The saviour of the British economy?

A safe pair of hands. Over and over again, British media outlets have used these words to describe Theresa May, the new Prime Minister. She is said to be stable and reliable, and yes, a bit boring. But maybe that’s exactly what the country needs now, after all the excitement that her predecessor David Cameron provided the UK with.

Similar things are being said about Theresa May’s new chancellor, Philip Hammond. The 60-year old has already held several ministerial posts – he was Foreign and Defence Secretary, among others – and has, contrary to many of his colleagues in the House of Commons, had a “real” job before becoming a Member of Parliament 19 years ago. After his studies at Oxford University, Hammond worked for a company that sells medical appliances, spent some time in South America as a consultant for the World Bank and became a partner at a consultancy firm.

Prior to the British EU-referendum on the 23rd of June, Hammond was part of the Remain-camp. It is expected that he will try to negotiate a deal under which the City of London can maintain its passporting rights into Europe, a crucial factor for London to keep its status as Europe’s leading financial center. At the same time, the Conservative will have to stabilise the British economy and regain trust from international investors. Thanks to its high budget and current account deficit, Britain will continue to rely on foreign funding – even more so, should there be a sharp recession looming.

Philip Hammond has had an eye out for the prestigious role for a while. Already in 2010, when the Conservatives formed a government with the Liberal Democrats, the man with the grey mane uttered his interest for the role as a Chief Secretary in Her Majesty’s Treasury, the second most important job after that of the Minister. However, at that point in time, a Liberal got the chance.

Thus, Hammond started in the Department of Transport before becoming Defence Secretary in 2011 and Foreign Secretary in 2014. A Member of Parliament, Hammond has represented Runnymede and Weybridge since 1997 – a constituency that voted Leave although their MEP supported Britain to remain in the EU.

Philip Hammond will now have to make use of his vast experience in order to reassure international investors that the UK is still a good destination for their money. “We don`t turn our back against the world”, he said after his appointment. Hammond pledged to take “whatever measures” needed to help stabilise the economy and retain Britain as an attractive destination for firms to invest.

It remains to be seen what this means for his tax policies. On Thursday, Hammond declined to comment on the announcements made by his predecessor George Osborne to slash corporation tax to 15 percent. Hammond is known for his support for low taxes. Nevertheless, it is still too early to tell whether Hammond will engage in, as some critics such as Pascal Lamy, the former head of the WTO, have claimed, extensive tax dumping in order to keep companies from leaving the UK after the divorce from the EU.

There is more to watch out for. There are two areas where Hammond could clash with his new boss fairly soon. First, there is fiscal politics. Hammond has a reputation of being a “fiscal hawk”. Nevertheless, he cannot just continue what George Osborne started in 2010 when he embarked on a massive austerity program that still is not finished. Prime Minister May has been very clear in the past days that the government’s first goal should not be – as planned before – to generate a budget surplus by 2020 but to make sure that more people benefit from economic growth and prosperity (assuming, of course, there is still something left to share after Brexit).

We might get a first glance of his fiscal plans when he presents the Autumn Statement in November. Different to what then chancellor George Osborne announced before the referendum, there won’t be an emergency budget. Experts like Kallum Pickering, the UK economist at Berenberg Bank, thus expect some more fiscal loosening in the short run whilst more cuts are being postponed towards the end of the Parliament.

Besides fiscal policy, there is a second topic that holds vast potential for conflict, the so called passport for the City of London. This framework allows banks headquartered in London to sell their products on the continent. Should the City of London lose these rights, several thousand jobs could be moved to Frankfurt, Paris or Dublin. London would subsequently lose some of its attractiveness for international banks. Hammond seems to be all too aware of this. On Tuesday, he stated at the British Bankers Association that the financial industry will be possibly hit the hardest by Brexit. “I know and understand the importance of passporting”, Hammond said.

Theresa May though not only needs to satisfy the banks, but also those 17 million Brexit-voters of which many requested the European Freedom of Labour Movement to be scrapped or at least reduced. Leading EU-politicians such as Jean-Claude Juncker, the President of the European Commission, or Angela Merkel, the German chancellor, have already made clear that there is not too much room for negotiation here. Access to the Single Market and passporting can only be sustained if the four freedoms remain in place. So where will that leave the two safe pairs of hands?

