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14 June 2022

Don't panic about the UK bill just yet

There is good news and bad news about Liz Truss's announcement of a bill that would allow ministers to override the Northern Ireland Protocol.

Let’s start with the bad news first. The bill is unilateral. It essentially pitches one single market against another, allowing companies to chose which regulatory regime they wish to follow. The bill would scrap checks on most goods trades between Britain and Northern Ireland. A dual regulatory scheme with green and red lanes would distinguish whether goods are destined for Northern Ireland or for exports to the EU. Disputes would be settled by independent arbitration, not the European Court of Justice. The bill also gives UK ministers the power to alter rates of VAT in Northern Ireland, something not allowed under the current agreement. Truss insists that the bill is legal as it acts out of necessity to preserve peace in Northern Ireland.

The good news is that there is still time for a compromise to be hammered out with the EU. The bill will have to pass the House of Commons and the Lords, which is expected to take at least a year. And the bill itself is not the hard version, in the sense that ministers would still have to set out regulations to bring the new rules into effect. This all buys time to find a solution. As we keep on saying, this is a high drama written by the Tories to keep Brexiteers happy. This is politics and the legal dispute is used to its effect.

How will this play out in Northern Ireland itself? The DUP welcomed the announcement, but only cautiously. They came up with seven criteria against which they will evaluate whether the measures are enough for them to return to power-sharing. We ourselves have to digest what is in the bill on a more granular level. But politics plays its role here too. The DUP has no desire to be part of a government in which Sinn Fein gets the job of first minister, and the protocol gives them a fig leaf to stay out. But a majority of members of the Northern Ireland Assembly, the region's devolved parliament, wrote to London expressing their strong objections to the bill, according to the Times.

If negotiations were to continue, exemptions and solutions could materialise if both sides were to find a way forward. A compromise between Truss’s green lanes and the EU’s express lanes should clearly be on the cards. The legal jurisdiction is more problematic but not impossible either, according to Tony Connelly.

What will the EU do? The Irish foreign minister warned Truss in their phone call against a breach of contract and mutual trust whilst creating more uncertainty. The EU may decide tomorrow whether or not to resume its infringement proceedings against Britain for breaching the terms of the Brexit agreement. But firm actions will be unlikely until the bill becomes law.

13 June 2022

Passerelle vs Escher's stairs

A passerelle is French for bridge: not a normal bridge, but more like a footbridge or a gangplank placed between two boats. It is the essential issue in the debate on constitutional reform in the EU. In the language of European constitutional debate, the passerelle constitutes a device that allows the European Council to shift towards qualified majority voting, one step at a time. This device exists already, but in a form that is entirely useless. It requires unanimity by everybody to get rid of unanimity. In addition, it is subject to the veto of national parliaments. The Dutch graphic artist M.C. Escher would have had his fun with the European Union, an endless source of inspiration for the absurd and the impossible. Here below is one of Escher's famous staircases, which we see as accurate renditions of the EU decision-making process right now.

English-language commentators have a tendency to dismiss the case for constitutional reform. They call themselves pragmatists. With the UK out, Denmark is the leader of that group. But as non-members of the euro area, Denmark and Sweden are ultimately not in position to block anything that would lead to their isolation. We believe that fixing that dysfunctional staircase, or footbridge, is absolutely essential, especially for its most dysfunctional part, the euro area. It is no accident that the countries most opposed to constitutional reform are also not in the euro area.

As Andrew Duff reminds us in his latest essay, the passerelle is the main issue. The goal of constitutional reform would be to lower the passerelle threshold. This sounds relatively modest, but would be highly effective. His proposal is to reform Art. 48(7) TEU, which lays out the current (impossible) requirements for the passerelle to be triggered. Duff makes three proposals: the first is to replace the unanimity requirement for a trigger of the passerelle towards super-QMV. This means that the motion would be approved if at least 20 member states accounting for 65% of the EU’s population approve. Second, the national parliaments can still object, but would have to do so collectively. Right now each one of them has a veto. Third, the passerelle would be opened to policy areas that are specifically excluded: the EU’s own resources, the EU’s budget, the general flexibility clause as laid out in Art. 352 TFEU and Art. 354 TFEU, and the rule of law mechanism. We are more sceptical on the desirability and usefulness of the rule of law procedure. We can see why it would be highly effective in a situation where no country has a national veto. 

