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13 October 2023

Tunisia returns EU funds

Tunisia returned €60m in funds to the European Commission, as relations between Tunis and the EU have collapsed since July, when both sides signed a migration pact offering €255m in funds in return for helping to keep migrants out of Europe. The return of the money was a sign of indignation over the low amount and the way the Commission was handling the matter. The Tunisian government argues that the €60m are part of funds that had been promised before the migration pact, and that the Commission is dragging their feet on the €255m, writes Politico.

As so often in today’s discourses, the past continues to weigh on relations. In a swipe against the EU, Tunisian Foreign Minister Nabil Ammar said an interview that they didn’t start wars and didn’t plunge humanity into world wars as Europe did. There are plenty of bad episodes in history from which no good relations can emerge. The Commission still counts on the pact with Tunisia as a role model for pacts with other North African countries. If it manage this the way it did it with Tunis, we do not expect a better outcome.

12 October 2023

French reactions to Israel-Hamas war

Hamas's terrorist attack on communities in Israel has provoked strong emotional reactions in France, not least because it triggered their own memories of terrorist attacks in Paris nearly eight years ago. Emmanuel Macron will address this issue on national television tonight. After a proactive, but ultimately unsuccessful, response at the onset of the Ukraine war, Macron is more cautious this time, consulting with party leaders before going public. Other party leaders have reacted more immediately to the attack last Saturday.

For France, it is all about finding the right words to condemn the attacks in a country that hosts not only the biggest Jewish community, but also the biggest Muslim community, in Europe. The conflict may be international, but it has direct domestic implications for France. This is about naming and framing the conflict, without creating one at home.

Jean Luc Mélenchon's refusal to call Hamas a terrorist organisation triggered the first big impact. The statement from his party, La France Insoumise, talks instead about an armed offensive by Palestinian forces led by Hamas. This polemic triggered a huge emotional response in the National Assembly earlier this week. The Socialists then decided to suspend their participation in the Nupes alliance over their disagreement on what to call Hamas. We see the conflict being divisive for the left throughout Europe, as Israel’s occupation of Palestine has been one of their symbolic narratives. Figuring out how to distinguish between Hamas, with its violent acts, and the Palestinian cause will keep them busy for a while without solving any of the underlying conflicts.

The second impact to watch out for is whether it ignites anti-Muslim sentiment in France to the benefit of the far-right ahead of next year's European elections. The coordinated nature of Hamas’s assaults on concert goers and various communities resonates with what happened in November 2015, when 130 people were killed by a coordinated terror attack on various events in Paris, including at a concert hall and a football stadium. There is thus a proximity in experience, though not in scale and the methods of delivery. But similar patterns are enough for populists to tap into.

The silence from Macron also created its own irritations. Showing solidarity with Israel is seen as important by Macron and his team, but why wait until Israel retaliates? To avoid an uprising of the Muslim populations in Paris’s suburbs, as Rassemblement National suspects? Yesterday, two ministers were sent to Jewish communities to assure them that the state would protect them. Today, Macron will follow up with a message, and try to walk a fine line between two polarised communities.

11 October 2023

What is friendship to you, Emmanuel?

The images emerging from Hamburg, where Emmanuel Macron and Olaf Scholz held a two day retreat with ministers, speak for themselves: Scholz’s wooden welcome to Macron; the cloudy and rainy weather during their boat trip, their joint promenade through Hamburg’s port; and a very different taste when it comes to Fishbrötchen, herring sandwiches, the favourite fast-food fare at the Hamburg port market. How far does friendship go in appreciating local food? Looking at the photo of Macron, who looks like he is about to throw up, and the two wives looking rather gloomy, this was probably not a highlight. The programme was also at odds with what is going on in Israel and Gaza, as if it was to underline the message that Europeans do not count in this conflict.

Inside the meeting rooms, ministers exchanged presentations covering AI, the tech sector, and how to transform industrial societies. The visit to Airbus in Hamburg was a throw-back to the good old days of Franco-German cooperation. Where to go from here will have to be worked out over the coming weeks.

The Franco-German friendship was also not helped by the decision in the foreign ministry to close down three Goethe institutes in Bordeaux, Lille and Strasbourg by the end of this year. Austerity also bites here, though the decision is still to be confirmed.

