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2 July 2021

OECD tax reforms look toothless

A historic moment for global tax reform yesterday as the OECD announced that 130 countries had agreed to a minimum corporate tax rate of at least 15%. The only problem is the hold-outs.

In the EU, Ireland, Hungary and Estonia are not on board with the deal. Paschal Donohoe, the Irish finance minister, said he was not in a position to join the consensus, and that he has expressed Ireland’s reservation. The country’s corporate tax rate is set at 12.5%, and the finance ministry had previously estimated that boosting the rate would cost Ireland more than €2bn of annual tax revenue. At 9%, Hungary’s rate is the lowest in Europe, and as we reported, Viktor Orbán has rejected a 15% minimum rate because it would hurt investment. Estonia applies taxes only on distributed profits of companies, and has criticised the OECD deal as harmful for enterprise, international competition and job creation.

Perhaps more significantly, the FT wrote yesterday that the UK is set to receive an exemption for its financial services sector, which will protect London’s largest banks from paying more tax on their profits in other countries. In exchange for this concession, the UK government will back down on its digital services tax that mainly targets large American tech companies.

The UK was reportedly shocked by American demands to apply the tax rules to all sectors, because regulations compel banks to be capitalised separately in every jurisdiction where they operate. This means they declare profits and pay tax in the countries where they do business. As a result, tax revenues received by the UK treasury would have been reduced as banks pay more tax to other countries. France and Italy might follow the UK in abolishing their own digital taxes, although both the OECD rules and digital tax phase-outs will likely be staggered and conditional on each other’s progress.

What this tells us is that European tax havens will continue to thrive despite intense diplomatic pressure, and that the OECD plan may not be all it’s cracked up to be. As we argued previously, the OECD plan will only come into effect on profit margins of more than 10%, and tech companies like Amazon have put tremendous efforts into keeping their profit margins low, on paper at least. If the biggest banks and tech companies are essentially spared any tax increases, the 15% plan will be a flop. Which once again begs the question – who is going to pay for the post-Covid economic recovery?

1 July 2021

Why the US needs a strong Turkey

We wrote a lot about why Turkey needs Nato and adapted a more moderate tone after heightened tensions last year. The arrival of Joe Biden in the White House played a role in this. But what is the US interest in a show of cameraderie with Turkey despite remaining conflicts? Recep Tayyip Erdogan gets away with buying Russian S-400 systems, attacking US allied Kurds in Syria, supports Hamas Islamist terrorists in the Gaza Strip and provoking Greece and the EU. Turkey's government ignores international law on maritime borders and provokes with its military might in proxy wars and the Mediterranean. But Turkey gets away with it. Why?

The Russian newspaper Vzglyad (hat tip To Vima) came up with a list of reasons why the US needs a strong Turkey. First, to hold back Russia. Turkey diverts Moscow's attention from European affairs, causing trouble in the South Caucasus, and having a subversive presence through soft power in Crimea, the Volga region and Siberia. The second reason is to confront China. The more islamised and unstable the region is, the more difficult it will be for the Chinese to trade with Europe through central Asia. Third, to face Iran. Not to fight Iran but by interfering with its appeal to a pan-Turkish identity and by alliance with Azerbaijan. Around 15% of the Iranian population are Azerbaijanis, also called Azeris, who were excited after Turkey won the war for Azerbaijan in the Karabakh war. Opposing Turkey openly is not something Iran is ready to do. And finally the US needs Turkey to take over in Afghanistan, defending American interests there after the withdrawal of US troops. 

The list of strategic interests is longer than the concerns. This is why Erdogan gets away with his provocations without being put into place. 

30 June 2021

How not to defeat Orbán

When bad guys are winning, it is usually because others let him. The Christian Democrats tolerated Viktor Orbán for too long. Angela Merkel cut a dirty deal with him, so that he would lift the veto on the EU budget. The very last thing you want to do now is to give him the honour of being censured by the media, and feed his fake narrative of a resistance fighter.

What he did is place adverts in several European newspapers, defending his law to ban LGBTQ material in schools and on public television under the cloak of family values. And to attack the direction the EU is taking right now. Several Belgian newspapers have refused to run this ad. The argument in favour of banning the ad is that Orbán has censured his own media, so he should not buy media space elsewhere. This is a very dangerous argument.

We think this is an own goal. Newspapers became so influential in the 20th century because editors resisted the pressure from advertising. But this goes both ways. Once editors start to vet advertisements for political correctness, you give them the moral high ground to do the same to you. They will.

