EU policy keeps food prices high, Brexit may bring cheaper produce – RBS Chairman Howard Davies

A divorce is not an easy thing: especially when it’s a divorce from the European Union. Diplomats in London and Brussels are getting ready to clash over the separation terms, as Brexit talks are due to start in less than a month. Both sides are standing their ground for now, but who will be the first in the talks to budge? Who loses out most if no deal is reached? And, does the EU need Britain more than Britain needs the EU? We ask the chairman of the Royal Bank of Scotland, former director of the London School of Economics – Sir Howard Davies.

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Sophie Shevardnadze: Chairman of the Royal Bank of Scotland, Sir Howard Davies, welcome to the show, it's really great to have you with us again, sir. So, The EU is demanding London pays what it owes the bloc before it goes. Prime Minister Theresa May insists that London doesn’t owe the EU a single penny, while Foreign Secretary Boris Johnson says it’s the EU who could be forced to pay Britain. Who will budge here? The UK or the EU?

Howard Davies: As you can see, we're in the shadow-boxing phase of the negotiation here, with a lot of grand claims on one side and a lot of rebuttals from the other side. It does seem to me, looking at the arguments, that there are some aspects of what the EU are demanding which are reasonable, which are budget commitments that all the countries have made for the next 2-3 years, and I'm quite sure that the UK government will not be unreasonable about that. Some of the other claims, for the value of EU assets, or for longer-term financial commitments running way after we leave - well they strike me as being matters that are going to be debated late at night at some European summit somewhere. But, I can't help thinking that an agreement will eventually be reached on that.

SS:The Commission has previously mentioned a ballpark figure of 60 billion euros. What’s your estimate – is that figure accurate? Will the UK pay it?

HD: I'd be very surprised if the figure came out at that level. As I've said, it breaks down into a number of different components. One is firm budget commitments, which we've signed up to, which run for the next two or three years. They are fairly solid numbers. Then there are some more speculative numbers about the cost of pensions in the future for civil servants in Europe, who were appointed and would've worked during the UK's time there. There are figures for much more longer term spending plans on infrastructure projects in Eastern Europe which they have agreed in principle, but haven't agreed on costings in detail - those strike me as being more speculative. So, you've got to break it down: I don't think one should pay too much attention to the headline numbers at this point, because I'm quite sure that when it comes to it, there will be a much more detailed negotiation.

SS:Nearly half of British exports go to the EU, so negotiating a free trade pact with the bloc is at the top of the agenda for the UK. Does Brussels have the power to withhold discussions on a free trade pact, for example, if the UK doesn’t give in to its demands?

HD: I think that, technically, that is the case, because the Article 50 process of exit is, technically, about the Exit - in other words, about the terms of your departure, how much you pay, what happens to EU citizens in the UK, to UK citizens in the EU, et cetera. That's what the Article 50 process is about. There's then a separate process, which is, what is the relationship between the UK and the EU 27 after we have left. Now, obviously, from the UK perspective, you would ideally want to negotiate these two alongside each other, but the EU, I think, at the moment, is saying: "Oh no, we've got to deal with the Exit first, and then we'll deal with the access bit later". In my view, these two things will come together, because, I think, there's a clear political relationship between the two, so I would expect that after some initial arguments about the budget, gradually, the two things - the Exit and the new relationship - will start to be talked about together.

SS:But I'm thinking, the fact that Britain has been part of the EU single market for so long should make it easier to reach a deal on that? No?

HD: It should do, in that the basis of trade with the EU is: do you meet the environmental standards, the labor standards, the technical standards, the safety standards for your goods, and, indeed for your services. And of course, as we sit here today, we are completely compliant with all of the European rules - we have followed them to the letter for the last 44 years. So, at the moment of departure we ought to be able to negotiate a good Free Trade arrangement ,because we are already meeting all EU standards. Now, the questions then become: "What if in future you diverge from these standards, what if you change your regulations and make it less costly and burdensome than the rest of the EU?" - what happens then? Those are the issues, I think, rather than whether we comply with the European regulations, which of course is what the normal issue is when you're agreeing a Free Trade deal with another country, you have to go into that country and say, well, do they "meet all the safety standards that we require in our markets". We already meet that, so the issue is more how do you cope with the prospect that there could be changes in the future. I think, in principle, that should be easier task.

