Cold comfort budget

Budget Day is a lot less exciting than it was under George Osborne. Gone are the 31 percent cuts to day-to-day public service spending and the incredulous response from, well, anyone who knew anything about public spending. Gone too are the confident assertions that the total elimination of the public deficit could be achieved in four years. No more insistence that the deficit could be cut at the same time as taxes without damaging public services. No more ‘Back to the 1930s‘.

The most interesting thing that happened yesterday was the publication of the Office for Budget Responsibility’s economic and fiscal outlook. As expected, this downgraded the GDP forecast from poor to utterly dire.

Even by the standards of recent years this is bad. It’s the first time that the OBR’s GDP forecast has been under 2 percent for every year. Half a decade of per capita GDP growth at less than 1 percent would be unprecedented in the post-war period.

So what has caused this downgrade?

Mostly the OBR’s re-evaluation of the UK’s productivity prospects. After years of expecting productivity to recover from its post-recession shock, the OBR has concluded that the UK’s low productivity may be set in for some time.

The report comments:

As the remarkable period of post-crisis weakness extends – and as various explanations pointing to a temporary slowdown become less compelling – it seems sensible to place more weight on recent trends as a guide to the next few years. But huge uncertainty remains around the diagnosis for recent weakness and the prognosis for the future. We have assumed that productivity growth will pick up a little, but remain significantly lower than its pre-crisis trend rate throughout the next five years.

Now it’s worth noting here that the OBR hasn’t written off productivity growth completely; it just thinks that the growth, when it comes, won’t be as strong as previous forecasts indicated. Should productivity growth disappoint even against this modest expectation and continue to bump along at the post crisis average, then we are looking at an even lower growth forecast but let’s not go there for the time being!

The upshot of all this is that the deficit reduction target has been kicked down the road. With forecasts like these even George Osborne couldn’t have brazened it out. A mere 19 months after George’s final budget, no-one is talking about eliminating the deficit in the near future. 

Chart by Resolution Foundation

As Torsten Bell said, this implies the acceptance of public debt remaining at around 80 percent of GDP. On current trends, it will be 2031 before the public finances are in surplus again. The bogeyman of public debt, on which two elections were won and lost, has disappeared over the horizon.

 

Does this mean that austerity is over then?

At first glance it might look that way. The government plans a 33 percent increase in per capita capital spending over the rest of this forecast period. It is also easing off slightly on the cuts to day-to-day public service spending (RDEL).


Look a little more closely though and much of this is accounted for by an extra £3bn for the NHS and an extra £3bn to prepare for Brexit.

Of the scorecard RDEL measures, the largest increases relate to 2018-19 and 2019-20, where a cumulative £3 billion has been allocated to Brexit preparation and another £3 billion for the NHS. The 2019-20 ‘efficiency review’ announced in Budget 2016 has also been scaled back. These measures explain most of the total increase in RDEL spending in those years.

In other words, there isn’t much to ease the pressure on other government and local authority services.

On social security there is also a slight easing, for example, removing the waiting time for Universal Credit but, as the Resolution Foundation says, the impact of this is dwarfed by the policies of the 2015 budget.

Figure 28 shows how the overall impact of measures announced before Autumn Statement 2016 are set to be far greater than the impact of those announced since. When it comes to tax and benefit policy George Osborne is basically still the Chancellor. These earlier policy announcements are set to leave the poorest third of households an average of £795 a year worse off, barely offset by a total mean gain of £75 a year in scal events since (including £35 a year from yesterday’s Budget). That compares to a mean gain of £210 a year for the richest third of households pre-Autumn 2016 and a net mean loss of £25 a year in measures announced since.

To sum up, then, the deficit elimination target has been kicked so far into the future as to be meaningless but the pain associated with it continues. The economy is so weak that we must keep borrowing and still keep cutting. The public debt is likely to stay where it is, relative to GDP, for some time.

Of course, the OBR could be wrong. Having been over-optimistic in the past it might be over-pessimistic now. That said, if the OBR has under-estimated the impact of Brexit on trade, productivity and public finances, things might be that much worse. When the economy is about to experience a shock, even the OBR’s modest productivity predictions look a tad optimistic.

I remember in 2011, people I know in the public sector talking about things ‘getting back to normal’. In other words, they expected a short, sharp shock of austerity and budget cuts followed by a return to business as usual in a slightly slimmed down organisation. They are not saying that now. Here we are six years on and things are looking as grim as ever. We are told we are on the way to sunlit uplands but when we get there, I fear the light will be cold and glittering.

