This term, I taught a new module in macroeconomics to starting PhD students. The lecture notes are available here.
After a chaotic two months in British politics and with little time remaining before the UK is set to leave the EU, its parliament has now requested the EU replace the crucial backstop protocol in the Brexit withdrawal agreement with some other set of unspecified “alternative arrangements.” The Prime Minister reversing course on the deal she agreed after two years of intensive negotiations was never likely to go down well with the EU27 and the immediate negative response from Donald Tusk suggests there will be no re-opening of negotiations.
Simply ignoring this latest request may work out for the EU. After a few more weeks without progress, enough MPs may finally decide that the impending chaos of no deal is worse than the deal Theresa May agreed to in November and which is still on the table. The UK could end up signing up to the November agreement, though this would be seen as a humiliating outcome for many of the politicians who enthusiastically voted for last night’s “Brady amendment”.
There are a number of reasons, however, why the EU, and particularly Ireland, should be wary of pursuing this strategy and I suggest they should consider an alternative route involving a clarification and a concession on the backstop.
The reasons to be wary?
First, without further negotiations or concessions, it is possible that the UK parliament may end up delivering a no-deal outcome that very few profess to want. In the absence of a deal that can pass the House of Commons, even after a potential delay of the Article 50 process, the no-deal crash out becomes the default option and odds on it continue to rise. The Brady vote has probably entrenched some Conservative MPs into a position they will find difficult to give up without some movement from the EU. It may make no economic sense whatsoever for the UK to exit without a deal but Brexit has never made economic sense and its most intense advocates are growing ever more determined to leave at almost any cost. The EU member state that would be most damaged by this outcome would be Ireland.
Second, the strategy of providing no response at all to the Brady vote could poison EU\UK relations and their North\South equivalent in Ireland for many years even if the November agreement is eventually passed. Many in the UK will feel, rightly or wrongly, that they were bullied into the agreement by the EU without appropriate considerations for the perceived problems associated with the backstop. In Northern Ireland, the DUP will claim the backstop was imposed by the EU against the preferences of a majority of the House of Commons. Unionist objections about a lack of democratic legitimacy of the backstop, in which Northern Ireland remains subject to EU regulations and customs rules but has no say in deciding those rules, will continue to be a cause of discontent for many years.
So what could the EU do to respond to last night’s vote?
Firstly, the EU could clarify that it has no objections to the UK leaving the joint customs union with the EU after the transition period, provided Northern Ireland remains within the EU’s customs union and aligned on goods regulations.
Brexit wonks could argue that this clarification shouldn’t really be necessary since this is the original version of the backstop that the EU offered, so it should be clear they are willing to still offer this. The all-UK backstop was a hard-won concession to the UK. It reduced the amount of trade disruption to be experienced over the medium-term by the UK while it was still negotiating trade deals with the EU and the rest of the world, and it prevented the need for customs checks on goods going from Great Britain to Northern Ireland.
Still, the nature of the all-UK version of the backstop does not seem to have been well understood in Westminster, partly because Theresa May never spent any time explaining its benefits. Instead, among Brexiters, it has become widely held that this all-UK backstop is an attempt to “trap” the UK permanently within EU structures and hamper it from successfully negotiating its own trade deals.
A simple clarification from the EU on this issue, to be added to the political declaration, could help to resolve this unnecessary confusion about the all-UK backstop.
That still leaves the question of the Northern Ireland element of the backstop. Theresa May probably did not devote much political capital to selling the fact that Great Britain could move out of the backstop without difficulty provided Northern Ireland remained in it because she was determined to keep the DUP on board and they would not have been pleased with this being sold as a positive feature. As it is, in addition to losing many Tory colleagues who disliked the all-UK backstop, May also failed to get the DUP to support her November agreement and has now acceded to their request that she ask the EU to modify the backstop.
So what can be done? The motivations of the EU and Irish government for the backstop proposal are well known and there are severe limits on how much they can move. Moreover, the nebulous mooted “alternative arrangements” to the backstop mentioned in the Brady amendment don’t present a useful basis for current discussions.
However, the EU could do the following: Use the political declaration to offer the citizens of Northern Ireland a referendum on whether to remain within the EU’s customs union and single market five years after the beginning of the operation of a Northern-Ireland-only backstop. This referendum could be repeated at perhaps ten-year intervals thereafter. Should a referendum show the people of Northern Ireland wanted to exit the backstop, the EU would agree jointly with the UK to end this arrangement.