29 June 2021

Why Labour does not win

We have not written much about British politics because not much of substance has changed. An event to watch out for is this Thursday’s byelection in a Batley and Spen in West Yorkshire. The sitting MP resigned to become mayor, triggering a vote.

Batley and Spen is part of the infamous red wall - erstwhile Labour seats in northern England, many of which fell to the Tories in the last election. Labour narrowly hung on to Batley and Spen. The expectation is that Labour will lose this byelection just as it lost the Hartlepool. Another complicating factor is the candidacy of George Galloway, a well-known politician of the hard left.

The news this morning is about the campaign turning toxic. What we like to focus on instead are the broader ramifications if Labour were to lose this by-election.

Labour’s problem in the north is that its leader, Sir Keir Starmer, was the architect of Labour’s support for a second referendum ahead of the last elections. We called this decision at the time one of the riskiest political moves we have ever witnessed. There was only ever a very small probability of success, but the many downsides of that decision are now becoming apparent. The UK ended up with the hardest version of Brexit. And Labour lost the Brexit voters of the north. Sir Keir wisely chose to turn attention away from Brexit when he became leader, but northern voters have long memories.

To get out of its hole, Labour will ultimately need a leader who can bring back the north, and who is not tainted by the disastrous policy U-turn in 2019. We think of Andy Burnham as the most plausible candidate. The mayor of Manchester supported Leave, but also appeals to Labour's metropolitan base in the south. Since the second referendum campaign has essentially killed any notion of a return to the EU, Brexit is no longer a narrow political issue even in the north. It is the credibility gap that turned out to be most persistent.

Sir Keir said he won’t resign if the byelection is lost. We think the most plausible outcome is that he will fight the next election, and lose. The question is whether the Labour Party will try to stage a coup beforehand. It would be out of character - though not impossible.

In a political system with two parties, the winner is not the best but the least worst. For as long as Labour remains in the state it is, Boris Johnson will be safe in Downing Street. Political problems are brewing up for the Tories in the south of England, largely because of rural planning policies. The resignation of Matt Hancock as health secretary is ultimately not important. It falls into the category of political entertainment. Another character who does not matter is Dominic Cummings.

With Sajid Javid back in the front line of politics, another potential successor has entered the cabinet, but the time is not yet ripe. During the reigns of Helmut Kohl and Angela Merkel, people wasted an awful lot of time speculating about potential successors. Those who ended up in that position, Merkel herself after a short interlude and now Armin Laschet, were not on anybody’s list.

We conclude therefore that the current constellation will keep Johnson in power for a while yet, well beyond the next election which has to take place by December 2024, but which could take place earlier, as the fixed-term parliament act is now in the process of being repealed.

28 June 2021

Cap reforms - not going to work

EU farming and fishery ministers will meet today and tomorrow to finalise long-awaited reforms to the union’s contentious common agricultural policy, Cap. Headlines trumpeted a triumphant breakthrough on Friday after months of deadlock, with the European Parliament winning key concessions from the EU Council on funding targets for eco-schemes, or sustainable agricultural projects and practises.

Agriculture ministers had been pushing for 18% of Cap funding to be allocated to eco-schemes, whereas the European Parliament had initially insisted on 30%. At the end of the day, negotiators agreed to 25% under the first pillar of Cap, which comprises direct payments to farmers and accounts for the bulk of spending. A 35% ring-fence for environmental spending was also established under the smaller second pillar, which focuses on rural development.

However, Green MEPs were unhappy with the compromise because of a rebate loophole allowing countries to spend less on pillar one eco-schemes if they have spent more than required on pillar two. There will also be an initial two-year learning period where pillar one eco-scheme funding can be as low as 20%.

Pascal Canfin, chair of the European Parliament’s environment committee, said the size of the budget and robust design of eco-schemes will prevent greenwashing. We beg to disagree. 

Dr. Norbert Röder, a researcher at the Thünen Institute Federal Research Institute for Rural Areas, Forestry and Fisheries, noted in January that the new Cap legislation will not come into force until 2023, and warned that not all farmers who want to participate in the scheme will be guaranteed enrolment because of a selection process that can be put in place if there is a risk that too many projects would drive pillar one’s unit payment amounts below the minimum level foreseen in each member state’s Cap strategic plan.

