Archive for the ‘Economics of Brexit’ Category

Understanding the Brexit vote: the interplay between economic internationalisation and cultural openness

crescenziThe Leave vote prevailed in regions where local workers do not interact much with foreign cultures – yet some of these places rely on jobs created by foreign firms. If internationalisation in the workplace does not match internationalisation ‘at home’, pressure on local workers to opt out from further economic integration increases, write Riccardo Crescenzi (LSE), Alessandra Faggian (Gran Sasso), and Marco Di Cataldo (LSE) in a recent study.

Some of the key questions floating around in the days after the referendum were: why has this happened? Who are the ‘Brexiters’? Several interpretations have been provided, pointing at some common characteristics of the voters who opted for the ‘Leave’ option. It became apparent that the electorate was split according to demographic characteristics, most importantly age and education. The main story that was told was one of cultural values, with an insurmountable generational gap between the younger “Europhile” generation and the older generation attached to traditional British values, and possibly more xenophobic.

Some commentators went as far as to explicitly discard any economic dimension behind the vote, defining Brexit as a purely cultural/psychological phenomenon. However, the emphasis on cultural priors and values offers limited insights on how further political tensions towards international disintegration and isolation might arise in the UK and in other EU member states. Alternative views claim that economic conditions of citizens and the economic geography of UK regions are at least as important as culture and identity to determine individual attitudes towards the EU and voting patterns at the 2016 referendum.

neither economic nor cultural arguments alone are sufficient to provide a complete picture of the voting patterns on Brexit

It is now apparent that neither economic nor cultural arguments alone are sufficient to provide a complete picture of the voting patterns on Brexit. Purely cultural explanations of the referendum outcome inevitably rely on the strong assumption that people living in areas such as Bradford, Hull or Sheffield (where Leave prevailed) have more connection, devotion or sense of rootedness to their hometowns than strongly pro-Remain locations such as Manchester, Leeds or Liverpool. Conversely, explanations based on economic motives are hard to reconcile with the fact that – for example – peripheral areas relying more heavily on employment generated by large foreign corporations have overwhelmingly supported Brexit. As an example, in the area of Sunderland only about a third of people voted Remain despite the presence of a “giant Nissan factory which exports more than half its output to the other EU countries”.

© Copyright Andrew Curtis and licensed for reuse under Creative Commons Licence.

To understand the deep motivations underlying the Brexit vote we need address the following paradox: although local jobs in many UK regions are highly dependent on foreign economic ties, workers in some of these regions openly rejected internationalisation by voting to rescind their links with the EU, the largest integrated market and investment space of the world. Why?

Domestic workers compete with other workers active in foreign locations via the inflow of imported goods (that can be sold on the local market at lower prices than domestically supplied alternatives thanks to cheaper labour inputs) but they might also be employed by the local subsidiaries of foreign firms (or by domestic firms with subsidiaries abroad). In other words, both foreign and domestic multinationals connect local and ‘global’ labour markets, offering the opportunity to work in more internationalised environments, but also fostering competitive pressures on domestic workers. Therefore, it comes as no surprise if some ‘internationalised’ constituencies voted ‘leave’ to ease this pressure.

However, voters’ decisions are influenced not just by their work-place dynamics but also by their social environment. Areas where social ties are more local and inward-looking, where people tend to get along well mainly with close circles of like-minded individuals are less likely to induce a positive and synergistic approach to the internationalisation of the economy. These socio-culturally inward-looking communities are more prone to see their employers’ internationalisation as a (potential) threat to both their values and their economic stability and welfare, and would take any occasion to vote ‘against economic integration’. Conversely, workers that are part of open and outward-oriented local societies are more inclined to bridge different social groups, understand and embrace multi-national working environments given more weight to the benefits of the economic internationalisation of their local area.

Following this line of reasoning, the result of the Brexit referendum can be seen as the result of a process of ‘split Europeanisation’ whereby Euroscepticism is triggered by the increasing mismatch – in specific constituencies – between internationalised firms (and corporate economic interests) and ‘localistic’ employees (and workers’ attitudes and cultural preferences).

Do data on the geography of the Leave vote support this story?

In order to capture the ‘economic internationalisation’ of UK regions and their ‘EU exposure’ we can look at date on in-flows and out-flows of Foreign Direct Investment (FDI). To get a sense of their ‘social internationalisation’ we can rely on a purpose-built ‘Cultural openness’ index, a composite indicator that combines different variables (looking at the propensity of people to travel abroad as well as their proficiency in foreign languages) that can be considered – when put together – as an overall measure for the cultural internationalisation of voters and their international social engagement.

Figures 1 and 2 show descriptive maps and scatterplot correlations of UK regions by the level of ‘social internationalisation’, as defined by our index, the proportion of inward FDI (‘or ‘economic internationalisation’, and the voting outcomes at the 2016 Referendum. As shown by the slope of the regression line in the left-hand graph of Figure 2, higher levels of cultural openness are associated on average with lower percentages of Leave voters. Conversely, the association between economic internationalisation (as captured by FDI) and Leave votes is much less clear-cut.

In a recent paper Riccardo Crescenzi, Marco Di Cataldo and Alessandra Faggian show that the interaction between ‘cultural openness’ and ‘economic internationalisation’ is the single most significant predictors of the share of Leave votes when tested against all other alternative explanations of the Brexit vote (from the demographic explanations to education, from immigration to unemployment) touched upon in the ongoing debate.