The Council is due to decide at its next meeting June 23 and 24 whether to reopen the treaties and set up a constitutional convention. It would only take a simple majority to do this. But treaty change still requires unanimity. So the path towards the end of the national veto is still subject to the national veto. Escher would have had this fun with this.

This is the ratchet theory of European integration. Once a passerelle is triggered, it cannot be revoked. This would allow European integration to move forward one spike of the wheel at a time. This will take time and could, in the long run, produce fragmentation. But that, too, would be a feature, not a bug.

10 June 2022

Learnt nothing, forgot nothing: Boris edition

The UK Conservative party’s own catch-22 is housing. Falling rates of homeownership among younger voters pose an existential challenge to the fortunes of a party that’s identified itself with owning since Margaret Thatcher’s time. But addressing this probably means slowing down the pace of house price growth, which risks alienating its current base of elderly voters who are likely to own their homes outright.

Rather than meeting this challenge face-on, Boris Johnson’s first major policy announcement since he survived the no-confidence vote earlier this week tries to sidestep it. The core of Johnson’s policy is boosting the ability of buyers to afford a home by allowing for housing benefits to be put towards mortgages. Johnson has also said that he wants to extend a scheme called right-to-buy, one of Thatcher’s flagship policy initiatives, to housing associations, a form of non-commercial housing provision.

This fits with our own prediction that Johnson would lean into a Thatcherite tack to hang onto his premiership, and the plans could win him support from MPs of similar convictions. Extending right-to-buy will be especially popular among his base, fitting a Conservative self-image of helping ambitious households help themselves. Johnson also sought to counter suggestions that the policy could lead to affordable housing stock diminishing by saying that houses sold under the scheme would be replaced one-for-one with new ones.

Being able to translate this short-term political gain into a longer-term solution to the Conservatives’ dilemma is less likely. First off, how many people the scheme will actually help is questionable. To put down a deposit for a new home, buyers would need savings. To get an affordable mortgage, these savings could exceed the £16,000 maximum threshold for housing benefit eligibility. Housing associations and mortgage lenders would also need to agree to the government’s plans, which is far from certain.

More seriously, the government’s plans do nothing concrete to address the overwhelming challenge to expanding homeownership in the UK: a lack of new housing supply. The government’s own housing target, set out in the 2019 Conservative manifesto, is to build 300,000 new homes a year. The House of Commons library’s research suggests this target should potentially be higher, at 340,000 a year.

But even the 2019 target hasn’t been met so far. At its peak, in 2019-20, 243,000 homes were built per year. Thanks to pandemic-related disruption, 216,000 were built in 2020-21. The government tried to clear obstacles from the UK’s planning system in 2020. After bruising by-election defeats in which the Liberal Democrats leveraged opposition to these reforms, they were quietly put on hold.

Try as he might, Johnson will not be able to escape the fundamental problem bedevilling UK housing. Homeownership among younger voters is declining because affordability is worsening. From 1997 to 2020, the UK’s average house price as a proportion of average annual earnings went from 350% to 720%. Last year, it jumped further, to 910%. Fewer people are buying homes because it is substantially harder to buy one.

The homeownership situation will not improve until affordability cools, unless the government is willing to subsidise home-buying at increasingly eye-watering rates. But to do that, house price growth compared to earnings growth will have to slow down, stop, or even reverse. That would provoke a revolt from Tory constituencies.  

9 June 2022

NI protocol bill to cheer Brexiteers?

