EU v UK – the balance of negotiating power

As the Article 50 starts to take shape, the question facing negotiators is who has the stronger position. The question has been addressed by select committees. Let’s take a practical look.

At the same time that debate is in progress, sundry parliamentary select committees are hearing evidence from different sectors. Key among them is Mike Hawes of the Society of Motor Manufacturers and Traders (SMMT). His lobbying has included hearings by two select committees during January alone.

Among Mike Hawes’ assertions are that Britain has a weak negotiating position. The basis for this is a much used argument by the Remain side during the referendum campaign. In short, 43% of Britain’s exports are to the EU. In return, Britain accounts for 7% of EU imports. This argument has been oft repeated, notably this week in the House of Lords debate.

EU position
The EU parliament’s Brexit negotiator, Guy Verhofstadt, has insisted that it is an “illusion” to think Britain could enjoy the economic benefits of the single market without accepting EU budget contributions and “free movement”.

He has also asserted that the EU will not accept any Brexit deal that will leave Britain better off than it was as a full member of the bloc because that could encourage others to follow the country out of the exit door.

EU Commission chief negotiator, Michel Barnier, has also suggested that no progress will be made until a “divorce settlement” is reached, something in the order of £50 billion. Leading EU politicians from the power base of Germany and France have insisted that there will be no deal on access to the SEM without free movement of labour.

Behind them, at least ostensibly, there are 27 nations and a Single European Market of 440 million people. Lined up against a solitary nation of 65 million, one might assume a position of strength for the EU.

That strength might also be a weakness, in that the leading powers that provide the bulk of EU funding have to agree to the same deal as the rest. That includes the South European countries undergoing austerity, the agricultural economies and those East European countries with pools of migrating labour.

British position
Theresa May has outlined a British position. Evolving from her “Brexit means Brexit” slogan, we now know her 12 point plan. We have also heard her assertion that no deal is better than a bad deal for Britain.

By asserting that Britain does not aim to be a member of the SEM, at a stroke she might have appeared to eliminated the EU’s strongest weapon. In real terms, how potent is this?

There is a beautiful simplicity to the British approach. We seek to cooperate with EU members where that is to mutual benefit. We seek to retain our sovereignty, including freedom to protect our borders, manage our own affairs and break free from the ECJ.

Britain would like a free trade deal with our friends. If they don’t want to share the same benefits, we have other friends who do.

Access to the SEM
It is worth pondering what exactly is meant by Single European Market (SEM). It is in fact an arrangement that puts up barriers to those from outside, effectively a protectionist zone that imposes tariffs on cheaper goods from outside.

The SEM will continue to be a collection of 27 countries using 24 languages. Of those countries, 14 use the Euro as a currency, the rest are working towards meeting the criteria for that currency.

The members diverge in many ways; the proportion of their economies involved in different industries, religious diversity, income, wealth and other demographic factors.

Much has been made of the need for the UK to secure access to EU services markets, not least financial services. This can be done by “passporting”, i.e. mutual recognition of regulatory frameworks.

In evidence given to Select Committees, David Davis has identified that the UK has 5,000 passports into the EU. The EU in return has 8,000 passports in the UK.

There are two key points to make about access to the SEM:

1. To be a member, we have to discriminate against those outside the SEM, i.e. the rest of the world, which accounts for 57% of British exports under WTO rules.

2. Membership of the SEM gives those other 27 countries access to the British market where the majority of countries have a trade surplus with us. They need us more than we need them.

Putting into perspective

Some other perspectives might be helpful. Instead of looking solely at exports, a more holistic picture can be seen from the balance of trade:

Overall, Britain operates a trade deficit with the EU. The largest part of that is with Germany, a country that has dominated European markets. This has been significantly helped by monetary union, the value of the Euro being held down by countries with different structures to their economies. This is estimated to give Germany a currency undervaluation, therefore competitive advantage of 15-25% according to the IMF.

Other countries have significant trade surpluses with the UK, notably Spain and France but let us for a moment use Germany as an example to focus the mind. It also helps to realise that Germany is the largest net contributor to EU budgets.

Germany’s car exports account for 12% of their total exports. Roughly 20% of those exports come to Britain. A significant proportion of those components are sourced from former East European countries. Germany and its neighbouring suppliers need to maintain access to the British customer.

