A tale of two economies

Former Prime Minister Manmohan Singh claims that India’s economy has been “systematically dismantled” by the BJP government. He should know that every nation’s economy is only a glass half full. Two of the world’s biggest economies, the U.S. and the U.K., are both facing uncertain economic times.

Economic woes

By next summer, U.S. President Donald Trump could claim to have beaten the 10-year growth period of 1991 to 2001. Cutting interest rates, injecting billions of dollars into the economy, cleansing the financial system so that banks can resume lending, tax cuts by the Barack Obama administration, and spending increases helped the U.S. economy recover. But average growth is still only 2.2% without a single annual increase of over 3% over the past 10 years. Half the growth benefits during Mr. Obama’s tenure went to the top 1% of households, and the lack of real income growth for society’s lower levels led to the discontent that pushed Mr. Trump to the top position. Problems are likely to start with the financial sector, tightening policy by central banks, and overvalued asset prices. The U.S. Federal Reserve has the difficult task of raising interest rates without precipitating a downward slide when the impact of the fiscal boost is fading. If this happens, Mr. Trump will be seeking a second term when the U.S. economy is in the doldrums.

Brexit troubles

In the U.K., the situation is worse. Leaving the European Union (EU) means getting into uncharted waters. Much of the acrimony is within the ruling Conservative Party over the exit plan, leaving Prime Minister Theresa May to negotiate both with the EU and her party simultaneously. Britain’s growth rate over the past year is half its average over the past 25 years, investment is stagnating, mortgage approvals are down by nearly a quarter, and almost half of EU businesses have cut back on their investment since Britain decided to leave the EU.

In the first quarter of this calendar year, the growth rate was slowest for five years. An expected interest rate rise has been deferred amidst talk of possible recession. Over the past year, inward investment has dropped by $181 billion, outward investment has risen by $120 billion and real income has fallen by 10% as employers resort to low-paid, low-skilled casual work. The services sector has become dependent on low-end EU labour. If visas are required for these people after Brexit, the outcome will be devastating. The only bright sign is that high-tech companies that threatened to leave Britain with the prospect of leaving the EU have not yet shown signs of doing so.

There is disagreement among the Conservatives over future links with the EU’s single market and customs union. To summarise, a country like Norway can be in the single market but not the EU: this involves eliminating tariffs, quotas and taxes on trade, and allowing free movement of goods, services, capital and people against payments towards the EU’s budget, and accepting the jurisdiction of the European Court of Justice. The EU is not only a single market, it is also a customs union. Thus a country like Turkey is in the customs union, which does not cover food, agriculture or services, but not in the single market or the EU. This option would solve the border problem between the Irish Republic and Northern Ireland, which would remain open, but the U.K. would not be able to strike free trade agreements with other countries, which remains the exclusive mandate of the EU. A Free Trade Area is one where there are no tariffs or taxes or quotas on specified goods and/or services from one country entering another. The negotiations to establish it can take years and there are normally exceptions, so agriculture and fisheries might be exempted, certain industries protected, and some goods not covered at all.

The Theresa May government confronts the painful truth that leaving the single market and the customs union will introduce barriers to buying and selling with Europe. Ms. May attempts to solve this dilemma by promoting her plan for a hybrid arrangement called a customs partnership, wherein on behalf of the EU, Britain would collect tariffs set by the customs union on goods entering the U.K., and if those goods do not leave the U.K., and British tariffs on them are lower, companies could claim the difference. This project has been criticised by hard line members of her cabinet who prefer a clean break with the EU. They had put forward an alternative ‘maximum facilitation’ plan by which goods would be tracked electronically and pre-cleared with tax authorities. This procedure would work with an established ‘trusted trader’ scheme to remove the need for physical customs checks and enable companies to pay duties every few months rather than each time they crossed the border. Both schemes are complex and lack clarity. More importantly, there is no indication that the EU will agree to either option, which in any case would not be ready by 2020 when the transitional period expires.

The EU wants the formalities completed by October this year while Ms. May is apparently counting on Brussels caving in at the eleventh hour rather than precipitating the mutual damage arising from the absence of any deal. But the EU can afford a waiting game while the U.K. cannot. With a succession of defeats in the Upper House, an uncertain majority in the commons and the deadline of March 2019 for the U.K.’s exit from the EU fast approaching, the public which voted to leave the EU might well ponder how prepared they are for a future outside Europe. Ms. May depends on the erratic tolerance of her own party to survive. Discussions and divisions have centred, with considerable ambiguity, on what constitutes a meaningful say for Parliament on any future Brexit deal. Ms. May argues that Parliament cannot tie her hands in the negotiations and should not act against the will of the majority that voted for Brexit.

Consequences of leaving the EU

Leaving the EU will affect Britain in many ways. It will be excluded from the EU space project Galileo, and lose access to the EU global positioning system that will challenge the American GPS as a market leader. It will lose EU funding for scientific research. The U.S. is likely to drive a very hard bargain for rights for British airlines. Britain will also lose its place as a leading country in the EU’s customs union. This asset is to be replaced by new trading relationships that will have to be painfully negotiated by Britain one by one. The growth model of inward investment based on Britain’s technology and access to the world’s biggest free trade area will disappear, and what will remain is an overpriced housing market in danger of collapse. Both the U.S. and the U.K. have reason to regard India’s economic prospects and political stability with some envy.

Krishnan Srinivasan is a former foreign secretary

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