 

 

 

 

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May and Merkel – will they get along?

The parallels are all too obvious. They are both females, in their late fifties or early sixties. They are both pastors’ daughters. They both studied untypical subjects (geography and physics). They are both known for being practical, having a strong endurance and, paying attention to details. In addition to all of this, they have fought their way to the top by beating the competition (mostly men) and by making sure that there is actually not too much competition left to challenge them in the future (Merkel has killed off all critics in her party while May was the last Tory-woman standing after a bruising Referendum campaign).

Both are known to be hard workers. Both have the reputation of wanting to get things done and, of just getting on with it, as people say here in Britain. Both Merkel, the German chancellor, as well as May, Britain’s new Prime Minister, have been around for a while (Merkel since 2005, May since 2010). Both are said to be a “safe pair of hands”, a safe bet. Neither of the two has the reputation of being too emotional, chatty, charming, or anything but business.

So, the question goes, will they get along, the German chancellor and her British counterpart? For sure, the relationship between Merkel and May will be crucial when negotiating Britain’s exit from the EU. Both will be studying each others previous negotiating quite closely, and they will be trying to predict the future by investigating the other’s past behaviour in negotiations where a lot was at stake.

From a German point of view, out of the two choices at hand – Theresa May and Andrea Leadsom – May is definitely the preferred option. This is not so much because she was a soft Remainer, but rather because she is expected to behave fairly rationally, pragmatically and reasonably. That’s not to say that Merkel and others should not expect some tough negotiating. Theresa May will, and I am sure that people in Berlin and Brussels will be aware of this, fight as hard as she can to get “the best deal for Britain”.

A lot will depend on the careful calibration of this relationship. Merkel might help May where other European partners don’t want to. But, as the leading representative of one of the most important trading partners of the UK, she can also play a huge role in massaging May into the desired direction.

As to the end result, I am not sure whether it makes a huge difference whether the two get along well, given the gigantic task that lies ahead of them. There is a fundamental issue here that needs to be resolved but that at the same time seems totally unresolveable. How do you keep full access to the Single Market if you plan to reduce the European Freedom of (Labour) Movement? Any negotiator will have to be very witty to achieve anything that comes close to this.

Depending on how the coming months unfold, Merkel could become May’s interconnector into Brussels and other European capitals. However, it could also be the contrary. Merkel might well become a strong adversary to May, should the British Prime Minister try to use the Europeans currently living in the UK as bargaining chips for the negotiations in Brussels.

However, we should not overplay the importance of the relationship between the two. Germany and the UK no longer have closely aligned interests (at least not as aligned as before June 23rd) and so each side will fight with might for what they want to get out of this situation.

Brexit: Implications for London

It’s been nearly three years since I moved back to London from Shanghai. For its part, London, the city in which I studied, pretended I had never really left. Not much had changed in 2012 and 2013, so I quickly got back in to my London life.

Since then, the city has been doing well. During the past three years, I have watched London’s population grow to over 8,6 million, a new peacetime record. I have observed the completion of the Walkie Talkie and the Cheese Grater, two stellar new skyscrapers in the City of London, and learned that there are more than new 400 high-rises under planning here in London – a sign of the huge architectural change that the city is undergoing.

I have heard it called “the greatest city on earth”, a description that ex-mayor Boris Johnson used when advertising the city to foreign investors. I have seen the night skies illuminated by numerous red lights, a testimony to all the construction work going on in London. I have seen house prices rise ever more (they are now at levels beyond most people’s reach) and noticed Chinese, Kuwaiti and Russian billionaires pouring money into London real estate and assets.

These are all indications that London is an attractive, thriving international city that stands out in comparison to other European cities. Londoners of course don’t compare their city with the likes of Berlin, Frankfurt or Paris. It’s New York and Hong Kong that they refer to when talking about other great, international cities.

However, a vote for Brexit could fundamentally change London. Over time, the capital could lose some of its great attractions for people, businesses and investors for whom London has been an easy entry-point into the continent, a bridgehead into Europe. “We would survive – but we would be diminished as a country and as city”, London’s new mayor Sadiq Khan said on Thursday.

Standing below a 1.5 ton piece of art (the so-called “flying table”) hanging from the ceiling in the “Second Home”, a co-working space in London, he explained to around 200 guests the potential consequences of a Brexit for London. According to Khan, the son of Pakistani immigrants, the capital has always been an open city, a city that welcomed otherness, new ideas and different approaches. “A Brexit would have serious consequences for London as a city”, Khan said.