I have proposed the idea of a referendum within Northern Ireland before, back in November 2017. I still think an approach of that sort should have been considered and polling suggests the backstop would have received majority support. It is too late now to consider a referendum of this sort prior to the UK exiting the EU. However, a promise to hold a referendum five years after the end of the transition period would provide a clear concession to those who believe the backstop arrangements would be harmful to Northern Ireland by offering them a chance to convince their fellow citizens to end the arrangements after a period.
This proposal would also give the citizens of Northern Ireland a number of years to experience “life in the backstop” and to consider the benefits and costs associated with it before making their own decision about whether to continue with this arrangement. I have detailed previously how the backstop would probably provide some important benefits for the Northern Ireland economy and that the perceived intra-UK frictions associated with it are likely to cause only minor difficulties compared with the far larger problems associated with a hard intra-Irish border. The costs and benefits of being excluded from future UK trade deals may also become more apparent. I suspect it may turn out that Northern Ireland consumers and farmers won’t actually be too concerned about missing out on the chlorinated chicken and hormone-injected beef brought about by trade deals with the United States or South American countries.
The Irish government and EU could also offer to work to address concerns about the “democratic deficit” associated with the backstop. It may be possible for Northern Ireland to have non-voting members of the European Parliament or for the Irish delegation of MEPs to include a couple of delegates elected via votes from those in Northern Ireland. The EU could regularly hold workshops and listening tours in relation to upcoming regulatory changes that could affect Northern Ireland as long as it remains in the backstop.
Another benefit of this proposal is that it would allow at least seven years for the UK and Irish governments to explore more fully the options for “smart border” technologies which have been widely promoted by some and heavily doubted by others. A well-funded joint project by the EU and UK on the possibilities available could be prepared to provide concrete information to Northern Ireland’s voters on the way the border would operate should they ever choose to leave the backstop. My guess is that no matter how smart the technologies, a hard border of some sort would be required if the backstop is removed but this proposal would give Ireland and the EU at least seven years to prepare for this potential outcome.
The danger of this approach from the perspective of the Irish government is that it may only kick the can of a hard border down the road by seven years or more. But it may also help to avert a no-deal Brexit and provide invaluable time to prepare Irish firms for potential future arrangements. One could also argue that if the backstop arrangements cannot receive majority support in Northern Ireland over time, then they are probably not politically sustainable anyway.
Would This Be Enough to Get the Deal Through the UK Parliament?
Would these clarifications and concessions be enough to avert a hard Brexit? It’s hard to know but a final attempt at outreach could at least convince some MPs that the EU and Ireland have listened and addressed their concerns about the UK’s ability to conduct future trade deals and the democratic legitimacy of the backstop for Northern Ireland.
I suspect the DUP will not accept a proposal of the sort outlined here but these ideas may be enough to convince sufficient numbers of Tory waverers and Labour leavers that the deal on the table represents a better outcome than no deal. In addition to helping pass the withdrawal agreement, a final effort of this sort from Ireland and the EU could hopefully also set a tone for a more co-operative future relationship with the UK.
A few points on the £39 billion payment which the UK government has agreed to pay the EU as part of the withdrawal agreement.
This payment is regularly raised by Brexiters as a key negotiating issue. It is often claimed the £39 billion saved by refusing to make this payment will allow the UK to spent lots of money on important priorities e.g. Priti Patel says “we would also not need to hand £39 billion over to the EU, giving the Government resources to support economic growth, job creation and new trade opportunities.” It is also claimed the EU are very scared the payment won’t be made and will thus make last concessions to secure the money e.g. Daniel Moylan at BrexitCentral reckons “It is possible that the EU could give in, agreeing the wholesale removal of the Irish backstop from the text in exchange for the money on which they have so desperately counted.”
The reality, however, is that both sides of this argument – the benefit to the UK and the costs to the EU – tend to be wildly over-stated by Brexiteers. Here is a useful table from a House of Commons Library explainer on the topic, breaking down the different elements of the £39 billion.
The table shows that the £38.7 billion bill includes £16.3 billion in contributions to the EU’s multi-annual budget during the transition period. During this period, the UK will continue to receive funding from EU programmes.The House of Commons Library report estimates the UK will receive about £8 billion of this funding back during 2019-20 in the form of payments to farmers, structural funds and funding for research (see page 8). These payments would not occur if there is no deal. This means the financial “benefit” to walking away from the withdrawal agreement would really be £31 billion, albeit at a cost of the UK being seen to have reneged on financial commitments it made to its EU partners.