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Dave, Boz and Lee’s Global Adventure

Dave, Boz and Lee are three relatively well-off brothers. Every year they like to spend a few weeks living it up at the 7-star Resort Europa. They have been going for years and all the staff know them well. They are sometimes a little badly behaved and have, on occasions, been quite rude. However, they are among the resort’s highest spending customers, which tends to mitigate any bad feeling their eccentric antics might cause.

This year, though, things have been worse than usual. Dave has been muttering about what a dump the place is and Lee has been telling everyone he could get a better deal at any one of dozens of other posh resorts. Boz has been especially rude, telling racist jokes and making up offensive ditties about the staff. It all came to a head this morning when the three brothers decided they were leaving. They wrote a terse note to Donald, the resort manager, then they packed their bags and walked out.

“But gentlemen, you have not paid your bill,” cried the receptionist as the lads walked out of the lobby.

“Whistle for it!” replied Boz as he flicked a v-sign.

But once outside, the boys had a bit of a surprise.

“I say,” said Boz, “it’s a bit parky out here.”

The boys had been so absorbed in the delights of the resort that they hadn’t realised the temperature had dropped considerably since they arrived and was now hovering somewhere just above zero.

“Let’s get ourselves a cab to the airport pronto. Who’s got the tickets?”

“I thought you’d got them,” said Dave.

“So did I,” said Lee.

“Sooo, you didn’t book the flight back Boz?” asked Dave.

“Well, ah, right, hmm. A minor problem. Look, we can just call the airport and book flights. I mean, how hard can it be to get a flight out of here?”

“I’ll get on it,” said Lee.

One hour later, Lee was looking a bit sheepish.

“Actually, this is turning out to be a bit more difficult than I thought. I spoke to some bloke called Roberto who said that it’s not that easy to arrange flights from here on the spur of the moment. He told me that usually people plan for these things well in advance and getting a flight out of here could take weeks.”

“Typical unimaginative and inflexible bureaucrat,” grunted Boz. “Oh well, let’s go and stay at one of those other places you were talking to.”

“Well I haven’t actually sorted any of them out yet….”

“Stuff this,” said Dave, “I’m not standing freezing to death out here. I could do with a drink. Let’s go back inside.”

“Yes, I fancy some cake,” said Boz.

“And I could do with a massage,” said Lee. “Holding that phone to my ear for an hour has given me a stiff neck. I think I’ll head for the health spa.”

The trio marched back into the hotel.

“Bloody door won’t open,” fumed Boz, as he waved his key card over the security pad.

“Neither will mine,” muttered Dave”

“I say, you,” shouted Boz as he grabbed one of the staff. “Why won’t my key card work?”

The concierge examined it with his hand-held device. “It appears you have checked out, Sir. The card won’t work once you have checked out.”

“But we only want to pop in for a drink and some cake. And we have spent a lot of money here over the past few weeks.”

“You can’t use the hotel facilities once you have checked out,” replied the concierge.

“More bloody red tape! Do you want our money or not? It’s no wonder this place is going down the pan when you turn away people who are trying to buy stuff from you.”

“Look, this is getting us nowhere. Let’s go and sort it out at reception,” said Dave.

“Bugger,” muttered Boz, “they’ve got Michel the head receptionist on the desk and he’s a right miserable sod.”

“Hi Michel,” said Dave , “we’ve got a bit of a problem. We’d like to grab a quick drink and something to eat but we can’t get in because our cards don’t seem work.”

“But you have checked out,” said Michel. “That’s why your keys won’t work.”

“Yes but we only want to pop to the bar and restaurant,” said Dave.

“Do you now want to check back in again? If you do, it would help if you paid your bill as well,” said Michel.

“Typical inflexible and unimaginative jobsworth,” shouted Boz, “Look, do you want our money or not?”

“Of course, you are good customers, replied Michel, “but the normal practice is to pay your bill.”

“Normal practice,” scoffed Boz. “You don’t conquer empires by going on about normal practice.”

“But I’m not trying to conquer anybody,” replied a bemused Michel, “I just want you to pay your bill.”

“Over there!” shouted Boz. “Dieter the barman will make you see sense. We spend so much with him, he’ll tell you to let us back in. Hey, Dieter. DIETER! We want a drink. Tell this idiot to let us through this bloody door.”

Safe behind reinforced glass, Dieter studiously ignored the commotion in reception and carried on rearranging his bottles.

“Hey Dieter, you big fat sauerkraut-munching wankerer. Do you want to keep selling us that premium German lager or what? Do you want the bar tips to keep coming? You know you need us more than we need you. Tell Michel to let us in.”

Dieter seemed to have gone deaf.

