Brexit, one week later.

1. Initial signs of Economic Chaos were overblown.

As of now the FTSE 100 has more than recovered all its losses, and the smaller FTSE 250 is only down 3.5% on pre-Brexit, taking it back to where it was in March 2015. The Pound is down against the Euro, but only to where it was in early 2014; it is historically down against the Dollar, but this should help boost UK competitiveness for exports. We will not know for months what impact it is having in underlying UK growth though. We could already be in (moderate) recession.

2. Political Chaos continues at full force though.

The Tories and Labour are both effectively leaderless, the government has temporarily ceased functioning, and the SNP are trying to destabilise things further. It is possible that Theresa May will be crowned PM within a week, but more likely the Conservative leadership election will go on until September. Democratically speaking, the Tories and Labour should both sort out their leadership problems, and then a General Election should be fought on different visions for Brexit. Economically this just risks eking out complete uncertainty until Christmas, with further negative economic effects. Economically we want to trigger Article 50 and get some things decided as soon as possible.

3. Obvious first steps.

It seems to me the following should be announced ASAP to reduce uncertainty now. Firstly, EU citizens currently in Britain should be guaranteed 'permanent leave to remain' post-Brexit, contingent on an equivalent guarantee from EU states for our citizens. Anything else is just playing games with people's lives. Secondly, the British government should promise to replace all EU funding on current projects in Britain with British money from our EU contributions. This will mostly be academic grants, infrastructure projects and agricultural subsidies. Thirdly, the government should announce all EU laws will be retained in UK law immediately post-Brexit, though after that they may be changed by the usual UK mechanisms. (Obviously not including those laws about our relation to EU institutions).

4. Our Further Negotiating Position

Given the state of the vote, I believe it is clear we should be pursuing the highest degree of economic links and co-operation in areas of law & order, science, environmental measures, visa-free travel, etc consistent with severing constitutional links and ending the total right of free-movement and settlement. If there was no right of unlimited immigration into the UK the Remain side would've won by a landslide. If the only issue was Free Movement then Leave would've won by a landslide. The only decent democratic thing to do seems to be to maximise and balance these truths. Given we already completely comply with EU law it should not be beyond the EU or the UK to reach a full agreement within the two years (though it will certainly be difficult). Brexit threatens the EU economy almost as much as it threatens ours, and the Eurozone is arguably in a worse position to deal with it.

Positively in the wider world there have already been expressions of interest in closer trade links with the UK from Australia, New Zealand, the US, and Iceland (assuming I haven't missed any). Negotiations with these states should start immediately. Someone suggested that there just aren't enough staff in Whitehall to do this, compared to in the EU. Hire some more then. Wider trade relations was meant to be one of the key advantages of Brexit. We can't afford not to at least try to make a strong effort at this.

Overall Brexit may turn out alright. But it certainly can be botched. As with many political choices how it's carried out and how other countries respond will be crucial to success. Our overall fate for better or worse was not simply determined on the 23rd June.

Oh, and please, for the love of God, no more Br-exit puns. No Bremain, No Bregret, No Scexit (Scottish, you get the idea).  Just stop it, stop it now. Thank you.      

The Future of Greater European Union

I have very mixed feelings about the EU and the referendum on UK membership.  I feel that we don't really want 'In' or 'Out' of the EU. We want co-operation with other European countries without getting dragged into Brussels' incompetent empire building.  We neither want to be dragged into the Eurozone, or the Schengen agreement, or an EU army, or a banking union, or any other of myriad EU schemes for closer union. Neither do we want to end up entirely outside the European community, unable to engage in academic co-operation, free-trade, law enforcement co-operation, visa-free travel, or lose all say on a wide-range of technical standards.

The Leave campaign wants to persuade us that we could retain the good things we want while losing the bad things we don't want. The Remain campaigns wants to pesuade us we don't have that option and if we want the good bits we have to take the bad as well. I don't know which is right. But a better, more long-term question is, firstly, why isn't there a better option than either?  Why can't we be in a European Community, with some limited say over how it works, without constantly having to fight to avoid being dragged into an 'ever closer union'? This question is intimately tied up with another important question. Where will the EU itself be in twenty or thirty years time? And where should it be? How can we make a long-term decision to stay if we don't know what we're getting in to.