Second, this net payment of £31 billion would be spread over time. Scrapping the additional net contributions to the EU budget would amount to saving of £4 billion per year this year and next. The rest of the payment is spread over time, with the bulk of it, £19.8 billion, being paid over 2021-28 and a smaller amount of £2.6 billion being paid over 2021-64. That works out to be a benefit of £2.5 billion per year over 2021-28 and £56 million per year thereafter until 2064.
How much will the UK government be able to do with this money? UK GDP was £2 trillion pounds in 2017. A trillion is one thousand billion, meaning the £4 billion savings this year and next would be one fifth of one percent of UK GDP and the £2.5 billion per year savings over 2021-28 would be about one eighth of one percent of UK GDP.
So while £39 billion may seem like a huge figure when quoted without context, the reality is that this will do very little to boost the spending power of the UK government. In fact, these numbers are well below the kinds of figure by which UK budgets often overshoot or undershoot doing to various random events without anyone paying much attention e.g. the OBR’s March 2017 forecast of the budget deficit over 2017/18 was £17 billion too high (see page 35). The dividend from not paying the Brexit bill will effectively be rounding error in the public finances.
And what about the EU27? The £2.5 billion net payment per year the EU would be losing over 2021-28 equates to €2.8 billion euro per year. EU27 GDP is estimated to be €14.538 trillion last year. That’s €14,538 billion. So this loss would equate to 0.02 percent of EU27 GDP per year for eight years. That’s one fiftieth of one percent of GDP. The idea that this tiny amount is being “desperately counted on” by the EU is laughable and anyone relying on the EU to fold because the UK won’t pay its “Brexit bill” will be sorely disappointed.
The bottom line on this issue is that, viewed from a macroeconomic perspective, the Brexit bill figures are tiny and people really should not believe that this bill represents an important part of the costs or benefits of Brexit for either the UK or the EU.
There is a wider issue here in relation to explaining macroeconomic issues to the public. Any figure larger than a few million seems to ordinary people to be “a lot of money”. So “£350 million pounds per week for the NHS” or “£39 billion to spend on whatever we want” seem like huge windfalls to a large fraction of the public who, let’s be fair, can’t be expected to know the actual totals for GDP or public expenditure. It’s thus important for those contributing to public debate to put raw macroeconomic numbers in an appropriate context.
I spent November 2018 in Sydney visiting the University of Sydney. While there, I competed my latest briefing paper for the European Parliament’s ECON committee “Monetary Policy in an Era of Low Average Growth Rates“. I also gave a seminar on the related topic of The Euro Area’s Long-Term Growth Prospects: With and Without Structural Reforms.
My latest briefing paper for the European Parliament’s Economic and Monetary Affairs committee is titled “Should central banks be concerned about virtual currencies?”
This is part of a collection of papers delivered to the committee prior to their meeting on July 9 with ECB President Draghi. The papers can be found by clicking here and expanding on where it says “Monetary Dialogue – 9 July 2018″.
Here is a presentation titled “The Lender of Last Resort in the Euro Area: Where Do We Stand?” which I gave in March at a workshop on financial stability at University College Cork.
The Eurosystem’s often-misunderstood TARGET2 balances have again become a topic featured in op-eds and bank briefing documents. I’m posting this a bit late but here is a briefing paper I did on these balances that was submitted to the European Parliament in November 2017. For those interested in a longer explanation of how the mechanics of how these balances come about, my 2013 paper covers a lot of different issues.
The past week has been the most fraught yet in the Brexit negotiations. The EU and UK have not agreed on how the “Irish backstop” proposed in December should operate. The UK government and the DUP are unhappy that the EU believes the “backstop” arrangement should only apply to Northern Ireland. The EU backstop would essentially keep Northern Ireland (but explicitly not the rest of the UK) in the EU customs union and single market unless other arrangements are agreed that would also rule out the need for a hard Irish border.
In Westminster and Northern Ireland, there is a lot of concern about the EU’s proposal, with many viewing it as implying a “border in the Irish sea” and Theresa May arguing that it would “threaten the constitutional integrity of the UK” and that “no UK prime minster could ever agree to it”. In Northern Ireland, unionists have argued this approach is inconsistent with UK’s commitment in the December agreement that there would be “unfettered access for Northern Ireland’s businesses to the whole of the United Kingdom internal market”. Arlene Foster has repeatedly insisted that this arrangement would be “catastrophic” for the Northern Ireland economy and, in a notable upping of the ante, said on Friday that the EU’s approach would amount to Northern Ireland being “annexed” from the UK.