“OK, what about Carlo, the restaurant manager? Hey Carlo, do you want us to keep buying your grub and all that prosecco we’ve been throwing down our necks? Come on, you need our money. Tell jobsworth Michel here to let us in.”

Carlo hunched his shoulders and concentrated hard on laying the tables.

“They’ll soon come round when they see their profits walking out the door,” muttered Boz.

“OK, here’s a suggestion,” said Dave. “We’ll check back in for another week or so at the full whack. How does that sound?”

“But it is normal to pay when you stay somewhere,” said Michel. “Paying for next week doesn’t get you out of paying for the last six.”

“OK then, just let us in for the next few hours for a drink and something to eat. Oh and a massage. Come on. You know you want our money.”

“It is true that you have been good customers,” said Michel, “but you chose to check out. Use of the resort facilities is restricted to paying guests. If we let people in off the streets, we would no longer be an exclusive hotel. We would simply be running pay-as-you-go bars and restaurants. The whole point of Resort Europa is exclusivity. That is what you have been paying for all these years. If we offered everyone the exact same benefits as those who pay, our brand and business model would be destroyed.”

“You can take your business model and shove it up…”

“OK, Boz, let me deal with this,” said Dave.

But Boz was on a roll, “Inflexible sclerotic bureaucrats! I’ve spoken to Mummy and she’s going to go over the heads of these suited nonentities and talk to the owners. That’ll sort them out.”

An hour later, though, the news wasn’t good…,

“Oh FFS!” said Boz, “I’ve just had a note from Mummy. She’s spoken to the owners and she thinks we will probably have to pay at least some of our bill.”

“And I’ve had a text from Uncle Phil,” said Dave. “He thinks we should pay up too.”

“Well Uncle Phil always was a boring old fart,” snorted Boz.

“Look chaps,” said Lee, “There are 60 hotels queuing up for our custom. I’ll ring round and see what deals I can do.”

“60? I thought you said 42,” replied Dave.

“60, 42, whatever,” said Lee. “Just leave it with me.”

Two hours later…..

“Well this is all a bit bloody strange,” said Lee. “I can’t get through to anybody. I’ve left messages but no-one is getting back to me. Must be these dodgy foreign phone systems.”

“What about the Orange Man at the Stars and Stripes?” asked Boz. “He always said he’d do us a good deal.”

“The Orange Man is behaving really oddly. One minute he loves us and the next he’s calling us names and telling us he’s going to increase the price by 220 percent.”

“But Mummy held his hand and everything,” said Boz.

“Excuse me gentlemen,” said Michel, “I am trying to be as flexible as possible here but you can’t hang around in the hotel lobby forever. You have checked out so you must make preparations to move on. Sooner or later I’m going to have to insist that you leave. The clock is ticking.”

“Well bugger you!” said Boz. “Come on chaps. When it comes to this dump, no deal is better than a bad deal. We’re out of here.”

“OK, so what now?” said Dave, as the cold late afternoon air sliced through his thin jacket. “It will be dark soon and we’ll freeze our nuts off if we don’t sort something out.”

“I’ll get on the phone to the other resorts,” said Lee. “There will be loads of deals on offer.”

Another hour went by and, with the sun sinking, the boys were running out of time.

“Still can’t get through to anyone,” said Lee. “It’s either straight to voicemail or I’m put on hold for ages. CAn’t understand it.”

“Well we need to think of something. It will be dark soon,” said Dave.

Just then, three SUVs with blacked-out windows pulled up across the road. Seven Chinese men in identical dark suits got out and began walking towards the lads.

“Wait a minute. I know him,” said Boz, pointing to the group’s leader. “Hi, Mr Xi! Remember me? We met at a conference in London.”

“Of course,” said Mr Xi, as he shook hands with Boz. “An interesting few days and a visit to one of your excellent English pubs with your boss, as I remember.”

“That’s it. And a spiffing banquet,” said Boz.

Mr Xi glanced at the boys’ cases. “Are you moving on somewhere?”

“Fancied a change of scene,” said Boz. “There are much better places than this one on offer.”

“So where are you headed?” asked Mr Xi.

“Oh, not sure yet, but there are plenty of sunlit uplands out there,” said Boz.

“Cut the bullshit, boys,” said Mr Xi. “It’s all over town. You’ve had a row with the Europa, done a runner and now no-one will do business with you. As I see it, you’re in a bit of a hole.”

“Well I don’t think that’s quite fair…” began Boz.

“Save it!” said Mr Xi. “I haven’t got time for this. Look, why don’t you stay at my place. It’s an up-and-coming hotel called the New Han Empire.”

“The New Han Empire, eh? Sounds swanky,” said Boz.