SS:If the EU gets tough on Britain and shuts it out of the single market, let's say, gives it limited access, will Brussels be shooting itself in the foot - losing out on the UK's trade contributions?

HD: Yes. I think that on physical trade, goods trade, it's quite clear that we have a significant deficit of goods with the EU. They sell a lot more to us than we sell to them. So if they were to give a bad deal and cut out trade or make trade much more expensive across the borders, then that would be disadvantageous to the EU 27. I think, that many people say that looking at those figures, that there's clearly a rationale for the 27 to agree a reasonable trade deal. It's a bit different when we come to financial services, which, I'm sure, we'll come on to talk about it.

SS:What will the British public feel if the UK is out of the European single market - will an ordinary person see a change in prices in stores, for example?

HD: That's not so completely clear. I think it would depend on the goods that we're talking about. So, if we did have a tariff imposed on European imports into the UK, then some things - and if you want to go and buy your BMW, you'll the price has gone up. However, on things like agricultural produce, where the common agricultural policy keeps prices relatively high in Europe in order to provide good incomes for farmers, I suspect, that if we were to buy our food completely freely on the global markets, that many times we would find that we bought butter more cheaply from New Zealand and beef more cheaply from Argentina, etc. Because when there's a surplus, we will probably be able to secure goods that would be relatively cheaper than we buy from Europe. So I think it will depend on what's you're buying. I don't think it's a good thing, however, because generally we benefit from free trade with our European partners, so I'm not looking forward to that, but I don't think necessarily it would mean that prices across the board went up.

SS:A former economic adviser to London mayor, Gerard Lyons told me in an interview that leaving the EU is going to give Britain a chance to reposition itself in the global economy. Will leaving the EU push Britain to strike up stronger economic ties outside Western Europe? Is it going to turn to China, India? I don't know.

HD: Gerard Lyons was in favor of Brexit and indeed campaigned to Leave and was an advisor to Boris Johnson, the former mayor of London, who was also a strong leader of the Leave campaign - so he has a particular point of view on this. I think that there's, perhaps, something in it, I think that we perhaps need to work harder in overseas markets, but interestingly, if you look at the EU, you find that Germany exports far far more to China than we do. And their trade with China has not been constrained by the fact that they are the solid member of the European Union. So, in my view, the idea that because you leave Europe you have the opportunity to go and trade more with other countries - that argument doesn't really stack up, because in fact other countries in Europe are doing rather better in markets like India or China than we are.

SS:Then again, Sir Howard, does having a free trade agreement - with the EU or India or whoever - really matter that much? The UK’s biggest trading partner country is the U.S. - and there has never been a free trade deal there…

HD: No, but of course, over a long period of time, the countries have negotiated deals of various kinds, including air transportation and all kinds of things. So, overtime, methods of trading have been established which are robust, and the issue, the disruption of moving out of the single market, and whether it's going to be possible quickly to put in place some replica trading arrangements. I think all of this can be done, but the timetable is rather restricted. I think, in fact, one good reason for having an election now is that it would give the new PM a five-year period to negotiate some of these things, perhaps, in a slightly slower timescale. So, it all can be done, the issue is the short-term disruption, which could be economically damaging if we don't get it right.

SS:Scottish First Minister Nicola Sturgeon is stressing that the Scottish - or the Scottish National Party - voice has to be heard by Brexit negotiators. Can she influence the talks, will the Conservative government agree to that?

HD: I think, probably not. PM May has said: "Look, these are the UK negotiations", that they will listen to the Welsh and the Scots and the Northern Ireland representatives, but I don't think they are going to be involved directly in the talks. There are, of course, some particular issues in relations to Ireland, about the border between the North and South, which currently, within the EU, doesn't really exist as a border - does that have to be reinstated? that's a big problem. And, of course, the Scots did vote by a sizeable majority to stay in - so, in Scotland there's more of a pro-European mood than there's in England. So, I think, Nicola Sturgeon is making that point to the PM.

SS:The talks between May and European Commission President Juncker have gotten off to a bad start - the Guardian reports Jean-Claude Juncker being very sceptical about the British position, while UK Brexit Minister David Davis called the EU’s stance on Brexit talks ‘illogical’. Can this all fail completely - and what happens if no compromise is found?

