A simple solution for #Brexit-related uncertainty

Prominent Brexiter Andrew Lilico, I see, argues that we could avoid the uncertainty created by triggering the Article 50 process by not doing so:

The Treasury says an instant triggering of Article 50 post-referendum would be a driver of uncertainty. In which case, maybe don’t do that?

Indeed. Article 50 of the Lisbon Treaty lays down the process for voluntary withdrawal from the EU. You trigger it if you want to leave the EU. If you haven’t, you haven’t left the EU. Not triggering it – staying in the EU – would indeed avoid quite a lot of uncertainty.

But, Andrew, we could go one better. We could completely eliminate it. All we need do is vote to stay in.

#Brexit, trade, and the J-curve

A couple of thoughts on the economic consequences of #Brexit. HM Treasury, the Institute for Fiscal Studies, and others have published their efforts to forecast the short- to medium-term impacts of leaving the EU, and it’s fair to say none of them are good. The point I would like to highlight is that everyone seems to expect a big – 15% is a consensus number – devaluation in sterling post-Brexit.

I’m usually quite a “cheap pound” guy, so you might think I’d see this as an offset to the risks of Brexit. Actually I don’t, and here’s why. Just as a “strong” currency isn’t good in itself, but instead good for some groups in society and bad for others, a “weak” currency is good for some people – exporters, basically – and bad for others – importers, basically. A fall of 15% in the sterling trade-weighted index will help exporters in that it’s an immediate 15% price cut, and harm importers by the 15% increase in their prices. On balance, you’d expect it to reduce the current account deficit by 15% * some elasticity parameter.

It’s not that simple, though – there’s the famous J-curve effect. It might take time for exporters to increase their volumes, while import prices go up straight away. As a result, devaluations often have a contractionary effect immediately, and then a greater, expansionary one later. The problem, in the Brexit scenario, is that we propose to do something that will induce a substantial devaluation at the same moment that we commit ourselves to a whole lot of uncertainty regarding trade with Europe.

The case for it all turning out OK is basically a bet that the lower sterling trade-weighted index will lead to enough growth in export volumes to make it up. However, we’re meant to be taking this bet just at the time we do something that’s likely to constrain volumes on about 44% of our exports, even if only temporarily. Also, a lot of export-heavy companies are manufacturers integrated in international supply chains, who probably use quite a lot of intermediate products sourced from inside the EU. These companies will see their input prices rise sharply, while they may not be able to take advantage of the cheap pound on about half their market. As a result, they will experience quite a dramatic margin squeeze.

I can certainly see this leading to a beast of a J-curve recession, even if it doesn’t manage to push the housing market off the wall. One important trigger for a big drop in sterling, by the way, would be a drop in foreign portfolio investment in the UK. A hell of a lot of that is real estate, and there is already evidence of investors putting purchases on hold.

Before you all write at once, I stick with the 44% number. This has been criticised due to the so-called Rotterdam effect, where goods going to the wider world get trans-shipped through EU load centre ports like Rotterdam, Antwerp, or Hamburg, and therefore counted in the port statistics as exports to the Netherlands, Belgium, or Germany. There’s a good account of it here. I do not accept that this is a problem. Rather, I do not accept that it is a valid argument that European trade is less important than we think.

If shippers in the UK choose to ship to, say, China via Rotterdam rather than direct ex-Felixstowe or Southampton, they presumably do so for a reason, typically that bigger volumes and bigger ships mean lower freight rates and more choice of routes and sailings. There is no reason, I think, to expect Maersk or whoever to call at UK ports more often post-Brexit. Shipping via Rotterdam to somewhere extra-European represents trade with the EU in that the UK imports port services from the Netherlands, paid for out of the revenue from exporting. If we had a port the size of Rotterdam, we certainly wouldn’t discourage European shippers from using it! And of course, we do – just it’s an airport, and it’s called Heathrow, and just listen to the business lobby hollering for more capacity there.

In conclusion, one of the contradictions of Brexit that bothers me is that its strongest advocates seem to believe that relatively petty regulatory burdens are enormous restraints on the economy, whose removal would lead to a surge of growth, while they also seem to believe that incurring even relatively petty trade barriers would mean, well, nothing much. You can’t have it both ways. Either the economy is robust to petty interference, in which case we might as well stay in, or it’s not, in which case we surely have no business putting a new layer of it between us and Europe. After all, it’s unrealistic to imagine the electorate ever agreeing to some sort of Donner Party libertarian utopia – we wouldn’t be swapping open trade, with levels of regulation that don’t seem to do German exporters any harm, for a tariff, but zero regulation. Instead we’d likely get a worse relationship with Europe by quite a lot, offset by a few doubtfully useful regulatory changes at the margins.

I find this baffling. Perhaps, in the end, the belief is that even trivial regulatory changes would be transformative, and the relationship with the EU would, well, somehow turn out OK in an unspecified manner. That strikes me as too many leaps of faith for one lunchtime.

