An academic study examined whether joining the Common Market/European Union increased Britain’s economic growth. This post reviews the paper’s evidence and conclusions.
This post presents a brief summary of part of a report by Cambridge economists – mainly Remainers – entitled, ‘How the Economics Profession Got It Wrong On Brexit’. They analyse the models and assumptions used by the OBR, ONS, Treasury, Bank of England, OECD, IMF, LSE, and others to establish what went wrong and how to improve future forecasts. The paper describes why forecasts by all these prestigious bodies have proven wrong. If the economists’ models ever worked things have changed, especially for countries like Britain, so they cannot now be trusted to forecast the future. The authors conclude that “most estimates of the impact of Brexit in the UK, both short-term and long-term, have exaggerated the degree of potential damage to the UK economy.”
It seems pretty important to understand the risks and opportunities far better than we have if we are to make good judgements on what to concede in negotiations. However we will look here at the first part of their paper which reviews whether membership of the EEC/EU “has been beneficial for growth in per capita GDP” over the entire period since the UK joined in 1973. The conventional and therefore popular view is that it has been very beneficial in the past so we may be about to lose those advantages after Brexit. Could that be wrong, or in other words, ‘What has the EU Ever Done For Us‘?
We then select examples of how the reported effects of leaving seem to have been misleading, according to the paper’s authors.
The whole paper (54 pages) can be downloaded from a vast database of economic research papers, here: https://ideas.repec.org/p/cbr/cbrwps/wp493.html. It is worthwhile reading at least the first part of the original to be sure our extracts are fair. We present them as a single, joined-up text but we have omitted much to keep it brief (our selections are from the first 20 pages). From here on our selected passages are shown in italics but without quotation marks; they are not always contiguous extracts from the original.
Did accession to the EEC in 1973 improve the UK’s economic growth performance?
As with the peace dividend, we don’t have a counter-factual for growth but the claim that it was better in Britain after we joined and because we joined is far from proven. However, the fact that UK growth may not have improved as a result of joining the EU doesn’t lead to the conclusion that it would improve if we left.
There was no improvement in UK growth in per capita after 1973 when compared with previous decades. [UK] GDP per head clearly grew more slowly after accession than it had in pre-accession decades … the slowdown was from 2.4% per annum from 1950-1973, to 2.0% per annum for 1973-2007. Over the period 1950-1973, per capita GDP in the EU6 grew at an unprecedentedly rapid average rate of 4.6% per annum, almost twice as fast as the UK’s sedate 2.4%. … The UK’s growth rate was reasonably rapid by its own historical standards and was sufficient to maintain full employment through most of the period.
The ‘golden age’ growth in the EU6 economies slowed down very soon after UK accession to the EEC. From 1979 to 2007 growth in per capita GDP in the EU6 was only 1.6% per annum, well under half of the pre-1973 rate. In 1973 UK economic growth at 2.4% per annum had been 2.2 percentage points a year slower than the EU6. After accession, and up to the banking crisis starting in 2007, UK growth was 0.3 percentage points faster than the EU6. The UK’s relative improvement was wholly due to the slowdown in the EU6 … there was no actual improvement in economic growth in the UK itself.
To believe that the UK growth post-1973 would have deteriorated outside [the EU], world factors, including the six-fold increase in the real oil price between 1973 and 1980 means this should have also affected other major economies including the USA, Canada and Australia, but here the post-1973 slowdown was minor and much less than in the EU6. A more obvious explanation is that rapid growth in these countries was initially due to post-war reconstruction and then due to post-war economic reforms in a context of reducing world trade barriers. Catch-up was largely complete by the end of the 1970s. Growth thus settled down at close to, or a little below, the US rate. UK GDP per head has remained close to 70-75% of the US level throughout the post-war period. There is no evidence that joining the EU improved the rate of economic growth in the UK.
The previously slow growing Commonwealth markets actually expanded faster than the EU over the long period since 1973.
Only one of the Treasury’s expectations has been clearly realised. This is the fall in the value of sterling. No recession materialised over the 12 months following the referendum. Nor has unemployment risen. Unemployment has fallen to its lowest level for 33 years. Treasury expectation that equity risk premia would rise, leading to lower equity prices, has thus proved wrong. Business investment has experienced healthy growth in 2017. Even in the absence of Brexit, economic growth was expected to slow in 2017 due to continuing government austerity and constrained growth of mortgage credit.
Overall, our estimate is that the Brexit referendum result has made little difference [to] growth in GDP in 2017 compared with what we predict would have happened without the referendum, and is expected to do the same in 2018. The forecasts listed [by] private sector forecasters of a 1% reduction in GDP imply that, with an out-turn of 1.8% growth, GDP growth without Brexit would have been 2.8%, which is higher than any year since 2007 except for the pre-election year 2014.
The UK is the only EU state, other than Malta, which exports more to non-EU countries than to other EU member states. UK exports of goods to the EU have usually been well below the levels predicted by [the Treasury’s] model equations.
… the share of UK exports (of goods and services) rose rapidly from accession in 1973 to 1990. Since 1990 the share first stalled and in recent years has been falling rapidly as non-EU markets have grown much faster than those within the EU and within the Eurozone. An analysis at company level finds that many British companies have been diversifying their trade away from the EU.
While tariffs on goods may be imposed overnight if the UK reverts to WTO rules, these tariffs are much smaller than when the UK joined the EEC in 1973. For many non-agricultural commodities the tariffs are now very low. Even if there is [a] new free-trade agreement, evidence suggests that many firms may prefer to pay the (low) tariffs to avoid paperwork. With the UK outside the customs union, there will also be additional administrative costs but the WTO Trade Facilitation Agreement of February 2017, recently signed by the EU, will help to minimise these. Other non-tariff barriers should be initially low since UK firms are mostly already compliant with EU regulations.
We have…become aware of a study of service trade (Walsh, 2006). This finds that services trade is influenced by size of economy and common language but not by distance. … If [we are] to accept Walsh’s conclusion of no EU membership impact on services trade with the EU, then our estimate of the total loss of EU trade following no deal on trade would be 12%. This equates to a 5% loss of total (EU plus non-EU) trade. This is much smaller than the Treasury’s estimate of 24% for the loss of trade in the event of no deal on trade. In our view, not all of the trade gains would be lost. UK firms would face a trade weighted tariff of around 4%, but outside food, drink, clothing and vehicles the tariffs are lower at around 1-2%. If firms were to increase their prices by the amount of the tariff and face an average price elasticity of -2 on their sales, then the loss of exports might be 4-8%. Regulatory issues should initially be minor due to the existing compliance of UK firms with EU rules, although there may be regulatory divergence over time. Kee and Nicita (2017) suggest that the loss of UK goods exports might be as low as 2% since commodities facing higher tariffs tend to have low price elasticities.
This paper recognises that the impact of EU membership was much smaller for the UK than for other EU members. We had assumed that HMT’s failure to recognise this key point in their 2016 report was due to an oversight, but the existence of the 2005 Treasury paper suggests that it was more deliberate. The omission could, of course, be due to a lack of institutional memory in an organisation with high staff turnover, but it is important to note that the official responsible for the 2016 report, Treasury Chief Economist, Sir Dave Ramsden (now Deputy Governor at the Bank of England), was employed at the Treasury in 2005.