“Brexit means Brexit” – a Translation

Following Prime Minister May’s speech on BREXIT, I have attempted to summarise and analyse the insights I have gleamed on the process over the last year below.

Immigration:

This has been one of the biggest areas of focus since BREXIT was announced, but we now have some clear outlines. First and foremost, the UK will not accept the EU’s freedom of movement, as it applies today. Instead it appears that the UK will offer its own equivalent of the American ESTA scheme, an online visa form which is approved quickly and lasts up to two years, for all EU nationals. This would mean that all European tourists, academics, artists and business people in would be able to visit the UK as easily as they can today, absent a 5 minute application online.  The second piece that we can say with a very high degree of certainty is that all EU nationals currently residing in the UK will be offered citizenship. Theresa May already offered this to the EU commission, in exchange for guaranteeing the rights of Britons living in the EU. We also know that the Home Office is pushing this approach as well. The costs and resources needed are extensive and frankly Theresa May’s government views this as an easy compromise that will encounter limited real resistance from within the UK or her party.

On work rights the picture now is also clearer. One school of thought is to create a skills based quota for each year and make it applicable for all global nationals, including the EU, which is in line with the US, Canada, Australia and other developed economies. This aims  to allow a quota of non-UK nationals to enter each year, provided they are sponsored by an employer. This is the approach championed by the Home Office under Amber Rudd (who previously supported Remain). The other option being proposed is to grant an automatic visa to any EU national who has a full-time job offer to work in the UK. This idea has been proposed by former foreign secretary William Hague. The ultimate choice is likely to be determined by the EU’s negotiating position. The automatic right to work, if an employer has made a full-time offer, allows the government to demonstrate that only “working migrants” are entering the UK, thus dispelling the pernicious lie that EU immigration is welfare driven. It also allows UK industry to recruit top talent across Europe, thus helping to address business fears about labour shortages in certain sectors (including the NHS). If implemented properly, this could even be a blueprint for the EU’s relationship with other future members, such as Turkey and Ukraine. However, if the EU appears to push for punishing exit terms and UKIP maintain the pressure on key Conservative seats, then the first option is more likely.

Foreign Policy and Security:

At this time there has been no suggestion that the UK wishes to change its cooperation with the EU at an international level. The UK has continued its increase in troop and materiel deployments to the Baltic states, and there are no signs of a thawing between the UK and Russia (unlike the USA). At the international level the EU often operates in a broader grouping that includes Canada, Australia and Norway at institutions such as the UN, World Bank and other multi-lateral agencies. It  appears clear that the UK will simply remain within this broader grouping, albeit with less influence on the EU’s ultimate position on issues than it previously held.

Amazingly the UK has not made any attempt to link security and NATO related issues to the terms of exit. This is despite a range of arguments that suggest the UK could leverage this angle, especially in light of the changing US position on NATO. While there have been early signs that the UK intends to expand its presence once again “East of Suez” and there have been discussions to re-open UK naval bases outside of Europe. However, given the UK’s limited manpower currently across the armed forces and its shrinking maritime presence, these recent moves appear to be more symbolic of a UK “open to the world” than a sign of significant redeployments to come.

Trade

While the Prime Minister has talked about staying in the customs union, it appears more likely that the UK will leave the EU single market and customs union. Given this outcome, the game will be about Tariffs, Equivalence and Regulation.

Let’s start with Tariffs. While there remain a number of technical issues to finalise, it appears certain that the UK will become an automatic WTO member, after its exit from the EU is completed. This membership ensures that both the UK and EU have strict limits imposed on the level of tariffs they can set on each other and when they can impose tariffs. To put into perspective the current WTO tariff levels, the tariff on cars between the USA and Europe is around 3%. For some areas the tariffs are higher, for example food, but as the UK is largely an importer of goods from the EU it is unlikely that the EU would want to impose large tariffs.

However, where the EU is likely to seek a clearer split with the UK will be around regulation and Equivalence. With an exit from the single market, the UK Financial services sector are likely to lose what are called “Passporting rights”, whereby UK firms can sell financial products directly to EU consumers and businesses without needing to have a local presence. What the net effect of this will be is unclear. The immediate answer will be that costs for all financial services companies in Europe will rise and the UK will lose some staff in areas like FX trading and clearing of some Euro denominated debt. Beyond that the picture is less clear. As the cost of regulation has increased since 1997, the Financial service sector has seen considerable consolidation, leaving Europe with a smaller group of larger companies than existed before the single market. As these players have operations all over the EU, it’s unclear whether firms couldn’t simply hire a staff member and a postal address in the EU to circumvent many concerns. This approach already exists to an extent within the EU today, as it allows companies like Facebook and Google to take advantage of different tax laws, see Luxembourg and Holland.

Again, the more positive outcome for both sides would be an agreement to keep all tariffs on goods at zero and to introduce “Equivalency”. This concept means that the UK financial services sector could sell goods into Europe, like a firm based in Europe, but they would be subject to EU regulation and EU courts. Moreover, the UK would have no influence on EU regulations and firms in the UK could be prevented from doing business in Europe if they did not match EU standards.

On the broader international trade piece, it looks as though the UK priority list will be the USA, followed by Canada, Australia and New Zealand. I would also add, though it hasn’t been mentioned, that Japan would likely be high on that list too. Japan is a large investor in the UK and moreover, the UK and Japan have few sectors of extreme competition, with the UK unlikely to threaten Japan’s agriculture or electronics manufacturing, while Japan poses few threats to the UK services sector. The UK would likely use templates from the failed US-EU trade talks as the basis of terms with the US (50% of all US gains from TTIP were due to come from greater access to the UK anyway) and the UK is likely to use the current EU-Canada trade deal as its template as well.

