Britain's future

Goodbye Europe

A British exit from the European Union looks increasingly possible. It would be a reckless gamble

Dec 8th 2012

BRITAIN does not dream of some cosy, isolated existence on the fringes of the European Community,” asserted Margaret Thatcher in 1988. Now, increasingly, it does. Opinion polls show that most Britons are in favour of leaving the European Union. Baroness Thatcher’s Conservative Party, which took Britain into Europe four decades ago, is divided between those who long for an arm’s-length relationship and those who want to walk out. The second camp is swelling.

Even the fiercest British critics of the EU are astonished by the speed at which things are moving. Parliamentary rebellions over Europe are becoming easier and easier to organise. Euroscepticism is hardening in the Conservative Party, in much the same way as social conservatism has gone from being a powerful current in America’s Republican Party to an intolerant orthodoxy. The United Kingdom Independence Party (UKIP), which wants to leave the EU, has abruptly moved from the political margins to the mainstream. A referendum on Britain’s membership of the EU now seems a matter of timing.
Continental Europeans are surprised too—and annoyed. They are bewildered that the British should be talking of leaving a club that many believe has shifted decisively in a free-trading, Anglo-Saxon direction in the past two decades. They also resent the way Britain seems to be using the threat of an exit as a bargaining tool, especially at a time when the euro is in crisis. As they see it, Britain wants to carve out a privileged place for itself in the European club, where it can enjoy free trade without any of the other membership rules. In Berlin and Rome, political leaders argue that Britain needs to make up its mind once and for all: does it want to be in or out?


For an economically liberal newspaper that has been sceptical of much that Brussels does, a British exit would be a double tragedy. Britons would suffer far more than they currently realise, as we explain in detail in our briefing this week (see article).

Europe would be damaged too. Britain has stood for free trade and low regulation, so without it the union would be more lethargic and left ever further behind by America and the emerging world.

The speediest way for Britain to tumble out would be an “In or Outreferendum called by a prime minister frightened by rising anti-Europe feeling in Parliament and the country as a whole. David Cameron, Britain’s prime minister, has tried to resist this, hinting instead that Britons would be given a choice between the status quo and a more detached relationship. But few are satisfied with that. Conservative MPs look over their right shoulders at UKIP and clamour for a sharper choice.

Another route out involves a diplomatic slip. The cleverer Eurosceptics, including Mr Cameron, do not want Britain to leave; they just want to bring back some powers from Brussels.

But their efforts to do so are making things worse. Last year almost all other EU members lined up against Mr Cameron, who was trying to block a fiscal compact to help resolve the euro crisis.

The British now hope that tightening euro-zone integration provides a chance for Mr Cameron to negotiate looser ties. They could be wrong. Other countries are tiring of British demands.

Many, including Germany, would prefer to avoid a British exit, but they are not so desperate to keep Mr Cameron in that they are prepared to concede much in the way of social and labour-market regulation. And some, such as France, might positively welcome the departure of the club’s most awkward member. Bad-tempered negotiations would increase the likelihood of an “outvote in a British referendum.

Little sovereignty, large cost

And what if Britain left? It could grab a few benefits quickly. The nation would save about £8 billion ($13 billion) a year in net budget contributions. Freed of the common agricultural policy, its food could become cheaper. If it pulled out of the single market, it could do away with annoying labour directives. The City would not have to worry so much about a financial-transaction tax and creeping European finance rules.

Yet these gains would be greatly outweighed by the costs of a British exit, which would dent trade with a market that accounts for half of Britain’s exports. The carmakers that use Britain as their European operations base would gradually drift away, along with large parts of the financial-services industry. Britain would have to renegotiate dozens of bilateral trade deals from a much weaker position than it enjoyed as a member of the EU. It would cut a greatly diminished figure on the world stage. It would have bought some sovereignty, but at an extraordinary cost to Britain—and its partners.

