There would be some initial disruption but no long-term damageby Graham Gudgin and Robert Tombs / November 2, 2018 / Leave a comment
There is confusion on what is meant by a no deal Brexit. Threats have abounded—for example that the EU will prevent flights from landing, or that the Eurostar would stop running. None of these threats is plausible. Negotiations are proceeding to avert outcomes greatly damaging to both the UK and the EU. A realistic no deal scenario would involve the absence of a free-trade agreement, at least for a while, combined with side-deals to maintain smooth operation of flights plus the safety of vehicles, medicines and other goods and services. Customs borders would be set up and tariffs imposed.
It is difficult to know how the UK economy would fare in such a “no-deal-lite” scenario because official forecasts are so unreliable. Forecasts in the UK come largely from the Treasury. The Office for Budget Responsibility and the Institute for Fiscal Studies do not generate their own estimates for Brexit. For this week’s Budget the OBR assumed a trade deal with mild impacts on trade and said nothing about a no deal.
The very negative Treasury forecasts should be completely ignored. Officials serving Ministers with known positions on Brexit are in no position to be objective. At least one former Cabinet Secretary would not have allowed the Treasury to publish estimates of the impact of Brexit for this reason.
The Treasury’s two-year forecasts published in 2016 have been hugely and embarrassingly wrong. They included a prediction that unemployment would rise by half a million when it has fallen by a quarter of a million. An error of three-quarters of a million over just two years is stupendous when total unemployment is currently 1.3m. Predictions of soaring interest rates and collapsing share prices have also proved false.
Some claim that a failure in short-term forecasting does not necessarily mean that the Treasury’s long-term (12-year) predictions will be wrong. However, we do know that these include assumptions that hugely exaggerated the estimated negative impact of no deal. Strikingly, a report obtained under the Freedom of Information Act shows that the Treasury must have known that the approach it took in 2016 was flawed. But it has subsequently refused to discuss this.
The Treasury has since dropped its discredited “gravity” model. We know little about the replacement model because the prime minister has refused a request from 60 MPs to supply details. We do know however that Canadian academics using what we think is the same model estimate a negative impact only one third that of the Treasury for no deal.
Some other studies of the long-term effect of a no deal Brexit also make large negative predictions, but these results are based on assumptions about Brexit’s impacts on immigration, trade frictions and productivity that are extreme or based on weak evidence. Unpublished forecasts done at the Cambridge Centre for Business Research show only a small no deal loss for overall GDP by 2030. But per capita GDP, the indicator of living standards, is higher than in a no-Brexit scenario by 2030 due to lower immigration, after dipping slightly in the 2020s. Unemployment is projected to be lower with Brexit.
These predictions are not based on unrealistically optimistic assumptions. They assume an immediate loss of 10 per cent of exports to the EU in 2020 and only a gradual recovery as free trade deals are signed. This export decline is much lower than the Treasury’s prediction, but other reputable estimates suggest a much lower fall still, of only 2-3 per cent. With the UK likely to face an average tariff on exports to the EU of only 3-4 per cent in a no deal world and UK regulations already aligned with those of the EU, there is little reason to expect the huge declines in exports predicted by the Treasury. There will be frictions such as costs of customs administration and some border delays but realistic estimates show them to be small. Even just-in-time manufacturers should be able to adjust—many already source outside the EU.
Importantly, realistic modelling must incorporate a weaker currency and assume sensible policy responses, including increased government spending and lower interest rates. The government would have other options, too: VAT and/or import tariffs could be cut to dampen price rises resulting from a weaker pound. Business taxation could be reduced to offset increased trade frictions and attract FDI. In brief, there may be some short-term disruption due to a no deal, but we see no reason to expect long-term damage to British living standards.