Blain’s Morning Porridge – Jan 16th 2019 – 30 years later…

Blain’s Morning Porridge  – 16th January  2019

“Governments crack and systems fall, cause unity is powerful, lights go out…”

In the headlines this morning:

There is little point commenting on yesterday’s Brexit shenanigans – except to note the degree of parliamentary indiscipline across the Conservative Party was even greater than even Rees-Mogg expected.

I avoided the whole thing by spending yesterday at the Euromoney CEE conference in Vienna – very interesting discussions and a phenomenal number of attendees. A real buzz to meeting – even more so than a similar event in London last year. There was a real sense of things happening.

I was asked to oppose the motion on an Oxford Union style debate:: “This House believes Trade Wars will kill economic growth in the CEE”. The proposer of the motion, the excellent Marcus Svedberg, of the Swedish State Pension fund, did a great job running through how much damage trade wars will certainly do to the developed European supply changes across the diverse range of Central and Eastern European economies. If there are tariffs slapped on European goods by Donald Trump, then the successes of the last 30 years in creating a number of vibrant European economies will be dented. Marcus is absolutely right.

I opposed that motion, arguing: “If its trade wars you are worried about, then you are worrying about the wrong things”.

The first issue is I still consider it unlikely we will actually get a trade war. We will get lots of market and confidence driven doom, gloom and angst – which will be damaging to sentiment, planning and investment. However, Donald Trump is angling for concessions from Europe because that’s what his electorate want. They have bought his story they’ve been legged over by Europe and China for years, with the US treated badly – and, to be fair, he’s got a point. The US has supported Europe, back-stopping its pathetic defence spending, and has been abused for its efforts. European leaders know they have to pay up. But, it’s far more likely trade negotiators will find a compromise to avoid trade crisis – both Europe and the US know there is much to lose if it were to happen.

Meanwhile, markets are doing their usual thing – overreacting and over-over-estimating the chances of a trade war. Investors get paid to assume the worst. And because the market has no memory, it reacts as if the worst-case scenario – allout trade war – is nailed on. Trade wars don’t happen because smart civil servants craft compromise agreements.. It would be a racing certainty, if it wasn’t for one thing.…

The fly in the ointment will likely be France, which will insist French Agriculture is protected from American imports – after all the primary reason for the European Union has and always will be to protect French farmers. Upset them, and there will 60 mm revolting yellow vests back on the street. Macron faces an impossible dilemma – he’s already effectively surrendered much to the protestors, and now he’s trying to unravel any discussion of Agriculture from any US vs Europe trade agreement. Trump won’t let it happen. Europe will have to open up, and not just to Soyabeans.

Which leads us to the second issue – France is not the only European economy under the populist cosh. Right across Europe we’re looking at European elections electing populist candidates right at the time the ECB and EU leadership changes. It’s going to have a significant effect on tripping the European dream. There is a nightmare scenario of an essentially ungovernable European and domestic parliament.

Unfortunately, I had to utter the B-word at the conference – how the UK’s decision to exit Europe has triggered an absolute breakdown of parliamentary party discipline and leaves the UK caught in an unresolvable voting vacuum. It’s a classic example of populism – MPs saving their own political skins over the priorities of the country. As I’ve said before – the optimal electoral position for a UK politician looking to keep their job is to support remain: on the basis 48% of the electorate will support you while the 52% Brexiteers are hopelessly split between deal and no deal!

Similar risks exist across Europe, fuelled by real and imagined social injustices. Since the global financial crisis in 2008 we’ve seen increasing income inequality as the policy responses of keeping the banks open and zero interest rates made the rich richer, while austerity made the poor poorer and cut back of the social welfare net. Other resentments range from the perception CEE is just a dumping ground for Europe’s immigrant problem, to the “one-rule for France and Germany, tougher rules for everyone else” so infuriating Italy, Greece and others. (I suspect even the EU huggers in Ireland will leave when Brussels stops building them new motorways and asks Eire to become a net contributor to the budget.)

Which leads us the third issue – Europe is not a single polity of shared and common purpose. Unity is on the backburner as it becomes clear Germany and France are both mired in primary domestic strife.  Each country still follows its own independent path – which suits them best. There is no unity of purpose across the Union – clearly seen by the hostility in parts of Extended Europe to EU “interference”.

Since the Iron Curtain rusted away in 1989, there has been a race from the former Soviet Satellite states to reform, adapt and grow. Their success has varied right across Central, Eastern and Emergent Europe. Some countries, notably Poland, Hungary, Czech and Slovakia, have done well – but, by becoming offshore cheap manufacturing for Germany. You can’t seriously consider launching a Fintech start-up without Baltic State involvement. But as you head further east, the cracks tend to become wider – educational standards slip, the rule of law and judicial independence becomes less taken for granted, and innovation and entrepreneurship is replaced by kick-back cultures.

This spawns a massive and diverse economic range across Extended Europe. Some have succeeded. Others are struggling. Skilled workers migrate from Ukraine to Poland, while the Poles move to Germany and the UK. As wages rise in CEE economies, productions moves East to where workers are cheaper, accelerating change and migration. We’ve seen that process in every single developing economy through history – the migration of the rural poor to manufacturing cities – most recently in China.

In the UK the 1707 Act of Union was followed by the industrial revolution and urbanisation as the rural population drifted into the towns. In the US we saw the same thing happen – the growth of strong manufacturing towns fuelled by plentiful labour. In these cases it was simple because the rural poor had shared culture, values and tribal backgrounds as the towns they moved to.

However, the demographics of moving from country to a new country are frightening. A Romanian or Bulgarian moving to London today faces an utterly alien cosmopolitan society – but their resilience has proved extraordinary as they quickly fit in. Eastern European labour has had a massive positive effect in the UK!

But, mass migration westwards leaves the  economies of Extended Europe drained of their labour, leaving a demographic timebomb of ageing population relying on remittances from overseas. It leaves hollow countries, and I pretty sure these countries didn’t clamour to join the EU to become CEE Disneylands?

When the Iron Curtain fell, we promised to nurture these new nations. The EBRD, or the Glistening Bank, was one such agency. If all that happens in Extended Europe is to become factory floors for Germany, or they become denuded empty lands, then we’ve failed. While some have succeeded, others remain challenging in terms of judicial oversight, law, corporate governance and corruption, while physical infrastructure remains “soft” across the region.

There are short-term risks in terms of the effects of a trade war, but medium term the much greater risks of policy mistakes from populist politics and long-term as a result of demographics and the possibility Extended Europe turns away from Western Europe and looks to China to provide the infrastructure investments it still needs, are far greater. And, this is all going to happen faster than we think – its only 30 years since the Wall fell.

For the record.. I did win the debate.

Back to normal porridge tomorrow!