City A.M.: The doom-mongering Whitehall forecasts are dismally misguided

AS CABINET ministers assemble at Chequers for yet another crunch Brexit showdown, doubts linger over the quality and accuracy of briefing papers prepared for them.

The good news is that civil servants appear to have quietly shelved the method behind the now-infamous long-term impact study published by the Treasury prior to the referendum.

This study used the so-called gravity model approach, which related trade to the size and proximity of trading countries. In reality though, this was really just a sequence of calculations based on a set of correlations – and the oldest rule in econometrics is that correlations do not prove causation.

The new approach – revealed in leaks about a secret unpublished Whitehall study earlier this month – appears to have dropped the partial gravity model in favour of a general equilibrium global trade model. This is a step in the right direction. However, the research remains flawed.

It appears that ministers are still being told that lowering trade barriers against the rest of the world will have little or no beneficial effect to the UK, and that pursuing barrier-free trade with a Canada-plus trade agreement will still result in huge border costs and lost trade with the EU.

According to the leaks, these latest doom-mongering forecasts show a six to eight per cent negative impact of Brexit on UK GDP. British exports to the EU account for 12 per cent of our GDP, meaning that Whitehall is suggesting the UK will lose at least half the value of its EU exports. This is patently absurd.

In sharp contrast, a new Economists for Free Trade study shows that three separate modelling approaches all produce a positive outcome from Brexit. A previous study by the think tank Open Europe showed that general free trade (zero tariff barriers on imports from the whole world) and a Canadastyle agreement would produce a net gain of 0.8 per cent of GDP.

These estimates also assume large border costs equivalent to one per cent of GDP. This estimate is surely far too high since, according to the World Bank, 98 per cent of trade is pre-cleared through customs. Consequently the positive gain from Brexit is likely to be understated in their study.

Adjusting for the impact of the removal of non-tariff barriers on UK imports from across the world shows a bigger gain from Brexit of around two per cent of GDP.

This is not the end of the story. The world trade model used by Economists for Free Trade has been validated for the UK, unlike the general equilibrium model in the leaked Whitehall report. This shows that the positive effect of Brexit gets larger the closer the model fits the facts of UK trade.

Furthermore, the Economists for Free Trade study shows that if the correct “gravity model” approach is used, it also produces a positive Brexit outcome.

In other words, whichever modelling approach you use – if done correctly – results in a positive outcome from Brexit of between two and four per cent of GDP. Moreover, if the wider potential benefits of Brexit are included (such as deregulation and ending EU budget contributions), the positive impact increases to seven per cent of GDP over the next 15 years.

To read Graeme Leach’s piece for City A.M. in full, click here.

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