No deal is better than a bad deal?
The default position, if no trade deal is concluded, is a reversion to WTO rules. Yes, that means that British produced cars may have tariffs applied when sold into Germany, at a rate of around 10%. That also means tariffs can be imposed on German cars coming into the UK, making them less competitive.

Theresa May also highlighted amongst her 12 point plan that free of the SEM, Britain is free to negotiate bilateral free trade deals around the world. Suddenly, cars built in the USA could gain a price advantage of 10% over those constructed in Germany.

Similar arguments can be applied to other EU trading partners and other industries. Consumers will note the range of agricultural products on supermarket shelves, from a heavily subsidised, labour intensive industry within the EU and with punitive tariffs on the rest of the world.

Red wines from Chile, Australia, the USA and others would have price advantages against those from France, Spain and Italy. The importance of the UK market to EU members, notably those who are net budget contributors, should not be understated.

To add to perspective, yes, the EU may account for 43% of British exports. That means the rest of the world accounts for 57%, under WTO rules. By exports, the USA is the biggest market for UK goods, Germany 2nd, Switzerland 3rd and China 4th. By surplus, Switzerland tops the ranking, followed by USA, UAE and Hong Kong.

In short, despite being the absence of a deal with a protectionist EU, Britain is afforded scope to profit from larger markets globally, both in lower costs of imports and freedom to sell into global markets.

Who wins with no deal?
On a political level, Britain gains democratic accountability. On a trade level, Britain regains the ability to deal with a world that has liberalised considerably over the last 45 years.

On what should theoretically be the mid point of the 2 years article 50 negotiations, in April 2018, the Commonwealth games will be held in Australia, a group of friendly nations accounting for 1/3rd of the world’s population, over 5 times more than the rump of the EU. This could be a timely reminder of the opportunities in countries which have a shared history with Britain.

Britain gains freedom to manage her own affairs, gains from reducing the net budget contribution, gains control over migration, gains from free trade with the growing economies of the rest of the world.

The EU would lose the net contribution, potentially face reciprocal tariffs with one of the biggest export markets for almost every one of the 27 remaining nations.

A corporate view
With much having been made of the car market during debate in Brexit, no apologies are made for staying with this example. Some further analysis shows that Germany is the biggest car market in the EU.

The top non-German brand sold in Germany is the 8th most popular model, the Skoda Octavia which is in fact German owned. The top non-German owned brand is the Ford Focus coming in at 14th. The Focus is also built in Germany.

To once again add perspective, in 2016 the Focus accounted for sales of 47,990 in Germany. There were 70,545 sold in the UK. In order to overcome a loss in demand, it might make sense for companies like Ford to avoid tariffs by investing in relocating assembly back to the UK, at least partially.

The relocation of investment argument might even be accentuated if, as suggested by Chancellor of the Exchequer, Philip Hammond, were to follow through his suggestion of reducing corporation tax. Adding value in a low tax economy as compared to the EU would encourage profit to be taken here.

Another angle is those German car makers with plants in other countries that could supply the UK market should trade deals be struck with, for example, Brazil or South Africa. We can always buy our Mercedes and BMWs from those countries. Better still, Jaguar would have a price advantage, more so if using British steel.

Summary
The EU institutions come from a perspective of self preservation, that of the bureaucracy that thrives on increased control. Member nations of the EU are diverse, with needs that vary. It is in the institutions’ interests to delay as long as possible, ensuring maintained net contribution from the UK.

Central to that self preservation is Germany whose industrial markets are artificially protected to sustain an economic engine for EU survival. The buffer states surrounding Germany depend on the net contributions from the bigger member nations to provide what growth exists in the EU markets. The Southern member states suffer with austerity.

Britain has much to gain from freeing itself from undemocratic bureaucracy. She has the opportunity to return to her national characteristics, based on a maritime history with global trade. We do not seek to protect ourselves from the world, rather embrace it with our friends who share a common language and/or a common history.

Whatever position the EU currently takes can soon change. Frau Merkel faces an election this year, as do the leaders in net contributing countries, France and the Netherlands. As well as negotiating with Britain, the EU has to negotiate with 27 member states, some of who will be asked for greater contributions, others who will be asked to accept less.

EU members need access to British markets to maintain a semblance of growth rather than recession. For Britain, the rest of the world once more provides opportunity. If the EU institutions seek to make Britain suffer, it is EU member states who will suffer, from decline in industrial and agricultural sales to a significant trading partner.

