BrexitCentral: The economic consensus on Brexit has got it all wrong

My new Politeia paper reviews the economics of the trade deal that will be struck between the UK and the EU under the international legal order of the WTO. I take the view that what will be agreed must be in the economic interests of both sides; and I try to quantify those interests.

The gains from Canada plus and why the alternatives are impossible

First I evaluate the economic gains for the UK and the EU of no Brexit at all – so-called ‘soft Brexit’ – whereby the UK stays in the Single Market and the Customs Union, even though no longer formally in the EU. Leaving aside the political loss of sovereignty involved, the UK would lose decisively from this option, to the tune of 7% of GDP over the coming 15 years, around 0.5% a year off growth. The reasons are straightforward: the UK makes big gains from free trade, so that leaving the Customs Union gives obvious gains and makes the present pushback from Remainers economically incomprehensible; it also makes sizeable gains from self-regulation and border control.

For the EU plainly matters are different: the EU gains if the UK changes its mind, because it continues to sell food and manufactures to the UK at inflated protected prices, it faces less competition from a differentially-regulated UK and it can continue to export its unemployed into the UK job market. Nevertheless, though Michel Barnier is playing a political game with our Remainer fifth column to stop Brexit in all but name, the gains to the EU from this cannot be achieved because such a ‘soft Brexit’ lies behind a plain UK ‘red line’- a line drawn by the politics of the referendum result as well as plain economic interest.

At the other extreme, I calculate the economics of ‘no trade deal’. For this case I assume that both sides adhere to international (WTO) law which dictates non-discrimination in standards and the maximum logistical efficiency in customs; thus customs costs are trivial and there are no non-tariff barriers erected by standards discrimination. This leaves tariffs which are permitted both ways by the WTO; again these must be non-discriminatory under WTO law, so that they would apply to the whole world other than those enjoying Free Trade Agreements. Of course, in the UK case there would be many such agreements so that it could well be that the only tariffs the UK winds up setting are against the EU.

‘No trade deal’ is economically expensive for the EU, for three reasons. The tariffs EU producers would pay the UK come to around £13 billion a year, while the tariff revenues the European Commission would receive would come to £5 billion a year, all of it from EU consumers. The Commission would not receive the UK financial settlement of some £40 billion. Also, Brexit would start two years earlier than under ‘Canada plus’, with the EU losses as just explained. For the UK, however, there are mirroring economic gains: Brexit starts earlier, it avoids the financial settlement, and it receives the extra tariff revenue. In net discounted present value, the UK gains £650 billion, while the EU loses £500 billion. While therefore a ‘no trade deal’ Brexit would be attractive to the UK, it lies behind an EU ‘red line’ and is not available.

Thus are we left with ‘Canada plus’. This consists quite simply of free trade both ways in goods and mutual recognition of service standards so that the same free trade occurs in services, including the City of London. This has the virtue of preserving the free trade that already exists between the two sides.

When one discounts red line territory that excludes the alternatives, this is ‘Win-win’ for both sides. The EU avoids the breakdown inherent in no trade deal. The UK proceeds with Brexit. There are also  gains to the EU from Brexit, even if now unappreciated, in the form of more competition from UK industry via regulatory competition; also the removal of the ‘safety valve’ of UK migration will force more labour market flexibility inside the EU, long an aim of the Commission.

Within the UK, the gains from Brexit enable the use of the Brexit fiscal dividend to reduce taxes and raise spending. These make possible a further round of Brexit gains which will bring austerity to a welcome end.

[…]

So whichever way you slice it, the economic consensus has got it wrong, with wrong modelling and incredible policy assumptions. My team and I may be outliers, but only because the rest have in common been in serious error.

To read Patrick’s piece for BrexitCentral in full, click here.

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