“Wait a minute,” said Dave, “I read a review of that place. ‘A gulag that treats its staff and guests like peasants’ was the verdict.”

Mr Xi bristled. “I find the term gulag highly offensive. OK, I had to lean on a few people for the star-rating but we hosted a very successful international sporting event recently. We had our conference a few weeks ago and I asked repeatedly if there were any complaints. There were none. Not a single one. You should not believe everything you read in your western guide books.”

“Look lads, why don’t we stay at Mr Xi’s place until I can get some of these other deals sorted out,” said Lee.

“Ah, those ‘other deals’,” chuckled Mr Xi. “Good luck with that.”

“OK. How much?” asked Dave.

“There’s no point in asking,” said Mr Xi. “You can’t afford it. Your reputation has spread and no-one out here will offer you banking facilities or extend you credit. You will pay your way by working for me. You are all fairly well-connected so you can help me build my global business empire. I may also have some other little jobs and errands I need doing.”

“What sort of jobs and errands,” asked Boz.

“That’s for me to say and you to do,” snapped Mr Xi. “In any case, I don’t see that you have much choice. You can either get in the car and come with me our freeze to death out here. What is the English saying? Ah yes. Beggers can’t be choosers. It’s your call.”

 

And there, dear readers, we must leave it, with our heroes on a cliff edge. Will Michel and the Resort Europa relent and let the boys back in? Will Lee’s deals come off in the nick of time? Will the boys freeze in the cold night air? Or will they throw themselves on the tender mercies of Mr Xi and the New Han Empire?

Watch this space for the next exciting instalment of Dave, Boz and Lee’s Global Adventure.

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1.5% growth is the economy’s speed limit

There was a good discussion on the Bank of England’s interest rate rise on the World at One yesterday. (It’s here at around 34 minutes in.)

Duncan Weldon explained that the interest rate rise was driven by pessimism, not optimism. The Bank has taken its foot off the pedal not because the economy is speeding ahead but because, even at the slow speed it is chugging along at, it is already starting to shake. Jajit Chadha also used a car analogy, explaining that the Bank can only use the brake and the accelerator but can’t do much about the problems with the engine.

The Bank of England was already on board with the motoring explainer, declaring that the economy’s speed limit is now GDP growth of 1.5 percent per year, way below its pre-crisis trend. The Bank believes that there is very little spare capacity in the economy.

 

The clapped out engine, of course, is the economy’s chronic productivity problem. This, says the Bank, is due to low investment and the inefficient use of labour and capital.

The contrast with the pre recession period is sharp. At the moment, all that is increasing is employment. The UK’s output is only rising because more of us are working and so the number of hours worked has gone up. What we manage to produce per hour hasn’t changed. As a country, we are working harder but not smarter. In previous decades, output increased because we became more efficient. Nowadays, like Rick’s Sandwich Bar, we are growing the business simply by throwing more and more low-paid people into the fray.

The Bank’s outlook is gloomy:

Taken together, these factors are consistent with productivity growth remaining subdued in coming years. Alongside modest labour supply growth, that will weigh on growth in the
United Kingdom’s overall potential supply capacity, which in turn will limit the speed at which output can grow before it leads to domestic inflationary pressure.

As Duncan says, this is actually more important news than the rate rise.

The Bank of England has drawn similar conclusions to the Office for Budget Responsibility; the UK economy’s problems are deep-rooted. The productivity stagnation and low growth isn’t simply a hangover from the recession, it is something that looks to be set in, at least for the next few years.

If growth of around 1.5 percent per year really is as good as it’s going to get for the rest of the decade, it will mark a significant shift from what most of us have been used to for most of our working lives. The economy used to trundle on at around two-and-a-half percent and most of us took it for granted. When there were recessions we made up the ground afterwards. Not any more. We have now had ten years of stagnating wages and what little growth there has been has simply been the result of putting more hours in. The Bank of England and the OBR have, effectively, written off growth prospects for the rest of the 2010s. Those people who warned of a lost decade when the financial crisis hit may turn out to have been optimistic.

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‘No Deal’ nonsense

Does anyone really believe that the ‘no deal’ Brexit option is viable? Even the No Dealers don’t actually believe it. The Institute of Economic Affairs released another of its amusing Brexit reports this week. Entitled Let’s get ready for ‘no deal‘”.

A no deal option “does not have to be the ‘catastrophe’ that many fear” says the IEA. Indeed, it might turn out to be a Good Thing:

With Brexit talks proceeding at a snail’s pace, the mantra that ‘no deal is better than a bad deal’ may soon be put to the test. The UK needs to be prepared to walk away if the EU is unwilling to show more urgency and flexibility. Indeed, a clean break in 2019 could still be a good outcome, even if not necessarily the best.