As Theresa May says, “no deal is better than a bad deal for Britain”. No deal would be a bad deal for EU member states. The British market is vital for the EU as a whole to maintain growth. At least one side will need to compromise. The EU has to recognise that its 27 member states will lose more by seeking to put up its own barriers to the British customer.

No deal for Britain would ensure no further contributions, would provide certainty in markets and start the march to trading with a growing world. It is up to the EU to decide whether they wish to adopt the philosophy of lemmings or to cooperate with an innovative country that has a global reach.

House of Lords – an opportunity for reform?

In the wake of the EU referendum, public attention has been aroused by suggestions that the House of Lords could be the forum to block Brexit. Were they to do so, would this make it the right time to reform or even abolish the upper chamber?

HoL1

The House of Lords is currently the second most populous legislative chamber in the world, only behind China. It has the largest head count of any chamber in the democratic world.

To summarise the statistics, the House of Lords is currently made up of almost 700 life peers, those being nominated by the Prime Minister. Additionally, there are up to 92 hereditary peers, those who have inherited ancestral titles. A further 26 are bishops.

Among the group of life peers are sports people who have achieved great things. There are also representatives of the legal profession, trade unionists, business people and other who have contributed to society. There is also a raft of failed and/or retired politicians, among them several expenses cheats.

There have been several half hearted attempts over the years at reforming the House of Lords. The most recent Act was in 2014 which merely created the opportunity to retire from the Lords and for members to be disqualified or removed.

The last major reform was under Tony Blair in 1999, which limited the number of hereditary peers. Following the House of Lords Act that year, the number of active peers was reduced from 1,330 to 669. Since then the number has grown again to 805, up by 15%. Each of the 3 Prime Ministers since and before Theresa May have flooded the ermine clad benches, there being over 850 who are either active or inactive. Cameron alone appointed 263 including his resignation honours.

HoL2

Given those numbers, a perspective might be given of attendances. In the year after Blair’s reforms, the average number of peers attending was 352 per day. At the time of the formation of a coalition government, this was up to 388 per day, a rise of just over 10%. By the time of Cameron’s resignation, the increase was to 497, a further rise of over 28%.

Those statistics generate a number of arguments.

At a time when they civil service and indeed the country have been subject to austerity, the Prime Minister has been able to appoint chums to a life of indulgence. Cameron did nothing to reduce the cost of government, at the same time as reforming state sector pensions, with the exception of parliament. They average cost of an active peer is over £130,000 each year in allowances and expenses.

At 805 members, it is hard to justify why the 21st biggest country by population should have the 2nd largest chamber, over 8 times the size of USA who have 5 times the population. The fact that is has grown so much since 1999 makes it hard to disagree that patronage is the wrong means for allocating seats. Incidentally, there is a maximum seating of 400.

HoL3

Anyone who even casually watches proceedings in the upper chamber will find it hard to believe the average attendance. It would be easier to believe the anecdotal stories of peers turning up to sign in whilst the taxi is left running. £300 per day might corroborate allegations aimed at the former Commons’ expenses cheats. There is rarely, if ever, standing room only.

Clearly, any future reform has to be directed at the number of Lords.

There are some alternate perspectives. No single party has a majority in the Lords. . Currently, it might be argued that the balance of power is held by the 26 bishops, 178 crossbenchers and 30 otherwise non-affiliated members. In the case of the former, the nation is afforded a moral compass, as for the others, they can vote with their conscience and on the quality of potential legislation. Independence of members has some attraction.

It may be a surprise to note how frequently the Lords have sent bills back to the Commons for amendment. In the last session alone, there have been 60 defeats involving 17 bills and other regulations.

Perhaps the most high profile of those was on in work tax credits. On that single issue, it seems reasonable to expect that the majority of the population would support the vote by the Lords. In fact, it is hard to argue that any recent defeats were anything less than appropriate measures to curb the excesses of a rash government with a working majority that could potentially last for 5 years under the fixed term Parliament Act.

On tax credits, the Cameron axis of government attempted to push through something which, if put to a public vote, would undoubtedly be defeated. This was also specifically against the electoral promises made by Cameron and his team.

Further analysis of those defeats suggests that collectively, the Lords have acted to uphold democracy and protect rights. Sundry Lords select committees also exhibit detailed and independent analysis of current events and policies. Not all that the lords do is bad and in fact much is for the greater good.