The interaction between cultural openness and economic internationalisation is a key explanation for the share of Leave votes

The degree of internationalisation of the local society – proxied by the cultural openness index – is associated with a statistically significant reduction in the share of voters supporting the UK departure from the European Union. The presence of foreign firms in the local economy also reduces the propensity to vote Leave. However, what seems to be the most important factor to shape local preference for EU membership is the interaction between the economic and the social sphere: the interaction term between the cultural openness index and inward FDI is negative and highly significant, suggesting a strong complementarity between these two dimensions.

These rudimental statistical regularities offer new material for an open discussion on the lessons to be learnt from the Brexit referendum. This matters for a better understanding of the UK society but also – for other EU countries – in order to ensure the political and social sustainability of the process of European economic integration. Even in high-employment countries like the UK, the intensified role of global investment flows and value chains in the economic tissue of EU countries and regions – in particular in the form of the increased presence of foreign firms operating across national borders – poses major societal challenges. If social and cultural attitudes towards integration and internationalisation are not developed in parallel with the globalisation of the economy, tensions are very likely to arise.

This post is based on the article “Internationalised at work and localistic at home: the ‘split’ Europeanisation behind Brexit” by Riccardo Crescenzi (LSE), Marco Di Cataldo (LSE) and Alessandra Faggian (GSSI) forthcoming in  Papers in Regional Science, (DOI: 10.1111/pirs.12350) and freely available (full open access) from the LSE website.  It represents the views of the authors and not those of the Brexit blog, nor the LSE.

Riccardo Crescenzi is Professor of Economic Geography at the London School of Economics.

Marco Di Cataldo is a Post-Doctoral Researcher at the London School of Economics.

Alessandra Faggian is Professor of Applied Economics  at the Gran Sasso Science Institute.

 

The DUP scuppered a Brexit deal for all the wrong reasons

Why did the DUP veto the proposed border arrangements for Northern Ireland? It was not because of pragmatic considerations, writes Anthony Costello (University College Cork), but through the simple desire to reassert unionism – even at the cost of a hard and damaging Brexit. Only if Northern Ireland can negotiate a new power-sharing deal will it be possible to force the party to properly represent the peoples of Northern Ireland.

The signing of the DUP-Conservative deal in June 2017 sent shockwaves throughout the UK and Ireland. For many observers, the deal cemented the foundations of a hard Brexit. But for those thinking outside the box – such as members of the Southern Irish government – it symbolised the opportunity to soften the UK’s obscure Brexit preferences.

According to this logic, the Democratic Unionists – in their new-found proximity to the British government – would use their political influence to make Westminster aware of the grave consequences that would ensue from a hard Brexit. Many observers questioned this notion, arguing that it naïvely overlooked the historical and contemporary politics and culture of the DUP. Still, some maintained that a combination of the economic and political constraints facing Northern Ireland, executive technicalities and party political ambition would surely influence the DUP to think pragmatically.

arlene foster

Arlene Foster attends a Remembrance Day service in Enniskillen, 2013. Photo: Northern Ireland Office via a CC-BY 2.0 licence

Now that the DUP enjoys considerable sway over the fate of Theresa May’s government, this small regional party has plenty of influence in the Brexit negotiations. It has used it to bring the Brexit negotiations and any opportunity for compromise to a standstill.

Since the deal was signed five months ago, the DUP has been relatively silent about Northern Ireland’s preferences. Instead, the party has repeatedly advocated a stance that would give the region equivalent status to the rest of the UK post-Brexit. Evidently, for the DUP the consequences of a hard Brexit are of little consideration as long as unionist objectives are met.

In the meantime, the Conservative Party is gradually learning that their initial ambitions for Brexit are unrealistic. Their proposals have shifted from a ‘frictionless border’ using technology to monitor trade and customs, to an offer of continued regulatory alignment. The latter would shift the external border of the UK to the Irish Sea, affectively creating separate rules for Northern Ireland that would bring the region’s trade rules and procedures into line with those of the Republic

Creative thinking in the face of such complexity must be admired. But the fact remains that the UK’s preferences to date have been fundamentally unrealistic and obscure. A hard Brexit – one which sees the UK leave the Single Market and the customs union – necessarily means a hard border between Northern Ireland and the Republic. It is difficult to see how special status for Northern Ireland would be politically feasible. Continued regulatory alignment for Northern Ireland alone would place Northern Ireland in a politically and economically vulnerable position – not least because it would be a devolved UK region influenced by EU trade legislation and regulations, but with no representation at the EU level because it would be a mere autonomous region of a sovereign non-member of the EU.

The uncertain logistics of trade and customs rules for Northern Ireland separated by a sea border would cause considerable problems for both the region itself and its southern neighbour. From a political perspective, this is not in the DUP’s interests. They perceive it as pushing Northern Ireland closer to the Republic and weakening its ties with the rest of the UK. DUP leader Arlene Foster has made it very clear that any deal agreed between the UK and EU should not create special arrangements for Northern Ireland that could weaken its position in the UK. The fate of the UK is the fate of Northern Ireland, she argues, and this must not be compromised.