But what about the aeroplanes?

There are many other agreements that would also need to be renegotiated, including access to EU aviation markets…

And the drugs?

..mutual recognition of pharmaceuticals..

And the nuclear stuff?

…and cooperation with EU-led organisations such as Euratom.

What about financial services?

Firms in the financial services sector, for example, would presumably have to request access to EU markets on the basis that the UK regulatory regime is ‘equivalent’.

Sure, but isn’t an ‘agreement’ or an ‘arrangement’ the same as a ‘deal’?  So it’s not really ‘no deal’ is it?

Yes but apart from the aeroplanes, the drugs, the nuclear stuff and financial services, the UK will walk away with no deal.

OK, I made that last one up but there is something a bit Pythonesque about all this.

As things stand at the moment, everything stops on 30 March 2019. All our agreements with the EU and those via the EU with the rest of the world cease. This is something that, for many people, still seems not to have sunk in. The failure of negotiation doesn’t mean that nothing changes. It means that lots of things change, mostly for the worse. To stop that happening, UK and EU politicians need to come up with something and they haven’t got long to do so.

Perversely, there has been much more detailed discussion of what might happen after Brexit since the referendum than there was before it. There has been significantly more since we triggered Article 50. Each time we take a step further, we decide that it might be a good idea to find out what we have done. It’s like that manoeuvre-signal-mirror approach that you often see on the motorway.

Consequently, we now know that the much vaunted option of trading under WTO rules is more complicated than it first appeared. For a start, the USA doesn’t trade with the EU under WTO rules alone. It has a series of treaties with the EU as do most other large economies. These facilitate trade in specific areas. As the Institute for Government pointed out, most of the EU’s trading partners have some bilateral agreements in place.

It gets better, though, because it appears that very few countries actually trade under WTO rule alone. Most have some agreements with other countries to facilitate trade. James Hardy ran a query on the WTO database and found only a handful of countries trading without trade agreements, most of which are outside the WTO. Of the members, only Mauritania trades under WTO rules alone. Even this is not the full story as Mauritania trades with the EU under its Generalised Scheme of Preferences which enables developing countries to trade with lower tariffs.

In fact, it’s difficult to find any country which doesn’t have some sort of trading agreement with another country, even if only its near neighbours. Yet this is the position the UK would find itself in if it left the EU without any agreements in place. All of our trade arrangements with other countries have been negotiated through the EU and all will cease to apply once we leave.

Perhaps it’s not surprising, then, that a lot of people don’t take the ‘no deal’ option seriously. Germany’s Zeit described it as an empty threat. Robert Peston doesn’t believe it either because, as he quite rightly says, as soon as the government starts putting serious money into preparing for a no deal Brexit, companies will take fright and start moving their investments and their people out of the UK.

Talk of game theory is nonsense. There is no point trying to convince the EU that we are serious about walking away from the negotiating table because it is quite clear how damaging that would be. This is not like a poker game. Everyone knows what’s in everyone else’s hand. They have the internet in continental Europe too. They know that our customs and immigration systems are unlikely to be ready by 2019 and that even our modest attempt to increase lorry parking capacity has run into the sand. They know the British state just doesn’t have the capacity to do Brexit 18 months from now.

That said, the implied threat of the EU running the clock down on the negotiations seems implausible too. It is true that the EU overall is likely to suffer less economic damage as a proportion of its total trade and its GDP. Nevertheless, EU countries are no better prepared for a no deal Brexit than the UK. France, Belgium and the Netherlands would all need extra customs infrastructure and would face disruption at their ports. Ireland’s position is even worse. It might suffer more damage to its economy than the UK.

No-one wins from a chaotic Brexit. If I am about to fall off a cliff and I know I will break my arm it’s little comfort to know that the person who caused the fall will break both his legs. I’d really rather neither of us broke anything.

If the UK leaves the EU without a trade agreement, either by walking away, being timed out or the negotiations failing, it will be a triumph of pig-headed stupidity over reason. It will be studied for centuries in the universities of future world powers. Which, at the rate things are going, will be a long way from here.

 

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Brexit: deals and no deals

What is a ‘No Deal’ Brexit? Part of the (sometimes deliberate) confusion around this is that there are, essentially, three deals to be done between the UK and the EU. The decision tree looks something like this:

Chart made with SmartDraw

Deal 1: Article 50 Agreement

This is an agreement on the terms of separation. It includes things like:

  • Liability for pensions for EU staff;
  • Share of the European Investment Bank;
  • Funding commitments made by the UK for projects beyond March 2019;
  • Relocation of EU agencies in the UK;
  • Rights of UK and EU citizens after March 2019.

