The Cost of Brexit

Matt RidleyViscount Ridley reminded the House of Lords during the recent Brexit debate that the previous, pre-Referendum Treasury forecast was a “clean sweep of failed predictions”. For example, “A vote to leave would represent an immediate and profound shock to our economy. That shock would push our economy into recession and lead to an increase in unemployment of around 500,000. GDP would be 3.6pc smaller.” Employment increased and the economy grew. In fact about the only thing it got right was that the pound would fall; it did but with mixed results – inflation went up for a while and the export gap closed as manufacturing rebounded, rather proving that sterling was overvalued anyway. The pound has now largely recovered but the variations have as much to do with non-Brexit issues, like oil prices, as anything related to the EU.

PredictionsNow the Civil Service has done it again, trying to predict the catastrophic effects on the British economy fifteen years ahead, presumably using the same brains and tools as before, then leaking the results without authority. It might be interesting if they attempted to model the EU economy in 2030, except no doubt they would make the most benign assumptions, such as the ECB safely winding down its QE program, the Italian banks avoiding insolvency, and ever-closer political union not triggering splits by ‘populist’ parties elected to resist the Franco-German elitist ratchet. What if there is a global recession? There is almost certain to be a cooling within this timescale and EU countries on a knife edge will be plunged into severe difficulties that will imperil the eurozone and indeed the cohesion of the EU as a whole. Hey, don’t worry, it’s just another economic forecast!

Gravity modelThe forecasting methodology used by the Treasury is anyway not without its critics. To begin with its complex mathematics incorporate what is called the economic ‘Gravity Model’ assumptions: by analogy with Newton’s inverse square law for the attraction between astronomical masses, this assumes a similar attraction between trading nations based on geographical distance and market size. France and Germany are heavyweight economies and fairly nearby so unsurprisingly they are substantial trade partners. The USA is more massive still but much further away and is our largest partner by a big margin, with fairly even import/export balance (unlike the other two). The model also relies on historical trends, naturally, but these data are becoming rather dated, reaching back to times when the EU/EEC was more lively and China, India, and others were far less so. For goods, air transport and containerisation continue to shrink the effective trade distances; for services (the UK’s strongest suit) modern communications have marginalised the distance parameter in many cases.Dynamic world-1

Thus the Treasury model crystallises the trading world as it used to be and not as we can reasonably expect it to become within the timescales it presumes to model; it is a static picture of a dynamic world. German growth has been widely predicted to be far less than it is, and was, for several reasons, including demographics (its ageing population). Despite the current cyclical rebound in growth, the EU as a whole is facing such serious imbalances and financial stresses that it is wholly unrealistic to expect this will continue for long; its central bank has practically run out of bullets to fight the next battle it’s going to face.

A Brexit on anything like the terms the EU is currently insisting on would be a disaster for Britain and the politicians who are making the Government’s resistance almost impossible are endangering our future. A trade deal for goods but not services will continue the present distortion. Full alignment of regulations will hold back the large majority of our business and businesses that are not engaged in trade with the EU for the convenience of the corporations that are but have the reach and resources to respond. 

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