The DUP’s objections to regulatory alignment for Northern Ireland alone are sensible and pragmatic. Although David Davis has indicated that the policy would apply to the whole of the UK, this has not been confirmed by the Conservatives. The option has uncertain political and economic consequences for both Ireland and the UK. However, while the DUP’s rejection is commendable in one sense, the reasoning behind it is very concerning.

In recent days, it has become clear that the DUP’s reasoning comes not from a place of economic, legal or constitutional logic, or even concern for the economic prospects of Northern Ireland and North-South relations. It is firmly rooted in nothing more than staunch unionism and romantic notions of British nationalism. From statements made by Arlene Foster and her party peers, Northern Ireland’s unique conditions are of little importance to the party in terms of the Brexit negotiations and outcomes. The DUP’s aim is nothing more than the reassertion of the British identity of Northern Ireland, guaranteed by distancing the UK from the EU. Regardless of the consequences of Brexit for Northern Ireland, and the potential consequences of a hard Brexit for the stability of the DUP party, Foster and her peers are willing to sacrifice the preferences and interests of a majority of the Northern Irish peoples for the sake of a party-centric goal. Even more concerning is the free rein that Foster has in the absence of Executive constraint in Northern Ireland.

The DUP can no longer be considered a potentially positive constraint on British preferences in the sense of influencing a soft Brexit for the whole of the UK. Holding the balance of power in Westminster, they risk derailing the whole Brexit process. To reiterate, the rejection of continued regulatory alignment is not the key problem. It is the party’s reasoning behind the rejection that is of concern – their willingness to jeopardise everything for a hard Brexit that secures their unionist identity. The DUP argues that it does not wish to see a hard border between North and South, yet their actions in recent days clearly indicate a desire for a hard Brexit, which must mean installing a hard border. This may be only the first of a series of DUP refusals to compromise.

More than ever, Northern Ireland needs  a power-sharing arrangement and the return of legitimate representation. Only through this can executive constraints be put in place in Northern Ireland that might encourage the DUP to rethink their position.

This post represents the views of the author and not those of the Brexit blog, nor the LSE.

Dr Anthony Costello is a Lecturer in the Department of Government and Politics, University College Cork.

Ultimately, public opinion is unlikely to tolerate a hard Brexit

dennis shenGiven the high costs associated with a hard Brexit, argues Dennis Shen (Scope Ratings), it is unlikely to happen. The EU27 see no advantage in significant concessions and the challenge of maintaining public support for a hard Brexit is considerable. A transition period concluding in a soft Brexit – or even ‘Breversal’ – are the most likely outcomes.

The UK government’s objective remains a hard Brexit – involving an exit from the single market and customs union – but, importantly, a softening of this stance has already taken place. The UK has already indicated its willingness to agree to a two-year transitional arrangement, to protect the rights of EU citizens in the UK and to continue payments into the EU post-Brexit. Given the obstacles to leaving the single market and customs union, the rush to fulfil the referendum mandate by March 2019 is unrealistic.

These obstacles are considerable. They include the new trade arrangements with the EU alongside 60 other nations (learning from the difficulties faced in Greenland’s much less complicated exit from the European Economic Community in the 1980s), the irreconcilable contradiction between Britain’s desire to maintain maximum access to the single market whilst negotiating controls on EU migration, and opposition from Scotland and devolved administrations. Recognising these challenges, I commented last year that even after Article 50 were invoked, Brexit remains far from a foregone conclusion, because of the need to retain political support for it over potentially multiple political cycles. The negotiation of a long-run hard Brexit could be decade-long. The already narrow public majority to leave in 2016’s referendum comes under pressure from multiple risks over extended horizons: May’s failed snap election gambit earlier this year was only one of them.

In a research note published with Scope Ratings – a European rating agency – my co-author and I argued that due to these hindrances and the material costs associated with any immediate, no-deal Brexit, the two most likely outcomes are instead: 1) a form of soft Brexit or 2) a no Brexit (or Breversal) scenario. These outcome expectations are assumed in our ‘AA/Negative’ rating and outlook on the UK. In Scope’s baseline, the UK concludes an eventual soft Brexit arrangement, maintaining full or partial access to the single market, perhaps in a phased process. The conclusion of a soft departure end-state could last well past the two-year window given under Article 50, potentially seeing post-Brexit transitional states and/or an extension of Article 50 negotiations (the latter postponing the UK’s exit date from the EU).

However, we noted also that in April, a YouGov/Times survey was the first to show a majority against Brexit since last June’s referendum. Last month, a YouGov poll saw 46% of respondents saying it was wrong for the UK to vote Leave, while 42% back Brexit as the right decision. The Labour party has shifted its position to support transitional membership of the single market and customs union, and possibly on a permanent basis (in a form of Norway+ model, which is not far from favouring remaining in the EU). As such, were public sentiment to harden in opposition to Brexit, negotiations to meet significant difficulties and/or the economy to face increasing headwinds, a no-Brexit scenario (in which the country revokes Article 50, and opts to remain in the EU) is not off the table, and, in Scope’s view, the second most probable outcome. This would presumably need to involve a second election and/or a second referendum. Our expectation of a soft Brexit or no Brexit contrasts with the opinions of financial institutions and research institutions, which anticipate a different outcome.

Why has the EU adopted a stern negotiating stance towards the UK? One reason is the unrealistic objectives of the UK government, and the significant gap between the negotiating expectations of the EU and the UK. Another is the EU’s determination that conditions outside the bloc must be worse than those within, in order to preserve the integrity of the European project.