As Anand Menon says, a failure to agree on these basic terms could happen in two ways; the UK walking away from the negotiations or a timeout where no agreement is reached by  the March 2019 deadline. This is what Professor Menon called the Chaotic Brexit:

There is no Article 50 agreement within the two year period, and no extension. The talks fail, because of disagreement over citizens’ rights, the role of the ECJ, money, or perhaps some other issue we haven’t yet focused on. On Brexit Day, the UK ceases to be a member of the EU – but, politically and legally, all the outstanding issues remain unresolved.

At this point, as Anne Robinson used to say to defeated Weakest Link contestants, we would leave with nothing. The arrangements which apply to 60 percent of our goods trade and the regulatory framework which has governed our economy for the last 25 years would disappear. This would have the effect of increasing, rather than removing, barriers to trade. Rather like a football match or a road traffic system, rules are what enable international trade to take place. The morning after Brexit would not see a new freedom but a new chaos. It would be like waking up on a busy weekday morning and finding that all the road signs, traffic lights and road markings had disappeared. That would leave motorists free to do whatever they liked but good luck with your journey to work. If you ever made it that far.

Would the planes stop flying? Probably, says Professor Menon. Aviation agreements have the status of full diplomatic treaties and they are highly restrictive. Airlines are already warning customers buying tickets beyond March 2019 that they may not be able to fly. Once you put yourself outside the legal framework, life doesn’t get easier, it gets a lot more complicated.

Chaotic Brexit would also leave us in dispute with the EU, potentially leading to court cases and certainly creating an acrimonious atmosphere which would poison the UK’s diplomatic and trade relationships with the EU for decades. It’s really not something either side would want.

Deal 2: Transition Period

Assuming no-one walks away from the table and we do reach a deal on Article 50, we then turn to the terms of our future relationship with the EU.

No serious observers believe that it is possible to hammer out a post-Brexit trade deal with the EU that can be implemented on 30 March 2019. Even if both sides agree the Article 50 settlement, they will need a transition period to work out the detail on tariffs, regulations and dozens of other agreements that currently govern the UK’s relationship with the EU.

This might take the form of a specially negotiated transition period or simply an extension of Article 50. There are potential problems with both options.

Some say that a transition agreement would be as nearly as complicated to agree as a final trade deal, so doing it in the next 18 months would be nigh on impossible. Far better, they say, to extend Article 50 and stay in the EU until the deal is done.

The problem with extending Article 50 is that the UK would remain in the EU beyond March 2019. That would be unacceptable to many of the Leave supporting MPs and their backers in the media who would kick up no end of fuss about it. There would also the embarrassing question of the elections to the European Parliament in 2019. The UK would have to elect MEPs to a parliament from which they were due to resign half-way through the period.

I was at a Resolution Foundation event on Tuesday where both options were debated by the learned panel. The conclusion they came to was that it will be damned difficult either way.

Whatever the complexities, though, if we don’t agree a transition period, it is highly likely that we will leave the EU without trade agreements.

This would lead to what Professor Menon calls the Cliff Edge Brexit:

The Article 50 deal is agreed, but the trade discussions go nowhere: either they break down, or they have made little progress.

So there is nothing to transition to. Meanwhile continuing the UK’s Single Market membership and/or free movement is unacceptable to one or both sides. So on March 29, 2019 the UK becomes a “third country”, with no special relationship of any kind with the EU. WTO rules will apply to the UK’s trade with the EU.

This is better than the Chaotic Brexit because having reached an agreement on Article 50 it at least leaves the door open to a more constructive future relationship. In the meantime, though, the UK’s trade situation would still be difficult.

According to Jo Maugham, a leaked Treasury report on Brexit contains these paragraphs:

There is much talk of trading under World Trade Organisation rules but very few countries trade with the EU under WTO rules alone. As the Institute for Government points out, the EU has bilateral agreements with most of its trading partners:

Do other countries trade with the EU on ‘WTO-only’ terms?

Not many. In 2016, of the top 10 trading partners with the EU by total trade, the US, China, Russia, Japan and India have a substantial number of bilateral agreements that go well beyond the terms of WTO trade. Of the top 20, there are no countries that trade on WTO rules alone with no bilateral agreements and no free trade deals.

If the UK left the EU with no agreements of any kind, then technically its relationship with the EU would be weaker than any of the EU’s main trading partners.

Trading under WTO rules would leave us in a slightly better position than those countries like Iran and Belarus, against which the EU has sanctions, but would have worse trading conditions with the EU than most other major economies. One step up from pariah state isn’t really where we’d want our relationship with our biggest trading partner to start.

