Monday, 19 February 2018

End of Project Fear ?

Will we ever see an end to Project Fear ?

At the height of the EU Referendum campaign, George Osborne's Treasury produced a report predicting that even the act of voting to Leave the EU would cause immediate economic disaster. Even arch-Remainer Kenneth Clarke has poured scorn on these Treasury figures.

Even EU officials in Brussels believe Project Fear is overdone, as Nick Gutteridge (Brussels reporter) observed: "I’m yet to speak to a single EU diplomat or official who thinks the economic fallout for the UK from Brexit will be anywhere near as bad as many British commentators predict." Even in Brussels, the expectation is a CETA plus outcome and no Brexit recession.

There is a problem at the root of Project Fear - it is an attempt to argue that a marginal increase in cost of trade with the EU trumps all other concerns (political & economic), even when exports to the EU account for just 10% of UK economy. This is exactly the same argument made for the euro - "10% of our economy depends on EU, 3m jobs at risk" . Allegedly, the UK retaining the £ would result in the City & UK car industry decamping en-masse to the EU to escape the cost of currency exchange in UK-EU.  Some 15-plus years on, it is clear that these economic forecasts were pure bunkum.

Of course, any forecast over a timescale of 15-years will almost certainly be proved wrong. Yet, in recent weeks we have seen leaked Treasury forecasts, suggesting UK GDP could be 8% lower over a 15 year timescale due to Brexit, paraded as "facts" by Remain supporters.

It should also be noted that this forecast of 8% does not imply a recession, rather it is a forecast of slower growth, i.e. 1.5% per annum rather than 2% per annum in coming decade or so, so an economy worth ~£2tn at start of a year will only increase by ~£30bn instead of ~£40bn over that year, so that each year economic activity is ~0.5% GDP or £10bn lower than the counter-factual scenario.  Interestingly, UK membership of the EU also costs ~0.5% net per annum, i.e. ~£10bn economic activity taken out of ~£2tn UK economy and diverted to activity in Brussels or other EU member states. 

It's not clear whether the Treasury forecasts have allowed for the gain from ending UK's net EU contributions in their forecasts. But it is interesting to compare the Remain campaign description of these 0.5% per annum contributions as a small price to pay for the economic benefits we get in return (as in a £70bn per annum trade deficit with the EU).

Given UK exports to the EU account for just 10% of UK GDP, the forecast 8% loss of GDP is equivalent to losing 80% of our exports to the EU. While there will be a marginal increase in cost of trade with the EU, but this does not mean that UK exports to the EU will effectively cease - just as marginal costs arising from rejecting the euro did not mean the loss of 3 million jobs.  By contrast, a 2017 paper by World Bank & UNCTAD economists suggested UK exports are "price inelastic" and that in the event of a No Deal scenario, UK exports to the EU would drop by no more than 2% - a negligible impact.

The Treasury also forecast that a Free Trade Agreement (FTA) with the USA would provide only 0.2% GDP gain over the same timescale. The USA economy is larger than the EU27 and with all the trade benefits of EU membership, UK exports to EU27 are about 3 times larger than UK exports to the USA. Yet the Treasury forecast suggests a GDP impact from Brexit and reduced EU trade would be some 40 times larger (not 3) than GDP impact of an FTA with USA. The Treasury forecast seems to assume that trade with the EU is uniquely beneficial to UK growth.

Historical data does not support this assumption that EU membership has been uniquely beneficial:
- In 2012, to commemorate 20 years of the Single Market and removal of internal customs borders, the EU Commission published a report claiming a 2% GDP gain (averaged across the member states). Even that figure is inflated, as the economic downturn from 2008 onwards was ignored.
A similar study by European (and generally pro-EU) think tank Bertelsman concluded that the UK had only gained 1% GDP (with Germany the winner with a gain of 2.3% GDP).
- In the same period 1992-2012, the UK economy grew by 67%. The introduction of the Single Market & removal of Customs Borders within the EU barely registers.

Economies and markets will always adjust to shocks such as Brexit. Trade and commercial activity will divert to the domestic economy and markets with the Rest of the World. In fact, there is a strong case that the UK needs to pivot away from an EU-centric economy:
- The EU's share of the global economy is in decline (having halved from a high of 30%, less once UK leaves).
- As even the EU Commission concedes, 90% of global growth will be outside the EU in coming decades.
- The share of UK exports to the EU (as opposed to the rest of the world) has steadily declined from a high of 55% at the turn of the century to 43% today, less if the Rotterdam/Antwerp effects are taken into account.
- UK trade with the EU has shown a persistent and widening trade deficit, whereas UK trade with the Rest of the World is broadly in balance.

All of which is a long way round to saying overblown economic scare stories, which have no foundation, take no account of other gains, ignore the 90% of economy that does not export to the EU - are pure distraction.  As we well know, the decision to leave the EU was to restore national self-Government & reject a future as a mere province in the Brussels bureaucratic empire. The whole sorry story of our entanglement with the EU has been attempts to deny the true aims of the EU coupled with Project Fear (right back to 1975 Referendum). June 23rd 2016 was the end of that.


  1. Good post Paul. As you have shown, the Treasury numbers simply don't pass the most basic of 'sniff tests'. There is no way on earth that an increase in trade frictions with the EU of (on average) a few percent is going to generate the kinds of GDP effects this study claims.

    And the level of non-tariff barriers you would have to assume on top of such frictions, to get effects of this kind, would have to be immense. Miles above reputable estimates.

    So where do the numbers come from? Sadly the Treasury seems unwilling to tell us, just as they have generally refused to discuss their earlier findings with reputable economists.

    But it seems likely they have again followed other studies in inventing all kinds of bolt-on negative effects - the most common of which is assuming a huge loss in productivity due to lower trade/GDP ratios and lower FDI. The foundations for this particular bolt-on are incredibly thin and yet it frequently accounts for a very large share of negative effects 'found' by studies of this kind.

    On the US trade deal, the number being bandied about is again extremely dubious - it may well be the lowest number anywhere in the literature for such an effect. It seems pretty clear that the Treasury has deliberately massaged down the number - trying to appear even handed by actually including an effect (this time) but in fact being anything but.

  2. Thanks ... "don't pass the most basic of 'sniff tests' " ... that's a good way of putting it.

    I think you are probably right RE the assumptions of negative effects RE productivity & FDI. I read one critique of the treasury assessment produced during Referendum suggesting that even worst case, a "static" analysis of trade impact => 2-3%, but by assuming "multiplier" secondary effects (such as productivity, FDI etc) they got the exaggerated figures presented in the report.

    Of course, we have not seen positive multiplier effects since advent of single market & removal of customs borders. Nor it seems have they allowed any positive multiplier effect from a USA FTA. It seems to be assumed that only leaving the EU triggers these multiplier effects.

  3. Paul - yes that's about right. If you follow the history of this literature back to the 1990s you find that early studies only looked at trade effects alone (usually based on applying higher prices to exports and/or imports) and found quite modest effects (especially when the UK's net contributions were netted off).

    As we moved 'forward', we first started getting gravity models used to claim that there were somewhat bigger trade effects, and then we started getting the productivity stuff added on as well. Somewhere along the line, a few studies managed to forget about netting off the UK's EU contributions as well...

    There's also a claim in some studies that EU membership only involves trade creation, no trade divergence. This of course flies entirely in the face of the empirical evidence from the 1970s and 1980s when the UK's trade with key commonwealth partners went into steep decline.

  4. Very interesting. You should write a blog post on that !