The UK's Achilles Heel

The government's decision to delay approval of the Hinkley C project, more than speeches about inclusiveness and broad hints that austerity is now passé, proves (if proof were needed) that the EU referendum result is a watershed in British history. Though it is being presented as an issue of national security, it is clearly economic in nature. As a symbol of both EU integration (a French energy provider) and the UK's role as the leading conduit for foreign investment in Europe (Chinese money), the project was informally predicated on a remain vote, hence the political capital invested in the plan by David Cameron and George Osborne earlier in the year. Even if the final decision is still to proceed, the hesitation signals a moment of doubt, not so much over a project whose technical and economic merits are far from compelling than over the future composition of the UK economy, and that doubt involves a reconsideration of the strategic decisions taken in the early 1980s.

Trade agreements these days are less about tariffs and more about the free movement of financial capital (i.e. the facilitation of foreign direct investment, both by UK institutions abroad and by foreign institutions in the UK), intellectual capital (e.g. IP protection), and human capital (the ability of multinationals to move human resources around the world). The UK industrial sectors that generate the largest export values are business services, finance, wholesale and retail, and transportation and telecoms. It's worth emphasising that much of "retail" involves consumer services and digital products, while much of "transportation" is also consumer services, such as airlines. The export of physical goods is nowhere near dominant in the makeup of the UK's trade flows and unlikely to take up much time in Brexit negotiations (the need for specialist negotiators is a reflection of the contractual complexity of services not commodities).

This is important because the UK's post-Brexit trade deals will inevitably involve trade-offs between the interests of various sectors, most obviously the interests of the City and international business service providers versus the rest. Domestic manufacturers of export goods are likely to be marginalised (though they'll get disproportionate media coverage), but that is not necessarily a problem (some would say, what's new?). In the markets that we export to, notably Europe, import tariffs are generally not a big deal except in areas that are deemed strategically significant (for reasons of domestic politics as much as national capability, like agriculture), or where foreign exporters are deemed to be overly-aggressive in seeking market share at the expense of domestic producers. A current example would be steel, where the EU has just imposed anti-dumping tariffs on China and Russia.

Much of the UK's manufacturing export sector involves specialised equipment (machinery, high-end cars, computers etc), luxury goods, non-substitutable products (e.g. pharmaceuticals protected by patents and intellectual goods protected by copyright), or distinctive cultural products such as food and drink (e.g. biscuits, tea-bags, bottled beer). It's unlikely that British manufacturers will face punitive tariffs, but equally unlikely that the negotiation of new free trade deals with all and sundry will result in a significant boost to exports outside Europe. The UK is never going to be the workshop of the world again, because the particular economic and geopolitical circumstances that allowed this to happen in the 18th and 19th centuries no longer apply. In that sense, there is no going back to before the accelerated deindustrialisation of the 80s, even if that nostalgic desire motivated some leave voters dismayed by the loss of skilled jobs and career security.

The key decision that was taken in the Thatcher years was not the closure of the mines or steelworks but the prioritisation of London as both a financial and business services centre. This has proved to be more socially damaging than the dereliction of former pit villages, largely through the impact on housing of a deliberate policy of property leverage and the impact on wages and job security of precarious employment and deunionisation. The creation of property-backed debt, which both fuelled the economy through consumption and magnified the profits of the City, was only made possible by the abandonment of social housing. Likewise, the growth of business services has led to the capital simultaneously sucking in huge numbers of people from the rest of country (and often the most talented) and huge amounts of money from the rest of the globe (and not always the cleanest), both of which have further amplified the property market.

Though it meant little to most leave voters, London enjoyed an enviable sweet spot as both an offshore front and the dominant provider of services to European businesses, able to leverage the advantages of language and an accommodating legal system. Historically, the EEC/EU has tolerated London's role as an offshore intermediary as a quid pro quo for the wholesale services it offered continental banks (many of which moved into the City in the 80s and 90s), much as it tolerated Switzerland's banking sector as a secrecy jurisdiction at the heart of Europe. Over the last 30 years, the global flows of wealth seeking a reliable return or protection from taxation have ballooned, the product of growing inequality and super-salaries in established economies and the emergence of a new super-rich class in developing economies. With European states facing a growing welfare bill due to ageing, and a shrinking tax base due to structural unemployment and low wages, the focus has turned to increasing the tax-take from both the rich and foreign corporations.

The gradual restrictions introduced on Swiss banking through EU pressure point the way. The future threat is not that Frankfurt will suddenly eat the City's lunch or Dublin take over the business services market, though there will be plenty of noise about anything that touches on the euro or "passporting", but that the EU will seek to impose de facto capital controls (or at least "hindrances") to prevent London syphoning off monies that would otherwise generate tax revenues for EU members, and to limit the ability of foreign corporations to access the single market via London without adequate recompense. The quid pro quo being outlined in the media is access to the single market in return for the free movement of labour, but the actual deal is more likely to come down to the continuation of both (with some minor adjustments for political PR) in return for the City being tolerated as an offshore front and London as an operating platform for non-European capital.

The decision on Hinkley C is being presented as a concern over Chinese influence and specifically the fear that they might "weaponise" the plant in the future, though more in the sense of threatening electricty blackouts than a nuclear meltdown. This is hype. Not only is the Hinkley reactor being designed, built and operated by the French state-owned firms Areva and EDF, but the entailed involvement of the Chinese in a future reactor at Bradwell is years away. The UK has more to fear from its current reliance on Huawei routers in BT's datacoms network. A more credible risk is that the EU (via France) might seek to use the project as leverage during Brexit negotiations. The government's decision to delay looks like a prudent call at a time of uncertainty, but the underlying issue doesn't lie in either Somerset or Beijing but in the City of London. Brexit isn't going to turn the clock back - nothing can - but there is a clear choice ahead: economic nationalism versus the primacy of the City. Theresa May has emphasised the former, but I suspect this is merely a gesture. The EU knows the City is the UK's achilles heel.