Among those who want out, there is talk of finding an accommodation by which Britain would leave the EU but still trade freely with it (the equivalent of eating in a restaurant but not paying the cover charge). Some Eurosceptics suggest Britain could join Norway in the European Economic Area.

That would leave it bound by EU regulations that it would be almost powerless to shape—a situation many Britons, especially Eurosceptics, would find intolerable. Others hope Britain might get the same deal as Switzerland, which is a little further removed but gets good access to the single market. It wouldn’t: the EU already regrets giving Switzerland the Swiss option, so it is scarcely likely to give bigger, more troublesome Britain the same deal. Again, disappointment and a referendum beckon.

Can anything be done to prevent this slow-motion disaster? Quite possibly, it can. Oddly, Mr Cameron should try emulating Baroness Thatcher. She is remembered today as a handbag-swinger who commanded Brussels to retreat, but she also knew how to make common cause with other European leaders. Unfortunately, the quality of British EU diplomacy has deteriorated in recent years. Obsessed with repatriating powers and with appearing tough to their domestic audience, Britain’s current leaders seem to have forgotten the art of dealmaking. Mr Cameron has a good case to make, especially when he argues for extending the single market to promote growth.
He also has powerful sympathisers in Europe, including Germany’s Angela Merkel, but they seldom become useful allies because Britain is seen as a blackmailing zealot.

The other priority should be educating Britons about what exactly a British exit would really involve. Big business and the City, whose interests lie solidly inside the EU, need to take a stand. The Labour Party, which has been playing a cynical and dangerous game, also needs to change its line. In October Labour MPs voted with anti-European Tories over the EU budget, handing the government its first major defeat. By strengthening those who want to leave Europe, Labour is making it more likely that a Conservative government will have to promise an in-or-out referendum. If it does, Labour may be bounced into promising the same.

Most of the heavy lifting, at home as well as in Brussels, will have to be done by Mr Cameron and his chancellor, George Osborne. They need to remind Britons of the victories that have been won within the EU and of the dangers of falling out of it. And above all, they need to rediscover the virtues of muddling along and keeping options open. The referendum is a good example.

Rushing to hold a simple in-or-out vote sounds clear and decisive. But stalling for time is wiser. The government should resist demands for a vote at least until it becomes clear what sort of Europe Britain would be voting to remain in or leave. This sort of wait-and-see approach may feel unsatisfactory, but it is what kept Britain out of the euro.

Britain’s position in Europe may become untenable, if the resolution of the economic crisis binds the countries of the euro zone ever closer and all other EU countries join. But that is not a certainty, and nor is Britain’s steady marginalisation. Difficult and often humiliating as it may be, the best course is to stick close to Europe, and try to bend it towards Britain.