Unsurprisingly, Boris Johnson is using the NI protocol as a payout for loyalty amongst Tory Brexiteer hardliners. After Monday’s confidence vote Johnson agreed to harden the bill that would include new provisions to override the withdrawal agreement. This hard version of the bill is causing already a counter-rebellion from some Tories who do not want to back a breach of international law. The harder the bill gets, the more perilous is its journey through the House of Commons and the House of Lords.

The Times reported that the legislation had undergone substantial redrafting after the confidence vote in an attempt to allay concerns of the Tory right. In a meeting with Liz Truss and a hardline Brexit Tory MP from the Eurosceptic European Research Group of MPs, Boris Johnson apparently agreed to changes that the cabinet was not consulted about. In discussions on Wednesday, senior ministers then rejected the demands from the ERG and sent the copy back to the foreign ministry for redrafting. Civil servants are also unhappy about this highly unusual procedure of consulting with a non-minister on the drafting of a bill.

One demand from the ERG was a new clause to make it clear that the legislation has primacy in UK law over the Brexit withdrawal agreement, which includes the NI protocol. They also wanted the bill to explicitly bring to an end the jurisdiction of the European Court of Justice in Northern Ireland, and include a sunset clause after which EU regulations would no longer apply in the region. These provisions would have ended all pretence that the bill was in line with international law.

Politics in Northern Ireland, meanwhile, will remain in deadlock. Whether London can unlock this for good is also not clear. The institutional setup with its mandatory power sharing rules, and the fact that 80% of the voters voted for either a pro-UK or a pro-Ireland party, suggests that as long as a border poll is a possibility, both sides will have their identities clearly defined. The Protocol just happened to bring those differences out. But economically, Northern Ireland fared rather well under the current version of the Protocol, as this graph in the FT suggests.

Apart from London, Northern Ireland is the only other region to register growth in the first quarter this year, compared to the pre-pandemic Q4 in 2019. This new graph has been much commented about on Twitter. But we also know that politics creates narratives that can remain alive despite facts that suggest otherwise.

8 June 2022

Time to focus on what Johnson will do

Here is a pro-tip for anybody who engages in the art of political forecasting. If you feel strongly about a person, or an issue, recuse yourself. The reason UK political hacks keep on predicting Boris Johnson’s demise is personal. Some have worked with him, and have seen him break all the rules of journalism, like making up quotes and stories. And now, he is prime minister, whereas they are still where they were 30 years ago: in the antechambers of power, waiting for some official to drop information into their laps to give them something to write about. What shall not be that cannot be.

As we emerge from another apparently exciting week of British politics, we realise that virtually all the forecasts were wrong. Johnson is still the prime minister, and will remain in office. The margin of his victory is irrelevant. The rebels had their chance. It’s over.

The right question to ask at this point is what will he do? Our base case scenario for the UK is an election in the spring or autumn of 2023. The UK is unique in that the government has the ability to call an election, an expression that you would struggle to translate into German or French. The concept does not exist there. If you keep pushing the date to the last minute, as prime ministers did in 1979, 1998, and 2010, you are losing the all-important first-mover advantage. The year 2015 was a notable exception. Thatcher and Tony Blair always called it early.

We see the only path for Johnson to have a fighting chance to win the next elections is the Thatcherite one. Not so much because it is the right one economically. But because tax cuts can be enacted immediately to maximum political effect. Supply-side reforms, like an increase in housing supply, work over longer periods. They can be part of your agenda, but they don’t win you elections.

There is rising pressure within the Conservative Party for a reversal of tax increases, including the yet-to-be-enacted rise in corporation tax, and the already-enacted increase in national insurance premiums for both workers and companies. Johnson’s biggest challenge does not come from the likes of the European Research Group, but from the Thatcherite wing. Their most outspoken representative is Lord Frost, of Brexit fame, who is preparing to give up his title and seat in the House of Lords to enter the House of Commons through a by-election. That may not even be possible. 

