Brexit doom mongers are looking ahead, but they may be wrong again

Brexit doom mongers may be wrong again. Photo / AP

Opinion

The failure of economists to forecast the short-term impact of Brexit has not dampened their enthusiasm to project long-term gloom.

Economic Remainers are now certain that leaving the EU is a huge anti-trade mistake. Several new studies conclude that the UK cannot make up for the lost trade caused by leaving the single market, even if we signed free trade agreements with the rest of the world. They therefore mock Theresa May's claim that "no deal is better than a bad deal".

But there are good reasons to think that the consensus might again be confident of conclusions which just ain't so.

The approach used to reach their findings echoes the infamous Treasury "gravity model" analysis on the long-term costs of Brexit. A well-evidenced result is trade between two countries tends to rise in proportion to the size of the economies and fall in proportion to the distance between them, like a gravitational pull.

Trade data across countries and time periods can be used to estimate the strength of these effects. This allows researchers to examine EU membership or signing a free trade deal increases trade beyond the gravity effects would predict.

Last year, the Treasury concluded EU membership more than doubled (115pc) trade in goods (imports and exports) relative to trading under WTO rules, without harming trade from non-EU countries. This drove its conclusion that a "Hard Brexit" would reduce GDP by 7.2pc.

Given that the EU is big, close to us, and an integrated market, similar analysis now suggests that free trade agreements with countries much further away will not compensate for these losses. To suggest otherwise is "denying gravity".

Yet a new paper by Dr Ken Coutts and colleagues at the University of Cambridge (a version of which will be published by Policy Exchange after the election) suggests that the effect of EU membership on UK trade is much smaller than the Treasury and others believe.

The important reason is that the EU uplift the Treasury estimated is an average across member states calculated from data over many years. The Cambridge academics show that this uplift has in fact been falling in recent decades. They find as well that the Treasury model significantly over-predicts the trade that the UK should be doing with EU countries, suggesting EU membership is less positive for UK exports than other member states.

There are good reasons why this might be the case. The UK specialises heavily in services (where the single market is less complete) and tends to be more liberal on regulation, meaning single market harmonisation might have been less beneficial here. Looking at the UK alone in recent decades, this new research estimates that EU membership increases UK exports by a much smaller 20pc-25pc (rather than the Treasury's 115pc).

But even this seems an overestimate of the impact of "no deal", as it is unlikely that all of these benefits will be reversed on exit. Many trade-enhancing developments attributed to the EU may have come from reforms that all EU states adopted, and the UK would not abandon. While tariffs and customs administrative checks would be imposed on UK exports to the EU, non-tariff barriers will also be initially low, as UK firms are already compliant with EU regulations. The fall in the exchange rate has compensated exporters somewhat too.

It's hard not to conclude that once again the economic consensus might be misjudging the impacts of Brexit and severely exaggerating the long-term impact of leaving the single market.

Regulations could diverge and present more problems for UK-EU trade over time, of course, but by then there would be strong incentives for either the UK and EU to sign a deep and comprehensive trade deal or for UK exporters to find new markets at world prices. Patterns of trade suggest this kind of diversion occurred when we joined the EU and in the long run we'd expect this re-orientation to be significant.

There are two further reasons why the gravity models overstate the downsides of a "no deal" scenario. First, the UK has the ability to unilaterally reduce its own tariff and regulatory protectionism after Brexit. This, as the work of Professor Patrick Minford from Cardiff University has shown, would reduce consumer prices and expose our exporters to global competition, boosting long term productivity.

Second, the models often neglect too that economic gravity will itself shift over time as developing countries grow. A recent Open Europe report, for example, explained that Germany's GDP is forecast to grow by just 14pc between 2017 and 2030, yet India's is expected to more than double. Examining the impact of signing trade deals with countries such as India today rather than in 2030 will therefore dramatically overstate the relative benefits of EU membership.

While gravity models do have significant pedigree then, they are backward-looking and may simply not be well suited to analysing large long-term regime changes such as Brexit. Indeed, as my former Economist for Brexit colleague, Professor David Blake, has outlined, Greenland's economy grew rapidly when it left the EU in 1985 and Ireland's trade with the UK was unchanged by its exit from the sterling area in 1979. The gravity model would not have predicted either. Yet it does imply that almost all countries worldwide would be better off joining the EU.

It's hard not to conclude that once again the economic consensus might be misjudging the impacts of Brexit and severely exaggerating the long-term impact of leaving the single market.

Ryan Bourne occupies the R Evan Scharf Chair for the Public Understanding of Economics at the Cato Institute.