I have always felt that Brexit addressed people’s real and legitimate grievances by proposing fake solutions based on a flawed analysis of what the real problems are. As the first post-Brexit year progresses, it becomes increasingly clear that it is worse than that. Not only is Brexit not providing any solutions for the real problems that caused it, it is actually going to make them worse. Those who voted for Brexit because of their grievances will suffer from its consequences as much – or more – than the rest of us. Or to paraphrase Jacques Mallet du Pan’s bon mot: By feeding its parents, like Saturn, Brexit will devour its own children.
Two news items underscore this ‘saturnian’ direction of Brexit: The agreement in principle on a Free Trade Agreement (FTA) with Australia and the report by the Taskforce on innovation, growth, and regulatory reform (TIGRR), published on Wednesday this week. To see why the Australian (and other) post-Brexit FTA and the TIGRR recommendations would aggravate the issues that caused Brexit, we need to start with these causes of Brexit.
What caused Brexit?
Brexit is a hugely complex phenomenon and as such has multiple causes. Different people voted for Brexit for different reasons. A study by the UK in a Changing Europe research centre finds not only low-skilled workers and pensioners, but also people from the ‘squeezed middle class’ supporting Brexit.
That said, academic research in the area of electoral studies find robust evidence that at the individual level gender, education, and age were the key characteristics determining the Brexit vote: Literally all studies (e.g. this one) find that the older and the lower the level of formal education, the more likely you were to support Brexit, especially if you are male. Conversely, the younger and the higher your educational attainment, the less likely you were to support Brexit, especially if you are female.
However, beyond the individual level, researchers argue that it is important to see these individual factors in the context of regional inequalities in the UK. Here, trade liberalisation and austerity are key determinants of Brexit: Firstly, studies have shown that areas that have suffered more from trade liberalisation-induced de-industrialisation since the 1970s, were more likely to support Brexit than areas with less exposure to trade-induced and hence deindustrialisation. Indeed, one study shows that this so-called ‘China shock’ – the deindustrialisation of regions of Britain due to the massive increase of imports of cheap Chinese products – has led to declining living standards in the industrial heartlands of the UK, which then turned to support the Brexit idea. Secondly, studies have also shown that areas particularly affected by the austerity measures imposed by the Coalition government since 2010 following the global financial crisis, were also the areas that most strongly supported Brexit.
These regional factors are important to understand the Brexit vote, because they help us explain why it was not only the so-called economically ‘left-behinds’ (the unemployed or workers who have seen their real wages decline, and pensioners who are struggling to make ends meet) who voted for Brexit, but also well-off middle-class voters. The latter may not have suffered directly and materially from globalisation, but they are confronted with the economic decline of their area. This may have caused worries about the future of the region or the country in general, which has led people to support Brexit regardless of their material interests (a phenomenon called sociotropic voting by political scientists).
In a nutshell – and arguably put a bit bluntly – the two root causes of Brexit were trade liberalisation (which caused the “China Shock”) and financial market liberalisation (which caused the global financial crisis of 2007-8 and then austerity). The Brexit-related news this week clearly show that on both accounts the Johnson Government is going to make things worse rather than better.
The ‘Bonfire of Regulation Task Force’
The first important event this week was the publication on Wednesday of a report by the Task Force on Innovation, Growth and Regulatory Reform (TIGRR) composed of Iain Duncan Smith, Theresa Villiers, and George Freeman. The report contains few surprises, but a lot of cause for concern. It is based on the simplistic and ideological libertarian assumption that any piece for regulation is one piece too many. Regulation is interpreted as the product of overzealous bureaucrats who want to constrain our freedoms for no reason other than justifying their own job. There is no acknowledgement that regulation is key to any highly developed, technologically advanced, civilised society.
As a result, the great benefit of Brexit according to this report is simply that it is a ‘”one-off” chance for UK to escape EU red tape.’ The 100 recommendations reach from reforming rules on clinical trials for drugs (arguing that UK would become world leader in medicine with a lighter-touch regime while of course ignoring the fact that having its own rules may mean UK drugs may not be approved in other countries), lowering data protection standards, allowing pension funds to invest in riskier assets, to reduce capital requirements for insurance companies certain put in place after the Global Financial Crisis (so-called Solvency II regulation).