The UK’s dilemma is compounded by the weak negotiating hand it has been dealt. As the potential economic, financial and political costs of any form of no-deal Brexit would be much more damaging to the UK than they would be to the EU as a whole (see, for example, Oxford Economics’ report that the immediate costs to the UK of a cliff-edge Brexit might be ten times greater than those to Germany or France), the UK government’s threat that it could easily leave without a deal rings hollow. Even a default to WTO trade relations, viewed as the safe fall-back option in the case of no deal, is not automatic and would require completion of complex talks with WTO parties, including the EU.

The EU’s greater leverage means that any negotiated settlement reached under constrained time boundaries would probably resemble the EU’s opening gambit. This means that any deal on Brexit sought under the auspices of Article 50’s initial two-year window benefits the EU position and necessarily demands climb-downs by the UK. In that, the more prudent strategy from the UK’s angle has been and continues to be an understanding of the complexity of Brexit, emphasising a long-term, phased-in process with short-term objectives. Unfortunately, this approach has so far been lacking.

European leaders have expressed hope that the UK’s decision to leave might be reversed. On the one hand, that could help to explain the EU’s unwillingness to compromise materially in the negotiations. But the EU should be careful what it wishes for. In the aftermath of the referendum, the EU has looked more united and stronger, with the common dilemma that Brexit represents enabling states to unite around a clearer and more purposeful message. It could be argued that a no-Brexit scenario – in which the UK remains, after failed negotiations – could revive momentum towards a multi-speed Europe, along with escalating Euroscepticism in segments of a divided UK.

This post represents the views of the author and not those of the Brexit blog, nor the LSE.

Dennis Shen graduated from the MPA in International Development from the LSE in 2013, and completed undergraduate studies at Cornell University. He is Associate Director in Public Finance at Scope Ratings, responsible for sovereign ratings based in Frankfurt. Previously, Dennis was with Alliance Bernstein, most recently as European Economist. His research interests include international political economy, global governance and environmental regulation.

We need to get the data issue right in the Brexit negotiations

As businesses in all industries become increasingly digital, describing the technology sector as a separate category makes a little less sense. Banking, retail, the media and all kinds of services are going online. This digitalisation of economic activity poses a challenge to the idea of borders, and makes the Brexit negotiations especially difficult. Julian David (techUK) says that a large number of industries today exist in the context of moving data. “What is banking? It’s 0’s and 1’s, isn’t it?’ he asked Helena Vieira. “We need to get two issues right (in the Brexit negotiations): data and talent’, he said. They spoke during Web Summit, in Lisbon, on 7 November.

We know that 80 per cent of the UK economy is in services. How much of it is represented by the tech sector?

If you take a broader sense of technology, which is technology suppliers and digital intensive industries – things like banking, financial services, creative industries, and so on, we’ve done a report that has it at 16 per cent of total UK GDP, so it’s huge. We define the digital sectors as the 12 most intensive digital-producing or digital-using sectors — a group that is likely to increase as more sectors digitise. And 96 per cent of these digital sector outputs are services-based.

We know little about how Brexit will evolve. Is it possible to foresee the impact on tech companies?

You’re right, we don’t know, which is a bit concerning in itself, a year on, and it depends on the outcome. Two issues really need to be got right among a list of five that we recently published. The first issue is data. The point about services is that it’s really driven by data. Data flows in the UK is about 3 per cent of GDP, but it’s 12 per cent of global data flows. So we’re a data economy, and a lot of that goes to the EU, so if we don’t get our data relationship right out of Brexit, that will be a big issue. The second big issue is talent and skills. The UK has attracted talent and skills from all around the world but a significant amount is from the EU, and in particular they’re very easy and flexible, which is what you need in a fast growing tech environment, so if we aren’t able to get those skills and keep them in the UK, that’s going to be an issue.

Can you explain what you mean by data flows and what are these companies that are heavy in data?

Well, if you think about the sectors that our report features, industries from telecom to software to devices and more conventional computer equipment. And then you think about industries like financial services, professional services, creative industries, media and others like that… Those are the industries that exist in the context of moving data. What is banking? It’s 0’s and 1’s, isn’t it? Nobody carries a big chest of gold around anymore. It’s all done in computers. And that is what goes on. So, any trade and e-commerce, anything like that is driven by data flows and you need data flows to make that happen. And increasingly even physical goods are getting data attached to that. If you think about supply chains, something like automotives, there’s an awful lot of data that moves around with the components. If you don’t have good data flows between the main economies, the main trading partners, that’s going to be a problem.

… we want to be a global trading nation. We want to strike free trade agreements around the world. Well, there’s a huge one right at our doorstep.

So the UK tech sector is data heavy…

Yes, it’s a services-based sector and 75 per cent of those services go to the EU. Yes, we’re looking to expand and we are expanding our trade with other economies around the world. But we need to preserve that 75 per cent while you expand.