I believe these concerns are fundamentally misplaced. Rather than being threatened economically, Northern Ireland would gain from the implementation of the EU’s backstop. To understand why, let’s look at how the backstop would work in practice.
Let’s start with the most obvious objection to the EU’s backstop: the idea that a “sea border” would make it harder for Northern Irish firms to sell into Great Britain. The DUP’s Arlene Foster has emphasised this repeatedly in recent months. Consider, for example, this statement from Foster in March
“What was there, in the [EU draft agreement] legal text, is around creating a border down the Irish Sea,” she said.
“And of course that’s not something we in Northern Ireland could allow from a constitutional point of view, but also in terms of economics, it would be catastrophic to have a border down the Irish Sea.”
“56% of our goods from Northern Ireland go to Great Britain, so it is incredibly important that that border does not exist.
This probably sounds like a reasonable concern but it is without foundation. Firms in Northern Ireland will remain within the UK, so there will not be and cannot legally be customs checks for goods produced in Northern Ireland when travelling to the rest of the UK. In addition, the UK itself promised in the December agreement that unfettered access would be maintained for Northern Irish firms and that “no new regulatory barriers” would affect these firms. Together, these points mean Northern Irish firms will have unfettered access to the rest of the UK under the EU backstop.
If you’re surprised by this and perhaps think I’m making it up, you might not know the UK civil service has already worked out how this backstop would work and they have said there would be unfettered access for Northern Ireland firms for the rest of the UK market. The document describing how this would work was part of a series of UK civil service documents leaked to politicians in the European Parliament and was discussed in various press stories in May.
This “customs channel” proposal implies no land border checks on the island of Ireland but some checks at the small number of ports in Northern Ireland that transport goods to Great Britain. Goods would either go through a “green channel” with no checks or a “red channel” which has checks. Crucially, goods from firms in Northern Ireland would go through the green channel. Goods coming from the Republic of Ireland to the Great Britain via Northern Ireland’s ports would probably have to go through the red channel if the UK required customs or regulatory checks on goods from the EU.
Viewed this way, the “border in the Irish sea” terminology is misleading because it will not affect firms from Northern Ireland. A better terminology would be “enforcing the land border at Northern Ireland’s ports.” With a small number of ports in Northern Ireland, all of whom are already checking shipping documentation of some sort, the implications for trade frictions for Irish firms would be far less severe than the alternative of enforcing customs and regulatory checks on a meandering 310 mile border with about 200 different crossing points.
Over time, various issues would need to be sorted out about how this arrangement would evolve. These issues are not trivial but they would be would not be too difficult to work out between the EU and UK. A few examples.
- Most likely, Northern Ireland would be given a “special economic zone” status, so that the free movement of goods from its firms to both the rest of the UK and EU is agreed and accepted internationally by all members of the WTO.
- Assurances may be required that the UK will discourage tariff-hopping via “name plate” firms setting up in Northern Ireland just to label products as a way to avoid tariffs that the UK may charge on EU goods (though these tariffs should be minimal if the EU and UK agree a sensible free trade deal).
- Some goods moving from Great Britain to Northern Ireland may need to be checked to make sure they meet EU regulatory requirements. Goods that are heading on towards the Republic of Ireland would also need to have EU customs procedures applied.
- The UK has promised there would be no new regulatory barriers affecting Northern Irish firms accessing the market in Great Britain. If the UK starts passing new product regulations that deviate from the EU’s, any new regulatory bill passing parliament could include a clause stating that Northern Ireland’s products (produced according to EU rules) are also allowed to be sold throughout the UK, i.e. that there is a form of regulatory equivalence. Ultimately, it is up to the UK government to honour its promise to allow Northern Irish firms unfettered access to markets in Great Britain and there should be little difficulty in implementing this.
Economic Impact on Northern Ireland
So the EU backstop isn’t going to turn Northern Ireland into an economic dystopia. It is far more likely to have a positive economic effect. Northern Ireland would become the only place where firms could export freely to both the EU and the UK. One could easily imagine Northern Ireland obtaining new foreign direct investment because of this unique selling point. Business leaders in other regions of the UK (for example Scotland) would view this kind of special status as a great opportunity if they could attain it but the EU has made clear that this can only apply to Northern Ireland.
Northern Ireland’s agriculture and food sector is also likely to do better under this regime than under any alternative approach. If the UK decides to pursue trade deals that allow cheap food from outside the EU into the UK, then Northern Irish farmers would have to compete with these imports in the Great Britain market (most likely in an environment with less generous state-funded agricultural subsidies). However, regulatory alignment with the EU would mean produce like chlorinated chicken and hormone-injected beef could not be sold in Northern Ireland, providing some protection for local producers. Northern Irish farmers would still also have full access to the European Union market without facing tariffs or quotas, which would provide some opportunity to diversify their sales.
