and imports by one fifth. If you add the impact of non-tariff barriers, the effect might approximately double, according to the researchers cited in the article. And, finally, the article also mention the complete lack of preparedness by the EU for a hard Brexit in the financial sector. The UK has a comparative advantage in financial services, and customers in the EU will suffer as a consequence.

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November 02, 2017

German court of auditors questions diesel tax break

The timing of this news is particularly sensitive, as it will no doubt fuel demands by the Greens to expedite the transition away from diesel technology. The German court of auditors said it disagreed with the finance ministry, which had concluded that there is no need to equalise the tax rates on diesel and unleaded petrol. Diesel carries a lower tax rate than petrol - an indirect subsidy to the German car industry given its high output of diesel cars. The court of auditors cites a variety of reasons for its scepticism: tax justice, ecological reasons, and health-related reasons, as diesel emissions cause tens of thousands of pre-mature deaths each year. The court noted that the tax shortfall as a result of the diesel subsidies amounts to almost €10bn, which would open up new financial room for manoeuvre for the Jamaica coalition. The auditors also criticise other forms of car-related subsidies, like the subsidy for company cars.

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November 02, 2017

On trade and violence

Kevin O'Rourke offers a wonderful historical perspective on the complex interaction between trade and violence. The article spans a wide historical and geographical space, and does not specifically focus on current affairs, but we could not help see the relevance of the following passage for a particular gloomy version of Brexit.

"Trade implies dependence on foreigners, and even if the dependence is mutual this can sometimes feel uncomfortable, especially if one is dependent upon sea-borne trade for the essentials of life. In particular, if a rising power fears that its trade might be blockaded by an incumbent naval hegemon in the event of warfare, it may decide to eliminate that vulnerability, either by building up its own naval forces, or by seizing control of resource-rich territories, or by doing both. And so, when a rapidly industrialising and increasingly populous Germany found itself increasingly dependent on imports of food and raw materials in the decades before World War I, one response was to try to build up its navy, with the consequences for Anglo–German relations that we know."

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