Let me focus on the area of financial regulation (pp.32ff). In this area, the proposals essentially boils down to moving away from cautionary, prudential regulation towards a more risk-driven approach to regulation. This is explicitly stated on p.13 where the report blames the EU regulation as based on “excessive caution that is often disproportionate to the associated risk.” (Many of the arguments are ultimately based on the century old – but deeply flawed and romantic – notion of a superiority of the Anglo-Saxon common law over continental civil law).
Two concrete proposal towards riskier financial regulation concern defined contribution (DC) pension funds and insurance companies. The report argues that allowing pension funds to invest in riskier businesses would provide new sources of finance for small and scaling-up companies (proposal 2.1). This could be achieved by changing the rules about the charge cap for fees and administrative expenses that currently seek to protect savers from overly risk and expensive investment options (such as private equity and venture capital). The report states that:
“The charge cap (0.75%) on the fees and administrative expenses that can be borne by savers is a sensible investor protection measure in principle, but in practice has driven many schemes towards passive investment to keep the charges well within the cap. UK savers therefore have limited exposure to high-performing illiquid assets, including private equity and venture capital that tend to outperform public markets.”
The report does not say, of course, that the trend towards passive investment strategies has been a global phenomenon since the GFC and has partly happened for good reasons: Actively manged funds are risky, expensive in terms of management fees, and often do not outperform cheaper, less risky, passively managed ones. That is not to say that passive investing is without problems, but simply allowing pension funds to invest in riskier assets without increasing (prudential) regulation is a recipe for disaster. Indeed, the pension fund industry has explicitly warned the government against lifting or removing the charge cap. But as always, the Johnson Government ignores practitioners from the industries concerned.
From the pensioners point of view lifting the cap from .75% to 1% could mean that the amount of money from their pension pot that is paid to people in the investment industry for managing their savings would nearly double (from around £92,000 to £170,000 over their life time according to the Department for Work & Pensions), while it is unlikely that the increased risk and fees would actually lead to increased returns.
Proposal 2.2 suggests lowering capital requirements for insurance companies set out by the Solvency II directive. This directive determines how much own capital insurance companies need to hold to prevent insolvency. According to TIGRR, lowering the requirement would mean that insurance companies could spend more of their capital investing, thus increasing supply of finance to the economy. The most worrying aspect of this proposal is that TIGRR seems completely oblivious of the reasons why this regulation was deemed to be necessary in the first place. Namely, the biggest financial crisis the world has experienced since the great depression in 1929. Indeed, there is a large amount of academic evidence that shows that financial crises are invariably preceded by a phase of financial liberalisation that is not accompanied by the establishment of ‘prudential regulation.’ Carmen Reinhart and Kenneth Rogoff have provided evidence from 800 years’ worth of historical data on financial crises. Similarly, the Global Financial Crisis (GFC) has hit precisely those Anglo-Saxon countries hardest who liberalised rigorously in the 1990s, but neglected to establish financial market regulation with teeth. IDS and his fellow TIGRRs now propose that we should go back to a pre-Global Financial Crisis area and let financial service firms take more risks. Of course, these are just highly aspirational proposals. But they do indicate what the dominant approach in the Tory party is.
FTAs – A race to the bottom
The second big news story this week was the announcement of an agreement-in-principle with Australia on a Free Trade Agreement. This was hailed as significant – actually ‘historic’ – news by the Johnson Government.
The reality seems to be a wholly different one. The UK farmers’ strong opposition can be shrugged off as an ‘interest group’ protecting its rents. Yet, it is more difficult to ignore the fact that both trade experts and UK businesses seem lukewarm at best about the deal. There are many reasons why the UK-AUS FTA will only provide limited benefits to the UK economy and they have been discussed before (including on this blog). Australia is simply too far away to compensate for lost trade with the EU. Also, which UK products precisely Australians will buy more of is unclear. The Express mentions whiskey, biscuits, ceramics, and cars. The contribution of these goods – with the exception of cars – to UK GDP are of course marginal. As for cars, the FTA is very unlikely to lead to a significant increase in demand for UK-produced cars. The vast majority of cars produced in the UK are part of global brands, owned by foreign companies who also have manufacturing plants closer to Australia.
What is remarkable, though, is the way in which this deal came about – against resistance within the cabinet, against resistance of UK farmers, without consultation of business (who reportedly had to rely on information of their Australian and Norwegian partners to obtain information that the UK government withheld from them!) and without any say for elected Members of Parliament (sovereignty versus unelected bureaucrats anyone?) who have now asked for a change in the rules about Parliamentary scrutiny for trade deals.