HoL sleeping

So how can we summarise the House of Lords? Certainly it is overpopulated. It is a retirement home for failed politicians and expenses cheats. It has also become a vehicle for unprincipled leaders to reward back scratching. Most importantly, as a revising chamber, it is a vital component in restricting the power of governments which go too far.

This makes the question of how to reform the House of Lords fraught with potential debate.

Some simple principles might apply. At this point, it should also be acknowledged that the House of Lords is unrepresentative in many ways; the predominance of men over women by a ratio of 3:1, the wealth profile and the age profile to name but three.

Firstly, there needs to be a multi tier peerage profile. Honours can be given to those who have excelled and served the public in many spheres. That does not have to be accompanied by entitlement to legislate. Indeed, not all hereditary peers have the right to sit. Extension of that principle would be no novel act.

There also has to be a time limit on how long those entitlements to legislate can apply. Under the current framework, a government has to submit itself to the electorate for 5 years. A peer is in the Lords potentially for life, regardless of competence.

Allowances should only be paid for all day attendance, clocking in before the start of proceedings and confirmed by attendance at a percentage of all votes, 80% does not seem unreasonable.

clean up the house of lords

Numbers should be reduced to a manageable level. It is hard to justify a figure of more than 400 active members, a comfortable seat each if they are to actually attend debates. On that basis, those attending the least can therefore be moved to the non-voting tier of Lords, to be reduced further as a democratic component is introduced.

That democratic component should number between 50% and 75% (to be agreed) which can be elected in between general elections and on a proportional representation basis, reflecting the democratic profile of the electorate. Such elections would hopefully provide a more reflective demographic profile.

The balance, quite rightly, should reflect the moral compass of the country. Bishops should be retained. £300 is a reasonable fee for legal professionals to scrutinise potential legislation. The balance of power should be held by those without other vested interests.

The need for reform is obvious, the solution can be simple, reducing the cost and abuses whilst retaining the brake on a government which exceeds its powers.

Brexit – some EU perspectives

The march towards Brexit continues. Finally, the Article 50 Bill has been presented to Parliament. What better time to consider perspectives from the EU on what Brexit might mean?

With the Article 50 Bill timescale, in theory at least, Theresa May should be in a position to invoke Article 50 itself during the EU Council meeting on 9th March in Malta. There will certainly be cause for reflection amongst EU ministers.
May blanked

It is worth taking a moment to consider what exactly the EU is. The highest priority from the Remain side is that the EU is a Single European Market (SEM), a free trade area for its member states.

A reverse perspective from outside the EU is that it is a customs union. Barriers to trade may or may not exist among EU members but for the rest of the world, the SEM is a market to which access faces barriers. The customs union also includes countries such as Turkey who have yet to become full EU members.

To many Leave voters and campaigners, the EU is a political union between 28, soon to be 27 countries. Among those, 14 are also involved in currency union with fiscal restraint in order to harmonise their economies and provide currency stability. In practical terms, this benefits some more than others, more of which later.

On 31st January 2017 the President of the European Council, Donald Tusk, has written to ministers. His letter can be seen here. Tusk is one of five EU presidents who collectively produce reports on the direction of travel, the 2016 report can be found here.

In short, these views can be seen a representative of the EU establishment. They are committed to ever deeper union and integration. This amounts to further convergence, fiscally, economically and in strengthening institutions.

To that end, Brexit represents a political threat. Tusk has identified what he calls “xenophobic sentiment” and “national egoism” as challenges within Europe. In short, democracy and the will of the people is secondary to maintaining and deepening the power of the institutions.

On top of the political threat, the EU administration faces a cut in its budget to the extent of a net £8billion (and growing) per year. This figure represents around 14% of net contributions. Brexit means that money will have to be found from elsewhere or that expenditure, with the power that brings, being diluted.

The EU administration is faced with the dilemma of doing a deal that respects democracy at the risk of other members being incentivised to leave or punishes Britain. The question remains, who would be punished more?

The EU is however still a collection of 27 nations, for the time being at least. It is remembered that even though its supporters see the EU as a valuable single market, those 27 states will have different views of what Brexit means. To explore those, let us start with relative trade positions.

trade balance

The above table represents the balance of trade, whether EU members are in surplus or deficit with the UK.

Top of the list is Germany with a surplus in excess of £25 billion annually. Their current strength is in full view of those who use Britain’s roads. Germany is the leading car exporter globally at almost twice the value of second in line, Japan and three times the value of USA in third.

To give more background, the UK accounts for 20% of Germany’s car exports. The car industry accounts for 12% of Germany’s total output.