Closing Comments:

The BREXIT process is subject to a huge amount of political brinkmanship. Should moderate EU parties do well in elections, the global economy accelerates, Theresa May remains popular in the country and Trump remains largely focused outside of Europe, then political leaders should have the breathing space to craft a reasonable and fair deal. If, however, Russia and the US increase pressure on Europe, the migrant deal with Turkey collapses and populists are successful in EU elections, a fortress mentality may set in. The EU, despite its challenges, remains extremely popular in Europe. For this reason I continue to believe that if the survival of the EU becomes more threatened, we are likely to see a youth led backlash in favour of greater EU integration.

The EU is, in the words of Romano Prodi “an unfinished project” and Europeans know this. Thus, how BREXIT plays out is not simply a story that can be told in isolation, rather, BREXIT is also the story of the European Union. Will it become what its fathers dreamed of, a full political union of nations, or will it unwind to an early form. Time will tell.

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Thoughts for the year – 2017

While many will have breathed a sigh of relief on the 1st of January that 2016 is over, the consequences of last year will continue to define this one. Firstly, we shall see what effect the far right electoral successes and Russian electoral interference in 2016 will have on European general elections. Alongside these events we will also receive further details on Mrs May’s plan for the Brexit negotiations in March, and by the mid-year, we will know whether the “Trump boost” which has lifted global equity markets and triggered a selloff in fixed income assets, will have been justified.

But 2017 is likely to be a tale of two halves. Political paralysis in the USA and Europe has hindered economic growth and encouraged extremely cautious investment strategies. Thus, the consequences of the political choices which Europe and the incoming Trump administration will have to make in early 2017, will provide markets, businesses and other stakeholders with a clearer sense of travel for the world’s largest consumer economies. The second half of the year will then revolve around how the rest of the world responds to these decisions.

If confidence in the economic growth of the US economy continues to rise, and subsequently leads to the projected three rate hikes by the Fed, then the US dollar will continue to appreciate, causing a flight of capital out of European and Emerging Market asset classes (whether they be equities or fixed income). This will cripple companies in the developing world who have large US dollar denominated debt, even if governments in regions like Asia will be better insulated from the effects this time than during the Asian Financial crisis in 1997. Moreover, if the dollar appreciation leads to a widening of the US trade deficit, as witnessed during the Reagan years in the 1980’s, we would expect to see greater emphasis on an “America First” trade policy. The rhetoric and responses to President Elect Trump’s tweets on Trade, already indicate that this may be the course of action.

Though these comments may seem overly financial, their wider societal implications are enormous. If investors see greater returns in US markets, alongside greater political instability in other global markets, then access to finance will become constrained across the developing (and perhaps even developed) world. This comes at a time when global investment in infrastructure remains well below the estimated requirements by the world’s leading international financial institutions, such as the World Bank, ADB, African Development Bank and Inter-American Development Bank. To put figures to this effect, it is estimated that Asia needs to spend between US $2-3 trillion a year on infrastructure. The figure to date is roughly US $1trn, or 50% of that required. Elsewhere in the world, notable Africa, the figure is even lower. Such infrastructure includes basic goods such as hospitals, schools, roads and power generation assets. Without the ability of governments to finance and provide these goods, then societal frustrations with consistently poor living standards may lead to greater political unrest and support for populist parties. This is especially concerning in countries that are still experiencing large population booms and who have a growing, young population that need economic growth to find jobs.

Moreover, as the value of the US dollar rises, oil producers who have operational costs in domestic currencies, will see increased financial returns. This will help alleviate some pressure on the balance sheets of oil dependant governments, but it will also increase the real cost of oil for citizens and businesses in emerging and developed markets (oil globally is priced in dollars, so a rise in the dollar v.s. other currencies will increase the cost of fuel for consumers).

Looking beyond the potential areas of concern, there are areas where optimism is warranted. In 2016 investment in Renewable Energy overtook investment in fossil fuel based power generation for the first time since the start of the industrial revolution. In 2017 this trend will only accelerate. The UAE has already committed, in the first week of 2017, to spending US $163bn to provide 50% of its power from Renewables by 2050. Others will continue to follow. Moreover, electric car growth will continue to expand, fuelled by government incentive schemes and the launch of several new car models, such as the newest Tesla vehicles, directly targeted at middle income families and competitively priced (though government subsidy support will still remain crucial). In science, we may also see a breakthrough cancer drug brought into final stages by AstraZeneca by the end of 2017, as well as several major space launches and satellite passes of earths neighbours in our solar system.

As a student studying the world from an ivory tower in Washington DC it is easy to get lost in the noise of the world. But the one prediction for 2017 that I can make with certainty is not a macro level prediction, it is a micro one. Despite all the concerns and hysteria that the press will cover in the next year I remain convinced that the vast majority of people in the world will experience few changes to their daily lives as a direct consequence of the headline grabbing events. In fact, the biggest question in 2017 is whether despite all these huge events occurring around us, people will become more engaged politically at all.

In November 2016 I had the privilege to stand outside the White House after the election results had arrived. In a large student city, which voted overwhelmingly Democrat, in an election where Trump was (and is) described as a threat to the very nature of the American political system itself, there were more journalists present than protestors. Nor did DC see many protestors or rallies of significant size in the weeks after the result. In the UK too, after Brexit the protests were few (if any) and the rallies were poorly attended (if held). All this in a country where 1 million people marched to prevent fox hunting from being banned in 2005. Thus one question for 2017, that I hope to see answered, is whether this year of change is also a year of political awakening for the generations of citizens who have been sleeping for the last two decades.

Time will tell!