While economically the impact of the Australia deal will be small, its effect on UK trade policy may be big. The Australia FTA sets a precedent for other trade deals, and thus potentially weakens the UK’s negotiation position. Many commentators have noted that the zero-tariff agreement for Australian agricultural products is something other countries may ask for too. It will be difficult for the UK to refuse that. So, this deal with Australia is at best a useless, but quite possibly a bad deal – not just because it allows access to the UK market to meat produced in horrific conditions – but also because of its impact on future trade deals. A test for this hypothesis is already looming: New Zealand has signalled interest in concluding a deal with the EU, the UK and others to counterbalance its dependence on China. According to the FT, NZ trade minister Damien O’Connor said any “New Zealand-UK deal would probably be similar to the UK-Australia trade agreement”, which implies “[t]ariff cuts on New Zealand farm exports including dairy, lamb and beef would be among Wellington’s demands.”
However, like I wrote many times before, FTAs have become completely reified and ‘superwoman’ Liz Truss and the Johnson Government conclude them regardless of their content. As Chris Grey underscores in today’s Brexit & Beyond blog, the Australia FTA is purely symbolic. UK businesses have urged the government to adopt a more cautious, long-term approach and stop concluding bad FTAs just to score political points.
An alternative or perhaps complementary (economic rather than political) interpretation would be that Brexiteers actually blindly believe in the benefits of free trade that any FTA is better than none. A statement after the conclusion of the trade deal with Island, Norway, and Lichtenstein (which has given rise to quite some ridicule and disappointment) by International Trade Minister Ranil Jayawardena summarises this perfectly: "More trade and more investment will drive growth and support jobs in every corner of our country."
That statement is provenly false. The research on the impact of the ‘China Shock’ in both the UK and the US clearly show that trade liberalisation creates winners and losers. This is why trade liberalisation needs to be accompanied by compensatory measures if it is not to produce large numbers of discontent people in a country.
Such a system of trade liberalisation with domestic compensatory mechanisms through welfare transfers or selective trade barriers was in place for much of the post-War period and was referred to ‘embedded liberalism.’ This embeddedness has been eroded ever since Margaret Thatcher and Ronald Reagan came to power in the late 1970s and early 1980s respectively and spread their ideology around the globe. It is this ‘disembedding’ of markets that has exposed workers to competition from low-wage countries, to a stagnation and even decline in real wages and thus to the discontent that has led to a populist backlash against the EU and globalisation in general.
There is no evidence whatsoever that the government’s post-Brexit policies will do anything to address these problems. To the contrary, according to the FT, the Trade Remedies Authority (TRA) already scrapped “safeguard” tariffs in more than 50 areas since the UK left the EU,” which means UK manufacturers are more exposed to unhampered foreign competition. This – together with the ‘zero-tariff approach’ to new trade deals – indicates that the Johnson Government’s vision for a post-Brexit Britain is one of disembedded liberalism – thus reinforcing the causes of Brexit.
Singapore on Thames or not?
In an interesting piece published yesterday, Alex Dean of the Prospect magazine stroke a rather optimistic tone about the direction of travel of post-Brexit Britain. He argues that the fear of post-Brexit Britain becoming a nirvana for laissez faire, free market libertarians was misplaced. According to him, post-Brexit Britain has moved in the opposite direction. The basis for this claim is the ‘levelling up’ agenda, the end of austerity, the public spending during the Covid19 response, but also the discussions of changes (increases) to the taxation of multinational firms around the G7 meeting.
I find this optimistic argument entirely unconvincing. I do not think the Chancellor’s Covid response is anything to go by to predict what the future post-Brexit economic and budgetary policies will look like. Covid sure was a once in a lifetime crisis (well, hopefully!). The exceptional interventionist measures that the Chancellor adopted will soon be wound down and the pendulum will swing back into a more conservative approach to public finances. This may not mean a return to open austerity as under Osborne. Dean rightly argues that this policy would go down very badly with the newly won ‘red-wall conservatives’ in the Midlands and the North of England. But cuts to public spending will take subtler (such as a smaller than expected pay rise for NHS staff) or less domestically controversial forms (such as cutting the foreign aid budget).
