What’s at Stake in Britain’s EU Referendum?

On Thursday, Britain will vote on whether or not to leave the European Union (EU). As things stand, the race is too close to call: a week ago, “Leave” were surging in the polls; this week, things have swung back towards “Remain.” But neither side has managed to build a lead beyond the pollsters’ margin for error, and veteran political campaigners suggest it will all come down to turnout. So what is really at stake as Britons submit their “Brexit” ballot papers?

To me, the case for Brexit is rooted in the idea of self-government, and the democratic accountability that goes along with that. The question facing British voters is, fundamentally, whether their parliament should be sovereign and their laws supreme, or whether such powers should continue to be pooled at the European level.

In other words, this is a constitutional referendum. It is not a choice between rival political platforms, or between rival sets of politicians; nor, indeed, does the result of the referendum have any immediate legal consequences. Rather, this is an opportunity for British voters to decide how they should be governed in future. Once the result is in, it will be up to the British government, and to parliament, to determine policy going forward.

This point is important, because it undercuts a lot of the fears people have about Britain leaving the EU. There is no denying, for example, that the Leave campaign has taken some unsavory positions on immigration, and promised unrealistic “bread and circuses” once Britain leaves the EU. But Leave are, emphatically, not a government in waiting.

Then there’s the government-backed Remain campaign, who have scarcely let an opportunity to scaremonger about the economic consequences of Brexit pass them by. From their increasingly shrill and outlandish claims, you would think that a vote for Brexit meant surrounding Britain with naval mines and never letting anything—whether goods, services, capital, or people—cross the border again.

That scenario is, of course, absurd. In reality, post-Brexit Britain is likely to rejoin the European Free Trade Area (EFTA), which it left in 1973 to become an EEC member, alongside Switzerland, Norway, Iceland, and Liechtenstein. These countries participate fully in the EU’s single market, without being subject to its political union. They are also free from the EU’s Common Agricultural Policy (which horribly distorts produce markets), its Common Fisheries Policy (which has helped to deplete European fish stocks), and its Common External Tariff (which prevents EU member states from trading freely with other countries).

The arguments against this “Norway option,” as it is often called, are well-rehearsed, but mostly without foundation. Yes, EFTA members have to contribute to the EU budget—but they do so at a far lower per capita level than full EU members. And yes, EFTA members have to adhere to a lot of EU regulation—but, again, far less than full EU members. More to the point, EFTA members have independent representation on the global trade and standards bodies that inspire most of this regulation in the first place, while EU member states are represented collectively by the European Commission. As a result, EFTA countries arguably have more say over the actual content of EU regulation than individual EU member states do.

There is, inevitably, a flaw in this plan: EFTA members, whether through parallel membership of the European Economic Area, or through a series of bilateral agreements with the EU (as is the case for Switzerland), must accept the free movement of people within the area covered by the European single market. And given how much Britain’s Leave campaign has focused on reducing immigration, that might prove a political tough sell—despite clear evidence that EU migrants are a boon to the British economy.

On the other hand, a YouGov poll commissioned by the Adam Smith Institute suggests that a majority of the British public would back EFTA membership in the event of a Brexit vote. The House of Commons also contains a clear majority in favor of continued membership of the European single market. So I am optimistic that British intransigence on European migration would not scupper a fully-fledged trading relationship in the event of Brexit.

But perhaps this all begs a question: Why am I willing to take the risk, however slight it may be, that Brexit will damage Britain’s trading relationship with Europe? My response comes down to two things. First, even if Britain were denied continued access to the single market, I am certain that a comprehensive UK–EU trade agreement could nevertheless be reached. An independent Britain would, after all, instantly become the EU’s single largest export market.

Such negotiations might prove difficult; their outcome would probably provide less access to the EU market for British agriculture and services; and British banks might lose the right to do business in other EU countries without establishing separate operations there. These would be real losses, to be sure. But they could easily be outweighed by freer trade with the rest of the world. Britain, as it happens, already sends more exports out of the EU than it does into it.