The Goethe institutes were instrumental in promoting the German language and culture back when we were younger. They were the main point of entry when one of us started living in France. But times seem to have changed with the internet and austerity. Even the Goethe institute in Toulouse, which is practically Airbus city, had to scrap its language programme due to budget cuts. In Hamburg, then, Macron made an offer that embarrassed the Germans: if they insist on those savings, he would find the money to compensate for the loss. Those institutes play an important role to help future generations maintain the Franco-German friendship. We happen to agree.

10 October 2023

Iron chancellor, wooden policies

If there is one word Rachel Reeves wants voters, and her own party, to associate with her, it is discipline. The UK’s shadow chancellor used her speech at Labour’s conference, which could be the last before a general election, to drive home the rhetoric of fiscal probity, without announcing new policies. This aversion to spending more money wherever possible shapes the rest of Labour’s economic agenda.

It is essentially a supply-side one, where a Labour government would grow the economy by overhauling the UK’s notoriously onerous planning regulations. Public services would get better thanks to reforms to make delivery more efficient, rather than big new injections of funding. That, plus policymaking stability that reassures investors, is the big plan for creating more economic growth while not spending any more money. 

This narrative might be politically successful, but it indicates the weird inversion of British politics’ attitude to what is, and isn’t, pragmatic in economic policy. Tying yourself into a fiscal straitjacket becomes the sensible thing to do, and the expectation is that everything can work out thanks to some sort of nebulous reform agenda. It’s strange that this something-for-nothing mentality has become the mature way of doing things when it is more wishful thinking.

One problem is the reforms themselves, which are currently either inadequate or not very well-defined. On housing, for instance, Sir Keir Starmer has suggested a target of building 300,000 new homes per year. This would be an improvement on the current situation. But to close the gap between the UK’s number of dwellings per person and the European average, you would need more like 450,000 new homes a year. Similarly, there’s not a lot of detail on how reforms to different planning regimes would interact to make it easier to build new infrastructure.

If you look at public sector reform, it’s not obvious how you can make sweeping changes to the UK’s public services without at least a short-term injection of funding. In the NHS, for instance, cutting the amount of administrative work medical staff need to do would, at least temporarily, mean having to hire more admin staff to cover it off. This is before we get to anything like revamping its IT systems, which would be a major undertaking.

Above all, there’s no clear indication that Labour, if it does form the next government, will be able to overcome the political obstacles that everyone else has stumbled on. Planning reform is something numerous other governments have tried and failed, as angry constituents lined up against their efforts. If you spend money on IT consultants rather than hospitals, you will face accusations that you are wasting money.

This is not to say that dealing with these problems is impossible. But it does mean recognising why it has been so hard to achieve the kind of supply-side agenda Labour is advocating in recent history and coming up with a plan to deal with it. There’s less evidence of this happening.  

What is happening, however, is that Labour is drawing all the wrong lessons from the Liz Truss debacle. Truss’s problem was not having a convincing reform agenda to back up her loose fiscal policy. Labour’s answer to that is to do things the other way around: reforms without the resources to incentivise or achieve them.

9 October 2023

Austerity gets tougher each time

One problem with economic and political narratives repeating themselves is that times can change, even if the story doesn’t. Another is that many of the suggested remedies to political problems that do occur are one-time tricks. Once you have killed the figurative golden goose, that’s it. It’s hard, for instance, to have an oil boom if you’ve used up all the easy-to-access oil the first time around.

This is something European governments may discover, as they face returns to austerity a decade after the first go of it. The problem with austerity is not just a quantitative one, but a qualitative one: the easiest expenditures to cut are investments, and state capacity-boosting administrative costs. Social spending, like healthcare, pensions, and education, are impossible to cut. So are unemployment benefits. By definition, the more you’re spending on those, the harder they are to cut.

What you end up with, then, is a vicious circle. You cut the investments and the admin. This hurts growth, and your state capacity. You now have less revenues to pay for the social expenses, which are still going up in ageing societies, and the state capacity problems make public sector reform more difficult. Each time you try and go back to cut something, it gets harder.

We’re now seeing this play out in one of the big proponents of austerity in Europe, the Netherlands. With elections coming up, there has been some fighting between the outgoing caretaker cabinet and the Dutch parliament over expenditures, and the assumptions underpinning the budget. According to the cabinet, the parliament’s view is too rosy. According to at least some in the parliament, the cabinet is being unambitious.

