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Handicapping potential outcomes in the Brexit saga

The latest news out of the UK is that British Prime Minister Theresa May has decided to postpone a Parliamentary vote on the deal she negotiated with the EU over the terms governing Britain's departure from the EU. Had the vote gone ahead, she would have lost… badly. So instead, she is looking to delay that vote until she can get a fix on the Irish border question that threatens to keep the UK in an indefinite legal limbo under the deal she negotiated.

The British pound sterling is down to 18 month lows on the back of this news. And UK GDP figures were released today, showing anemic growth as Brexit looms. There is a lot riding on this outcome, economically and politically. And since there are so many moving parts to this, let me handicap a few scenarios we should be thinking about.

The variables in Brexit

The UK is attempting to undo a 45-year EU membership status in a two-year time frame. That would be a tall order for any negotiating team. But, with Brexit, come a lot of other variables which make it difficult.  Here's a partial list below:

  1. The deadlines of 21 Jan 2019 for the UK Parliament to have a say on the Brexit deal and 29 Mar 2019 when Brexit will occur 

  2. The widespread fear of crashing out of the EU on 29 Mar 2019 without a deal

  3. The lack of obvious ways to deal with the border between Northern Ireland and the Republic of Ireland in a world in which Northern Ireland is not inside the EU

  4. Theresa May's dependence on the DUP of Northern Ireland to achieve an absolute majority in the UK Parliament

  5. The uncertainty on whether 48 Conservative Party MPs would be willing to submit letters to Altrincham and Sale West MP Graham Brady, the 1922 Committee Chair, to start a Tory Party leadership contest

  6. The lack of obvious alternatives to Theresa May as Conservative Party leader

  7. Conservative Party fear of a general election which would allow Labour Party leader Jeremy Corbyn to become Prime Minister 

  8. The widespread desire to avoid any kind of second referendum around the Brexit question, no matter which questions are asked, due to the perceived anti-democratic nature of such a vote

  9. Conservative Party division on whether a no-deal Brexit is a viable, non-catastrophic alternative to a deal

  10. The lack of a clear majority in UK opinion polling concerning most of the major issues surrounding Brexit

I could make an even larger list of variables complicating this decision. But the ten above are enough to make the situation in the UK unpredictable. So, it is extremely difficult to say with any degree of certainty what will happen next.

The key here is that uncertainty surrounding the viability of different outcomes is driving the entire process now. Everything is couched in terms of fears about economically catastrophic outcomes or anti-democratic political maneuvers.

Reducing complexity

This is toxic, of course. And I believe most career politicians fear complexity, particularly when that complexity means that potentially catastrophic outcomes are not relegated to outlier scenarios. And so, I believe the UK will eventually be forced to try and delay Brexit or revoke Article 50 altogether, if May cannot pull a rabbit out of a hat in the next round of Irish border negotiations with the EU. The goal will be simply to stop the clock ticking to eliminate catastrophic outcomes and reduce complexity.

As I was writing this post, Theresa May confirmed that she will indeed delay a Brexit vote in Parliament in order to get a better deal on the Irish border issue from the EU. I doubt that she can do. For one, there's Irish Prime Minister Leo Varadkar's point. While he doesn't speak for the EU, his opinion matters here. And he has said today that it is simply not possible to renegotiate the Irish border backstop proposal without "opening up all aspects" of the Brexit agreement. With the clock ticking, I don't believe there is enough time to get anything done there.

And so, I believe Theresa May will come up empty-handed after delaying the vote. This will undermine her standing as party leader and could lead to a leadership challenge, if a more obvious 'caretaker' PM emerges in the next couple of weeks.

That PM candidate would campaign under the premise that “we don’t want to crash out with no deal. And we need more time to get our ducks in a row. We can’t let the EU blackmail us into Theresa May's bad deal by using the ticking clock. I will save us from that". A new Conservative Party leader campaigning under the guise of moving to a(n antidemocratic) second referendum or of crashing out of the EU would not get enough support to be able to win an election contest in my view. That would not reduce uncertainty or complexity. It would increase the potential for politically and economically disastrous outcomes.