HD: It could, I very much hope that it won't. I think that we are now in is still this sort of skirmishing phase - and in any negotiations, whether it's commercial or political, you know, people take positions and make statements at the beginning to show that they're tough and all of that. Some of this, I have to say, I hear, but I don't really listen to - because they haven't got serious yet. But, there's a possibility that the talks fail and there's no deal, at which point we fall back into a position that we are third country, technically, and we have WTO rules applying to our trade. Some people say that wouldn't be so bad, I don't think it will be great outcome, myself, but that is the fallback position if no deal is done. But I think that both sides will be very reluctant to get to that point.

SS:The Independent newspaper reports that almost half of EU businesses are already looking to cut ties with UK suppliers, jobs are already being moved out from the UK to EU countries - so while formal talks haven’t even begun, has business already started the Brexit separation process?

HD: I don't know very much about whether people have been cutting supplies in the manufacturing area. I haven't actually seen very solid news of that. It is certainly true in financial services, that there are firms in the City who think that their access to the European financial markets will be more difficult after Brexit, and they are hedging their bet by installing subsidiaries in other countries, in the EU 27, in order to provide themselves with some optionality. Mostly, for the moment, that doesn't involve very large numbers of people transferring, but it does involve people setting up legal entities in other parts of the EU, so that if they do find that there's a difficulty in servicing their EU clients from London, they can go around and service them from an EU-based subsidiary. We are seeing that definitely. I haven't seen much reliable evidence of manufacturing suppliers changing contracts yet.

SS:Right now there’s over 2 million EU nationals working in Britain. The UK’s Office for Budget Responsibility has estimated that falling migration in the run up to Brexit alone could cost the economy 16 billion pounds. What happens when free movement with the EU is cut off completely?

HD: Yeah. I think of two issues here. One is - what happens to the people already in the UK, and there, I would say, is a very strong consensus across the political spectrum, even people who were in favor of Brexit, to the effect that those people's rights should be guaranteed. So, I'd be very surprised if we saw a great movement out of London of people or the UK generally, of people who have been here for a year or two and are working and living here. Most people think that would be unreasonable, even the people who were the strongest advocates of getting out of the EU, don't think that it's the right thing to do to push people out. Now, then, of course, there's the question of future flows, and the government are renewing their commitment to cutting net migration down to below a 100,000. Now, of course, a cynic would say that, well, actually, that kind of commitment has been in place since 2010, and the government hasn't actually met it because they have allowed people to come in when there were jobs for them. So, whether that commitment will be absolutely met - I'm not quite sure, but it will be renewed. Half of the migration comes from the EU, and about half from outside of the EU. So then there's the question of whether we actually cut-off extra EU migration or intra-EU migration. There's also a further question as to whether the economy will grow as rapidly as it has done in the last few years and whether we will therefore need all these additional workers. So, the position is very unclear, but as far as the UK people, UK-based EU citizens are concerned, I'd be very surprised if they were asked to go home.

SS:So, how would that technically happen for the Europeans who are in London now? The UK may impose visas on EU nationals in general, but Brussels wants some preferences for Europeans in the UK - can London agree to that, do you think? It already has those kinds of agreements with countries like Canada…

HD: Some, although nothing like as generous as with the EU. I think what will happen is, there will be... a cut-off day will be established, which might be the date of the Brexit referendum or something like that, and so that anybody who was in the country before then, can stay, and will not have to have the work permit etc. And then, there will be a new arrangement for new people, who want to come in after that date. What that new arrangement will be - we don't know yet, that will be part of negotiation, but we have quotas for immigrants to come in, or you have rules that people can only come in if they've got a job - that might be one possible... at the moment, a Spaniard can come to london and look for a job, without any restriction, so it might be that you'd say: "Ok, well, in future, you can only come if you already got an offer of a job" - so, there are plenty of different ways in which this could be done, but I think for the ones who are here, my expectation - although it's not been agreed yet - my expectation is that they will be told that they can stay.

SS:Also there's a million Britons in the EU - what happens to them? Will they have to pack up and go home?