But as Ulko Jonker, writing for Het Financieele Dagblad, points out, this is a bit of a sideshow to the real problem facing future Dutch budgets. Most of the budget is taken up by health, social security, and education expenses. Add to that stuff like security, defence, and EU budget contributions, which are almost impossible to cut, and you have very little to fight over. Jonker points out that cuts made by Mark Rutte's successive governments have mostly focused on public administration. Now that the politically easy stuff is out of the way, making real savings in the future would mean much harder choices. 

The Netherlands still has a growth fund, intended to make investments in the country’s transition to the economic model of the future. But politicians from various parties have been sizing this up. The problem remains a structural one, however. If you draw from the growth fund to pay for short-term bromides, what will remain once that’s gone?

This could play out in one of two ways at the EU level. One possibility is that the union’s fiscal policy stances slowly, but surely, cohere to an anti-austerity consensus as various member states hit dead ends. Fiscal rules could lose their appeal if, or when, almost everyone struggles to comply without making swingeing, and electorally risky, cuts to healthcare, pensions, education, or unemployment.

Another is that fighting over fiscal transfers could get worse, and opposition to a fiscal union may increase. If a zero-sum logic sets in, countries might become wary of any obstacles to keeping their social policy commitments, including fiscal transfers. The Netherlands, after all, still spends less than 18% of GDP on social expenditure, less than the OECD average of 21%, and much less than Italy at 30%.

6 October 2023

The grand cru effect

Politics is as much a result of political necessities as it is an expression of cultural phenomena. How people vote nowadays is not so much linked to their programmes but to the affinity they have for the candidate in the elections.

Even in a secular country like France, common habits and beliefs have an influence on people when they choose their presidential candidate. This phenomenon has been well-documented by Jérôme Fourquet, director of the Opinion department in the Ifop polling institute. A geographer by training, he has a passion for weaving together the links between geographical situations, economic, social and cultural behaviours, and electoral attitudes. For example he finds that those drinking coffee from capsules, like the ones from Nespresso, are likely to vote for Emmanuel Macron rather than Marine Le Pen. Those who drink the grand crus from Bourgogne also prefer Macron, while Le Pen voters opt for the cheaper wine regions further afield.

When it comes to professions, Le Pen leads amongst those who work in hardship professions, while Macron is leading in professions where there is no hardship at all. The left is predominant in the suburbs around large cities like Paris, where it competes against Islam as the predominant ideology. Support for candidates like Jean Lasalle, a mayor of a small community in the Pyrenees who ran twice in the presidential elections, has been rising with every metre of altitude, as if he is the elected shepherd of the mountain people. Éric Zemmour came first in communities along the Mediterranean, and some chic locales like Versailles and Neuilly. Fourquet even found a correlation between those with a subscription to the magazine Valeurs Actuelles and support for Zemmour. Geography and common daily life experiences matter in a time when politics cannot deliver fundamental change, or answers to the big questions.

5 October 2023

More Scholzing

Olaf Scholz has formally decided against the delivery of Taurus cruise missiles to Ukraine on the grounds that they might hit targets in Russia, we learn from Bild. The story was later corroborated by ARD-Tagesschau.

Both France and the UK urged the German government to deliver the missiles, but Scholz focused on a legal difference. The British and the French have their own troops in Ukraine to control the geodata for the missiles. In Germany, the Bundestag would have to give its assent to the deployment of German troops abroad. His argument is a straw-man. Both the Greens and  the FDP, Scholz's coalition partners, supported the delivery of the missiles. So did the CDU/CSU. A large majority would have been assured. As is happening more frequently, Scholz is hiding behind some technical excuse so he does not have to reveal the real reason. 

We suspect the real reason is a political red line Scholz does not want to cross. He does not want to deploy German soldiers to Ukraine. Nor does he want German military gear to be involved in an attack on Russia. Bild quotes government sources saying that Scholz was concerned that the missiles would hit the Kerch bridge. Comments like these underline the limits of western unity about the goals of their support operations for Ukraine. They all agree that they don't want Vladimir Putin to succeed, but there are different views about Crimea, and whether western weapons should be used in Ukrainian attacks on Russia itself. 

The UK, France and Germany have approximately similar numbers of missiles. The Bundeswehr has 600 Taurus missiles, but only 150 are operational, the result of chronic underinvestment. Ukraine appeared very keen on those specific missiles. The strategic use of these missiles would be to damage Russian logistics. 