A new German government would certainly be opposed to any sort of deal that damages her own interests. Failure to strike a deal potentially leads to the fall back position of WTO rules. That means of course that British car exports to Germany may face tariffs, in the order of 10%.

Reciprocally, tariffs might be imposed on one of the German car industry’s key export markets. Whilst the SMMT assert this will increase the price of cars by £1,500, there is also the distinct possibility that British consumers shift their buying patterns to those vehicles produced here. Will company car fleets shift from Mercedes or BMW to Jaguar?

There are further threats to Germany. If bilateral free trade deals are struck between Britain and other partners, Japan and the USA, German competitiveness is further diluted by those exporters into British markets as well as British vehicles into American markets.

There is a solution for the car manufacturing companies. German producers, as well as those owned by external investors such as Ford and General Motors can relocate production elsewhere, even back to the UK.

A summary of Brexit for the German economy is that loss in demand from the UK can mean the difference between modest economic growth and recession. Extra competition in markets where bilateral deals are made and disinvestment can lead to depression.

The same principle can be applied to those other countries with significant trade surpluses with Britain, imported cars coming from 7 of the top 8 EU countries which have a surplus with the UK. The exception is Poland which provides components across Europe. Poland’s main export to the UK is consumer goods, including shoes, a relatively labour intensive industry.

Incidentally, the UK happens to be Poland’s 2nd largest export market accounting for Poland’s largest surplus.

Poland is a prime example of another phenomenon, an estimated 800,000 nationals working in the UK and sending a proportion of that income home. Free movement has a greater proportional impact.

The other major trading partners also rely exporting on labour intensive goods to Britain. Among these are heavily subsidised agriculture products; wine, cheese, fruit and cured or processed meats. Reciprocal tariffs would increase these prices in the UK market by up to 80%. Conversely some of these products will become cheaper from the USA, the Commonwealth and the rest of the world.

Jorge Brotons, President of the Spanish export federation Fepex has already identified a cut of 15% in his members’ revenues from the UK, largely as result of currency movements. This would surely be exaggerated by full Brexit and the imposition of reciprocal tariffs. France and Italy can expect similar.

Although campaigners for prioritising access to the SEM choose to minimise Britain’s importance, it can be seen that a shift in Britain’s trading patterns has the potential to impact significantly at the margins. The SEM is not in fact a single market. Rather it is a collection of 27 markets with one dominant currency and 9 others using 24 different official languages.

Remember all of those countries have to agree to a deal.

Not all of the EU is prosperous as was identified on this site here during the referendum campaign. Intriguingly, those with the highest growth rates are typically those former members of the eastern bloc, still with their own currencies and modernising with western investment.

Those with lower growth rates are typically the more mature EU members, outside the German centred powerhouse and who are struggling to meet austerity conditions. These economies are also susceptible to small changes in investment, either through government policy or a fragile banking system.
5 presidents

This brings us full circle back to the institutions leading the Brexit negotiations on behalf of the EU. For all of the above reasons, it is in their interest to delay Britain’s exit, maintaining free access to British markets, freedom of movement and the net contribution. However, all nations involved must agree, including the UK. It is in our interests to seek bilateral agreements with the rest of the world which provides 90% of our economic growth. The EU can not rely on Britain’s compliance.

Restrictions on budgets, if they are to be overcome, require extra funding to be found from somewhere when EU growth is negligible. With elections this year in Germany,France and Netherlands, how can they strike a deal that maintains Germany’s artificial advantage through a Euro that is too strong for most of the rest of Europe? Will the resolve of members reflect the self interest of bureaucrats or will “national egoism”, what we call democracy, mean that they have to accept a scaling down of the vision?

It would not be surprising to see the bigger players in Europe influence the change of direction in of the EU. What Tusk misinterprets as “xenophobic sentiment” might actually be the embryo of devolution, seeking to bring decision making closer to home. Mr Tusk, the concept is called sovereignty.

The EU itself may well find itself in conflict with its members. Further integration can only work if funds flow from the rich in the EU to those suffering with austerity. Is that acceptable to the rich? Can the EU survive without?

So we can see a different context. The EU institutions and 5 presidents may seek to take a hard line with Britain. Voters across Europe may thwart their political will by replacing members of the Council with more nationalistic representatives. The goal may shift from power maximisation to loss minimisation. The only thing certain in the EU negotiating position is uncertainty.