Frankly, nobody answers these question because the EU basically has an unofficial plan of not having a long-term plan. The EU's model for european unity has always been deliberately one-step-at-a-time. Looking where you're going might just terrify you, and lead to an almighty argument about the choice of destination, but if you concentrate on taking each step you get there eventually. Closer union does not advance with any big bang, but with a directive here, an agreement there, power after power, slowly standardised and shifted to Brussels. This approach has its advantages but the chaos of the Eurozone crisis and the refugee crisis, not to mention the risk of Brexit, and eurosceptic sentiment in countries like France, the Netherlands and Denmark, suggests it is no longer up to the job, to say the least. Obviously the future is uncertain, especially the future of the EU, but there are some things we can be reasonably sure of. And that offers an answer to the first question as well as the second.

This is the EU and Eurozone as it stands. The Eurozone in dark blue, the rest of the EU in light blue.

The European Union has expanded since 1953 when it was just France, Germany, Italy and the Benelux countries. From 6 countries it has now expanded to 28 and it is clear what further expansion plans there are. The remaining Yugolsav countries are only still outside the EU because of their low political and economic development, largely a result of the terrifying wars of the early 90's. Slovenia and Croatia have already been absorbed, and the rest almost certainly will. As will, eventually, the bits of Ukraine that Russia can't detach. In ten to twenty years the EU will most likely look like this.

At this point EU expansion hits a block though. It runs out of small European countries to swallow up. The only ones left on its borders are either vast and foreign (Russia and its satellites, Turkey) or have already said no (Switzerland, Norway, etc). All the east-european countries have signed up to join the euro so I'm assuming they will eventually, though this part of the picture is more uncertain. The EU will not just be geographically larger, it will be more integrated as well. 'Ever Closer Union' is the EU's one creed and it will work out its inevitable logic, slowly but surely. Even the EU's most serious troubles, the Eurozone and migration crises, have only fuelled the calls and need for ever closer union. Within twenty years we will probably have, and I would say, should have, the workings of a fully fledged European Superstate.

Not a strong federal state, a United States of Europe, it will never be that centralised or constitutionally uniform, its central government will still be weak compared to the member states. More like a European Confederacy, a diverse multi-lingual block with a central government whose brief is purely to manage cross-state relations and issues and represent their interests to the wider world, not to take precise and detailed control over everyone's lives and money. It will be more like a giant Switzerland than a European US, though still with its own common currency, banking system, central bank, scientific program, space agency, external border, trade policy, legislature, technical standards, immigration and asylum policy, army, agricultural policy, limited fiscal transfers, etc. More than enough to be getting on with.

And, for most European countries, this would be a good thing. Most of them are small, recent inventions, who are entirely surrounded by fellow EU neighbours and have neither the need nor the expertise, nor any interest in running their own currency, or their own foreign policy, or even their own armed forces. The 21st century will increasingly be dominated large states: America, China, India, Russia. These are many tens of times the size of Slovenia, or Belgium. On their own they'll get squashed but together the European Confederacy can stand toe-to-toe with the other great powers of the world.

A future in the European Confederacy is not for everyone though. Britain, whether it votes Leave or Remain on 23rd June, will not be in the European Confederacy. We're already outside the Euro and Schengen zones, and between the renegotiation, and the referendum lock the distance between us and the core of EU countries is only going to grow. It is likely that more and more decisions will be taken within the EU core and we will be increasingly side-lined. If we vote Remain we'll end up a semi-detached formal member of the EU, but outside the European Confederacy including almost the entire rest of the EU, a leviathan stretching from the Channel to Ukraine with the Euro as its currency. If we leave we'll most likely end up in the EEA or EFTA, in a very similar position, with a modicum more freedom to act outside the EU and a modicum less ability to influence policy inside the EU. This will leave the European Confederacy ringed by states to whom it is closely linked but either, to its north have chosen not to join 'ever closer union' (Britain, Norway, Iceland, Switzerland, possibly Denmark and Sweden), or, to its East, are too large and alien to be satisfactorily integrated (Russia, Turkey).