The CDU's defence spokesman, Roderich Kiesewetter, accused Scholz of not wanting Russia to lose. We, too, think that Scholz is playing a double-game, as he has been throughout the war. 

4 October 2023

Centre-right can no longer win

You see it in Spain, in Germany, in France, and now in the UK, too. The traditional centre-right party can no longer win elections from the centre. In Spain, the moderate Alberto Núñez Feijóo failed to form a government after a disappointing election. It is possible that the PP will be condemned for another term on the opposition benches, presumably not with Feijóo as leader. Isabel Díaz Ayuso, the populist-conservative head of the Madrid region, has been waiting patiently.

In France, the traditional centre-right has lost three presidential elections in a row, and its most realistic prospect is usurpation by Éric Zemmour's Reconquête, a national party that sits between Marine Le Pen and the traditional centre-right. Marion Maréchal is the party's lead candidate for the European elections, no doubt a trial run for something bigger. 

In Germany, Friedrich Merz is trying to take the CDU to the right, but does not dare to make the big move without which this cannot succeed: tearing down the firewall his party has erected against the far-right AfD. His party is not letting him. So far he has not shown a willingness to confront the still powerful Merkel-wing of the party. Three grand coalitions under Angela Merkel's leadership at the expense of an agenda created a void filled by the AfD, which is now polling steadily at over 20%. Polling numbers never add up neatly. But a back-of-the-envelope calculation tells us that these are the 20% the CDU has lost since Merz took over. 

The UK is similar but differs in one important respect: the first-past-the-post voting system condemned far-right parties to the political fringes. What happened instead is that far-right ideologies have become mainstream within the Conservative Party. The two most notable events at the party's conference this week have been the firebrand speech of the right-wing home secretary, Suella Braverman, and a speech by Liz Truss, who is now positioning herself as the leader of the right. Conservative Party members have not forgotten that she was ousted in a palace coup by MPs who installed Rishi Sunak in a process that conforms with constitutional law, but which the members themselves don't regard as democratic. If the Conservatives lose the next elections, Sunak will be gone. There is, politically, no point to him when he is not in power. Truss will still be there. And so will Braverman.

The political centre has a strong institutional hold on power. We saw during the Brexit wars that a genuine revolution of the right is hard to deliver, even if you have political majorities. The problem with the centre parties all over the western world is that they are getting electorally weaker. The Democrats and the Labour Party still manage to hold their coalitions together, though in Germany the centre-left split into classic social democrats and Greens. We may soon see more fragmentation with the arrival of an anti-metropolitan party of the left. 

So far, the most important shifts have happened on the right. Donald Trump's election in 2016 and the Brexit referendum in the same year were not the singularities centrist commentators hoped they would be. They marked the beginning of the end of a political era that started in the early 1990s - post-Thatcher, post-Reagan - that was dominated externally by globalisation and internally by social democracy. Bill Clinton and Tony Blair were the quintessential representatives of that era. Our era is characterised by two parallel bifurcations: the globalised world is splitting into a western and an eastern party. The centrist domestic policy consensus, as exemplified by centrist coalitions in continental Europe, is also giving way to the coalitions of the right. 

We see the deep reason in the political failure of globalisation. The story is long and complicated, but we always found Dani Rodrick's trilemma a good way to think about this. Globalisation, democracy and national sovereignty constitute an incompatible set. The political agenda of the new right is re-nationalisation and the return to the nation state. This is one way of resolving the trilemma. 

The other way is the method on which the EU is based: trying to add a democratic layer to European integration. That did not happen with globalisation as a whole. We see the EU method as the only logical counterpart to the position taken by the right. This is obviously not a united view in the centre-left, not even in the EU itself. However this turns out, any successful political constellation will have to avoid the trilemma. The centre-right does not shift further to the right. Where the centre-left is going is much less clear. 

3 October 2023

Bias - the bane of all forecasting

The Makridakis Open Forecasting Centre at the University of Cyprus has been running a fascinating forecasting competition between old and new world models for some years now. The interesting thing about these competitions is not really who wins, but what type of modelling approaches work best. The trend seems to favour modern neural networks. The latest competition was on stock market forecasting. The new world won hands down, with a couple of notable exceptions.  We wrote about this before, but today we would like to emphasise an important aspect. It is all about bias.