In a recent interview, Adam Posen, of the Peterson Institute, said the UK may even strike a trade agreement with the US, but it would be more symbolic than anything since the two countries’ are about 80 per cent services, competing in the same sectors…

There’s a lot of work and a lot of business between the UK and the US tech sectors. It already is happening. Building a free trade agreement with the US would be a great thing. Including services agreements in free trade agreements is not something that has been commonly done, it’s not very easy to do. It’s generally a small part or there are restrictions. It would be great to do that with the US, but it’s not an easy thing to do. Do they compete with us? Yes, they do, but equally, they’re also present in the UK. I mean, a huge amount of the UK tech industry is international companies based in the UK. These international companies are just as interested in getting the data flow arrangement and the services agreement and the trade agreement right with the EU, from the UK as our tech companies are. In fact, Wilbur Roth, the US Secretary of Commerce, was in the UK this week, talking at the CBI conference, and he made the point that a lot of US companies came to the UK in order to do business across Europe. And they’re very interested in us getting the right deal, the right arrangement. You can say the same about Japanese, Chinese companies. International companies want to be able to trade across the whole of Europe.

Public Domain

Would Brexit not taking place be the ideal for you?

This is an interesting one. Our industry didn’t want Brexit. That was very clear. We polled our members, and they were overwhelmingly (85 per cent) in favour of staying in the EU, particularly the single market. Looking particularly to exploit the growing digital single market. However we are where we are. So what people are now saying is, “well, if there is going to be a Brexit, then it’s really got to take account of these issues, and the best way to do that is the single market. We’re saying that our industry wants to stay in the single market. We had a conference last week and we asked the question, these instant feedback things that you do, instant polls, and again, it was 90 per cent of people saying the single biggest issue for them was Brexit.

A common example of the difficulties of Brexit is the automobile industry, whose supply chain crosses borders back and forth between the UK and Europe many times before the final product is ready to be shipped out of the UK. Is the example valid for the tech industry?

Yes, if you think about what I’ve mentioned on services and if you think about the number of international companies that trade across the whole of Europe, they do that as an integrated proposition. They want to be able to provide services, and if you think about the ancillary industries… I don’t know if you know, but something like half of all TV production in Europe is done in the UK, and then it’s broadcast in one shape or another. We’re talking about all sorts of companies, including Amazon, Netflix, etc. So if you lose the ability to do that because of restrictions on country of origin or original content or just really other regulatory issues, that’s going to have a big impact. The same applies to people running cloud services, or other services across Europe. They need to be able to service that from one single point, and at the moment a lot of that is in the UK. So it’s really going to be a problem. Then if you broaden it out, you think about all of the other industries, they move data around the place just as much as the automotive industry moves And we’re already seeing again, there was a survey out recently that showed that European companies are starting to think about their supply chains, starting to look at how do they deal with the potential that they won’t be able to move components from the UK the way they used to.

You want to be global, Britain? You’ve got to behave like it. 

Access to the EU market is key, then…

Just to stress this, we want to be a global trading nation. We want to strike free trade agreements around the world. Well, there’s a huge one right at our doorstep. So, really, it’s really important to get on it. Despite what people say, proximity does matter. The UK does more trade with the EU than it does with the US. And particularly in services, the ability to move people, which is often a component part of the service provision… Yes, our industry makes stuff available now through virtual means, online means, etc, but there’s still that need to do that and to have a recognition of your services, your professional standards, regulatory agreements, data arrangements, intellectual property rights, all things like that.

Without passporting rights, will fintech have to look for other markets? What would the impact be?

Fintech is looking for other markets and it’s global. Even places that don’t have a great financial services footprint can and produce fintech solutions. For instance, Israel doesn’t have a big financial services industry but they have quite a lot of innovative stuff going on. The challenge is what makes you the centre for this stuff versus anywhere else, and sets a connection for everything. London is a perfect place. It has a financial services industry, a tech industry, legal and professional services, fantastic regulatory environment, all in one place. The time zone, English law, which is really important in financial transactions. A huge amount of financial transactions say that they will be done under the English contract law, even if they’re not connected to England. Put all that lot together in one place and we have a standout success factor. Start to break it up, that’s an issue. Now this is an issue for Europe as well, by the way, because the idea that you can disassemble London and grow it in six to ten other places around Europe, is just for the birds. It’s not going to happen. Some stuff will move, we’re seeing that. And some stuff will start to grow in new places. But the likelihood is that, if we don’t reach an agreement, this stuff won’t be moving to places in Europe. It’ll be places like Hong Kong… That’s the price for both Europe and the UK.

Europe doesn’t have an English speaking capital that would be the equivalent to London…

No, although I think you can see here at WebSummit, everyone is working in English, even the French.

Are you worried about the UK losing access to the EU’s pool of talent?

Yes, and that’s quite a broad problem. If you look at our research and development places, if you look at universities, the whole science space, how many times do you see European talent in leading roles, and throughout the technology scene, you see it very much at start-ups. So many Europeans either moved their business to London or started their business somewhere in the UK because of the advantages that they see, and the fact that they don’t have to worry about visas, about family members coming to visit, much of that stuff. Well, all of a sudden they do. We used to say EU skills are welcome here, EU people should stay here and contribute here. And tone is very important here. One of the most disturbing things is the tone of the conversation that was happening a year ago post-referendum. It’s so important. You want to be global, Britain? You’ve got to behave like it. And that involves welcoming the best talent from around the world.

