The anti-Brexit Project Fear reached its zenith yesterday. Having published a paper suggesting GDP per household would fall by £4,300 in the long term (by 2030) if Britain left the EU, the Treasury yesterday turned its guns on the short-term implications of leaving.
And guess what? Research produced by a department run by a chancellor who thinks we should stay in the EU suggests the results of leaving would be very bad! If we vote to leave, we’d supposedly see a year-long mild recession, the economy 3.6 per cent smaller relative to remaining after two years, inflation higher, house prices lower, higher unemployment and a range of other bad outcomes.
As with the first lamentable Treasury offering, key to dismembering this biased account is working out the assumptions behind it. And here we do not need to dig long to find buried bodies. Essentially, the results are driven by three economic phenomena: people adjusting their spending and investment patterns because they expect Brexit to permanently lower their incomes, the near-term effects of uncertainty, and volatility in financial markets.
The first impact can be summed up quite easily as “rubbish in, rubbish out”. A large part of the result is driven by people reducing spending and investment because the Treasury assumes that the results of its long-term paper are correct (that we would be poorer than if we remain) and this changes behaviour now.
As outlined previously in this column, however, that Treasury paper was riddled with bizarre assumptions – not least that we would not adjust any regulatory policy or pursue more expansive trade when we had secured those freedoms outside the EU. This is particularly amusing, because just this weekend a leaked civil service document outlined how other member states made the EU a barrier to more free trade.
The first Treasury paper’s modelling methods were also extensively critiqued by our Economists for Brexit group – for relying on a range of economic associations with little theoretical underpinning and for being prone to extensive biases in the equations.
The short story is this: if you use the highly exaggerated negative long-term Treasury results then this effect on spending will be exaggerated in the short term too.
If, on the other hand, you presume that sensible policies on trade, migration, regulation and government spending are adopted and expected post-Brexit, and that as a result Brexit was beneficial to long-term performance (as papers by CEBR, Open Europe and Economists for Brexit have shown), then the short-term effect would in fact be an economic boost. The biggest threat of a negative impact happening from Brexit, therefore, is precisely the scaremongering of the Treasury and its effect on expectations.
Of course, no sensible person on the Brexit side would suggest that there would be absolutely no uncertainty from leaving the EU. The Treasury is well within its rights to model that effect on investment and spending. There will be some short-term adjustment in the two years after Article 50 is triggered and an exit is negotiated (though during that time all current arrangements will remain in place and it would be in the interests of both parties to pursue a mutually-beneficial transition).
To a degree, therefore, Brexit will be a very short-term shock, the probability of which will already be factored in. But previous research by the OECD has shown that economies react better to shocks when they can adapt quickly – with independent macro policies, flexible labour market policies, a political system conducive to structural reform, and a liberal approach to trade. The UK fulfils these criteria and thus is much more resilient to shocks than, say, the Eurozone. In fact, Brexit would enable the UK to improve the economy’s institutional flexibility to future shocks further, as we would not be sucked into greater political union.
So the flipside of any short-term Brexit risks is a range of significant long-term opportunities. An opportunity to run a more expansive trade policy and exit the disastrous common agricultural and fisheries policies. An opportunity to reshape regulation to domestic circumstances. An opportunity to protect the City of London from Brussels’s regulatory zeal. And an opportunity to spend money better or cut taxes from any savings from our large gross contributions to Brussels.
Provided one trusts that the UK’s democratic processes will over time produce good policies in these areas, there is nothing to fear from the economics of Brexit and thus the Treasury’s results fall apart.