HD: I think very unlikely too, because they will be part of the negotiation and I think whatever the UK agrees for other EU citizens in London, for the UK it will be agreed the other way around. There are, of course, rather different types of people. Most of the 1,000,000 UK people that are in the EU are, in fact, retired people - in Spain, in France, and to some extent, Italy. So they are not on the whole people migrating for work. There are some, for sure, young professionals around Europe, but for the most part they are more retired people. So I doubt if that's going to be a big issue. I don't think that France and Spain are going to want to send them home, they are mainly living there on UK pensions, living in Spanish properties. Of course, one thing that can happen to that, is the pound has fallen, so the value of that pensions in Euro has gone down, so some may come home because of that, but that won't be to do with the legal change.

SS:You wrote that Brexit is going to put London’s position as one of the world’s financial hubs at risk. Can the city lobby the Brexit negotiators to be more flexible in order to preserve its status?

HD: The City is making its point clear to government and to Brussels in a very firm way, I can tell you, because I'm directly involved in that. And we have pointed out what the risks to the City are from not agreeing a sensible deal post-Brexit. But to give you some figures, about 20% of the business in the City of London is undertaken with clients in the EU 27 countries. So, if you like, there's 20% of the business that is at risk. I'd be surprised if all of that 20% moved somewhere else, because I think that quite a lot of it will be possible to do across the border even if we are out, but some of that will probably move back into the EU 27. So, it's absolutely clear that there will be an impact on the City. But I think, for the foreseeable future, the City of London will remain not just the biggest financial center in Europe, but the biggest financial center for the EU 27, because so much of the capital raising and trading undertaken by European banks, that's non-UK European banks, so much of that happens in London, that I can't see that changing in the short term.

SS:So, let's say those who go -where do they go? I mean, the financial elite? Where better than London?

HD: I think, "where better than London" - that's a rhetorical question, but I think, I agree with you: I do not think that there will be one single center that will replace London. Some people have said "will it be Paris? Will it be Frankfurt?" I don't believe it will be any of them, I believe what will happen is that some business will move into each of the European centers. So, for example, if you're an investment bank and you have clients in Italy and Spain and France, etc, at the moment many of them service those clients from people based in London. Actually, Italians based in London, fly to Milan every monday and go and deal with their clients. They do that, because they want to keep their trading center and their control systems all in one place. I suspect what will happen is that quite a lot of those people who deal with Italian clients will move from London back to Milan. Those who deal with French clients will move from London back to Paris. So there'll a repatriation, if you like, of some activity to the individual centers. There's also be one or two things, like investment management, where you're going to need to have a base in the EU to sell funds to retail clients, for example, and I think, Luxembourg and Dublin are going to benefit from that. Quite a number of investment management companies are setting up operations there. So I think you will see quite a change, quite a distribution of London activity, and not a replacement by one big center.

SS:The City of London overwhelmingly voted to stay in, and the power is where the money is - can London push for some kind of "special post-Brexit" status, using its leverage as a global financial center?

HD: Yeah. In fact, the mayor of London, Sadiq Khan has suggested something like that, particularly on migration, to say, that the city should have a special deal, because it lives off bringing in experts from everywhere, from Russia or whatever. I find it difficult to see quite how that would work, in legal terms, actually. I think the only thing I could imagine, is that there may well a different regime on migration for highly-paid people. On the whole, if you ask people here, ordinary, even the people who voted Brexit - what do you care, what do you worry about in migration? They worry about people coming in and taking low-paid jobs and undercutting the wages of the UK citizens. If you say, "Do you mind if somebody comes in to get 100,000-pound a year job in a financial firm or an 80,000-pound job in a university teaching financial mathematics" - they don't care about that. They think that's fine. They are not coming in and undercutting wages. So, I think that from a recruitment point of view, I think there will be in effect a deal for  the city, but it will be based on them being able to recruit people for particular jobs and that require particular skills. I don't think, politically, that is of great concern, I think that will carry on.

SS:Thanks a lot for this interview. We were talking to Sir Howard Davies, Chairman of the Royal Bank of Scotland, former head of the London School of Economics, discussing the tense Brexit negotiations between London and Brussels and their impact on the UK economy. That's it for this edition of SophieCo, I will see you next time.