Response to Ambrose Evans-Pritchard in The Telegraph

By Patrick Minford

A E-P reports on the views of John van Reenen and in particular quotes his estimate that the WTO option would reduce UK GDP by 2.5% via trade, plus an effect of reduced foreign investment and so productivity effects, bringing the total reduction to 8.5%.

In effect van Reenen’s position is like Winters’ and that of the Treasury’s Project Fear, to which he was an adviser. In the response to Winters above I have explained once again why this approach is wrong and gives the opposite of correct answers. Also I and others set out a comprehensive critique of the Treasury’s approach and results during the referendum, to be downloaded from www.economistsforfreetrade.com (Minford, 2016 a, Blake 2016 and Dowd 2016). Similarly I responded at length to van Reenen and the LSE critique of my work in ‘Reply to LSE’, available in the same place (Minford, 2016 c). For those wishing to see more recent debate my oral evidence to the International Trade Committee, in discussion with the LSE’s Swati Dhingra and the TPRO’s Jim Rollo is available from the Committee’s website (Economists for Brexit, 2016).

In a nutshell the Treasury made its trade calculation assuming continued UK protection in the same gravity model which in turn calculates the effect of EU membership on trade via trade gravity regressions for many countries: the coefficient is therefore an average of many countries’ experience on joining the EU. It is not in any way linked to detailed tariff and non-tariff barriers and it reflected many factors affecting events at the time of joining. Hence there is no way of deducing from these what the effect would be of the unique event of the UK leaving and changing its trade barriers v the EU.

Furthermore on the FDI relationships these are the usual regressions of productivity by industry on FDI plus another set of regressions relating FDI to trade among other things. The problem about such regressions is their interpretation because these relationships come from underlying policies (such as controls, taxes and trade barriers) and business opportunities at the time: FDI and trade are both aspects responding to these other factors (they are ‘endogenous variables’) and again one cannot read off these the ‘effects’ of trade or of FDI.

To macroeconomists these are all old familiar points as is the spuriousness of the empirical tests claimed by these and other trade economists- there is no ‘test’ involved in fixing up the parameters of a trade model so as to yield the results of gravity equations. It is as if these economists have

simply failed to understand the significance of the revolutions in macroeconomics in the past few decades. Unfortunately this incomprehension carries a policy cost as this ad hoc approach based on gravity and related regressions is hostile to free trade and fails to give a proper account of comparative advantage. In this theory such as it is one trades as one does because one is close and for no particular other reason other than sheer size: hence policy should simply build up what is, in an echo of the infant industry argument for protection. The fact that policy such as that of the EU is protectionist can under this theory be good as it fosters more of what you have.

Yet how come then at the UK is heavily specialised in financial and other services which are sold all over the world? It is plain enough that this is so because the UK has a large supply of skilled people who can provide these services effectively and it has withdrawn barriers to entry (e.g. via Big Bang in 1986 in the City). What this highlights is that to understand trade patterns you must bring in the economy’s supply side, especially factors of production available in the country. Also, to make sense of the widespread penetration by the UK of many countries’ markets you must assume free entry into the world market together with implied high levels of competition. All this is typically denied in gravity models. However even under imperfect competition free trade remains the welfare- dominant policy except in most unusual circumstances and free entry pushes this world close to that of full competition where free trade is unquestionably the welfare-dominant strategy.

In short van Reenen et al are espousing a neo-protectionist agenda based on a model in which there is little real competition. It is no wonder that they attack free trade with the world as a whole, preferring EU protectionism. But for the UK government this has rightly come to be seen as a position quite harmful to the UK’s long term interests which manifestly lie with global free trade as quantified in the classical model of trade with worldwide free entry and competition and comparative advantage based on supply-side factors.

Original Piece:

* Britain needs fighting ‘Plan B’ for trade as EU turns screws on Brexit AMBROSE EVANS-PRITCHARD
26 APRIL 2017 • 8:56PM

The European Union is hardening its terms on Brexit. There is a new hint of hostility in the language. The tone is peremptory.

Those of us who hoped that Germany would push quietly for an amicable settlement can no longer be so confident. We now learn from Handelsblatt that the German finance ministry insisted on some of the most unfriendly changes to the EU’s latest working documents.