My view of likely outcomes

I think Theresa May's days are numbered. The only reason she remains in power now is that there are no obvious successors. And fear of Corbyn is too great to take a risk on changing leader while the Brexit process is ongoing. This calculus changes considerably if Brexit can be delayed or Article 50 revoked unilaterally, as the European Court of Justice confirmed is possible today.

From a purely political perspective, this makes delaying Brexit past 29 Mar 2019 the obvious priority for the majority of MPs within the Conservative Party who are not committed to a no-deal Brexit. And if that delay cannot be achieved, due to EU recalcitrance, Parliament will be forced to consider revoking Article 50 altogether, simply to stop the clock ticking.

Theresa May may not survive until then, of course. But, as soon as either of these two outcomes occurs, Theresa May's utility will cease to exist. And the Conservative Party will find a new leader it can sell to the electorate as someone capable of negotiating  a better Brexit.

The issue of a second referendum will continue to loom in the background as this occurs.

Politics don't get more complicated than this.

General Motors is proof that slashing wages isn’t the ticket to profitability

German and Japanese auto manufacturers succeed despite sticking to a high-wage model.

By Marshall Auerback

This post first appeared on Salon.com

General Motors just gave its workers a lot less reasons to feel grateful, announcing right after the Thanksgiving holiday that the automobile manufacturer planned to cut its salaried workforce by 15 percent, to dump most of its car models and to kill off five North American plants, in Detroit and Warren, Michigan;Warren, Ohio;White Marsh, Maryland; along with its Oshawa, Ontario plant north of the border. Yes, it’s a globally competitive business, and General Motors, like other American automobile manufacturers, has faced challenges from abroad. Additionally, some of GM’s problems have been self-inflicted, given its patchy record on safety matters and its abhorrent downplay of the resultant accidents. The company also put some of the blame on Trump’s steel and aluminum tariffs, which they claimed added about $1 billion in additional costs.

Upon closer inspection, however, the layoffs can’t simply be dismissed as an inevitable byproduct of globalization, or the impairment of free trade.There is something else going on here, a consideration that goes to the heart of GM’s flawed business model. It is tied to financialization, notably the CEO stock market-based compensation, which induces decisions that might elevate the share price in the short term, but often to the detriment of the company’s long-term success (like GE).

Along with the financialization of GM, the decision to offshore manufacturing in relatively low-wage locations hasn’t helped much. Outsourcing manufacturing in this way has, paradoxically, exacerbated GM’s problems.The sedan market (where GM is experiencing a large proportion of its competitive difficulties these days) typifies this conundrum.The lower and middle ends are dominated by Asia, which operate in a market segment where GM can never get its labor costs low enough to compete against them; the high end is dominated by Audi, Mercedes and BMW, German manufacturers that have devoted considerable capital investment so as to shore up the top-of-the-line models. Here, GM is unable to match the German brands, having chosen the soft option of offshoring its labor, avoiding extensive investment that would have otherwise allowed them to upgrade their production.

As Seymour Melman has noted in his work "Dynamic Factors in Industrial Productivity," the unremitting focus on low-cost labor, which has been a key component of business models adopted by American corporations such as GM, creates disincentives toward capital investment decisions that would otherwise drive GM’s products further up the technology curve toward higher-margin products (which in turn yield higher profits and are less prone to competitive pressures from low-end car manufacturers, thereby alleviating the need to outsource manufacturing in the first place). It is quite likely that the historic paranoia about labor organizing in the U.S. is the underlying driver for this monomania.

By contrast, the stress on high-quality domestic engineering capability is something that Germany extends to other forms of high-tech manufacturing goods and services.Economists Jesus Felipe and Utsav Kumar have conducted a study illustrating that countries such as Germany have used capital investment to move up the technology curve to all sorts of higher-end products.Hence, it has a market share of 18 percent in the total world exports of the top-100 most complex products, vs. France 3.6percent, Italy 3.1percent, and Spain 0.9percent.

