Economic Theory

Why economic forecasts get the impact of Brexit wrong


The economics profession has not exactly covered itself in glory in recent years. Few people forecasted the crash. Forecasts of economic recovery after the crash were dreadful. Neither the Office for Budget Responsibility nor the Bank of England have had a particular good recent record and, also, the widespread forecasts of doom and gloom in the event of a Brexit vote have proven to be wide of the mark.

There is a reason for this. Most economists tend to put sophistication above broad principles. As such, they develop complex models that are designed to forecast with a great deal of accuracy what will happen if the current conditions broadly carry on or if there are changes in economic circumstances that can be handled within the model. When things happen that are outside the scope of forecasters’ models, they tend to flounder. This is especially so given that the apparent mathematical rigour of a modern economist’s training has led them to be ill-equipped (in my view) to think through issues in detail conceptually. However, for the record, let me say a little about what some forecasters have said about Brexit.

The Treasury Model suggested that, by 2030, GDP would be over 6 per cent lower if we left the EU and then negotiated a separate trade agreement with it. This is about £4,000 per household. However, the assumptions behind this modelling have been widely criticised. The way the Treasury models trade would not have predicted changes in trade patterns that have happened in recent years and the model essentially assumes that politicians do absolutely nothing to react to the new policy environment.

The second set of forecasts noted here is wildly optimistic about Brexit. I don’t agree with the author of the forecasts despite the fact that I published the book. However, I do like his approach which provides quite a good way of conceptualising the issues.

Patrick Minford suggested that there would be gains from leaving the EU in terms of our net contribution to the EU’s budget and the removal of the EU’s protectionist trade barriers – the EU is a free trade area and customs union and is quite protectionist, especially in relation to products that tend to come from poorer countries – of around 4.5 per cent of national income. We would obtain these gains if we did not put up trade barriers to replace those imposed around the EU. So we would have cheaper food, clothing etc.

I think this is relatively uncontroversial. The controversial bit is that Minford then assumes there would be huge gains from leaving the EU because we would no longer have to suffer big increases in regulation and future bailouts of the euro zone if we were not members of the EU. Secondly, he assumes that there are no losses as a result of leaving the single market or from the trade barriers that the EU might put up when we leave. The second issue is complicated, but it is probably fair to say that Minford has been unrealistic and too positive about leaving the EU in the same way that the Treasury has been unrealistic and too negative.

Behind the two diverging forecasts is a debate about future trade patterns. The general gains from trade are lower prices for consumers and more opportunities for exporters. The importance of trade for consumers is often ignored leading to some dead ends in the debates we have about Brexit. Also, in the long term, production tends to take place where it is more efficient and that raises living standards.

According to the WTO the two major trade agreements of the 1990s — the WTO Uruguay Round and the North American Free Trade Agreement between the US, Canada, and Mexico — generated increased purchasing power of $1,300 to $2,000 per year for the average American family of four. The European Union argues that the creation of its single market led to the average European consumer gaining by €600 a year.

So, what will happen to trade when we leave the EU?

Unlike in the US and unlike in the UK with regard to migration, there is very little pressure, thank goodness, to adopt a protectionist position post-Brexit. The key issue really is how our trade position changes. Currently we are in a customs union where there is total free trade within the EU but trade barriers around the outside. For example, the EU applies a tariff of 17 per cent to footwear, 15 per cent to bicycles, 12 per cent to many basic foods and 10 per cent to motor cars. There are some exemptions.

When we leave, we could have chosen to effectively lock in the current position by joining the customs union and the European Economic Area – nothing much else would then change. It has been said that this will not happen, but we could negotiate a settlement that leads to some of the features of the customs union being kept.

Alternatively we could, and should in my view, try to negotiate some other settlement that allows us to remove the tariffs that the EU imposes and develop freer trade with, for example, North America, India and other areas and countries. We could, indeed, just move to unilateral free trade, New Zealand style.