Turkey, for example, has been inching towards EU membership since the 1960s, first formally applied for membership in 1987, and is currently in the customs union with the EU. I consider it very unlikely that Turkey will become a full EU member any time in the next twenty years or more. Turkey is no poorer than Bulgaria or Romania, but it has 80 million people compared to 26 million between the two of them, all of whom would be eligible for free-movement across a continent that has become paranoid about immigration. Turkey has a border that stretches into Northern Iraq and Syria about which the less said the better. It has a conservative Muslim population with cultural views predominating very different to that in the rest of the EU, a problem with military influence on the government, a repressive policy towards its large Kurdish minority, which responds in turn with a terrorist insurgency. Its sheer size and poverty means that it would immediately become the largest EU country and the poorest, making it eligible for a huge portion of the EU budget, draining money away from every other country, and the most powerful country in the EU parliament, as well as the Council of Ministers, etc.

All of these are good reasons why giving Turkey full membership of the EU would be a bad idea, and more prosaically, why it will be blocked by other EU states at any point in the foreseeable future. Similar considerations apply to Russia, even if at some point in the next generation they drop their antagonistic stance to Europe. But that doesn't mean that the EU shouldn't have close, friendly relations and co-operation with both Britain, Turkey, EFTA and possibly others. It should, for both our and their interests. It's just that none of these states, for very different reasons, is going to be part of Euroschengenland.

The obvious answer to this problem is a two-speed European community. There should be an inner core, a very large one, of states continuing 'ever closer union', moving towards a sort of European Confederacy, and an outlier of states semi-connected to the European Confederacy, forming a wider European Community. This already kind of exists. It's kind of like the relation between the EU and EFTA, and it's kind of like the relation between the Eurozone and the non-euro EU (like us). But formally it's neither. Formally the EU has opposed any idea of a two-tier Europe in the hope that everyone would move inexorably towards the same goal. That's why the EU requires all new members to eventually join the Euro, even if they have no wish to do so. That's why they talk in terms of Turkey eventually becoming just another EU country, even though for obvious practical reasons they've been blocking it for thirty and more years. That's why people in Brussels still hope we'll eventually join the Euro even though that will obviously never happen.

Accepting a two-tier Europe would be, in a very limited sense, accepting defeat, and so they are psychologically resistant to it. But the time when that has been a useful response has long since passed. Greater European Union can no longer be built on sheer stubborn insistence but must accept that certain countries cannot or do not want to fit into one size fits all. It would have obvious advantages for both the Euro-core and the European periphery. Instead of having different legal and institutional bases for relations with each of Britain, Norway & Iceland, Switzerland, Turkey, it would simplify and unify relations between the European core and periphery on a stable permanent basis, while allowing a degree of flexibility and independence. This map shows the countries that may be involved in such a system, with the European Confederacy in dark blue and the states around its borders with close semi-linked relations in light blue.

But how could a two tier Europe work? Issues and policy areas would be divided into two groups. There would be a cluster of policy and governance areas that would be bound together and form the province of the European Confederacy. These would include the following areas: currency, banking system, central bank, external border, trade policy, legislature, cabinet, free-movement zone, immigration and asylum policy, army, agricultural policy, fishing policy, structural support grants. These areas would be under supranational control under whatever rules the European Confederacy wanted to use, presumably with strengthened versions of current EU institutions: EU parliament, EU commission, EU Councils, civil service, court, etc. Brussels would be its sole capital and parliament seat, Commissioners could be democratically elected from each country to increase EU legitimacy. The EU confederacy would be recognised globally as a single sovereign state, with a single UN seat, probably a permanent security council one. It would be in NATO, and would generally have a role commensurate with its status as one of the largest, wealthiest and most powerful countries in the world.

It would sit on a second layer, that of the European Community, including the Euro-Confederacy and all the states around it I've discussed. This would share a free-trade area, a scientific programme, a wide range of technical standards, a space agency, crime and terrorism co-operation, minimum environmental standards and co-operation, the European Convention of Human Rights, Eurovision, etc. It would make a modest contribution to the Euro-Confederacy budget, or some formally separate budget to fund these activities but would not be financially on the hook for Euro-confederacy policy areas or issues. Community decisions would be taken inter-governmentally by councils of the relevant government ministers. Decisions could then be taken unaninmously, or by some super-majority of both the Confederacy and Community states, or whatever. Community states would be represented by their own governments and not have either parliament or commission representation in Community decision-making. The Euro-confederacy would lead for the whole Community on limited international issues with the approval of those governments and Community nations that wanted to integrate further in specific areas, such as Switzerland's membership of Schengen, could do so on an individual, negotiated basis.

