What if No Deal is not that bad ?

For the last 3 years we have had numerous Government / Treasury / Civil Service economic forecasts of doom regarding Brexit, which have been proven hopelessly wrong regarding the post-Referendum period. One longer term forecast leaked earlier this year has been been used to undermine the case for a "clean" Brexit, with a lurid headline of 8% less GDP in a WTO scenario (see above).

In fact this is 8% less GDP by 2030, i.e. slower growth, not recession. But this figure is only arrived at by using grossly exaggerated assumptions for non-tariff barriers (NTBs) outside the Single Market & Customs Union. Let's have a looks at these numbers.

Tariffs

EU trade weighted average tariff is indeed 4.5%, but is just 2.3% for industrial goods (i.e. stripping  out agri-food). The UK trades at greater than 3:1 deficit with EU in agri-food, so in a WTO scenario the major impact would be on our consumption and imports. But there are plenty of countries who would jump at the chance to supply UK with tariff-free food, especially meat (where tariffs tend to be highest). The UK could solve its Tariff Rate Quota (TRQ) disputes at WTO by offering more generous TRQs to the relevant parties . So it seems to me the tariff impact of a WTO scenario would be significantly mitigated via agricultural quotas with third countries.

Customs NTBs

The figure of 5.6% for Customs Non-Tariff Barriers strikes many observers as high. A 2011 Government Paper on "Trade Facilitation" quotes "for the UK ... the estimated tariff equivalent of the time taken to trade across borders is around 4.2%" (page 7), based on trade with non-EU countries. 

But this figure includes inland transport, which is obviously a cost today for trade with the EU. As the paper also quotes " If inland transport costs are excluded, the TF costs are 2.3%", which is the cost that will be added to trade with the EU post-Brexit.  Note also that the 2.3% figure covers "Customs Clearance and Technical Control", i.e. border checks for health & safety, regulatory compliance etc are included.

The government paper also refers to a 2009 study of the clothing and footwear sector – a sector which accounts for around 5% of UK’s external trade, but around 30% of all Customs Declarations. The study provided some interesting observations on current trade barriers as an EU member (which we would have scope to improve post-Brexit):

• complexity & difficulty of: EU tariff, Intrastat (reports trade within EU), complying with rules of origin and duty relief scheme.
• One of the most effective ways of removing some of these regulatory barriers is to eliminate the tariff themselves, thus removing much admin as well as the tariff payment
• many regulations affecting UK traders–around 93% of the overall burden - emanate from Europe, and it has proved very difficult to reform trade regulation at the EU level

Access & Regulation NTBs

Then we come to "access & regulation" barriers which have been estimated as a whopping 20.3% in a WTO scenario. This figure seems wildly overstated, especially as border regulatory checks is already covered in customs NTBs above.

As I covered in an earlier blog on the Common Rule Book, most of the gains from the single market comes from use of common standards (which of course we can maintain voluntarily) allowing a single design, manufacturing & assessment process for both UK & EU markets. The impact of leaving the single market then amounts to a one-off relocation of individuals/roles to fulfill the requirement for an EU/EEA based importer/representative, and a very low risk of border regulatory checks (already included in the Customs NTBs estimate).

Do significant barriers to services trade arise ? Financial Services have relocated a very small number of "front-office" jobs to EU related to Retail activities. Wholesale activities, where the City makes it's money, are unaffected. The great majority of business & legal services exports are via companies who already have an EU/EEA presence. The few hundred lawyers who need continued access to the EU Lawyers Directive are qualifying for the bar in Dublin. In short, the picture fits the consensus there is no significant single market in services.

Agri-food, specifically meat/dairy, is the sector that will face highest regulatory barriers, especially meat/dairy. Firstly, UK approved establishments have to be re-listed by the EU as third country establishments. After  that, meat/dairy exports will face border veterinary inspections. (100% paperwork checks, physical veterinary inspections according to product, some products at 50%). Of course these sectors attract the highest tariffs and so are already impacted by tariff barriers under the WTO option before considering the regulatory barriers. What this does show is that the main No Deal mitigation will need to be supporting meat/dairy exporters, diverting their produce to domestic markets while developing a long term plan.

The estimated size of the "access & regulation" barriers to trade with the EU would only make sense if the UK had completely de-regulated and/or switched to a completely different set of regulations (e.g. US regulations). Yet the government estimate has only minimal gains from de-regulation and a Free Trade agreement (FTA) w/ USA. This implies we would have completely overhauled our regulations for no gain - so why do it ? It is far more likely that divergence from EU regulations will be gradual and limited, thus minimising regulatory barriers to trade with the EU in the short to medium term.

GDP Impact

It seems to me that a tariff impact mitigated by TRQs with RoW agricultural suppliers, plus a realistic assessment of non-tariff barriers (based on the Government report), puts the equivalent tariff impact at about 7%, not 30.6% as claimed by the government forecast. That would translate to a GDP impact of about 1.5%.

It's also worth noting the Government estimate cites lower immigration resulting in 1.2% less GDP. Post-Brexit, immigration policy will be entirely for us to decide, so it is misleading to count this as a consequence of leaving the EU. Most people want "controlled" immigration focusing on high-skill, high-wage labour, which is hardly likely to make us poorer (quite the opposite). But of course increased population via mass migration means a larger economy, even if no-one is any richer.

A newcomer to twitter, Derrick Berthelsen, produced a sublime twitter threads on Brexit economic forecasts and how they are dominated by assumptions on immigration & productivity rather than direct trade impact from leaving single market & customs union (link). He followed this with a thread looking at historical economic data (link). He references the EU commission's own estimate (2% GDP gain averaged across all EU member states) and the Bertelsmann Stiftung study UK gaining just 1% from single market & customs liberalisation since 1992. Derrick also concludes impact from leaving single market & customs union as 1-2% at most. I thoroughly recommend reading these thread and following Derrick.

These forecasts assume reduced trade with EU is permanently lost economic activity, but in practice much of this trade/activity will simply be diverted to domestic and RoW markets. Ashoka Mody, visiting professor of international economic policy at Princeton University and former deputy director of the International Monetary Fund’s European and Research Departments, writes in the Independent:

The economics is straightforward. When trade barriers between the UK and the EU go up, British producers will sell less to the EU and will sell more within the UK and to the rest of the world. 

No trade economist believes that the long-term cost of this shift in sales patterns is any more than 0.5 per cent of GDP. Throw in 2 to 3 per cent of GDP as temporary disruption costs. Estimates higher than that are ad hoc.

Conclusion

What if No Deal is not that bad ? The Government estimates of trade barriers associated with the WTO option look seriously over-cooked, even comparing with pre-Referendum government information.  Using more realistic estimates the impact is only 1-2% GDP by 2030. And that is before allowing for mitigating effects of trade diversion, or gains from de-regulation or Free Trade Agreements. And it is still likely that a Free Trade Agreement would eventually be struck with the EU.

This I suggest completely changes the political calculations. If No Deal / WTO is not that bad, then surely it is not "extreme" ? In fact there are many positives and opportunities associated with the WTO option  - not least because it avoids the traps set in Article 50 negotiations and completely fulfils the EU Referendum mandate.

It seems to me (and many observers) that we are still seeing Project Fear being deployed. The establishment's real fear is not economic impact, it is fear that we will actually be fully free from the EU. As per the headline of Ashoka Mody's article in the Independent , we should "Ignore the Brexit scare stories - they have no basis in sound economics".