- The latest ‘no-deal’ warnings by Chancellor Phillip Hammond and the Office for Budget Responsibility (OBR) are yet another reheating of ‘Project Fear’
- Hammond’s claims that barriers to UK-EU trade will make the UK worse off are simplistic and some of his claims are inaccurate
- The OBR’s claims about the effect of ‘no-deal’ are based on an IMF analysis which is sloppy, outdated and in some respects totally implausible. An uncharitable observer might well characterise them as ‘rubbish in, rubbish out’
- A new UK prime minister needs to dump Project Fear analyses and concentrate on practical measures to assist UK businesses to adjust to changed circumstances after Brexit
Chancellor Philip Hammond and the Office for Budget Responsibility (OBR) have, over the last couple of days, both warned of negative economic consequences of a ‘no-deal’ Brexit. Both of their analyses are deeply flawed, being re-heated versions of economic analyses that are skewed and methodologically unsound.
Hammond claimed it was ‘terrifying’ that anyone could believe ‘we’d actually be better off by adding barriers to access to our largest market’. There are several things wrong with this statement:
- The EU is not the UK’s ‘largest market’. For most UK businesses, the UK is the largest market and within foreign trade, non-EU markets are larger than the EU. UK exports to the EU represent only around 13% of UK GDP, UK exports to the rest of the world about 16% of GDP.
- There is no reason why trade barriers overall need rise in a ‘no-deal’ situation. Outside the EU customs union and regulatory system, the UK has the opportunity via trade deals with third countries and/or unilateral tariff reductions to reduce overall trade barriers with the rest of the world – our real ‘largest market’. Indeed, the government’s draft no-deal tariff schedule would be one of the most liberal in the world, with an average unweighted tariff rate of just 0.7%.
- Hammond’s analysis misses a whole range of other factors. Hammond’s simplistic equating of UK living standards with the extent of EU trade barriers ignores a whole range of other changes and policy moves a ‘no deal’-style exit could open up for the UK. Smart regulatory reform (worth perhaps £20-30 billion a year), an end to £10 billion a year net budget payments, new agricultural and fishing policies and reform of welfare benefits could all yield significant gains for the UK. We have shown that such measures, plus freer trade with the rest of the world, could easily outweigh plausible estimates of negative effects from new trade barriers with the EU.
What of the OBR analysis? At the core of the OBR’s claims is an analysis of a ‘no deal’ Brexit produced by the IMF. This analysis was published in the IMF’s April World Economic Outlook, and we wrote an article at the time criticising the IMF’s claims as ‘sloppy and overblown’. Key problems with the IMF analysis include:
- The IMF assumes that implausibly massive trade barriers appear between the UK and EU. As well as tariff barriers of 3-4% (which are relatively small), the IMF claims non-tariff barriers of up to 24% of trade values will be created. This estimate is extreme – a range of sensible academic studies suggests such barriers will be more like 3-4% of trade values while some industry-level studies put them as low as 1% of trade values. Many UK firms have already completed work-arounds to side-step such barriers (including switching testing and certification to EU-based bodies).
- The IMF assumes UK exports are very price sensitive. The IMF has suggested that for every 1% rise in the prices of UK exports of goods and services, demand for them falls by 4-5%. This would create a big drop in UK exports to the EU for even moderate trade barriers. But the IMF’s estimates here contrast sharply with much academic evidence that points to UK exports being relatively price ‘inelastic’: such studies suggest that for a 1% rise in the prices of UK exports of goods and services, demand for them falls by only 1-1.5%.
- The IMF assumes the UK loses ‘most’ third-country free trade agreements in place via EU membership, with these being replicated only after two years. This assumption is out of date as the UK has already agreed rollover deals covering 60% of UK trade covered by these EU deals.
- The IMF’s claims on financial services are nonsensical. The IMF has claimed that UK financial services exporters under ‘no-deal’ would face trade barriers with the EU worth 50% of trade values, with their output down 25% in the long run compared to a baseline where the UK stayed in the EU. These claims are based on wild overestimates of the importance of financial services ‘passporting’ to the UK and draw heavily on a discredited consultancy report by Oliver Wyman which claimed Brexit would lead to 75,000 job losses in the City of London (the latest estimates suggest a total of just 2,000 roles have moved or been created overseas). Relying on this poor-quality report to calibrate such an important element of their work is sloppy practice by the IMF.
- The IMF assumes away key policy responses. The IMF analysis allows for some moderate policy easing by the UK authorities to smooth the impact of no-deal but fails to incorporate some of the most likely moves. For instance, the IMF claims government and corporate bond yields would soar and the authorities would take no action to stop this – but we know that in reality such action would be taken. For example, the Bank of England would be likely to restart a quantitative easing programme, in the same way it successfully did in 2016, to curb any rise in bond yields. A considerable loosening of budgetary policy would be likely too – for which the UK has plenty of room with the budget deficit down to under 2% of GDP.
So, the OBR’s claims are centred on an IMF analysis which assumes away most upsides, features extremely pessimistic assumptions including trade barriers and trade elasticities that are as much as five times too high, and includes financial sector effects that have no proper basis in quantitative work at all. Any fiscal projections that are drawn out from such an analysis should be treated with, at best, enormous scepticism. A more uncharitable observer might refer to the OBR’s latest exercise as ‘rubbish in, rubbish out’.
It is to be hoped this latest pair of official Project Fear missives will be the last. A new UK prime minister needs to end such shroud-waving analyses and concentrate on practical measures to assist UK businesses to adjust to changed circumstances after Brexit.