Of course, a transition period doesn’t mean that we will definitely achieve a trade deal but it certainly makes it more likely.  It is possible that we might simply delay the Cliff Edge Brexit for a few more years but, having gone to the effort of agreeing a transition it seems unlikely that talks on the final deal would then falter,

Let’s be optimistic and assume we agree a long enough transition to move on to Deal 3.

Deal 3: Trade and Future Relationships

While it might be possible to agree the outline of the future trade agreement before March 2019, it is only with the Article 50 Agreement settled and a transition period in place that we can finally get down to the job of negotiating the detail of what the future relationship between the UK and EU will look like.

The options range from almost no change, where the UK stays in the single market and customs union, to varying degrees of free trade agreement. This table by the Institute for Government gives a succinct summary.

Essentially, the further you go to the right, the more independence the UK would have over things like immigration and trade deals with other countries but the less preferential the trade terms with the EU would be. This is the range of ‘soft’ to ‘hard’ Brexit options, though it is more of a continuum than a binary choice.

If the government is absolutely determined to be outside the EU customs union, something like the agreements made with the Ukraine or Canada look like the most likely options but these have been years in the making. Most of the discussion in the British media about the deal with the EU has focused on Deal 3 but there is a way to go before we are likely to reach an agreement on our future relationship with the EU. We need to do Deals 1 and 2 first.

There are, then, several stages to go through before we agree our future relationship with the EU and a number of points at which it could come to grief. A Cliff Edge Brexit is in no-one’s interest and a Chaotic Brexit would be a disaster. The former ministers who have urged the prime minister to walk away from the talks really should know better. ‘No deal is better than a bad deal’ is the silliest soundbite to come out of the Brexit process. ‘No Deal’ is a bad deal. About as bad as it gets. It’s not something that anyone should be wishing on this country.

 

 

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No-deal Brexit: it’s already too late

As things stand at the moment, eighteen months from now the UK will leave the EU without any agreement on trade regulation or tariffs, either with the EU or any of the other countries with which it currently has trade agreements. The arrangements which assure the smooth running of 60 percent of our goods trade will disappear. Once we are outside the regulatory framework, many products, particularly in highly regulated areas like agriculture and pharmaceuticals, will no longer be accredited for sale in Europe.  Aeroplanes will be unable to fly to and from the EU to the UK. Those goods which can still legally be traded with the EU will face lengthy customs checks. Integrated supply chains and just-in-time manufacturing processes will be severely disrupted and, in some cases, damaged beyond repair. Unless politicians do something, that’s where we are heading.

International trade and commerce doesn’t just happen. It is facilitated by a framework of agreements on tariffs, quotas and regulations. Without these, trade is either very expensive or, in some cases, simply illegal. Therefore, if the UK were to leave the EU without concluding a trade deal, things wouldn’t simply stay the same. They would be very different and very damaging.

Of course, it would be disruptive for the rest of the EU too, although it is much easier to find new suppliers and customers in a bloc of 27 countries than it is in a stand alone country with no trade deals. Even so, most of us have assumed that common sense will prevail at some point. No-one in their right mind would let such a thing happen so surely both sides will do what is necessary to between now and March 2019 to avoid it.

Incredibly, though, our government, egged on by ideologues on its own back benches, has been talking up the prospect of a no-deal Brexit, apparently as a negotiating ploy to make the EU realise that we are serious about walking away. Almost as soon as the no-deal idea was suggested, Philip Hammond said that he was not willing to set aside any money to fund it. In any organisation, that’s a sure-fire sign of a project that’s going nowhere. If the finance director won’t even stump up the cash for the planning phase, you might as well forget the whole thing. Mr Hammond said that he would wait until “the very last moment” before committing any money to prepare for a no-deal scenario. Which means it’s not going to happen because the very last moment passed some time ago, most probably before we even had the referendum.

To prepare this country for the complete removal of trading arrangements that have been in place for decades would be an immense task. The customs implications alone are massive. Ports like Dover, Folkestone and Holyhead have no customs infrastructure. They have been designed and developed on the assumption that they are, to all intents and purposes, domestic ports. The proposed inland customs area would need to be vast to cope with the number of lorries. There was already a plan to build a lorry park in Kent in anticipation of increased traffic but this has stalled after local objections and is now subject to a judicial review. It is unlikely that work will start for some time even on this modest proposal. The idea that a fully functioning inland customs processing facility could be up and running in 18 months is just fanciful.