The Debtor Prisoner’s Dilemma

Harold James

04 December 2012


PRINCETONAny economic slowdown increases debt burdens, whether for households or for states. Today, both are looking for ways to reduce the weight of debt – and some would prefer to escape it.
Deeply frustrated and angry people – especially in southern Europefrequently hold up Argentina’s defiance of the international community in 2001 as a model. Argentina then used a mixture of coercion and negotiation to get out from under the mountain of debt that it incurred in the 1990’s, effectively expropriating foreign creditors, who were viewed as dangerous and malign.
In the 1990’s, Argentina tied its hands with a dollar-pegged currency in order to enhance its credibility as a borrower. The strategy worked too well: the large credit inflows that it attracted triggered an inflationary boom that reduced the country’s competitiveness. By 2001, a combination of devaluation (exit from the currency straitjacket) and partial default was inevitable. Default was followed by nominally voluntary restructurings in which creditors were invited to take some losses.
Up to now, the Argentine model has seemed successful, yielding substantial economic growth for the country since 2001. That is what has made the model so appealing to debt-burdened southern Europeans.
But a recent New York court ruling against Argentina in a case brought by a holdout hedge-fund creditor has dramatically raised the stakes of sovereign default and bankruptcy. When holdouts are rewarded by court decisions, and the rights of recalcitrant creditors are recognized in other jurisdictions, efforts at “voluntaryrestructuring become unsustainable. More and more parties will resist writing down some debt in favor of trying to seize whatever assets they can.
For Argentina, the writing is now on the wall. One of the creditors favored in the New York case, Elliott Capital, had already successfully requested the seizure in Ghana of the Argentine Navy’s three-mast sailing ship ARA Libertad. If the fallout of the New York decision is an extensive Argentine default on other obligations, foreign trade will become practically impossible, many goods will become scarce, and domestic inflation will increase further. In short, the Argentine model of debt reduction in the 2000’s has collapsed as completely as its borrowing model in the 1990’s did.
Two fundamental facts have created an apparently insoluble dilemma for the global economy, and have turned countries like Argentina and Greece into victims of an impossible logic. First, debt continually grows; second, there is no really satisfactory way of getting rid of it.
The financial sector’s explosive growth over the past two decades has fueled the accumulation of exceptionally large volumes of debt. In the absence of some positive shock such as an acceleration of GDP growthservicing that debt becomes impossible for at least some borrowers.
Real debt defaults are historically rare. For both borrowers and creditors, the risks and costs are enormous. The borrower is cut off from international markets, and essential imports can no longer be purchased, while large-scale defaults threaten to plunge creditors into insolvency.
The consequence is a complicated gamecurrently exemplified by the saga of Greek voluntary restructuring – in which both sides stare into the abyss and then turn away from the out-and-out conflict that would send them plummeting into it.
Latin America experienced this dilemma in the 1980’s, when its debt arithmetic had become unsustainable. At the outset of that crisis, major US financial institutions’ capital exposure to Latin America was near 200%, making candid recognition of debt unsustainability the surest route to wiping out the global financial system.
Most of the big Latin American debtors took extraordinary pains to avoid an explicit default. The only sustained exception was Peru, which defaulted in 1985 and became an international pariah. Of the largest borrowers, only Brazil, in 1987, formally defaulted – and only briefly. As President José Sarney, backing down, admitted, “The fact is that we cannot destroy the international system. We can scratch it, but it can destroy us.”
Instead, banks in the 1980’s offered new money in an attempt to extricate themselves from the crisis. Managing modern debt crises always involves the extraordinary logic of throwing good money after bad in the hope of masking the underlying unsustainability. The same logic has been applied in the euro crisis, with official money taking the place of private-sector exposure.
The emergence of inextinguishable debt replicates other troubling aspects of contemporary life. Governments, businesses, and individuals all face the build-up of other sorts of liabilities in the form of accumulations of information that cannot be deleted. E-mail, Facebook, and Twitter accounts all produce a permanent record that perpetually accompanies users, even when their circumstances change. The legacy of the past continually resurfaces to constrain action in the present.
Just as countries might want to wipe out their debt and start anew, individuals might like to erase their electronic past in a dramatic act of liberation. But that would destroy the useful together with the embarrassing or irrelevant. If a clean start is impossible, the best that can be done is to try to bury the old information with such an inflationary flood of new data that it simply dwindles into insignificance.
The analogue in the world of debt negotiation is that a new start that allows borrowing to begin all over again is also impossible. A cleanup is impossible. That leaves only one solution: pile on new claims to such an extent that old debts appear paltry. Those who cannot forget the past are condemned to inflate it.

Harold James is Professor of History and International Affairs at Princeton University and Professor of History at the European University Institute, Florence. A specialist on German economic history and on globalization, he is the author of The Creation and Destruction of Value: The Globalization Cycle and, most recently, Krupp: A History of the Legendary German Firm.

December 5, 2012 8:25 pm
Time to use room for manoeuvre
Ingram Pinn©Ingram Pinn

Non, je ne regrette rien. This should be George Osborne’s motto.

The chancellor of the exchequer cannot admit that his strategy bears blame for the absence of anything that looks like a recovery. He also insists that “it’s taking time, but the British economy is healing”. If disability is health, the chancellor can make this claim. Otherwise, he cannot.

