Monday, 31 July 2017

The cost of Brexit

How much will Brexit cost?

The impact of "Hard" Brexit (falling back on WTO rules) was subject to a number of analyses during the Referendum campaign, all predicting a loss to GDP by 2030, e.g. : -6% (HM Treasury); -3.5% (PWC for CBI); -2.2% (Open Europe). George Osborne (former chancellor) has been subsequently widely discredited for the Treasury's overly pessimistic assumptions.

The theory is that a higher volume of trade translates to greater economic efficiency and higher growth. Leaving the EU will bring additional frictional costs to trade, which will tend to reduce the volume of trade and hence reduce economic growth.
  • As Andrew Lilico has noted, the EU Commission's own estimate is that the Single Market has added just 2% GDP on average across EU member states and the UK's gains are probably less than average at around 1%. Nor will leaving the Single Market automatically mean losing these gains.
  • Open Europe have modelled the impact of leaving the Customs Union as resulting in 1-1.2% GDP loss. Most of this impact arises from Rules of Origin cost assumed as 4% of transaction values. Reintroduction of customs controls & declarations will also contribute to increased cost of trade.
  • A "hard" Brexit would also mean an imposition of tariffs. Most tariffs are relatively low and similar cost to Rules of Origin - so in many cases traders will simply opt to pay the tariff. The sectors most impacted will be agriculture (typical tariffs of 40% or more) and finished cars (tariffs of 10%).
Many Remain supporters argue that we simply cannot afford any frictional cost to trade with our largest partner. But a counter argument exists.
    Trade may be simply diverted, either via new trade agreements with third countries or by repatriating supply chains to the UK. The UK car industry has been increasing the percentage of components sourced from the UK since before the EU Referendum. The forecasts for "hard Brexit" tend to be pessimistic about an independent UK's trade prospects.
    The EU does not constitute an open and fair  market. German manufacturing is bolstered by an undervalued currency (the Euro vs the old Deutschmark) and often sets the rules to its own advantage (e.g. Diesel emissions; James Dyson's experience with vacuum cleaner regulations etc). Germany and France seem able to bend the EU's state aid rules, whereas Britain has very little joy with the ECJ. The EU's agriculture policy is famously geared towards French and other continental countries farming industry, to the detriment of Britain's smaller but more efficient farming industry. Britain's key strength is services - but the EU has made little progress in liberalising this sector. Consequently, Britain has an enduring and widening trade deficit with the EU.
    We abandoned our largest trading partner (the Commonwealth) when we joined the EEC in 1973. Trade with the EEC was then less than 20% of our overall exports. Exports to the EU peaked at 60% in 2000, but has been declining ever since, and is currently 40% of all exports (after allowing for Rotterdam, Antwerp & Dublin effects). Even before the Referendum, UK trade has been pivoting towards global markets and away from the EU.
To put these figures into context:
  • Total UK GDP is ~£2tn, UK's annual £10bn net contribution to EU is ~0.5% GDP.
  • The "Brexit bill" the EU want to charge Britain with is alleged to be €100bn / £85bn, i.e. over 4% of GDP.
Freedom of Movement has resulted in 3 million EU citizens in the UK versus 1.2 million UK citizens in the EU - with an associated fiscal imbalance (see link):
  • Many of the British emigrants to Europe, especially Ireland, Italy, Germany, Cyprus, France and Spain, are self-sufficient retirees. In 2013/14 the UK spent £1.4 billion on state pension payments to recipients living elsewhere in the European Union.
  • In 2013/14 the UK paid £580 million to other EEA countries for the treatment of British pensioners in the EEA while it received just £12 million from other EEA countries for the treatment of EEA pensioners in the UK.
  • Figures for benefits claimed by EU migrants are hard to come by. Research by Migration Watch suggest EU migrants tend to have higher claim levels for housing benefits, tax credits and child benefits, but lower levels for unemployment and sickness benefits, compared with UK citizens. The UK Government spent £140bn on benefits (excluding pensions) in 2015 - a substantial amount of which will have gone to the 3 million EU migrants who form about 4.5% of the UK population.
It is hardly an understatement to state there has been a continual attempt to overstate the economic cost associated with leaving the EU. George Osborne's Treasury forecast of 6% loss of GDP is excessively pessimistic, especially considering UK exports to the EU only account for just over 9% of GDP. The more balanced estimates of GDP impact from PWC and Open Europe are actually less than the Brexit bill the EU propose to charge Britain. Moreover, these forecasts suggest only a diminished rate of growth - not  recession or depression. There are also potential fiscal gains from being free of UK contributions to the EU and benefits payments to EU migrants.

This is obviously a simplistic analysis. Many will complain that non-tariff barriers may have a devastating impact, although I've looked at these in detail and it seems to me that these concerns are also being overplayed. This scenario assumes the EU would effectively declare a trade war, which at the same time would damage their own traders and economy, as well as damaging their international reputation.

But nonetheless, a "big picture" or "bottom line" view of Brexit like this is useful for perspective. Brexit, even on the basis of worst-case “hard Brexit” forecasts, is not the apocalypse. Pivoting to a global trading when free from EU control both mitigates the impact on EU trade and is an entirely necessary process, given the pre-existing trend of UK trade and the fact that 90% of global growth in coming decades will be outside the EU (as the EU commission itself admits).

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