It is also worth highlighting research by Economists for Brexit, whose modelling suggests that a post-Brexit policy of unilateral free trade within the WTO framework could deliver substantial benefits over the status quo, without requiring any bilateral trade agreements whatsoever. That might not be a politically palatable option, but it does suggest that the single market need not necessarily be the be-all and end-all of Britain’s trade policy.

Second—and finally—let me come back to where I started: this referendum isn’t ultimately about trade, or immigration, or even about economics in general; it is about whether Britain should govern itself, or whether it should cede an ever-increasing portion of that responsibility to the institutions of the European Union. There are principled arguments on both sides of that question but, for me, the answer is clear.

Britain’s common law tradition, which asserts our freedoms from government, and which assumes we are at liberty to do anything that isn’t specifically prohibited, sits uneasily alongside the continent’s Napoleonic approach, which tends to create positive entitlements that can be enforced against government, and which often assumes that anything the law does not explicitly provide for must be illegal. Britain’s majoritarian political culture, which prizes above all the ability of voters to get rid of one government and replace it with another, does not chime harmoniously with Europe’s permanent coalitions, technocratic governments, and late-night deals made in proverbial, smoke-filled rooms. Nor does Britain’s laissez-faire, internationalist view of economics marry well with the EU’s dirigiste, fortress-Europe mentality.

In the end, that’s why I believe Britain should be free to rule itself, while also seeking the most open possible trading arrangements with both its European neighbors and the rest of the world. A Brexit vote alone, it must be stressed, will not make those things happen. But it would mark the beginning of a process that could eventually prove very beneficial for Britain—just so long as the right policies are pursued in its aftermath.

Originally published at Cato.org.

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Cato Journal: Revisiting Three Intellectual Pillars of Monetary Wisdom

A new issue of the Cato Journal, which collects the proceedings of last year’s Annual Monetary Conference, was released last week.  Those proceedings include a paper by Claudio Borio, head of the Bank for International Settlement’s monetary and economic department, which Alt-M readers may find particularly interesting. Continue reading

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Competition in (British) Banking

Writing for FT.com’s “The Exchange” blog, economists Diane Coyle and Jonathan Haskel suggest that Britain’s regulators — namely, the Competition and Markets Authority and the Bank of England — have got it wrong on competition in banking.  The authors argue that “the CMA and the BoE” have overlooked “the ruinous effect on competition of the ‘too big to fail’ subsidy” in their recent reports and policy announcements, and that, if anything, it is becoming “harder than ever for new entrants to gain a foothold” in the banking market.

In my view, Coyle and Haskel are right, but their argument doesn’t go far enough.

Let’s start with the basics: what is the too-big-to-fail subsidy, and how does it affect competition in banking?  The fundamental idea is that the bigger a bank is, the more likely it is to be bailed out if it runs into trouble.  The events of the 2008 financial crisis seem to confirm this, as do the assumptions of government assistance that some rating agencies build into their “support” ratings.  And as the 2011 report of Britain’s Independent Commission on Banking points out:

If one bank is seen as more likely to receive government support than another this will give it an unwarranted competitive advantage.  As creditors are assumed to be less likely to take losses, the bank will be able to fund itself more cheaply and so will have a lower cost base than its rival for a reason nothing to do with superior underlying efficiency.

The result is that small banks struggle to compete against larger rivals, while market entrants have difficulty establishing themselves against privileged incumbents.  All of this makes the banking sector less dynamic — and more comprehensively dominated by large, established firms — than it might otherwise be.

As Coyle and Haskel see it, however, Britain’s CMA thinks the problem has already been solved: that the competitive playing field has been leveled by the Bank of England’s proposed “systemic risk buffer,” according to which larger banks must hold more equity capital against their risk-weighted assets than smaller competitors.  In consequence, the CMA’s October 2015 provisional report on Britain’s retail banking market mostly ignored the too-big-to-fail problem, focusing instead on the rather more mundane question of how consumers can be encouraged to switch bank accounts more often.

