The Telegraph: Establishment economists’ gloomy Brexit forecasts have no credibility

How many economists does it take to change a light bulb? Let’s assume that we know the answer. How many economists does it take to stitch up Brexit? The answer is hundreds.

Last week we were bombarded with gloomy prognostications from the Treasury, telling us that our long-term future would be much worse outside the EU, particularly if we leave “without a deal”. On the same day, we had to endure an even gloomier onslaught from the Bank of England, telling us that the short-term impact would be dire.

How much credibility should be attached to these forecasts? None. They have been prepared by people with both an agenda and an appalling track record of getting the big issues wrong.

What do economists know? The answer is “not a lot”. This isn’t because they are dastardly or incompetent. The trouble is that the economy is complex and the future is pretty difficult to foresee. You might think that this should breed a certain modesty. But no, your average establishment economist is a strange creature. Despite repeated experience of being grossly wrong, they seem to think they can pontificate about the future, even down to a decimal point.

The Treasury’s assessment of the post-Brexit future is especially remarkable for how little benefit is derived from free-trade agreements (FTAs) with the rest of the world – a mere 0.2pc of GDP. Yet, when the EU itself looked at the benefits of concluding FTAs with these countries it put the gain at 1.9pc. Meanwhile, the Treasury seems to think that the benefits of having an FTA with the EU amount to almost 3pc.

It has managed to produce its bizarre results by making a series of assumptions that are buried deep in the technical annals of its document, where mere mortals are not supposed to tread. In particular, it assumes that we do deals with only half the world, non-tariff barriers are only partly abolished and then only a quarter of this agenda is actually accomplished in the period under review.

In other words, it purports to show that the gains from a strategy of global free trade are minimal by basing its assessment on the assumption that we actually manage to make minimal progress towards free trade. Nice one, Cyril!

Another key economic argument for Brexit is that it will enable us to make our own regulations, leading to a less onerous regulatory burden on business. There is a small gain from this source factored into the Treasury assessment of a no-deal Brexit, but it is nugatory. Interestingly, the gain from this source is about the same under a no-deal Brexit as under Mrs May’s agreement. Go figure!

The study is also remarkable for the costs it attaches to trade “frictions”. It tries to estimate their costs by using all the usual economists’ tools. Yet we have direct evidence that such costs should be minimal, including the evidence from various ports, which tell us that they inspect a tiny fraction of cargoes and that documentation is handled electronically before shipment.

But I think the most convincing argument on this issue comes from some basic facts. If “frictions” are so significant how is it that non-single market countries export so much into the single market and indeed that the rate of increase of their exports is greater than that of most single market members to other members?

This should ring a bell. In the debate in the late Nineties about whether or not we should join the euro, those arguing in favour adduced the argument that if we did not join, British business would face substantial costs deriving from “uncertainty and transactions costs”.

They weren’t wrong in either theory or practice. But they were completely wrong about the magnitude and significance of these costs compared to other factors. For “uncertainty and transactions costs” then, read “frictions and non-tariff barriers” now.

The Bank’s apocalyptic vision of the immediate aftermath of a no-deal Brexit is even more absurd. In the modern world, supply-side shocks have often not had the impact that was expected. The reason is substitution, and substitutability has increased, thanks to globalisation and the digital revolution.

There are now more alternative sources of supply, more alternative products and, because of information technology, we now know more about how to access those alternatives.

In any case, if we do leave without 
a deal this can hardly come as a complete shock. We have been moving towards this conclusion for months, and if Parliament votes down Mrs May’s deal, individuals and businesses will have three months to prepare.

The Bank’s study is also peculiar in that in its worst case scenario it puts up interest rates to 5.5pc. No wonder that house prices fall by 30pc. But I do not remotely believe that this would happen. In the past, when a supply shock or a fall of sterling has caused the inflation rate to spike up, the Bank has looked through this temporary upsurge. Quite rightly. I am sure that it would do the same again. Indeed, it may well cut rates.

The Bank’s view on interest rates is heavily conditioned by its view that the pound would fall a long way. This is perfectly plausible. But currencies frequently make fools of us. I can readily imagine circumstances in which the pound rises after a no-deal Brexit. Some disruption is already expected. If it proves to be less serious than anticipated then there will be a sense of relief in the markets.

But for most market operators, the most important fear, far more important than Brexit, is a certain Mr Corbyn. If a successfully accomplished no-deal Brexit is followed by a boost to the Government’s standing and a fall in Labour’s support, then I could see a substantial capital inflow into UK assets, causing the pound to rise. Nowhere is such a possibility reflected in the Bank’s thinking. I suppose that the models don’t do politics. Or reality.

To read the piece in full, click here.

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