Universities are worried about that too. If students don’t choose the UK anymore, and you don’t retain them here, you don’t allow them to work, then they’ll leave…

Yes. We’ve always thought that including student numbers in immigration numbers is not right. Now there isn’t the problem that the government said. The students aren’t coming here in disguise and staying as illegal immigrants. But what they can do is they come here, bring skills, develop those skills, build the university sector in the UK, start to team up with other people, UK people, and build businesses in the UK, or contribute to them. Look at Graphene. Who are the people who had the breakthrough in that? It was incomers to the UK. And we must insure we get those. The best from all around the world, not just Europe, and we certainly mustn’t make it difficult for the Europeans.

Can the government compensate by investing in technical education for UK students?

Yes, there are opportunities. If you are able to have a smarter, more agile approach to things in the UK, maybe even taking positions that the EU is unable to take or takes a long time to take, then you can see some advantages. So, can the UK do something about it? Yes it can, but it would require a different approach to investment, R&D, increase our R&D percentage by both the government and the private sector. We’re behind other countries in this, or best practices in other countries in this. Skills and tech education. It’s taking a long time for us to actually develop a proper tech education to build the proper skill base in the UK, and of course that takes a long time to come through. You’re not going to solve the problem in 2019 by starting some computer courses now.

Is it possible for the UK to thrive without a free trade agreement with the EU?

We think it’s really hard. Firstly because getting these kinds of agreement services-based, remember how significant the services side of our industry is, with other countries, is not an easy thing. That’s going to take time, it will involve a give-and-take and a willing partner. That willing partner, all of them have said “we’re interested, but we want to see what your agreement with the EU is, first”. And like what Wilbur Roth said, if you don’t have passporting, a lot of the US financial institutions are going to be concerned about investing in the UK. It’s what he said this week. So, that’s the first issue for us. The second issue is just the number game. How do you replace 46 per cent of your trade in one go? For us, although some parts of our industry, world trade, very small tariffs, it can’t be accommodated. The pound has already gone down 15 per cent, so some people say, that’s really not addressing the point of regulation, services agreements and recognition of those things. And those are the really important things. So we think not having a deal will be a bad thing for the tech industry.

This post gives the views of the interviewee, not the position of LSE Brexit or of the London School of Economics and Political Science. It first appeared on LSE Bussines Review.

Julian David is the CEO of techUK, an association representing 950 tech companies.

Expect a backlash if the £50bn offer doesn’t move negotiations on

After threatening to pay nothing to the EU, then conceding £20bn, the government has finally indicated it will pay a Brexit ‘divorce bill’ of £40-50bn. The initial reaction from Eurosceptics has been rather muted, writes Iain Begg (LSE). But if the European Council does not allow exit negotiations to move to the next stage, we can expect a serious backlash – not least as the impact on public finances (including the NHS) becomes clear.

After the promise, implicit in Theresa May’s Florence speech, to offer some €20 billion to meet the UK’s obligations towards the EU, it now seems the UK is prepared to pay double or more by way of a ‘divorce’ settlement. The reason for doing so is to persuade the other 27 Member States to launch negotiations on the future relationship between the two sides in a timely manner. Three obvious questions nevertheless arise: why now after holding out for so long; how much will the final bill be; and can the government deliver on the amounts promised?

One can speculate on why the government took so long to grasp that it had to change its position, although it is worth recalling how recently Boris Johnson sent the message that the EU could ‘go whistle’. Now, we hear, he and other prominent Brexit figures in the Cabinet have acquiesced in putting forward the higher amount, so long as it secures a good deal on the new relationship. Even so, to go in the space of just a few months from ‘not a cent’ to €20 billion and now to something in the region of €40-50 billion testifies either to a failure to appreciate the importance the EU attached to the issue, or to the dysfunctionality of the government.

If the stories are correct, it would seem ministers heeded the warnings from Michel Barnier and Donald Tusk to put more on the table before the beginning of December – failing which, the next European Council, two weeks later would be unable to say there had been sufficient progress on the three initial dossiers (the other two being the Irish border and citizens’ rights).  Had that happened, the next deadline, possibly not until March, would greatly have compressed an already tight negotiating timetable.

The amount on the table has been left ambiguous through resort to the formula of agreeing principles, but leaving the precise amount to be calculated at a later date. This was always what Team Barnier sought and there are indeed good reasons why a precise figure cannot be given. There may be agreement, for instance, on the obligation to pay towards the future pensions of Eurocrats, but legitimate doubts about how much of the money has to come from the EU budget – for example, because of changes in the interest rate. Similarly, some of the unfinished projects towards which the UK now seems to be accepting it should pay may be cancelled, reducing the obligation.

But do not be misled: all the finance ministries involved will have someone at hand with a spreadsheet, able to feed the amounts at stake to their minister within a matter of minutes.  EU budget negotiations were ever thus. A plausible figure, at least at the level of billions, if not to the third decimal place, will emerge and, certainly in the UK public debate, become as totemic as the infamous £350 million a week for the NHS.

The politics could easily then turn highly toxic, especially if other likely effects on the public finances are taken into account. Initial reactions to the revelation of a much higher divorce bill have been surprisingly muted, with variations on ‘unfortunate, but a price worth paying’ surfacing as the mainstream response from Eurosceptics. This suggests the Prime Minister will be able to hold the line, at least until the forthcoming European Council. But if the outcome of the Council falls short of British expectations of the immediate launch of the next phase of negotiations, a concerted backlash against the new divorce bill must be expected.