Germany’s manufacturing success, therefore, is not a function of lower wages. Germany’s manufacturing unit labor costs have declined in a relative sense (especially relative to its Eurozone competitors) over the past decade, but in absolute terms, Germany’s manufacturers, including the auto producers, did not resort to a strategy of nominal wage squeezes or extensive offshoring to cheap labor locales such as China. As the economist Servaas Storm has argued: “It was German engineering ingenuity, not nominal wage restraint or the Hartz ‘reforms,’ which reduced its unit labor costs.”Engineering ingenuity largely came about through well-targeted capital investment and enabled German labor productivity to increase some 8 percent relative to its European and American counterparts.

As a result, Germany has become stronger and more productive in high-value-added, higher-tech manufacturing.Although some manufacturing has been outsourced to adjoining Eastern European countries, its leading companies have preserved an industrial ecosystem, which has enabled Germany to conserve more high-end jobs domestically in aggregate.

On the flip side, American manufacturers have generally taken the soft option of outsourcing and “demodularizing” production.As a result, they degraded industrial quality, increased development lead time, and increased unit costs in the process(Boeing’s 787 “Dreamliner” being a spectacular case in point).At this point, the U.S. doesn’t have what you could call a dynamic manufacturing economy. This has led to a perverse situation described last year by business journalist Jim Harger:

“Industry experts say that cadre of talented tool and die makers is growing in short supply in Michigan just as the demand is increasing.

“‘The average tool and die maker is 56 years old,’ says Baron, president and CEO of the Center for Automotive Research (CAR).

“‘We have not been back-filling. We are running out of talent as the cadence for cars is increasing and the launch rate is increasing.’

“About 75 percent of the tool and die makers in the workforce today are expected to retire in the next five to seven years. Meanwhile, it can take up to 10 years to train a master tool and die maker.”

So Detroit was left with production bottlenecks, because of the shortage of tool and diemakers, which represented an important missing gap in production.

Of course, if management’s main incentive is to manage the company’s stock price, rather than the underlying business, it tends to do things like offshoring, which helps to juice the short-term quarterly profits. The share price generally follows suit.The long-term cost (which is usually seen well after the stock options have been cashed and the executive compensation has been paid out) is a production deficiency in the future, which can’t be easily replaced, as Professors Gary P. Pisano and Willy C. Shih explained in Harvard Business Review:

“As manufacturing plants closed or scaled back, many people in those occupations moved on to other things or retired. Seeing fewer job prospects down the road, young people opted for other careers. And many community and vocational schools, starved of students, scaled back their technical programs.”

As if by clockwork, GM’s share price initially greeted the news of the plant shutdowns with a 5 percent upward spike (that is, until adverse comments/threats from President Donald Trump, which muted the rise). The initial market reaction is exactly the sort of thing that further incentivizes stock-laden management to continue to formulate strategy with a view toward goosing a share price, rather than focusing energies on the underlying business operations themselves.

Following a classic pattern we have seen since the 1980s, GM’s CEO, Mary Barra, is the highest-paid auto CEO in the world, via a combination of salary and stock awards. In general, highly paid American manufacturing CEOS have been compensated for their willingness to hollow out compensation to their labor force.For the last two years, Barra has earned over $21m annually.Clearly, she has neither suffered the consequences of her company’s defective ignition switches, nor her company’s declining market share in the sedan market (the ostensible rationale for the layoffs).

The GM layoffs should not be blithely dismissed as another inevitable casualty of globalization.Nor are they a parable illustrating the dangers of increased protectionism (even though that is the narrative that GM wants you to believe). In fact, it is part of a much broader story, particularly in the U.S., where workers continue to deal with the consequences of labor casualization (i.e., flexible “alternative work arrangements”), the outsourcing of manufacturing to other countries, and the ultimate blowback to these increasingly financialized corporations, such as GM, as they continue to embrace measures that degrade their workforce, diminishing America’s viability as a source of highly skilled, good-paying jobs as a consequence.

There are other alternatives, as Germany proves.We occasionally get glimpses of the scale of this homegrown deterioration when a big layoff announcement is made.But seldom do we truly examine the underlying causes, the consequences of which continue to be masked by a hitherto ebullient stock market, which has become a wealth recycling machine for corporate CEOs, even as it provides nothing more than the aura of a Potemkin-like economic prosperity for the rest of us.

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