This is, I think, exciting. I don’t think Christian leaders have anything especially interesting to say on the details of whether we leave the EEA or the Customs Union. However, the increased ability to have deeper economic relationships with other countries which membership of the EU has made more difficult because all 28 countries have to negotiate trade agreements together is a great opportunity for developing international economic relationships.

The removal of tariffs will be a greater benefit for UK consumers. As the UK does not have strong import-competing industries where some of the highest tariffs exist, this will not even cause difficulties for British businesses. Where there will be problems is in relation to regulatory barriers to trade.

The purpose of the single market, in effect, is to unify regulations so that trade can take place freely with the same regulations being used in each country. The huge increase in regulation, especially in fields such as finance, has made the development of free trade much more complex. Trade deals are several thousand pages and the process can become captured by interests groups.

Ideally, especially when it comes to services, countries need to become more relaxed about regulation when it comes to trade. In practice, it is difficult to see this happening. Not being in the single market may therefore make it more difficult for UK companies to export services. Against this, completing trade deals in this complex world within one country rather than as one of 28 countries should be more straightforward.

Against this background, and with the election of Donald Trump, I also believe that the UK must make the case for free trade globally. We should cast our minds back to the very rapid damage done by the Smoot-Hawley tariff act in the 1930s to see that one should not be sanguine about the prospects for free trade.

 

This article was first published by Reimagining Europe.

Philip Booth is Senior Academic Fellow at the Institute of Economic Affairs. He is also Director of the Vinson Centre and Professor of Economics at the University of Buckingham and Professor of Finance, Public Policy and Ethics at St. Mary’s University, Twickenham. He also holds the position of (interim) Director of Catholic Mission at St. Mary’s having previously been Director of Research and Public Engagement and Dean of the Faculty of Education, Humanities and Social Sciences. From 2002-2016, Philip was Academic and Research Director (previously, Editorial and Programme Director) at the IEA. From 2002-2015 he was Professor of Insurance and Risk Management at Cass Business School. He is a Senior Research Fellow in the Centre for Federal Studies at the University of Kent and Adjunct Professor in the School of Law, University of Notre Dame, Australia. Previously, Philip Booth worked for the Bank of England as an adviser on financial stability issues and he was also Associate Dean of Cass Business School and held various other academic positions at City University. He has written widely, including a number of books, on investment, finance, social insurance and pensions as well as on the relationship between Catholic social teaching and economics. He is Deputy Editor of Economic Affairs. Philip is a Fellow of the Royal Statistical Society, a Fellow of the Institute of Actuaries and an honorary member of the Society of Actuaries of Poland. He has previously worked in the investment department of Axa Equity and Law and was been involved in a number of projects to help develop actuarial professions and actuarial, finance and investment professional teaching programmes in Central and Eastern Europe. Philip has a BA in Economics from the University of Durham and a PhD from City University.


1 thought on “Why economic forecasts get the impact of Brexit wrong”

  1. Posted 06/04/2017 at 12:54 | Permalink

    I find this article the most balanced I have read in relation to our economic future post Brexit. Therefore I will try to make use of it whenever I need to challenge visceral opposition to Brexit.

    However, I do question the assumptions in the third and second paragraphs from the end. First, the EU has itself acknowledged that the single market in services is largely inoperative. Second, whilst it is always risky to generalize from a small particular example, may I offer my own experience of trying to sell services within the EU?

    For the ten years from 2006 to 2016, I was closely involved in a small, London based company that provided interim resources to facilities services companies. Our clients were mainly large, international corporates – many on the list of contractors that are strategically important to the UK government. In those ten years we grew from 6 to 250 people. I became operations director and then, for the last two years before I retired, I was the managing director.

    Whilst most of our work was in the UK, we placed interim personnel in various African and Middle-Eastern countries. We had many potential leads in France, Germany, Italy and Spain. We never succeeded in making a placement in an EU country. The restrictive labour laws in each of those countries always managed to undermine our efforts. In my view, there is no single market in services in the EU; just a lot of hot-air about it. So, as far as I am concerned, selling services to EU countries is difficult now, and that will not change after Brexit

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