Community to Confederacy relations would then be a cross between Norway's current relation to the EU and Britain's current relation to the EU core. The obvious question then is why would the much larger Euro-Confederacy choose to negotiate with the Community fringe, rather than just dictating terms as we are told they do to Norway?  Well partly because the Community would be much larger than Norway, including all the EFTA states, Britain, Turkey, and possibly Sweden, Denmark and others. These would be a relatively formidable block on its own, and thus harder to dictate to than little Norway. Largely though because the Euro-confederacy would gain little from treating the Community badly, but would gain from agreed co-operation. The areas I've mentioning as community areas are largely uncontroversial, and the Euro-confederacy would make its own economic and political surrounds more secure and productive by formally co-operating with the states around it under one system, which allowed it to concentrate on internal integration and its problems, and would gain little, and just annoy its neighbours, by bullying them or pushing them around.

Community countries would gain a sustainable, formal relationship with the Euro-confederacy that combined limited control and input on community issues with wide sovereignty on everything else, but hopefully also maximise the benefit they gain from access to European markets and scientific and other co-operation. Perhaps the other objection that might be raised then is what incentive would this leave to actually join the Euro-confederacy if countries could have such a relationship? Well, because they genuinely want and would benefit from the closer co-operation and integration that the Euro-confederacy provides. Particularly, it would be necessary if they wanted the Euro. The EU cannot and should not operate by trying to keep states inside by blackmailing them with threats of terrible revenge if they leave or choose to stay outside. The euro-confederacy can only work in the long-term, like any state, if all its parts are happy to be inside. The EU would probably operate better by moderately increasing the distance to its most eurosceptic and awkward members like Britain, thus allowing it to focus EU institutions on making closer integration work, as well as having a formal, permanent semi-status for countries it does not want to fully integrate like Turkey.        

It's impossible to tell what countries will choose to fully integrate into the Euro-confederacy and which will not in the next 30 or so years. Maybe Russia will join the Community or maybe not. Maybe Sweden and Denmark will join the Euro-confederacy, or maybe Euro membership will be the dividing line, and like Britain they will find themselves moving increasingly away from the EU-core as integration centres around establishing the necessary governance institutions to support the Euro. The exact borders of each group don't really matter. But I think a formal two-tiered Europe is inevitable and beneficial, and it would be better to formalise close links with states outside the EU-core (Britain, Norway, Switzerland, Turkey, at least) rather than engage in a self-defeating all-or-nothing mentality that will eventually drive them further away.

It is possible that if Britain votes Leave, the EU will cut off ties as far as possible to punish us, and it is possible that if we vote Remain they will take this as the best chance to force us into closer integration.  Both would be foolish and counter-productive approaches: the geo-political equivalent of cutting off their nose to spite their face. Given that there is going to be further integration in the EU core, and that Britain is not going to be involved with this, and both EFTA and Turkey will still exist as well, if not other non-Euro countries, then some kind of two tier Europe will exist and deepen anyway, better to approach the problem explicitly and create the separate governance institutions that will allow such a relationship to continue sustainably for the decades to come.

There were alternatives to the Greek Crisis - Grexit or No Grexit

The incompetence of the EU's approach to the Greek debt crisis has been staggering. 5 years of failure have gone by and we are closer to Greek default and exit from the euro than ever.  At every stage EU policy has failed to meet its stated objectives while inflicting penury and unemployment on Greece (and other periphery countries) on a scale usually associated with a major war, and which, in this case, was largely avoidable.

It is worth briefly cataloguing just how badly EU policy has failed on its own objectives.  Back in 2010 EU leaders were loudly trumpeting the need for a bailout to avoid 'contagion' of the debt crisis. This was loudly and repeatedly stated until Greece, then Ireland, then Portugal had all fallen like heavily indebted dominoes and Italy and Spain were staring into the brink. It was an odd policy even from the start. If you are really trying to avoid 'contagion' you generally separate yourself from the contaminated object or person: the analogy here would presumably be ejecting Greece from the eurozone. Instead the bailout policy resembled hugging Greece close and giving it a direct person-to-person blood transfusion. Unsurprisingly, when you plug the financial systems of various countries into each other through massive country-to-country loans, the bad blood spreads.

