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January 21, 2020

A truce over French digital tax and US tariff retaliation - really?

The news last night was that Emmanuel Macron and Donald Trump agreed a truce in their dispute over digital taxes. This will mean neither France nor the US will impose punitive tariffs this year. The threat lingers, though, as no-one has yet confirmed that the two men agreed to pull their mutual tax and tariff threats according to Bloomberg. French media reported the two sides gave themselves until tomorrow to avoid an escalation, so we are not there yet. 

Last January Paris imposed a unilateral tax on large digital companies of up to 3% of their turnover in France. This was intendd to kick-start high-level negotiations at the OECD to come up with an international framework for a digital tax. Donald Trump complained the French tax would single out American companies like Amazon, Google, Facebook, Apple and Netflix. He threatened to retaliate with 100% duties tax on French products worth $3bn per day. At the same time, after blocking the OECD talks for several years, Washington relaunched them last year. But in the end this was only to make proposals in December which France rejected. France had already indicated it would abolish its own tax once an international agreement was found. 

Bruno Le Maire is less sanguine than Macron about the prospects of success, and described the ongoing negotiations with the US as difficult yesterday. Avoiding sanctions is far from assured, he said. Sanctions could still be announced as soon as tomorrow, after the two countries' finance ministers are due to meet. Today it is up to the EU finance ministers to discuss progress of the OECD work on an international framework for a digital tax. The OECD is likely to work on this issue until the end of this year. There are many threads that need to come together for this negotiation to succeed and the tariff threats to be pulled off the table for good.

The digital tax is only one of the lingering disputes France, and in fact the EU, has with the US. A 25% tariff on French wine remains in place due to a separate trade dispute related to Airbus. The trade conflict between Europe and the US started in 2018 when the Trump administration invoked national-security considerations to impose tariffs on steel and aluminium imports from Europe. Trump's government threatened levies on European cars on the same grounds. A truce was hastily agreed, together with a pledge to cut industrial tariffs across the board.  But the Trump administration has since refused to start the tariff-cutting negotiations unless Europe includes agriculture in them.

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January 21, 2020

Climate crisis faces central banks with radical uncertainty

The Bank of International Settlements and the Bank of France have just jointly published a book on climate risks to financial stability that makes interesting reading for the issues of economic analysis and policy it raises. We cannot do justice to the book's 100 pages here and so we might revisit it in the following days. Today we would like to focus on the idea of radical uncertainty and forward-looking risk assessment.

Those who followed the conceptual debates at the time of the global financial crisis that started in 2007 may recall discussions of risk and uncertainty comparing it to the 1930s. These include Frank Knight's distinction between risk and uncertainty. Put simply, he understood risk as quantifiable uncertainty. Statistical techniques, in particular those underpinning financial risk management, are about turning unmanageable uncertainty into manageable risk. But thinkers such as John Maynard Keynes went further with their concepts of radical uncertainty. Put simply, radical uncertainty means uncertainty even about the possible future states of the world. At the time of the global financial crisis the concept of radical uncertainty was popularised by metaphors such as Nassim Taleb's black swan, after the animal that upset all expectations based on past experience that all swans were white.

Radical uncertainty features prominently in the BIS/BdF book, aptly named The Green Swan. For the authors, climate change faces central banks with radical uncertainty because it involves structural changes of a physical, social and economic nature which invalidate backwards-looking statistical risk analysis. The tool of choice in this case is forward-looking scenario analysis. The realisation of radical uncertainty and the growing adoption of scenario analysis is seen as an ongoing epistemological break. To an extent this started with the global financial crisis, and as we have pointed out was already present in debates around the Great Depression 90 years ago. But the climate crisis makes it inescapable.

The Green Swan book makes two additional points about this. One is that, even with scenario analysis, individual risks will remain unhedgeable unless systemic action is taken. The other is that central banks are likely, once again, to need to step into uncharted policy waters as they did with unconventional monetary policy in the past decade. One example the authors give is the possibility that central banks may have to massively buy assets that become suddenly depreciated as a result of a climate-related event, which could even be a policy change. This is the problem known as stranded assets. The authors of the report are concerned that goodwill by central banks to become climate rescuers of last resort may result in governments becoming complacent. For this reason, they advocate that central banks proactively push for coordination of climate policies with other authorities.

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January 21, 2020

Why strong enforcement rules will be critical in the EU/UK trade agreement

The FT has an interesting story about a document currently making the rounds in the corridors of Brussels in which the EU sets out some of its post-Brexit negotiating positions. One of them is a request that the trade agreement with the UK is governed by a strong set of enforcement rules. Both sides can take action if they feel that the other side violates its obligations.

We think this is actually good news. If there is no trust - there obviously isn’t - then it is best to agree enforcement rules. These constitute an important insurance mechanism, and matter especially in the internal discussions within the EU. 

We don’t see this as a problem at all. On the contrary, the story includes some hints that there may be more realism within th EU about the talks than we feared when we heard the bloc was seeking a high degree of regulatory alignment regardless of the nature of the ultimate trade agreement. Given the EU’s trade surplus such a position is neither fair nor sustainable, especially not in the final stages of the negotiations. We think that the fear of social dumping, as undercutting labour laws and other social protections is known on the European continent, is better addressed through arbitration and the right of unilateral suspensions than through attempts to force regulatory alignment.

The article makes the point that the EU is drawing lessons from its agreement with Switzerland, a country that enjoys extensive access to the EU’s internal market but with no procedures to handle disputes. Among the dispute settlement mechanisms under discussion for the UK deal are mediation, an independent arbitration panel, and a procedure for unilateral temporal remedies. For so long as the procedures are fully symmetric, there is no reason to object to them. The article quotes one unnamed official who acknowledged that the EU cannot stop the UK from diverging. The greater the divergence, the greater the friction. To us, such a position stakes out a sensible path. A minimal trade agreement focusing only on tariffs, rules of origin, goods transport and aviation would still impose a high degree of friction on the bilateral trading relationship. It would be unreasonable for the EU to insist that the UK follow EU rules in this scenario. 

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