The eco-schemes themselves are also problematic. The European Commission published a list of schemes that could qualify for green funding in January this year, highlighting agro-forestry practises that include growing woody perennials on agricultural land, agro-ecology, which includes conversion to organic farming, precision farming, which is a management concept focused on using technology such as drones to monitor crops, and carbon farming, which would retain more carbon pools in soils and vegetation through practises like soil rewetting.

But as Röder argues, there is very little alignment between the EU budget calendar and real-world farm practises. In the case of agroforestry:

“The potential positive effects (economic and environmental) will occur only after a significant time delay. Given the 5-year period of the next Cap, it is hard to imagine that farmers will establish agroforestry systems on the basis of eco-schemes. Only if the sum of the annual payments exceeds the investment cost will farmers opt for this option. This means the costs must be capitalised within 5 years or less, resulting in extremely high payments per hectare.”

Monitoring and evaluation will also be tricky. Crop rotation, for example, would require national authorities to track the management of individual fields for multiple years, irrespective of who is managing them, as well as the creation of an information system for farmers with details on the management of their respective areas in recent years. Precision farming faces similar challenges as agroforestry – the costs of the technology needed for precision farming do not scale in line with the farmed area, meaning that if payments for these schemes are linked to the size of the farmed area, large farms will be tremendously over-compensated.

We don’t think 25% of Cap funding is enough – indeed, we don’t think 30% would be enough given the enormous investment costs associated with a conversion to green farming practises. Despite assurances to the contrary, greenwashing looks to be the only face-saving outcome possible for Cap policymakers.   

25 June 2021

Teflon Orbán stands his ground

Viktor Orbán’s bad week continued at yesterday’s European Council summit, where angry confrontations erupted over a recent anti-LGBTI bill passed in Hungary.

Although the topic was not on the official agenda, it rose to become one of the main events after 17 European leaders signed a joint letter deploring threats to fundamental rights, including the principle of non-discrimination on the basis of sexual orientation. Emmanuel Macron stated that the new law is not in accordance with EU values. Micheál Martin, Ireland's Taoiseach, said the same, while Xavier Bettel, Luxembourg’s openly gay prime minister, took Orbán to task for stigmatising gay people, warning that many LGBTI youth die by suicide as a result of the hatred they face.

The angriest of all, though, was Mark Rutte, who finally said what many are no doubt thinking: if Hungary does not withdraw the legislation, there is nothing left for them in the EU. The Dutch prime minister told media that the issue is so fundamental, abandoning it would mean the EU is nothing more than a trading bloc and a currency.  

Orbán stuck to his guns of course, painting himself as a defender of the cause by reminding the Council that he was a freedom fighter under the communist regime, which included fighting for homosexuality to be legalised. It was legalised in Hungary in 1961, two years before Orbán was born. 

Diego Velazquez, a journalist at Luxemburger Wort, rightly notes that the summit also saw half the EU advocate closer ties with Putin’s Russia, before going on to lecture Orbán about LGBTI laws that were essentially copy-and-pasted from Russia. Maintaining the moral high ground becomes impossible when the hypocrisy is so evident, and while the EU did eventually reject plans for a summit with Russia, it is unlikely to make much headway in confronting Orbán.

Leaders are talking tough, but as we’ve been arguing, the rule of law compromise hammered out last year is not an effective weapon against democratic and human rights backsliding: under the December compromise, the EU cannot use the mechanism until the ECJ gives its judgment on the procedure. Rule of law action will only be brought to protect the financial interests of the union, and it will have to be proportionate. As we argued at the time, this means it cannot be used in cases of human rights violations.

And as was the case during negotiations last year, the EU is not united. Hungary was supported by Poland and Slovenia yesterday, and no decision was taken on what to do about the law. The theatrics were spectacular, but Orbán is standing his ground and unlikely to be punished for doing so.

24 June 2021

Has Brexit been worthwhile?

The fifth anniversary of the Brexit referendum has been largely an exercise of confirmation bias. What struck us in particular are the repeated assertions in Germany and from the European Commission yesterday that Brexit hadn’t paid off.

This is an odd claim because it turns the debate upside down. The vote was a rejection of economic utilitarian arguments. The case for Brexit was an economic one. We can see why the Germans and French are confused on this point. In Germany, all politics is subordinated to industrial interests. People voted Leave because they did not want to belong to the EU.

That said, we keep an open mind on the Remain campaign’s central claim - that leaving the EU would make the UK worse off in the long run. However, we won’t know the answer to that question for a long time.