Then the shout was that it was vital for Greece to avoid any default at all. Then in summer Greek 2012 default occurred.  We were told that the ECB couldn't possibly buy government bonds from distressed countries, or engage in general QE, right up until the moment both of those things happened. We were told capital controls were unthinkable, but now, you guessed, they have occurred in both Greece and Cyprus. The list goes on. Perhaps the biggest and saddest lie of all was the idea that the Euro was the great triumph of European solidarity. But in the very first major Euro crisis the rich countries have adopted a policy of taking the poor countries by the throat and squeezing the life out of them.  Where has European solidarity been for the last 5 years, as Greek and Spanish unemployment topped 25% and youth unemployment went over 50%?

At every step the EU has adopted policies that kicked the can down the road for a few weeks or months in the short term but that transparently had no hope of resolving the crisis in the long-term. And all this was predicted as far back as 2010.  There were always alternatives to the ludicrous policy the EU has chosen, and critics and sceptics have been pleading for them ever since this awful mess started.  They have been ignored and the inevitable, predictable results of economic gravity have ensued as sure as someone dropping a rock over their foot.    

There were two quite clear alternatives to the Greek crisis that could have been taken. One that kept Greece within the euro and one that saw it leave back in 2010.

Grexit.

If EU countries weren't willing to give Greece the money it needed to realistically sustain its economy while reducing its deficit then they should have let it leave the eurozone.

Grexit could have been managed in secret over a very short period of time to ensure a minimum of chaos. This would have required some outright lying to the press in advance, as the necessary official preparations were made in secret, but not much more than governments usually engage in. With preparation and support it could all have be done over a long weekend, with the banks able to open the next week in the new currency. Greek euro note and coins would have continued in use for a few weeks while new ones were prepared but now acting in the new currency. Greek banks would have to be shut and capital controls introduced while the change was made, but these could have been raised again relatively quickly once the transition was made.

The new Greek drachma would have immediately devalued massively, this would have sparked significant inflation but this would have been over relatively fast. It would massively increase Greek competitiveness overnight, giving huge boosts to Greek industries such as tourism and shipping and would only have effected international imports. Greece should have defaulted by 30% on all private debt in order to get out from under its debt mountain at that point, and reduce interest payments as a one-off measure.  From that point onwards all debt would be honoured in full.

Some eurosceptics have implied that this could all have occurred totally harmlessly, with a hop and a skip and a jump. This is foolish and ridiculous. The process would not be pain-free. The Greek people would still suffer a big fall in real income due to the inflation but with the advantage that it would be over quickly and Greece would rapidly recommence a real recovery rather than the permanent grinding recession that has seen GDP fall by 25% since 2010.  European governments would still face significant costs.  They would need to bailout their own banks where they had taken big losses in Greece. But from that point on all danger of 'contagion' would be severed as the link to Greek banks would be severed.

The EU would also be wise to sink significant sums into Greece in EU managed structural fund investments to help get the Greek economy back on track. This whole program would be with the aim of a recovered Greece being able to rejoin the Euro on proper terms in 15-20 years. Certain quantities of loans would also be sensible, but massively less than under the two bailouts we have seen thus far. Greek banks would need to be recapitalised but without Greece shifting into hyperinflation due to mass money printing to recapitalise Greek Banks. Hence the wisdom of providing some outside cash to allow Greek banks to rebuild their balance sheets with solid euros rather than just printing drachma.

The ECB should've at the same time cut interest rates to 0.5% and launch a large bank support program for Ireland, Italy, Spain, Portugal, but with the safety of knowing they no-longer had responsibility for Greece, by far the worst case. Ireland would still need a bailout, which should have been conducted on more generous terms, and maybe Portugal.  But with proper ECB assistance Italy and Spain should have been able to avoid the stress they came under in mid 2011, and hence so would the rest of the Eurozone. This should mean the entire 2012 double-dip recession could have been avoided, saving European countries billions more in gained output than they may have cost helping Greece with structural funds.

