BrexitCentral: The Treasury’s policy-based evidence making on Brexit has got to stop

In his letter of 23rd August to Nicky Morgan, Chair of the Treasury Committee, the Chancellor, Philip Hammond, repeated the Treasury’s prediction of an 8% reduction in GDP over the next 15 years under a no-deal Brexit.

This is exactly the same prediction that his predecessor, George Osborne, gave during the referendum campaign in his short- and long-term analyses of the economic consequences of a Leave vote. Mr Osborne said that the short-term analysis:

“…comes to a clear central conclusion: a vote to Leave would represent an immediate and profound shock to our economy. That shock would push our economy into a recession and lead to an increase in unemployment of around 500,000, GDP would be 3.6% smaller, average real wages would be lower, inflation higher, sterling weaker, house prices would be hit and public borrowing would rise compared with a vote to Remain”.

Only one of these predictions was realised, namely the weakening of sterling – which actually had significant benefits in terms of boosting both exports and the returns on investments held overseas.

The Chancellor’s letter also notes the support for his projections from organisations such the IMF, the OECD, the LSE and NIESR. Those organisations use the so-called ‘gravity model’ of international trade – as did the Treasury at the time of the referendum. This model predicts that more trade will be done between closer, larger economies than more distant, smaller ones. However, the predictions of the ‘gravity model’ have been very poor since the referendum. A particularly poor prediction was the impact on employment. Instead of falling by 500,000, employment has risen by 600,000.

The gravity model would also have been a poor predictor of trading relationships well before the referendum. For example, it would have failed to predict that Britain’s principal trading partners in the nineteenth century were not European, but rather the US, Canada, the West Indies, Argentina, Brazil and China. These are the very trading partners we can re-engage with now once we now longer have to rely on Brussels taking seven years to negotiate a typical trade deal which is then subject to a veto by Wallonia.

As a result of the poor predictions, the Treasury has changed its model, but it won’t reveal how. It is now believed to be using a ‘computable general equilibrium’ model of trade called GTAP (from the Global Trade Analysis Project at Purdue University). This is a more ‘classical’ model of trade and has both a ‘supply’ side (involving production functions with factors of production, such as labour and capital) and a ‘demand’ side. This is very different from the gravity model, so it is surprising to hear the Chancellor continuing to assert that the IMF, the OECD, the LSE and NIESR support the new Treasury model, unless they have also switched models and kept quiet about it.

Despite using a new model, the Treasury has clearly calibrated it to produce exactly the same dire predictions as the previous gravity model – a strategy known internally as ‘policy-based evidence making’. The new model was then used to produce the ‘Cross Whitehall Briefing’ forecasts that have informed preparations for the UK’s departure from the EU across all Whitehall departments. Yet the only information about the new model that the Treasury has put into the public domain – very reluctantly – is the poorly photocopied set of PowerPoint slides on the parliamentary website. These reveal nothing about the structure of the model or how it was calibrated. Even the Prime Minister describes the new Treasury model as a ‘work in progress’.

Even more disappointing is the fact that the Treasury refuses to publish the results from the new model under the assumption that the UK implements the kind of free trade agreements (FTAs) that our main trading partners are begging us to introduce once we leave the EU in March next year.

Fortunately, it is possible to assess the benefits of these FTAs using a similar ‘computable general equilibrium’ model built by Professor Patrick Minford of Cardiff University and Chair of Economists for Free Trade (EFT). EFT have used the model in our new Budget for Brexit Economic Report – which forecasts huge economic gains in the event that Britain leaves the EU under a SuperCanada deal. The report also calls for a Post-Brexit Fiscal Fund to demonstrate that ‘Britain is open for business’.

Minford calculates that by 2020, there would be £25 billion per annum for the Post-Brexit Fiscal Fund and by 2025 this will have increased to a huge £65 billion per annum. To give an idea of the type of policies this could fund, Minford says:

“A 1% rate cut in:

  • Corporation tax would cost £2.6 billion in 2020 (hence £3.2 billion by 2025-6)
  • The standard rate of income tax £4.9 billion (£5.8 bn in 2025-6)
  • The standard rate of VAT £6.4 billion (£8 bn.)
  • The top rate of income tax £1.3 billion (£1.6 bn.)
  • The very top (‘additional’) rate £0.2 billion (£0.3 bn.)

From 2025, the further dividend of £40 billion per annum could be taken. At this point,

  • The standard rate could be cut by 2%, at a cost of £12 billion (raising the tax threshold is very expensive and hardly affects any marginal rates, mainly going in the form of lower taxes to the better off, barely helping the less well-off because they lose benefits); or else VAT could be cut by 1.5% for roughly the same cost
  • Corporation tax could be cut another 3%, costing another £10 billion; and
  • The top rate could come down by 2%, costing around £3 billion.
  • The remaining £15 billion could be used on spending.”

These figures give a very different view of the prospects for the UK economy post-Brexit. It is clearly unacceptable that key economic decision-making about the future of this country’s economy depends on a ‘work in progress’ model by the Treasury that is not in the public domain or subject to independent scrutiny. Even the Treasury’s two pre-referendum models were put in the public domain and were subject to the criticisms they justly deserved.

It is time for the Treasury to immediately release a technical report outlining the structure of the model and the assumptions it used to calibrate it. A key set of assumptions that were used in the ‘Cross Whitehall Briefing’ study is that the UK will impose the same set of tariffs on trade with the EU that we are forced to impose on the rest of the world under the Common External Tariff. These increase the cost of food and manufactures to UK consumers by an average of 20% once non-tariff barriers are taken into account.

It is in the gift of the UK Government to set the tariffs it imposes on imports from abroad after we leave the European Union. The Government could immediately agree to reduce these tariffs on imports from all countries in order to benefit UK consumers as EFT have been recommending for some time. For example, it could reduce tariffs by 12%, the same as the devaluation of sterling at the time of the referendum, so that the prices of imported goods are no higher than before the referendum.

This would greatly benefit UK consumers, but the Treasury has deliberately not modelled this scenario either. The Treasury must therefore immediately release full details of the new Treasury model so that others can use it to estimate the huge economic benefits from cutting taxes and import tariff as well as the other benefits to Global Britain pursuing free trade deals around the world.

To read the piece in full, click here.

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