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The embarrassing role of economists on Brexit

Just when the Brexit talks were beginning to look humiliating for the UK, the position has begun to be reversed. The absurd EU negotiating framework has stretched the patience of the British side to close to breaking point and preparations are at last being made for the possibility of no deal with the EU. Australians with decades of experience in trade negotiations with the EU tell us that the EU always bargains ferociously and that the only sensible response is a tough one. A negotiating bottom-line of no-deal should have been the British position from the start but going along with the EU’s self-imposed constraints has at least exposed just how difficult the EU can be. The new note of toughness from the UK is producing results, and may have influences Michel Barnier’s request to the EU for more flexibility to begin some talks on trade.

None of the EU’s three negotiating priorities make much sense. The Irish border priority makes least sense of all. It has been obvious since the start that there is little possibility of detailed proposals for border arrangements until the shape of the UK-EU trade deal becomes clear. Even devoted remainers like Lord Jay, former head of the Foreign Office and former ambassador to France, agree that the EU is at sea on this. On the second EU priority, the rights of EU citizens in the UK, Brussel’s insistence that disputes be adjudicated by the ECJ rather than British courts is an obvious non-starter, but again no flexibility has been possible.

The third, and probably most important, priority is that sufficient progress must be made on an exit bill before any trade negotiations begin. One of the many unsatisfactory aspects of the EU negotiating stance is a demand that the UK names a sum for its ‘exit bill’. When the UK did so, it was of course deemed too low. The informal figure of 100 billion euros from EU sources is equivalent to ten years of UK annual net payments. While a figure of two years annual payments is justifiable, it has been difficult to imagine any justification for a sum as large as ten years payments. Britain is offering contributions to the EU expenditure already committed under its current seven-year plan ending in 2020. The pension rights of UK staff members in the European Commission and membership contributions to pan-European collaborative schemes including university research and student exchange, should cause little difficulty. All of this might amount to a grand total of 20 – 30 billion euros, well short of EU demands.

 

It is difficult to know whether the EU’s cussed stance is caused by inevitable inflexibility of an unwieldy rules-based organisation, or as Yanis Varoufakis, former finance minister of Greece suggests, by the European Commission’s willingness to damage both the UK and EU economies to assert the political interests of European cohesion. Whichever it is, the UK needs a clear-eyed approach to its own interests including future relations with the EU.

A major impediment to clarity has been the weight of advice from what Michael Gove calls ‘organisations with acronyms’ suggesting that  a ‘no deal’ on trade will greatly damage the UK economy. Our careful and detailed re-evaluation of the reports issued by the Treasury, OECD, the LSE’s Centre for Economic Performance and others, shows that much of this was wrong. The key flaw in each case was the use of inappropriate benchmarks to judge the potential losses to the UK economy.

The method used by all of these organisations was to calculate the likely loss of trade and investment due to new tariff and non-tariff barriers and then to add a knock-on impact of lower productivity associated with the new reduced level of trade. Both stages used flawed methods. The estimates for loss of trade were based on the average trade pattern across all EU members, and not on the very different experience of UK trade with the EU. The calculation of an additional productivity effect was even worse. This was mainly based on an outdated academic paper which examined the relationship between trade and productivity across a large number of mainly under-developed countries. A re-examination of this relationship with more recent data, and concentrating on the richer (OECD) countries of relevance to the UK, shows no relationship whatsoever. The net result is a much smaller estimate of the negative impact of Brexit on the UK economy.

There is also a widespread belief that membership the EEC/EU since 1973 has been a substantial benefit to the UK economy. Some economists estimate that the UK economy is 10 percent larger as a result of its EU membership. This belief is based on the observation that the UK economy grew only half as fast as major EEC members before joining in 1973, but has subsequently had a better growth record than those economies. However, the actual growth of the UK economy did not improve after joining the EEC. It looked better than France, West Germany, Italy etc only because growth in these economies slowed down drastically after the 1970s. Their slowdown was much greater than in the USA, Canada, Australia, New Zealand and other major economies, and reflected the end of the post-war reconstruction and catch-up with US productivity levels. None of this was of relevance to the UK economy, which continued to grow at the same rate as the USA, just as it had also done before joining the EEC. A more appropriate benchmark for the UK, namely the USA, reveals no evidence of any improvement in UK performance from joining the EEC/EU.

After a decade of failure, on failing to predict the banking collapse, to anticipate the excessively slow post-crisis recovery or to explain the cessation of growth in productivity, the performance of the economics profession in estimating the impact of Brexit is yet another embarrassment. One former Cabinet Secretary says that the Treasury should never have been asked to produce a report on Brexit, given the obvious political constraints on its conclusions.  The likelihood is that the negative impact of no-deal is much smaller than suggested by most economists. No deal involves real difficulties, but my calculations using the Cambridge CBR model indicate that it will involve at worst only a minor and temporary reduction in UK incomes.

Dr Graham Gudgin is Chief Economic Advisor at Policy Exchange, and associate researcher at the Centre For Business Research, Judge Business School, University of Cambridge.


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