Frost’s importance at this point is not so much as an active politician, let alone leadership challenger, but as an agenda setter. Frost is right in his analysis that tax cuts are critical to the Conservative Party’s electoral prospects. The rise in National Insurance contributions is hitting the working poor particularly hard. Businesses will suffer from the soon-to-be-enacted rise in corporation tax. If you are in power, trailing in the polls, and have one year to make an impact until you face the electorate, the reversal of tax increases would seem a rational thing to do.

The UK government did more than others in Europe to insulate the poorest households from the impact of the price rises. This is the stuff that wins or loses elections. Not Downing Street parties, a misdemeanour that will soon be forgotten. The real lesson from history is not that narrow victory margins in a leadership contest are predictors of a leader's demise, but that in the privacy of the polling booth, voters are focused on their cold self-interest.

7 June 2022

Losing the gas tug-of-war

European natural gas buyers might have said a lot about their desire to diversify from Russia, but so far their actions have not quite matched their rhetoric. There’s been a significant contrast between Asian competitors’ appetites to sign new gas deals and Europe’s sluggishness at coming to long-term contracts. That could spell trouble if European countries jump, or are pushed, into a move away from Russian gas.

China has so far signed nine different long-term deals for liquefied natural gas with American suppliers over the course of this year. The most recent, between China Gas and Energy Transfer, was inked earlier this week for 0.9 bn cubic metres per year of LNG for 25 years. Chinese buyers have also signed several major deals with Qatar in the last few years, ahead of a significant expansion project coming online in 2025.

By comparison, Germany, the EU’s biggest buyer of natural gas, only signed their first new US deal in the year a couple of weeks ago. German buyers are also still wrangling with Qatar over contract length and pricing mechanisms, which Chinese buyers are more flexible over.

They also aren’t Europe’s only competitors in the competition for potentially limited supplies of LNG in coming years. India’s also looking to expand its share of the pie, and Narendra Modi has set a goal of more than doubling natural gas’s proportion of the country’s energy mix, from 6.7% to 15%. Petronet, an Indian buyer, is looking to extend and increase volumes on a 9.6bn cubic metres per year deal with the Qataris that is set to run out in 2028, though it wants a lower oil-index price.

This activity matters because of the medium-term picture that the world’s LNG buyers are facing. By 2025, according to Credit Suisse’s projections the world could be looking at a shortfall of more than 125bn cubic metres, which is more than Germany’s annual consumption of gas. In a market where most supply is bought and sold according to longer-term contracts, being late to sign deals is a problem for security of supply.

There are several explanations for European intransigence over deal-making. The most charitable is that the longer end of long-term contracts, like the China Gas-Energy Transfer one, are incompatible with the EU’s climate goals. In support of those goals, the European Commission proposed banning long-term contracts with a term length running beyond 2049, which would forbid signing 25-year deals beyond 2024.

Another is that gas buyers are banking on Russian gas still being readily available, despite governments’ pledges to phase it out. If this is their calculus, and they believe things can go back to normal with Russia, why sign a contract on unfavourable terms?

Banking on a return to the status quo with Russia does, however, seem like a bold move. Regulators and shareholders have received a rather nasty wake-up call with the war in Ukraine. They are well aware of the undesirability of Vladimir Putin being able to cause a European recession at will. Europe’s gas buyers, and those who hold them to account, have been excessively naive about this reality. Will they continue to be?

6 June 2022

On the diplomacy of humiliation

Emmanuel Macron got a lot of people upset when he said we should not humiliate Vladimir Putin. We know, of course, that this is the French policy. More importantly, it is the Franco-German policy, and therefore it will end up as the EU’s policy as well. We should therefore look at this policy more closely.

Macron is right, of course, that in the end there will have to be a diplomatic settlement. What he should have made clearer is how this will reflect the military situation on the ground. The outcome of this war is still uncertain. The war shows no signs of ending. Since the west is not willing to engage directly with Russia, wisely in our view, we have to keep an open mind about different military scenarios. There will be a time for diplomacy. But that time is not now.