PS – don’t trust me, ask a Felixstowe docker!

It will make a difference. FXT will surely suffer as they will no longer be able to tranship to R’dam and elsewhere without documentation as they can now. Why would shippers go through two lots of clearance procedures when they can cut FXT out and ship straight to the continent?

Timeliness challenge

The IMF Board considered the annual surveillance of the UK economy barely 2 weeks ago, and the associated report was published even more recently. And a couple of days after that, its main findings about fiscal policy — trumpeted by George Osborne during the visit — are effectively dead. Here’s what the Fund says (page 10) –

Relative to the last pre-election budget (March 2015), the authorities’ latest fiscal plans as announced in the 2015 Autumn Statement envisage a smoother path of deficit reduction. Consolidation is also now based somewhat less on spending cuts than previously projected, partly due to revised revenue and interest expenditure projections and new revenue measures. The consolidation path is appropriate in the baseline scenario. Continued consolidation is needed to rebuild buffers, thereby allowing more aggressive countercyclical policy during the next recession.  

Similar language is peppered throughout the report. The problem is now out in the open in that Osborne used a G20 trip to Shanghai and a linked interview with the BBC’s Laura Kuenssberg to confirm what had been obvious to analysts for a long time: the revenue, growth, and modeling assumptions underlying the Autumn Statement cannot be met.

Imagine if an African country finance minister uncorked a worse economic scenario than he’d told the Fund just weeks after their visit!

Ireland and Iceland: when cosiness kills

The fate of the Irish and the Icelandic banks are intertwined in time: as the Irish government decided on a blanket guarantee for the Irish banks, the Icelandic government was trying, in vain, to save the Icelandic banks. In spite of the guarantee six Irish banks failed in the coming months; the government bailed them out. The Icelandic banks failed over a few days. Within two months the Icelandic parliament had decided to set up an independent investigative committee – it took the Irish government almost seven years to set up a political committee, severely restricted in terms of what it could investigate and given a very limited time. The Irish report now published is better than nothing but far from the extensive overview given in Iceland: it lacks the overview of favoured clients and the favours they enjoyed.

A small country with a fast-growing banking sector run by managers dreaming of moving into the international league of big banks. To accelerate balance sheet growth the banks found businessmen with a risk appetite to match the bankers’ and bestowed them with favourable loans. Lethargic regulators watched, politicians cheered, nourishing the ego of a small nation wanting to make its mark on the world. – This was Iceland of the Viking raiders and Ireland at the time of the Celtic tiger, from the late 1990s, until the Vikings lost their helmets and the tiger its claws in autumn 2008.

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Language adjustment

The IMF World Economic Outlook update is out. Despite all the China and financial markets talk, the movement in the forecast is more about the uselessness of BRICS as an economic concept: deeper recessions than foreseen even 6 months ago in Brazil and Russia, extreme sluggishness in South Africa, what the Fund still views as an adjustment and not a crash in China, and strong growth in India.

But anyway, the projection contains its typical sentence from the post-2008 years: Risks to the global outlook remain tilted to the downside.

Why does it never say The projection remains tilted to the upside?

Edward Hugh, RIP

Unfortunately the dark and cold days of winter tend to bring some untimely departures and this season’s deaths now include our blogging colleague Edward Hugh, who we gather died yesterday in Spain. Edward’s posts here and on other platforms marked him out as someone with the fresh eyes of an economist who had made his own way to an analytical framework that found its ideal subject in the Eurozone financial crisis. The slow-burning demographic strains of which Edward had long written remain even as the banks get very slowly cleaned up, and are of course a subtext to the current migration crisis. Here’s a link to the New York Times profile of Edward from a few years ago which further broadened his audience.  Our condolences to those who knew Edward best.

UPDATE: The New York Times has a nice obituary.

Right said George

imf_gbr

From UK Chancellor of Exchequer George Osborne’s opening statement at the joint news conference with the IMF yesterday, Mme Lagarde in attendance, to conclude the IMF assessment of the UK economy -

Yes, there are still risks. The IMF have identified the risks, and they are the same risks we’ve identified and are taking action to prevent. I take this as an endorsement of our plan to fix the roof while the sun is shining.

The table above is from the IMF’s July 2008 assessment of the UK economy. Bear in mind that the first tremors of the global financial crisis had happened nearly a year earlier. The debt and deficit are now over twice as high as these numbers. The IMF team of course doesn’t have much choice but to sit there politely when Osborne uses his 7 year old political slogan about fixing the roof etc. But by the IMF’s own standards, the roof was in good shape in summer 2008. The pile of rubble fell afterwards.

Asymptotic Austerity

OBR_Nov2015

If George Osborne continues to be able to find enough new future cash via changed modeling assumptions to spread around, he might yet get the growth of GDP, and eventually the level, back to where it would have been before austerity started!

Figure source Office for Budget Responsibility Economic and Fiscal Outlook November 2015. Chart 2.1: Selected vintages of ONS real GDP estimates and OBR forecasts.