Other Brexit-related influences on the UK’s public finances could, in any case, be much more significant. The increase in the forecast government deficit, revealed in the November 2017 UK budget documents, is some £18 billion per annum, more than doubling the new figure for the divorce bill over the three years following Brexit. These projections reflect a down-grading of growth prospects for the economy, largely because of more pessimistic assumptions about productivity growth, but there are good reasons to believe Brexit will aggravate the negative effect. It is easy to argue that forecasts are always wrong and can therefore be dismissed, but they can also be right or even unduly optimistic.

In addition, the UK may seek to remain within certain EU policy programmes, such as for research. If it does there will be a cost. Norway and Switzerland, often cited as possible models for a future relationship between the UK and the EU, make sizeable annual payments into the EU – sometimes, if somewhat misleadingly, referred to as payments for access to the single market.

For anyone ever tempted to believe the promise of £350 million per week, the message could not be more clear: even if it had not been mendacious, any windfall gain for the NHS will be a very long time coming.

This post represents the views of the author and not those of the Brexit blog, nor the LSE.

Iain Begg is Professorial Research Fellow at the European Institute and Co-Director of the Dahrendorf Forum, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.

Post-Brexit UK trade policy remains a wish list

CEPAbout half of UK’s trade and investment is with the EU and, as a member of the single market, the UK implements similar standards for products and services as the EU. Furthermore, as a member of the customs union, the UK operates a common external tariff, and goods and services can move seamlessly with no customs or compliance checks. How the UK exits the EU will, therefore, have profound impacts on trade, investment and economic growth in the UK, write Nikhil Datta and Swati Dhingra (LSE’s Centre for Economic Performance).

The government white papers have made clear the intention of the UK to establish its own trading schedules (import tariffs and quotas) at the World Trade Organisation, replicating the existing EU tariffs as much as possible.

Such a move would inevitably mean that the UK leaves the EU’s customs union, which in turn means goods from the UK exported to the EU, and vice versa, would face ‘rules of origin’ checks at the border. These checks ensure the goods are produced in the exporting country, and are not simply being re-routed from another country that is subject to higher tariffs.

But the problem with these checks is that they are time-consuming, and estimated to cost about 8% of the value of the good. It is these sorts of issues which ranked Norway (a member of the single market but not the customs union) as the most problematic trading partner for Swedish businesses in a survey by the Swedish National Board of trade: one of the most common complaints of trading with Norway was the “incredibly cumbersome” customs handling and rules. Other procedures, such as custom searches and filling declarations and risks of delays at ports, are concerns voiced by stakeholders.

The latter of these is of particular importance to industries relying on fresh produce or operating just-in-time production lines such as the automotive industry. Major disruption to their production lines could occur if customs procedures are not as smooth as they have been previously. It is, therefore, promising that in both the white paper and the future partnership paper the government has given attention to the future customs arrangement between the UK and the EU, and has proposed two possible arrangements.

One – a “highly streamlined customs arrangement” – would seek the implementation of a technological solution for fast movements through roll-on, roll-off ports, and would attempt to negotiate a waiver for declarations. The other – a new customs partnership agreement – would involve mimicking the EU customs arrangement specifically for goods to be consumed in the EU. However, the former would most likely require a large amount of infrastructure spending, while not mitigating all costs, and the latter would need some form of enforcement mechanism.

Unfortunately, little information has been offered on the detail and implementation of such arrangements. Given these have not been attempted before, it is such details which are arguably the most important. However, it is almost certain that, outside the customs union, HMRC will need to expand to ensure it has both the personnel and the infrastructure to handle the increased workload.

CC0 Creative Commons

Deep trade deals, which increase trade volumes, go beyond tariffs and customs issues. They aim to reduce the divergences in standards and regulation between countries so that businesses face lower costs of compliance and operation across borders. This is what turns a free trade area into one large single market. By following a common standard, or at least having mutual recognition of standards, products do not need to be certified to mark that they meet domestic requirements.

It would be hoped the UK could make a mutual recognition agreement with the EU, covering items such as electrical goods and machinery, similar to those struck with countries such as Australia and Canada. The larger issue, however, concerns the services sector, which makes up 80% of the UK economy. For example, the loss of financial passporting rights (which allow UK based financial institutions to do business across the EU) could have major implications for the financial sector. Even if some sort of regulatory equivalence was recognised, this is unlikely to cover commercial banking or primary insurance, as not all EU financial regulations currently offer the possibility of equivalence.

Access to the single EU aviation market could be disrupted because current rules require headquarters to be located within the EU. This is the main factor behind EasyJet setting up their Austrian HQ. Estimates suggest that non-tariff barriers in services have an ad valorem equivalent of 8.5% to 47.3% between the EU and US. Outside of the EU, the UK could face a proportion of these costs, and that proportion would rise as standards diverge between the two areas.

Out of the EU, the UK might find it easier to strike bilateral agreements with new trade partners, because it would no longer face the constraints imposed by 27 other members. As a smaller economy though, the UK would also lose bargaining power, which matters significantly in trade negotiations. This was Switzerland’s experience when striking its trade deal with China (a proposed FTA partner for the UK): as noted by the Lalive Report, the “FTA is more favourable to Chinese exports”. A survey by the Swiss Chamber of Commerce further noted that “the FTA is not very attractive”, while the Swiss Embassy has noted that service exports from Switzerland to China haven’t grown as a result of the FTA.