Macron is wrong to phrase his comments the way he did. He caused offence with the innuendo that Putin’s humiliation is caused by the west, as opposed to his own bungled military strategy. A more subtle point would have been this: Since we have no way of ascertaining whether Putin will be removed from power, we have to base our own planning on the assumption that he will stay. You are more likely to get a peace deal with somebody who has political room for manoeuvre than with somebody who is hanging on to power by their fingernails.

Just as it is unwise for a butcher to reveal what goes into a sausage, diplomats should also keep their dark arts under wrap. Stuff gets said during negotiations that would not hold up to the moralising scrutiny of hyperventilating academics, or idle journalists.

What needs to happen, however, is for a degree of realism to return. The west cannot, and will not, maintain its current level of support for Ukraine indefinitely. Politics is intruding in all countries. In Germany, the balance of public opinion is narrowly in favour of sending heavy weapons to Ukraine, but within the SPD, the balance is against. In France, too, there is a strong body of public opinion against interference in the war.

Our big worry is that this will leave the EU even more divided than during the Iraq war. Diplomacy will have to deal with that problem as well. Remember old and new Europe? Italy, these days, is closer to France and Germany than to the UK. The division is not so much centre-versus-periphery, as it was then, but on Europe’s most vulnerable fault line, between east and west. We struggle to recall the sheer degree of east European anger directed at Germany. The Germans have grown a thicker skin over the years, but this anger cannot be simply shrugged off, as the official policy seems to be. If the war were to end with a Russian annexation of the Donbas, expect to see a lot of anti-German sentiment emerging.

Scholz's strategy is a little different from Macron. He says one thing, and does another. In the process, he simply revealed himself as a dishonest operator. Between the two, Macron’s discourse is the more honest one. He may want to choose more succinct words.

1 June 2022

ADHD: European edition

The German political economist Benjamin Braun made an astute observation about the editorial line of a German newspaper. In fact, it is an observation about the German policy consensus forever.

“Eurobond? Never, it’ll kill us all. Eurobomb? Bring it on.”

We find it incomprehensible that the EU is now discussing yet another field of political integration when the big task it set itself 20 years ago is incomplete. This is a polite expression. You can call the monetary and economic union dysfunctional, as we often do. It is plagued by still-widening imbalances. Integration of banking has been going in reverse direction. Banking supervision is working. But the bank resolution regime is a joke. The debate on deposit insurance is stuck. And the impetus for a capital markets union is lost. This is a first-order policy failure.

Instead, we are now discussing a security and defence union, yet another opportunity for our attention-deficit, hyperactive disorder-afflicted policy makers to pretend that they are pro-European. If you can’t do a proper economic union, you should stop right there, and fix the problem. Otherwise you end up with a dysfunctional economic union, an ineffective foreign policy regime, and an army that can't fight. At that point, even reasonable people will conclude that European integration is a bad idea. But this is only so because we have lost all sense of focus.

We cannot emphasise enough the future of the EU will depend primarily on boring economic matters like innovation and the capital markets union. The EU will require a eurobond: a real one, not a recovery fund that is ultimately backstopped by national governments. The purpose of a real eurobond is to stabilise an unstable monetary union. It is not to fund structural reforms in member states. There are foreseeable fintech innovations that will upend power structures in global banking, and that requires banking reforms and a capital markets union for Europe to participate fully. That, and climate change, is what the EU needs to focus on. And for that to happen, it needs treaty change.

But this is not going to happen. The treaty change discussions are all about secondary issues, like who gets to do what in Brussels. The Russia sanctions are turning into the political disaster we expected from the outset. This is not about the lack of qualified majority voting, but the fact that we allow countries like Germany to pursue national economic strategies at the expense of the union. That is where we would need to start. The fact that this is not happening is telling us that we are now entering a twilight zone of reverse integration, coupled with a sense that we are still moving forward because we are not paying attention.