First, Brexit did not happen five years ago, but in February 2020. The economic framework only became active in January this year. Six months is a little early for an assessment of a long-term economic impact.

Second, the last 15 months were accompanied by a pandemic. The UK was hit worse than the EU average for reasons unrelated to EU membership. Brexit was a factor in the UK’s fast roll-out of vaccines. The pandemic has been an unprecedented economic roller-coaster during which the noise cancelled out the signal.

Third, the test of Brexit will come from regulatory divergence. Data is probably the single biggest factor - underestimated by the trade specialists because data trade is not an officially recognised category. So here is our speculation: if the UK manages to extricate itself from the EU’s overly-burdensome data protection laws, it could reap economic windfalls on a scale of North Sea oil in the 1980s. There are many other regulatory issues that will matter too, including for financial services. But we reckon that the data environment is going to be the big one.

Economists think about trade of physical goods in terms of gravity. The closer you are to another country, the more you trade with it. The argument against Brexit followed on the same lines: if you destroy your trading relationship with the EU, you will not make up for the losses by trading more with Asia and the Americas.

But Brexit - like EU membership before - is a long-term decision, so that's the time horizon over which you need to measure the impact. In the long run, data trade will become more important - and data are not subject to gravity. Production is becoming more decentralised due to technological innovation in robotics and 3d-printing. In the very long run, it is conceivable that we trade data mainly - and raw materials - and do the rest locally. We are not in this world yet. But this is a world within the time horizon of a post-Brexit industrial era, one in which data regulation is critical.

The economic success and failure of Brexit will therefore depend on political decisions that have yet to be taken. It is far from clear that this will happen. Dominic Cummings pushed this agenda. But there was no broad-based political support in the Conservative Party behind this. The current focus is on industrial development and planning. Cummings' departure from the inner circle of No 10 Downing Street makes it less likely that the UK will opt for a radical departure from GDPR, the EU’s data protection regime. In that case, the UK would forego some of Brexit’s potential benefits.

Our best guess right now is that the long-run economic impact will be hard to discern in practice because economies adjust in non-foreseeable ways.

It is economists who don’t.

23 June 2021

Big tech's €2tn warning

In other big tech news, an alarming report published by the industry group Digitaleurope last week found that restricting data flows in Europe could cause €2tn of economic damage and lead to 2m fewer new jobs being created.

Europe’s digital decade should not be quashed by the general data protection regulation, GDPR, according to Digitaleurope. While it recommended that certain GDPR transfer mechanisms, such as standard contractual clauses and adequacy decisions, should be upheld, it also called for a quick conclusion to negotiations for a deal on data flows as part of the World Trade Organisations’ eCommerce negotiations.

The study found that Europe’s manufacturing sector would be hit hardest by restrictions to data flows, with the sector facing €60bn in potential export losses, while the media, culture, financial, ICT, and business services sectors would also be facing a 10% loss in exports. Data localisation requirements could also hurt sectors that do not participate heavily in international trade, such as healthcare, with up to a quarter of inputs into the provision of healthcare already consisting of data-reliant products and services. Perhaps most interestingly, the report found that data transfers will be worth at least €3tn to the European economy by 2030.  

That’s a huge number, and one of the first efforts we’ve seen to valuate data as a commodity. And as Digitaleurope writes:

"This is a conservative estimate because the model’s focus is international trade. Restrictions on internal data flows, e.g. internationally within the same company, mean this figure is likely much higher."

We, too, have argued that GDPR requirements are overly burdensome for small businesses, and we think this is one area where we will see significant regulatory divergence between the EU and the UK - and the rest of the world - in the future.

We would also like to note, however, that Digitaleurope’s members include Amazon, Apple, Facebook and Google, among many other large corporates. European data transfers may reach €3tn in value by the end of the decade, but the companies that will profit most have been extremely reluctant to pay their fair share of taxes in Europe. Food for thought.

22 June 2021

Is the UK un-European?

The Daily Telegraph has a story that the European Commission is about to undertake an impact study on whether the UK is overrepresented in the EU’s audiovisual markets. Apparently somebody has asked the Commission to stop Amazon and Netflix offering UK programmes on the grounds that they can now be classified as un-European because of Brexit.

For starters, this isn’t going to happen for reasons we explain below. We are relaying this story only as a cautionary tale of wasteful opportunity costs. We advised the EU back in 2016 to accept Brexit as a democratic choice and move on. It won’t determine the fate of European integration. But the stuff you don’t do whilst hyperventilating about Brexit will. If it is our goal to ensure a vibrant and diverse European cultural offering, getting rid of The Crown or Downton Abbey is both stupid and counter-productive.