Much has been made of technological solutions to the increased administration brought about by Brexit but the specification for the new customs IT system was written before the Brexit vote. It was future-proof to the extent that it was designed to handle around three times the current number of customs declarations. The trouble is, that number is now likely to multiply by six, with many declarations from companies that have never had to use the system before. Increasing its capacity in time for the Brexit deadline will be challenging. It may well not be ready by March 2019.

As well as infrastructure and IT, HMRC will have to take on more people. A lot more. It has estimated that some 3-5,000 new customs  staff will be needed. Other departments face similar challenges. The Home Office has said that it will need at least a year to recruit and train the staff it needs to handle the additional border and immigration work. As the Institute for Government pointed out, customs alone has an impact on many public sector organisations. They will all need extra resources and organisation to deal with these changes. On top of that, new regulatory organisations will need to be built from scratch. Capability is a combination of capacity and ability. It’s not that the civil service lacks good people, it just hasn’t got enough of them for this colossal task. The British state doesn’t have the capacity to do Brexit in 18 months.

Chart by Institute for Government

There comes a point in any project when, if a certain amount of work hasn’t already been done, there is just no way you are going to meet the deadline, no matter how much money and resource you throw at it. Some things can’t be fast-tracked. This is especially true of recruitment, training and setting up new organisations. If anyone ever finds a way of microwaving the acquisition of skills and the bonding of teams they will become very rich. For now, though, these are not processes that are easy to speed up. As a colleague of mine used to say, nine women can’t make a baby in a month. Some things just take as long as they take and there isn’t much you can do about it.

The UK had a decade to prepare for the Olympics. Brexit is a much bigger job. If we had decided to make a clean break from the EU as a well-thought out and considered policy, it would have taken us years to plan and prepare for it. We should probably have started several years ago. As it stands now, it is far too late to do anything that will have a significant impact on the chaos that would follow in the wake of a no-deal exit from the EU. However much money the government throws at the problem, there won’t be enough. It is simply too late. Philip Hammond knows it, the civil service knows it and, most probably, Michel Barnier knows it too.

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No money behind the sofa for Philip Hammond

The Office for Budget Responsibility has, it appears, given up on the long hoped for productivity spurt. Chris Giles reported in the FT last week that it is to release a more pessimistic productivity forecast in this year’s budget.

For a time, a couple of years ago, it looked as though productivity might be on the rise again but it has stalled recently. The take-off never came. The ONS figures released on Friday show output per hour and per worker more or less where they were at the end of 2007. That’s almost a decade without any productivity growth.

As Gemma Tetlow explained, although employment is at record levels, much of the increase has been in the economy’s least productive sectors and firms, which has created a drag on productivity.

Britain’s productivity woes have deepened in the past year because less productive services companies have hired more staff, while higher value manufacturing has shrunk.

Albert Bravo–Biosca and Stian Westlake noticed something similar when they looked at the allocative efficiency of the UK economy in the decade before the recession. The net effect of new firms coming into the market, they found, was to reduce productivity; the opposite of creative destruction.

It appears that, after a brief post-recession respite, the economy reverted back to its tendency to create low productivity jobs.

Chart by Gemma Tetlow, FT

Also released last week were the ONS measures of economic well being. The ONS points out that the overall household income level didn’t fall as much as other measures because low interest rates reduced mortgage payments. That this effect is now spent as inflation is starting to bring down real household incomes. The general picture is that, whatever measure you use, the economy has barely recovered from the shock it experienced a decade ago. The UK’s post-recession increase in GDP is, therefore, mostly accounted for by an increase in population.

As the Resolution Foundation’s Matt Whittaker said, we can’t blame Brexit for all of this (my emphasis):

The bigger picture here is that household income per person remains no more than 5 per cent higher today than it did a decade ago. The decade before the crisis delivered growth in the region of 30 per cent. It’s easy to fixate on the impact on Brexit, but it shouldn’t blind us to other domestic challenges that have led to a tough ten years for living standards, let alone the last 12 months.

The OBR looks set to adopt a more pessimistic stance by downgrading its productivity projection at the forthcoming budget. That decision is being driven not by an assessment of lower productivity in a post-Brexit world (previous OBR outlooks have already incorporated some such assumptions), but rather by the conclusion that post-crisis productivity stagnation is more permanent than previously thought.

That’s the worrying bit. We were running into productivity problems before 2007 and the recession just made them worse. The British economy’s weaknesses, it seems, run deep.

The OBR has come to the conclusion that we are not likely to see much improvement in the near future. That is likely to mean less tax revenue and, most probably, a significant hit to the public finance projections in next month’s budget.

It’s only two years since the OBR found some money for George Osborne down the back of the sofa. Philip Hammond won’t be so lucky. The sofa is on the skip. Until productivity improves we won’t get a new one.

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