31 May 2022

Cyprus without Russians?

Russians are part of Cypriot life, and its business model. The small and sunny island’s banking system, as well as the golden visas Cyprus offered until 2020, attracted an influx of Russian people and money, and with them new businesses and services. The war and Western sanctions is now threatening this model. There is already an exodus of Russian-only services, some Russian assets have gotten frozen, and business relations with Russia have been cut off. This is not the end of business though. Cypriots have become quite inventive, and they've found ways to keep business going with sanctions in place, as a feature in Politico suggests.

The government’s decision to back sanctions against Russia was uncontroversial. But depending on how far sanctions could go and how long the war lasts, it may deliver a substantial blow to the economy.

Already the uncertainty surrounding the current sanctions and the potential threat of an outright ban on business and services with Russians is influencing business decisions. Some consider leaving to non-EU countries if the situation remains like this for the coming months. Others abort or put on hold investment plans in Cyprus. The rupture of the war is visible in the unfinished construction sites in Limassol, where 50,000 of the city's 235,000 inhabitants are Russians. To cut ties with everything Russian would be foolish and impossible.

Accountants and lawyers are seeking clarifications about how current sanctions apply in exact terms and to which companies, according to Politico. They want the EU to allow Russians to pay their debts to Cypriot companies at least. Would sanctions go so far to prohibit any legal or auditing service to Russians living in Cyprus? A ban based on nationality would constitute racist discrimination, while the real problem is more the dubious nature of the business.

Historically, Cyprus had less of a problem with Russia than it has with a Nato member, Turkey. Will Turkey pressure Nato into accepting a two-state solution for the island as a bargaining chip for accepting Finland and Sweden into Nato, as Ahwal alluded to? Its territorial integrity has been challenged by Turkey for decades.

Cyprus did not hesitate to back first sanctions against Russia. But their backing may be less assured in the future if they are caught in a tight spot.

30 May 2022

An inch of Brexit

There was always more than one version of Brexit, which is one of the reasons why the whole political process was so divisive. There is the version of a global entrepreneurial Britain, the one that would have used regulatory freedom to its commercial advantages, at the expense of a loss of existing trade relations. That version would have started with reforms of an out-of-date education system, and would have focused on targeted deregulation. That would have been the Brexit of the entrepreneurs.

And then there is the Brexit the UK is actually getting, the Brexit of the inches and the gallons. Boris Johnson said that as part of this week’s Jubilee celebrations, it will become legal for shopkeepers to revert to ounces and pounds. The latter is not to be confused with the continental pound measure, which denotes a half-kilo. The imperial pound is 454g. The ounce is 28.3g. There is nothing confusing about inches and pounds, except when you are coming from the metric system.

We ourselves have no strong views on the imperial system. Anyone who ever lived in the US knows that it is confusing to continental European minds, but that you get used to it eventually. No system is intrinsically superior or inferior. Imperial measures are still widely used at sea, and cause confusion to some continental seafarers, who switch between nautical miles on the sea, and kilometres back at home. The problem arises only if you try to transit from one to the other. Over a period of 50 years, the UK will have gone through this process twice.

Or will they?

We doubt that many shopkeepers will re-denominate their weights, if only because most shopkeepers no longer measure anything. Maybe manufacturers see an opportunity by reducing a package size from 500g to 454g as a way to pass on a hidden 10% price increase. But we doubt that most food manufacturers would want to take the risk. Competition should be between brands and shops, not between measurement systems.

What this episode is telling us is that the UK is wasting all the opportunities of Brexit, but is still paying all the costs. The reintroduction of imperial measures constitute an act of pure Brexit populism. Brexit is about the colour of passports, the number plates, and the pounds and the inches. 

If a policy or a regime has no substance, it becomes reversible.