The strategy is transparent: define failure as success and, to the extent that this does not work, blame one’s inheritance and the external environment. Politically this works. Economically it is unconvincing.

The legacy is what it was when the government came into office. If things have ended up worse than expected, it is partly because the government failed to understand its inheritance. Again, the claim that events beyond government control are to blame for the disappointing outcomes is specious. This is not only because the UK economy has done badly in comparison with its peers, but because the government decided not to use available policy instruments. The UK economy is suffering the longest period below a pre-recession peak for a century. Given this, employment performance has been good. That, however, is the mirror image of the collapse in productivity growth. If these are signs of the desired return to health, what would chronic sickness look like?

One growth downgrade has followed another. We have also seen huge slippages in borrowing plans, compared with what the chancellor initially expected. Thus, in the emergency Budget of 2010, the forecast for cumulative public sector net borrowing between 2011-12 and 2015-16 was £322bn. In the latest forecast, this increased to £539bn, a rise of £217bn, if one excludes various special factors: the treatment of the Royal Mail pension, the debts of Bradford & Bingley and Northern Rock, and the transfers from the Asset Purchase Facility. (See charts.)

The government is not responsible for the mistaken economic forecasts. Responsibility has been transferred to the Office for Budget Responsibility, which notes that “the error is split fairly evenly between: weaker private consumption (reflecting demand uncertainty and credit conditions); and weaker net trade (concentrated in the first half of 2012)”. But the question is not what is to blame for the weak economy in any given period, but whether the government can and should do more about it and, if so, what exactly it should do.

The government’s conviction is that the overall task for fiscal policy is to balance the structural current deficit and bring net debt under control. But stabilisation of the economy is the responsibility of the central bank. Unfortunately, with the banking industry impaired and interest rates so close to zero, this assignment does not work well. With further fiscal tightening also under way – a structural tightening of the current budget by 4.7 per cent of gross domestic product between 2011-12 and 2016-17, and a reduction in public sector net borrowing by 5.3 per cent of GDP over the same period – the economy will face strong headwinds. Growth is likely to remain sluggish for a long time.

What will be done? Almost nothing, beyond postponing achievement of the fiscal targets further into the next parliament. What should be done is another matter. The government can and should reconsider fiscal, monetary, financial and structural policies, in order to accelerate the recovery.

First, the government could consider credibly temporary fiscal expansion. The obvious policy instruments for this are higher public investment and tax cuts, particularly cuts that are likely to be spent at once. Yes, this means more borrowing. But the government can reasonably argue that with such a weak economy, but cyclically-adjusted net borrowing forecast at only 3 per cent this year, it has given itself the room to delay tightening. This will lead to cries that credibility would be utterly destroyed. On the contrary, with the lowest long-term interest rates in UK history, it is the weakness of the economy that is, alas, all too credible.

The case for temporary increases in borrowing is very strong. Moreover, the promise to tighten further in the next parliament is barely credible, since a parliament cannot bind its successor. But what the government can do is leave a strong economy. Nothing could do more to make consolidation credible.

Second, the arrival of a new governor of the Bank of England is the ideal time to consider a change in the monetary framework. Possibilities would be either targeting of nominal GDP, with an increase of, say, 5 per cent a year for the next five years; a move to targeting domestic inflation, perhaps with a target of 4 per cent for nominal earnings; or even an exchange rate ceiling against the euro, as practised by the Swiss.

Third, the banking industry is far more constrained than most people initially believed. It is essential to find ways of recognising losses and recapitalising banks, without shrinking balance sheets further. Again, the government can borrow the money needed for such purposes.

Finally, the government needs to tackle structural obstacles to growth. Policies that both promote demand and expand supply would be ideal.

The economy is far weaker than expected, while public finances are healing. This gives greater room for manoeuvre to the government’s attempts to accelerate the recovery. What should it do? The answer is: more than it is doing. It is easy to understand the political case for insisting that there are no alternatives. Yet there are. It should adopt them.

Copyright The Financial Times Limited 2012