Kudos to everybody who took and who allowed themselves to be counted out in the full light of public scrutiny. We noted one entry from the financial forecasting team at Oracle, which used highly sophisticated statistical methods, and which did very well at one point but ended in some middle position in the end. Their method is very much premised on the idea that anything that happens today had been matched by previous episodes. Their method was to find those episodes that match our current situation the closest. In fairness, their approach is much more sophisticated than what we outlined, but it is ultimately an approach based on historic patterns.

The winning entry, by a young economics student from the Czech Republic, used an approach called meta learning: learning how to learn. This type of model does not know what it wants from the outset. It chooses its own models as more data come in. This is an important trend in forecasting because it addresses the single most important problem of all forecasting including some modern machine learning methods, that of forecasting bias. The belief in technical historic patterns constitutes a bias. So does the pre-determined choice of any specific modern machine learning method like specific types of neural networks. So does the assumption inherent in central bank forecasting models that the central bank can guide expectations through inflation targets and communications. This is why inflation forecasts always predict a return to the target. Central bank forecasting models are the ultimate bias-machines. They constitute an attempt to objectivise prejudices. New Keynesians do not only disagree with monetarists. They also produce different forecasts.

The reason why meta learning outperforms both of them is the lack of bias. We noted before that the ECB's forecasting is so terrible that it is outperformed by a pure random process, the proverbial monkey with a dart board. We would love to see an economic forecasting competition, but doubt very much that economic forecasters would want to enter a competition with non-economists. We also note a generalised absence of a critical review of economic forecasting performances. Years ago, we remember one independent review of the European Commission's economic forecast, commenting that it achieved the rare success, if you want to call it, of a correlation coefficient of exactly zero when measured against the future outcomes. The researcher noted it is quite rare for a model to be so bad that it hits zero precisely. 

A policy lesson from this is that you would do better if you closed down your forecasting department, and replaced it with one of the modern methods. What makes them superior is the lack of bias.

It also has been our observation that the successful investors we met did not have a better theory or better models, let alone access to exclusive information. Different methods yield different results for sure. What they had in common was an ability to take bias out of their own thinking, which is a rare skill. 

2 October 2023

Getting High Speed 2 wrong

The big political news story in the UK has moved on from how many bins the government was going to make people use for their recycling to weightier matters: what to do with High Speed 2. This debate has focused on whether the UK should even be building the rail line between London and the North and Midlands, and how much it should be building, which is strange since construction has already started. We think this misses the point. Instead, the real discussion is about why this project has become so expensive, and why, compared to European peers, it is so unambitious.

For the uninitiated, high-speed trains running at the level typical of, say, France’s TGV network cannot operate on most of the UK’s rail network. To change this, the idea was to connect London with Birmingham, Manchester, and Leeds, three of England’s biggest cities, using lines capable of accommodating TGV-speed trains. This would, so the theory goes, reduce journey times between these cities and London considerably, and free up more capacity on existing rail lines for regional services.

The first proposal for a system to do this, High Speed 2, came about in 2009. Since then, the project’s cost has ballooned, and the Leeds leg has been scrapped. It looks likely that the project will come in at over £100bn in its current form. The government could end up doing away with the Manchester leg, and the line may end up stopping in London’s outskirts, rather than the intended central London terminal of Euston.

However, even though the cost estimate has gone up, what’s received less attention is that High Speed 2 was always going to be much more expensive than European railways. Sam Dumitriu and Ben Hopkinson have pointed out that even at its 2013 cost estimate, it would have been 3.7 times the cost per mile of the LGV Sud Europe Atlantique, a recently constructed French TGV line connecting Tours and Bordeaux. This is not a problem that is isolated to trains: political indecision and the UK’s sclerotic planning process make almost all kinds of infrastructure very expensive compared to its peers.

We also think another possible problem for High Speed 2, both economically and politically, is that the entire scheme was not bold enough. One of the reasons why countries like France, Spain, and Japan can build high-speed rail so cheaply compared to the UK is that they do a lot of it. Extensions to these countries’ rail networks arrive every several years, allowing expertise to accumulate, lowering costs, and improving outcomes compared to the alternative.

There are also political benefits to this. One of the reasons why High Speed 2 has been so difficult has, frankly, been lobbying against it by those who would face disruption from it being built, but not receive any of the benefits. Integrating High Speed 2 into a much wider plan for a comprehensive network would have improved buy-in, creating more potential winners from a new network to counteract the losers. The government also probably should have spent the extra money it has put into disruption-reducing features on improving local transport and infrastructure instead.