Immediate exit from the the euro and default would probably have produced a significant negative shock to GDP.  I have no idea how big, but even if it had been 10% of GDP, if it meant growth had returned within a year or so, then by now Greece would almost certainly be in a vastly better position, as would the rest of the Eurozone. Greece would probably have almost returned to 2010 levels by now instead of still being down by almost a quarter of its economy compared to 2010.

If such a program had been launched in full in 2010 then Greece should have rapidly returned to significant growth by 2012-ish and by now we could be discussing the Greek and Eurozone recovery, falling Greek debt burdens and the prospect of Greek readmission to the Euro (under more stringent regulation and monitoring) in perhaps another 10 years max.

No Grexit.


If Greek exit from the Euro was truly unacceptable to Eurozone countries then there was an alternative that kept Greece within the EU and alive. A lot of the stages would actually be remarkably similar. Rather than actually raising interest rates in 2010 the ECB should have immediately cut interest rates to 0.5% that summer. What inflation there was in the Eurozone was down to commodity price rises and would soon be quenched by the economic downturn. Slashing interest rates immediately would have helped give some small support to periphery country debt costs.

The ECB should furthermore have launched an immediate and substantial program of QE or bank support, as it eventually did.  €1 trillion euros of support whether aimed at states or banks would have been a good start, supporting distressed countries on a formula that mixed need and size. Crucially this should have been done before markets began attacking weak states, not some time afterwards when damage had already been done to investment and trade.

Greece would need to be bailed out, but on considerably more generous terms. A 30% default should again have been enacted immediately to reduce debt payments and levels. The bailout should have been considerably more generous, with Greece charged for support strictly at the rate of cost to the lending countries of raising the money. This should have been combined with an expanded program of infrastructure support projects, effectively grants, run through Brussels directly though so as to avoid any perception of the Greeks wasting the money.

Support to Greece should have concentrated on a more gradual reduction of the Greek deficit towards a current surplus, with deliberate efforts to maintain Greek economic activity. There would still need to be significant, cuts, tax rises and privatisations but with an eye on headline GDP and employment. Direct cash transfers and low taxes on poorer consumers, as well as infrastructure spending, should have been protected, while at the same time tax rises should be concentrated on wealthier Greeks and land and property, while spending cuts were concentrated on relatively economically unproductive public services.  The overall purpose of this would have been to conserve economic demand as far as possible while making significant but not suicidal progress in reducing the deficit.

Support should have come in large quantities not just in the form of loans, but also technical support in improving public sector productivity, privatisations, and improving the Greek tax take.  Tax avoiders and evaders of all classes should have been gone after like police hunting down terrorists, as a matter of national security.

While such a program would have probably taken more money than was included in the first round of Greek bailout in 2010, some €110 billion, it would almost certainly have not taken more money than was included in both rounds of bailout put together, a total of €240 billion euros. When combined with the fact that it would have hopefully seen a much smaller fall in Greek GDP, Greek debt levels should have been LOWER under this plan than what has actually happened.


Conclusion.

The counter-productive effect of current policy has been massive.  Greece has suffered a 25% recession to cut their deficit by 12%. That is €1 cut from headline GDP has only reduced the deficit by 50c while inflicting utter devastation on the Greek people. This in turn contributed to a double-dip recession across the Eurozone as a whole. If Greeks had borrowed just as many euros as they currently have, but their economy was the same size now as in 2010, then their debt burden would be only 120% of GDP instead of the 180% it is at the moment, just due to the effect of dividing the debt in euros by a larger GDP figure.

Leading politicians such as Merkel should have clearly said that you don't make yourselves rich by beggaring your customers; nor by producing a rolling 5-year crisis without any hint of resolution, which has just shook confidence across the entire EU and particularly within the other weakened countries: Spain, Italy, Ireland, Portugal. Merkel's policies (Merkelism if you will) could be fairly characterised as Thatcherism without all the upsides. Being a Leader involves, you know, leadership, and that means taking people where they need to go, not pandering to their daftest instincts.

Which brings us to our present moment. On Friday Greece will vote in a referendum on its future. Greece has never been so close to an messy euro-exit. Vote No and such an exit might give the country a chance of a better economic future, but in a severely more messy manner than could have been possible with a structured Grexit back in 2010. Vote Yes and there is nothing to look forward to other than years more grinding poverty and mass unemployment. Either way it is an utter shambles.