Another difficulty that the UK will face when negotiating with its large trade partners – the US, China and India – is that its regulatory framework is substantively different from these countries. Thus striking deep deals, which achieve regulatory harmonisation without compromising domestic standards, would be difficult in future negotiations with these non-EU trade partners. The goals set out in the Department for International Trade’s most recent policy paper are ambitious. As negotiating deep trade deals can be a lengthy process, this is a long-term strategy for trade policy and is unlikely to cushion immediate drops in trade volumes under plausible scenarios, like a no-deal Brexit in which tariffs would apply right away.

The goal outlined by the government to achieve a transition agreement, which will maintain current market access and customs arrangements with the EU, is therefore a step in the right direction. It will avoid a cliff edge in eighteen months, and buy the government time to negotiate its future terms with the EU. Ultimately though, a transition arrangement will need to give way to a new arrangement with the EU. The government papers give no details of the specific set of policies that will be put in place to achieve the stated ambition of frictionless trade with the EU. Without these workable details, UK trade policy remains a wish list.

This post represents the views of the authors and not those of the Brexit blog, nor of the LSE. It first appeared on the UKinEU blog.

Nikhil Datta is a Research Assistant at the LSE’s Centre for Economic Performance

Dr Swati Dhingra is a Research Leader at The UK in a Changing Europe, and an Assistant Professor in Economics at the LSE

The productivity gap adds to the concerns about how Brexit can be navigated

In this blog, Iain Begg (LSE) explains why the low expectations of the trend of productivity growth in the UK, published by the Office for Budget Responsibility, add to the concerns about how Brexit can be navigated.

Chancellors usually try to achieve three things in their annual budget speeches: setting a course for the economy; pulling rabbits from their hats to please their core supporters, in and out of the political bubble; and demonstrating their competence and prudent stewardship of the economy.

Philip Hammond’s rabbit was meant to be his package of measures to transform Britain’s dysfunctional housing market, and he announced a number of initiatives intended to improve the supply-side of the economy, with the underlying aim of preparing for Brexit.

However, both were overshadowed in the headlines by the down-grading of forecasts for GDP growth. The slowing of the economy should not have been much of a surprise, because it had already become evident in the data published for the first three quarters of 2017. Even so, the projections of growth being stuck in the slow lane for the next five years are eye-catching.

Image by Nick Youngson, License: Creative Commons 3 – CC BY-SA 3.0

As expected, the Office for Budget Responsibility (OBR – the independent fiscal watchdog) lowered its expectations of the trend of productivity growth. Having been accused of being of being too optimistic previously, it is arguable the OBR has now become too negative about productivity.

But as has been explained previously, the UK’s productivity growth – the key to increasing prosperity and household incomes – has stagnated in the last decade and is the lowest of the leading industrial nations. Britain’s productivity level is also well below that of major competitors, such as Germany and France.

Does any of this matter? There will be cynics who note the poor track record of economic forecasters and therefore seek to dismiss the OBR’s projections. But at a time when the global economy is enjoying steady growth, and even the Eurozone recovery seems to be gathering pace, it is disappointing that the British economy is not doing better.

The lower growth now projected for the next five years can only add to the concerns about how Brexit can be navigated. The initial resilience of the British economy following the referendum stemmed largely from the strength of consumers’ expenditure, but rising prices and low wage growth are making it harder for consumers to sustain the economy.

Unless productivity starts to pick up, allowing employers to pay more, real incomes will stagnate. However, the UK has one of the lowest rates of investment among the richer economies, and without growth in both private and public investment, it will not be easy to boost productivity.

Lower growth will also mean further pressures on already shaky public finances, because tax revenues typically increase in line with the strength of the economy. Public debt will be higher in 2020 than previously expected, despite a redefinition taking housing debts off the public balance sheet. If there are further rises in interest rates, it will gradually cost more to finance the debt.

Hidden away in the OBR tables is an estimate that the government deficit will be an average of £18 billion higher than previously expected in each of the three fiscal years following Brexit: 2019-2021. This is close to double the current British net contribution to the EU, and means any lingering illusion that there will be more money for the NHS soon must be dispelled.

We also have to add in the cost – probably spread over a number of years – of the Brexit divorce bill which Ministers are grudgingly, if belatedly, conceding will have to be paid. The response to the demand from NHS head, Simon Stevens, for an extra £350 million a week may well, to coin a phrase, have to be ‘go whistle’.

Politically, the Chancellor has been applauded for an astute budget, for avoiding any gaffes and for offering enough to the Remainer and Brexiteer factions in his party to see off his critics: for now, the verdict seems to be that his job is no longer under threat.

But let’s be clear: even without any direct effects of Brexit, the British economy is not in the best of health and has medium and longer-term challenges to confront. This is the message decision-makers should take from the budget and factor into the calculations of how to secure the best Brexit deal.

This article gives the views of the author, not the position of LSE Brexit or the London School of Economics. It first appeared on The UK in a Changing Europe.

Iain Begg is Professorial Research Fellow at the European Institute and Co-Director of the Dahrendorf Forum, London School of Economics and Political Science, and Senior Fellow on the UK Economic and Social Research Council’s initiative on The UK in a Changing Europe.

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