The article does not say who is asking the Commission to undertake the study, or whether the Commission is taking this seriously. But it raises an important issue: Areas where the EU stipulates thresholds for EU content have obviously been affected by Brexit, and have to be recalculated.

The EU’s audiovisual media services directive stipulates European content of 30% of TV programmes or streaming services. Last year, the EU just pipped this threshold: The EU 27 countries had 22% of content, the UK 8%, the rest of Europe 2%, making for some 32%. France imposes a European content rule of 60%.

What these numbers are already telling us is that the key issue is the definition of European content. It does not say EU content. So this boils down to the question of whether UK is European.

As the article points out, the UK is a member of the European convention on Transfrontier Television, which is part of the Council of Europe. For readers unfamiliar with the many councils: this is not an EU institution, but an international organisation with 47 members, which pre-dates the EU. The EU’s audiovisual directive makes a direct reference to that convention. This means that Brexit should not, prima facie, affect the definition of European content.

21 June 2021

Reflections on the G7

After a week of summitry - G7, Nato, EU/US, US/Russia - we have come away with the reinforced impression that multilateralism is not what it used to be. If we let the 15 years of Eurointelligence whizz past our inner eye, we see the failure of multilateralism as the thread of our narrative.

We were surprised Gordon Brown, one of the erstwhile, fans of multilateralism, arrive at the same conclusion, when he wrote that

“the G7 will go down in history as another turning point where history failed to turn.”

He said the summit failed to agree on a substantial supply of vaccines to poorer countries, and to lift the patents, which is primarily due to German opposition. He lists a whole series of failures: plugging the pre-Cop26 financial hole in climate funds, and the failure to use special drawing rights to help low income countries.

Unlike Brown, we are not observing the failure of multilateralism with indignation and moral outrage. G7-summitry constitutes a top-down form of governance, deeply undemocratic at its core. It started off harmlessly in the 1970s, when Gerald Ford, Helmut Schmidt, Valéry Giscard d’Estaing and four other leaders sat around a fireplace and chatted about the state of the world - with virtually no press in attendance. These events have since turned in global media junkets.

The history of European integration is a microcosm of the ups and downs of multilateralism. The EU has two planks - a multilateral one at the centre of which sits the European Council - and an integrated one, with the Commission, the EU Council and the European Parliament - and the CJEU. The integrated strand is more narrowly defined, and this is the one that is working quite well because it is based on a solid institutional and legal framework. It is the ad hoc, multilateral stuff, like vaccine procurement, or fiscal policy co-ordination, that the EU is struggling with.

The overriding lesson of European integration has been that you can’t leave it to governments acting unanimously. That’s how Austria ends up boycotting sanctions against Belarus, and how Hungary vetoes action against China. The only functioning institution during the euro area’s sovereign debt crisis was the ECB. Without deflecting from Mario Draghi’s personal qualities, the deep reason for that success lies in a legal and institutional basis that allowed the ECB to purchase national assets without limits during an emergency. All the European Council ever did was set up the European stability mechanism. It did more at the start of the pandemic when it agreed to the recovery fund, an instrument vastly hyped in the media, both in terms of its size and its long term impact. We already hear people hail the success of the associated reforms even though they so far only exist on paper. A lesson is that multilateralism comes with a lot of hype and PR. As Brown rightly observed: the G7 is an irrelevance. Our expectations for the recovery fund is that future econometricians will not see in the macroeconomic data. That will be the test.

The fanboys of our multilateral world say there is no alternative. We think this is nonsense. European integration offers many valuable lesson of what works and what doesn’t - lessons that global multilateralists may want to reflect on. Successful multilateralism will have to be based on solid legal frameworks and parliamentary processes. This means that in the absence of world government, the route will be slow. It will pass through the strengthening of international law, and it will have to be accompanied with democratic processes. There is a trade-off between speed and depth. The European lesson is: go for the depth. 

And finally, beware of lazy myths like the one according to which integration proceeds through crises. The successful institution-building in the 1980s and 1990s was not a response to a crisis, but a strategic choice. All we did during the later crises was to fudge our way through. The banking union is a great project in theory, but the financial systems are nowadays more disintegrated than they were ten years ago. It is a project that has yet to happen.