Why IS hates refugees, and what that tells us about it

The Syrian passport found on one of the Paris attackers turns out to be a fake. The Egyptian one Le Point thought belonged to another turns out to belong to a bystander. The only attacker for whom we have a positive identification so far is a Frenchman. There are a couple of possible readings for this – it’s possible that a home-grown terrorist who went to Syria used the fake document to return discreetly, that a terrorist who entered the EU as a refugee used a fake document because they came from Daesh country, where valid ones are not issued, or that the attackers wanted to label their act as a blow struck in the Syrian war, or alternatively, that they wanted to smear the refugees. Mike Giglio, of Buzzfeed, was early with this one.

This may seem a bit conspiratorial, but you ask Germany’s interior minister, Thomas de Maiziére. Since I drafted this post on Sunday, more information has emerged and it turns out all the passports so far found are stiff, and every one of the perpetrators so far identified are either French or Belgian nationals. Even the Daily Hell has recast its original OMG REFUGEES coverage as how easy it is to buy fake passports. It seems to be approaching the status of conventional wisdom.

In fact, there’s quite a lot of evidence that the leadership of Daesh is furious with the refugees. Aaron Zelin has collected a string of their propaganda videos in which Daesh leaders alternately implore the refugees heading for Europe to stay, denounce them as traitors, and assert conspiracy theories about replacing proper Sunni Muslims with Shias, Druze, and Christians. With exquisite irony, this last mirrors the ideas of Umvolkung or the grand remplacement dear to European right-wing extremists. During September, as the exodus began, this seems to have been a major theme of IS propaganda. Over the weekend, they reprised the theme.

The explanation of this is the S in IS – it’s a state, and it’s a particular kind of state. It offers a particular religious and political group – Muslims who accept its claims – three things. First, a defensive haven of security. Second, a beacon of inspiration. Third, a champion of strength, waiting in overwatch to defend them outside its borders. This is to be achieved by emigration as a form of revolution.

Moving to the Islamic state helps to create it. It also helps to achieve its aims. And it is also a way of pursuing personal transformation. Emigration to Daesh is both a physical journey, and a journey in the sense of Tony Blair’s memoirs. Participating in the creation of the state is meant to change both the community, and the individuals who take part. War is either accepted as necessary in self-defence, or actively sought as an accelerant to the process.

This was true, more or less, of many other states. The United States of America incorporates this mythos into its official founding story. This tweet is snarky, but it gets at the point.

The Soviet Union started off a bit like that. You could say the same for the Crusader kingdoms – they aimed to protect the Christians of the Levant and their holy sites, to deter anyone else who threatened them once that was achieved, and to transform themselves by demonstrating both Christianity and chivalry. Bits of those four elements show up repeatedly in colonial-era narratives about emigrating to escape the decline of the old country and to be a better person. And Israel probably expressed all four elements more thoroughly than any other state. In fact, I borrowed the elements pretty much from Theodor Herzl.

A more radical and aggressive version of this sets out to force its people to leave and join the new state. Consider some more IS texts. The point is to eliminate even the possibility of coexistence, to force everyone to take sides.

There were even people in the Revisionist wing of Zionism who were willing to treat with the Nazis for exactly those reasons, as the ultimate polarising force. Whatever you might say about this Hitler fellow, he wasn’t going to leave any grey zones of coexistence lying around.

This ought to be familiar, again, because it’s the doctrine of Barry from Four Lions:

The idea of seeking security in Paris – or, heavens forbid, Berlin – is intensely subversive to such a state. It crushes their claim to provide a safe haven for the faithful. It tramples Daesh’s claim to be an inspiration to Muslims. And it makes the idea of providing a defensive overwatch to them around the Middle East look absurd.

The refugee exodus is also harmful materially. IS is a state, and a state at war craves manpower. It has frequently been pointed out that young men are over-represented among the refugees. This is because they went ahead, hoping to find a home and bring the rest afterwards. And it is also because IS is most likely to conscript them. It may also be because when the World Food Programme temporarily ran out of cash, people calculated it was more likely to keep feeding the most vulnerable. They had a choice; believe in IS, or in Europe.

Perhaps we should see the last few weeks as the result of an IS crisis. The movement of refugees was a political disaster. Although a lot of people are sceptical about Russian aims, they can hardly have been pleased to see the roaming Hinds overhead. US airpower has been hitting high-value targets again, after it was reinforced recently. Other Syrian forces have been receiving a lot of guided weapons again. The Kurds have been advancing towards Sinjar, which they took on Saturday, and threatening to cut the road from Deir ez-Zour to Mosul. What to do?

The answer seems to be to strike in the deep, using their ability to recruit in Europe as a kind of terrorist air power. The point is simply to impose costs and spread fear, but also to put soldiers on the streets who might otherwise be deployed somewhere closer. And if they’re really lucky, on the strategic level, to prove that we agree with them deep down on at least one issue.