Most importantly, the EU’s backstop keeps the land border open and allows the all-island Irish economy to continue to operate freely. Contrary to Boris Johnson’s uninformed sneering, the reality is that more firms in Northern Ireland sell goods to the Republic than to Great Britain and integrated all-Ireland supply chains are of huge importance to many firms, North and South. Northern Ireland would keep this important element of its economy, without losing anything.
Constitutional Integrity? Annexation?
But what about the constitutional integrity of the United Kingdom which is supposedly a great concern to Theresa May? Well the UK’s constitutional integrity is a complicated thing, not least because it doesn’t actually have a constitution.
The reality is the UK has a patchwork of different governance arrangement across its regions. Northern Ireland, in particular, already differs sharply from the rest of the UK in lots of ways, including its form of government, rules on gay marriage and abortion and the plethora of ways in which the Good Friday agreement has introduced North-South co-operation. In truth, the DUP’s desire for Northern Ireland to have a different corporate tax rate from the rest of the UK is probably a more substantive difference in economic policy than anything new that would emerge from the proposed backstop.
Is this Northern Ireland getting annexed by the EU or Republic? Clearly not. Northern Ireland would still send MPs to Westminster. Its people would still pay UK tax, hold British passports (if they wish), have access to the NHS and the UK social welfare system, and be subject to UK laws in most areas. The people of Northern Ireland would probably barely notice their new status. By contrast, they would certainly notice the return of a hard border, which is the most likely alternative option if the EU’s backstop offer is rejected.
The Politics: Still Time (Just About) for a Broader Discussion
It now looks like nothing will be settled between the UK and EU until the Autumn. This still leaves some time for an informed debate in Northern Ireland and Westminster about the consequences of the EU backstop proposal. For a number of reasons, this debate has not taken place so far and there is a general lack of understanding about how the EU backstop would work. These reasons include:
- Northern Ireland does not have an assembly operating. The assembly would certainly have held extensive committee meetings to discuss the various options and this would have helped to debunk the scaremongering about the so-called “border in the sea”.
- Many in the UK government probably know the EU backstop would work well for Northern Ireland. Under other circumstances, they could give assurances to everyone in region that the backstop would work well for them – it is not the EU’s job to explain how unfettered access to the UK market could be maintained. However, the Conservatives are reliant on a hard-line unionist party for their majority at Westminster and do not want to upset the party keeping them in power by asking them to consider a proposal they are so uncomfortable with.
- The last UK general election meant the DUP and Sinn Fein were the only parties in Nothern Ireland with MPs and Sinn Fein do not attend parliament. This has left the Westminster debate without nationalist or non-sectarian voices (such as the Alliance Party) who could have argued for the EU’s backstop. It is also seems likely that the current DUP leadership has handled these issues in a more aggressive manner than, for example, Peter Robinson would have (see for example Robinson’s speech last week imploring leaders on both sides of the community to compromise to get the Assembly up and running again.)
- Finally, the Irish government appears to have outsourced most of the communication on Brexit to Michel Barnier (who has a lot on his hands) rather than working hard to publicly explain the benefits of the EU backstop to all sides of Northern Ireland’s community.
Northern Ireland may not have a functioning assembly but the MLAs that were elected last year must surely understand they have a political responsibility for what happens next. Even if the assembly does not formally convene again this year, it must be possible for the MLAs to meet to debate the options and perhaps hold a “consultative vote” on the EU backstop. The DUP do not speak for all of Northern Ireland (they received 29% of the vote in the 2017 assembly elections) and they should not be the only party with an influence on the final outcome. Even if it had little legal standing, a vote by a majority of assembly members registering approval for a form of the EU backstop would have a profound political impact.
A final word on the long-term political implications. The DUP clearly believe that Northern Ireland remaining in the EU’s customs union and single market is a step towards a united Ireland. I doubt if this outcome would actually change perceptions of a united Ireland by much since it would mainly involve a continuation of the status quo for most people in Northern Ireland. Indeed, a special economic zone status within the UK but with full access to the EU could be popular even with some nationalists. However, the alternative outcome – the return of a hard land border with Northern Ireland firms having poorer access to the EU – may convince many nationalists that they are better off to re-join the EU via unification. With a border poll sufficient to trigger unification, a rejection of the backstop may turn out to be a crucial stop on the road towards (rather than away from) a united Ireland.