Yet the CMA’s position is mistaken, say Coyle and Haskel, for three reasons.  First, switching bank accounts doesn’t always make sense for consumers: in the UK, at least, one bank account is pretty much the same as another, so consumers’ status quo bias is often quite rational.  Second, the level of additional capital big banks must hold as a systemic risk buffer is not high enough to outweigh the funding benefits that accrue from being too-big-to-fail.  Third, the stepped schedule of systemic risk buffer requirements outlined by the Bank of England might make big banks less likely to compete with each other, by effectively creating high marginal tax rates when banks move from one “systemic risk buffer” tier to another.  As Coyle and Haskel say, “This might restrain the emergence of gargantuan banks, but the purpose of competition is to promote rivalry, not hold up expansion at arbitrary regulator-determined thresholds.”

So far, so good.  But there’s a bigger picture here that Coyle and Haskel don’t see, or at least fail to mention.  For one thing, it isn’t just lower funding costs that make too-big-to-fail such an anti-competitive doctrine.  In fact, the very act of bailing out a failing institution itself constitutes a powerful strike against market competition.  As Europe Economics’ Andrew Lilico has put it, “company failure is an essential and ineliminable part of the competition process.  One of the most important obstacles to new entry in the banking sector, impeding competition, is that failing banks are saved by the government.”  If you want smaller banks to grow, and new banks to prosper, in other words, you can’t keep saving their bigger rivals from the consequences of bad investments.

More important still are the grounds upon which banks compete.  And it’s here that our financial regulatory authorities have the most to answer for.  Yes—of course—banks should compete with one another to provide the best possible service at the best possible price.  In an ideal world, however, banks would compete on something else as well: namely, their safety, stability, and reliability.  That banks do not tend to compete on these grounds today is testament to the fact that their depositors, bondholders, and shareholders do not see the need to pay attention to such things.  “Regulatory badging,” that illusory sense that banks must be safe because they are subject to regulators’ oversight, means that people seldom ask how highly-leveraged their banks really are.  Deposit insurance means they might not care about the answer, even if they ask the question.  And too-big-to-fail compounds the problem: if your bank is going to be bailed out, why worry about its risk profile?  No amount of regulatory oversight can compensate for this loss of competitive market discipline.

Ultimately, then, Coyle and Haskel are right to stress the importance of competition: if financial stability is the goal, then competition must be central to any banking reform agenda worthy of the name.  But before regulators can be part of the solution, they must understand the ways in which they are part of the problem.  And that, alas, has yet to happen.

Originally published at Alt-M.org.

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Obama v. Brexit


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The Battle Lines over “Brexit”


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Quantitative Easing: A Requiem

When the Federal Open Market Committee (FOMC) meets in Washington next week, its members are widely expected to vote to raise interest rates for the first time since June 2006. By doing so, they will move towards monetary policy normalization, after more than seven years of near-zero interest rates, and a vast expansion of the central bank’s balance sheet.

But how did monetary policy become so abnormal in the first place? Were the Fed’s unconventional monetary policies a success? And how smoothly will implementation of the Fed’s so-called “exit strategy” go? These are among the questions addressed by Dan Thornton, a former vice president of the Federal Reserve Bank of St. Louis, in “Requiem for QE,” the latest Policy Analysis from Cato’s Center for Monetary and Financial Alternatives. Continue reading

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Rethinking Monetary Policy – Cato’s 33rd Annual Monetary Conference

More than two hundred people gathered at the Cato Institute last Thursday for our 33rd Annual Monetary Conference. Over the course of three addresses and four panel discussions, a distinguished cast of speakers — including St. Louis Fed president James Bullard, Richmond Fed president Jeffrey Lacker, and Stanford economist John Taylor — covered topics ranging from the rights and wrongs of monetary rules, to the ins and outs of the Fed’s long-awaited “exit strategy” from quantitative easing and near-zero interest rates. If you didn’t make the event, here’s a synopsis. Continue reading

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