Similarly, the government’s ‘levelling up’ agenda for now involves some spending on underprivileged areas of the country. Yet, partly this money is redirected from other areas (e.g. the moving of parts of the civil service out of London) or is infrastructure spending (such as the environmentally disastrous HS2 project). While some public money will be spent on such projects to maintain electoral support for the Tories, this in itself is hardly a sign that the ‘Singapore on Thames’ vision of post-Brexit Britain is off the table. Indeed, the TIGRR report already contains suggesting that the financing of the levelling up policy and of other infrastructure spending should become an opportunity to encourage private investments (cf. proposal 2.3 by TIGRR). In other words, levelling up may soon become an opportunity for privatisation of infrastructure projects.
Same for the G7 global tax reform: It took only a few days after the G7 meeting for the UK government to undermine its spirit by pushing for an exemption for financial services.
More generally, the fact that there has not been an actual ‘bonfire of regulation,’ does not mean that deregulation is not happening. Believing that the post-Brexit ‘Singapore on Thames strategy’ would consist of a quick, radical reduction in the size of the state or regulations was always a naïve believe. But small changes – such as lifting the cap on management charges for pension funds – are enough to fundamentally transform and further disembed the UK variety of liberal capitalism. Yes, in some areas there is more regulation (at the borders notably), but the regulatory reforms that TIGRR and without a doubt Sunak’s and Kwarteng’s Cabinet ‘Better Regulation Committee’ will be driving still can trigger a race to the bottom in standards.
Incidentally, it is also wrong to claim that the second ‘Thatcherite revolution’ has not happened, because the state has not shrunk significantly in the past year. In actual fact, under Thatcherism too, ‘shrinking the state’ – outside of welfare cuts – has always only ever been rhetoric. Thatcherism was not a small state project – state spending grew by an average 1.1% a year under her premiership. Even though that is less than under other governments, it’s hardly evidence for a libertarian ‘drowning the state in a bathtub’ approach. Indeed, Andrew Gamble used the title The Free Economy and the Strong State to characterise Thatcher’s policies. Thatcherism was definitely anti-welfare and anti-public interest, but it was anti-state only in rhetoric. In reality, Thatcherism is very much pro strong state. Indeed, this is another way in which Singapore seems to continue to inspire the Johnson Government and other Brexiteers: Not only is Singapore a case of fairly unregulated capitalism, but also is it politically an undemocratic, authoritarian regime. Like I wrote last week, that is indeed something the UK government also seems to be aspiring to.
The wrong kind of vision – the wrong kind of competition
While the deregulation may not have taken off yet, the fact remains that inside the Tory governing circles it is the only game in town. From the infamous Britannia Unchained book – co-authored by no less than four current cabinet ministers – to the discourses by the PM himself and the – of course aspirational but possibly not uninfluential TIGRR report –, it is evident that the current Tory leadership cannot think about economic matters other than in very simplistic libertarian terms. The mistake of underestimating the ruthlessness and determination of Brexiteers to pursue their vision – however absurd – has been made before.
The UK government is stuck in a 19th century understanding of capitalism and liberalism and it will ruthlessly pursue that vision. Their favourite model is a Manchester capitalism-style system of laissez faire that is hugely profitable for producers and owners, but disastrous for everyone else. The only plan is to compete with the EU for FDI by lowering standards and regulations and thus making it cheaper for companies to produce in the UK. The only way Brexiteers can conceive of competition is in terms of cost competition: You beat your competitors by producing more cheaply and offering cheaper products – not better-quality ones. Colin Hay has warned of this dangerous obsession with cost competitiveness nearly a decade ago. Competing on quality rather than cost - and thus selling your products at higher prices – is what allows you to pay higher salaries and thus avoid the downward spiral of ‘beggar-thy-neighbour competition,’ which causes the discontent that led to Brexit. There are no signs that any of the post-Brexit strategies point in that direction.
The hyper liberal laissez faire capitalism of the 19th century eventually broke down with the 1929 stock market crash and was blamed for the rise of fascism in the 1920s and 30s. Various political movements from left and right - including the US Democrats under Franklin D. Roosevelt, William Beveridge in the UK, and the post-War German ordolinerals around Christian-democratic Minister for the Economy Ludwig Erhard - understood that markets need to be embedded through social policies, welfare states, and market regulation. Neo-liberalism was born out of the insight that free markets require embedding and compensation of the losers of competition to not constitute a ‘social explosive’ (as the German neoliberal Wilhelm Röpke put it). Of course, neoliberalism has since been perverted by neo-classical economists and turned into its contrary. But the fact remains that after the 1930s people had understood the disastrous effects of ‘unchained markets.’ The UK government has not understood. As long as the UK government does not learn that lesson, Brexit will always only have one ultimate outcome: It will devour its children.