That not only refers to the huge amount of continental Europeans who are working in London, thanks to the freedom of movement (I am a beneficiary as well). It also refers to those businesses in London that are doing business with the continent and that will be in limbo after a Brexit-vote on the 23rd of June, given that it is far from clear what kind of economic relationship the UK and the EU would have after a vote to leave.

One of the sectors that might be hit hardest is the financial industry. It creates around eight percent of national GDP and contributes around 13 percent of UK corporation tax receipts. Of the over than one million jobs in the British financial industry, one third is in London, in the City and in Canary Wharf – right across the street from where I work. In contrast to countries like Germany, under Margaret Thatcher the UK decided that services and banking, not industrial production and manufacturing, would be the basis of the UK economy. That has led to a significantly different structure than that of for example Germany where manufacturing still plays a much more important role.

The centre of this economy is London, Europe’s leading financial hub. Other financial centres, such as Luxemburg, Paris or Frankfurt, look pale against the dominance of London. “Nearly 40% of European assets under management are managed here. We’re home to around 40% of the world’s foreign exchange trading and 50% of derivatives trading”, Jonathan Hill pointed out last Monday at the London School of Economics (LSE).

The EU Commissioner for Financial Stability, Financial Services and the Capital Markets Union was quite clear in his assessment. “Last year, London was once again rated by the Global Financial Centres Index as the world’s most competitive financial centre – hardly a sign (by the way) of a City drowned or strangled in red tape as is sometimes claimed”, the Brit stated.

The key to London’s success is not just its historic role as the leading trading hub for Europe, but also the Single Market and the EU-passporting regime. Thanks to this, British firms and banks can do business wherever they choose in Europe. From their base in the UK, they can provide services and capital to 27 other EU-countries. “They can lend freely into the single market, and they do”, Lord Hill stated. In 2015 alone, British banks lent over one trillion euros and took deposits of over one million euros across the EU.

The scheme also works the other way around. It not only provides access to the EU, but also to the UK, and to the City of London in particular. Due to that, 20 percent of banks operating in the UK are headquartered elsewhere in Europe. American, Asian and African banks use London as their European headquarter and trade into Europe from here. “Half the world’s financial firms have chosen to base their European headquarter in the UK”, Hill said.

As a result of this integration, the surplus from Britain’s trade in financial services has more than doubled – from 23 billion pounds in 2014 to 58 billion ten years later. “This (…) is a success story of which we should be proud, and which we should be keen to keep”, the Commissioner reiterated.

It is exactly this which is at stake. According to economists, London risks losing some of its weight as the leading financial centre in Europe. A country that did not join the Euro and still uses the pound, the UK has nevertheless been able to attract a lot of transactions denominated in Euro. In case of a Brexit, this could change – why bother going via London if the UK does no longer use the passporting system?

As a consequence, many banks could move at least some of their business to continental Europe in order for them to make sure that they are able to access the single market. “There are 75 foreign banks in London”, a female CEO of a financial fund told me last week, “just guess how many of them would move?”

It’s a tricky question, given that many banks have gone quiet on this recently. However, a few have stated what they are planning to do. HSBC for example would relocate around 1000 bankers to Paris whereas Deutsche Bank has announced that they would move parts of their business from London to Frankfurt, should there be a vote for Brexit.

“The American banks would move to Dublin, the German ones to Germany, the French ones to France”, the CEO of the fund mentioned earlier explained to me. Add to that the uncertainty – it will take at least two years if not longer for the UK to negotiate it’s exit – and you end up with a pretty bleak short term outlook for the City of London. PwC estimates that there will at least be 70.000 to 100.000 fewer jobs the British financial industry by 2020, should there be vote for Brexit.

The problem with this is that it could take years, if not decades until we are able to investigate the size of the damage that a Brexit would do to the City of London. There are not just European competitors like Frankfurt, Paris and Dublin that want to increase their share but also international financial centres like Hong Kong, New York and Singapore that might benefit from a gradual decline of the City.

I don’t have a crystal ball. I am not a forecaster. But I do think that British voters should be aware that these days, nothing is carved in stone anymore. Not even the role of the City of London.