Berlin stipulated that Britain must honour “all obligations” (Verpflichtungen) for divorce payments, a tougher wording than the earlier, gentler talk of legal and budgetary “duties” (Pflichten).

It demanded that Britain desist from tax dumping and financial deregulation that would “jeopardize the stability of the union”. This demand is almost insulting. British regulators have led efforts to recapitalize banks. It is the eurozone and Germany that have dragged their feet on tougher capital rules.

There is no longer any attempt at diplomatic tact. The document states that the European Commission will “determine” when the UK has made “sufficient progress” as it jumps through the hoops, the way it handles accession talks for supplicants hoping to join. It reads like an imperial curia discussing a colony.

The French too have stepped up their demands, insisting that financial services be excluded from the trade deal. The City of London must respect the “regulatory and supervisory standards regime” of the EU in any future arrangement, suggesting that Britain will have to accept the sway of the European Court.

Some argue that France will soften its line under a President Emmanuel Macron. His economic strategist is the anglophile Jean Pisani-Ferry, co-author of a Breugel paper proposing a ‘continental partnership’ between Britain and the EU that preserves very close ties.

Sadly, Mr Pisani-Ferry has made no headway with this idea. I have met Mr Macron enough times – or have seen him at EU venues behind closed doors – to detect a messianic fervour for the European project. He is a crusader by political religion, the EU’s latterday Bernard de Clairvaux.

But it is the hardening mood in Germany that is most ominous. The reason for the sudden change is unquestionably Theresa May’s snap election. While we think that the Prime Minister’s motive is – in part – to build a buffer against Brexit ultras in her own party, that is not the view in Berlin. Germans see her gambit as anti-EU sabre-rattling and a breach of good faith.

“The EU wants to counter Theresa May’s rhetoric and kill the idea that a bigger conservative majority will make any difference to their negotiating position,” said John Springfield from the Centre for European Reform.

The German press has likened Mrs May’s demarche to the defiant posturing of Alexis Tsipras in Greece. They almost take it as a given that her Brexit plan will fail and that she too will be forced to capitulate, grovelling for mercy. One wonders where the briefings are coming from in Berlin.

The parallel with Greece is on one level absurd. Syriza caved after the European Central Bank cut off liquidity and shut down the banking system. Britain is not in the euro or vulnerable to such coercion, and the strategic contours are entirely different.

Yet the Greek saga is instructive. The lesson is that you do not bluff with the EU power structure. If Theresa May still thinks that “no deal is better than a bad deal”, she had better have a credible Plan B, and she must be willing to activate it.

Falling back to the minimalist option of the World Trade Organisation and hoping to craft global trade deals smacks of defeat. It would leave Britain in limbo, pleading with the US, Japan, China, India, and other countries to embark on talks when they have larger matters at hand.

So it is time to think in revolutionary terms. Parliament’s Exiting the EU Committee called earlier this month for a detailed study of what it would mean if the UK left the EU without a deal.
Downing Street should answer this legitimate request, and the menu should include the nuclear option of unilateral free trade.

This is a heady Cobdenite manifesto, a turbo-charged version of the Repeal of the Corn Laws in 1846. No developed country has ever attempted such a thing, though New Zealand comes closest, leaving aside the special cases of Hong Kong and Singapore.

All tariffs would be cut to zero. There would be no restrictions on imports besides obvious safeguards, such as policing child labour or environmental abuses, or for national security reasons.

It needs no reciprocation, working from the premise of Adam Smith that if any other country wishes to impose or maintain barriers that is their own folly. They suffer the welfare loss. The currency would adjust to the new equilibrium, keeping the current account close to balance over time.

Adam Posen, head of the Peterson Institute in Washington, said Britain would face a rough time with no EU trade deal but at least such a plan has creative allure. “It is far more credible than other options,” he said.

The current dismal narrative on Brexit would be transformed overnight. Britain would suddenly be seen by the rest of the world as pioneering nation at the forefront of globalism, reasserting Thatcherite audacity, rather than a crabby islanders in decline. “People’s jaws would drop,” says Professor Patrick Minford from Cardiff University.

Pure free trade cuts through the Gordian Knot, eliminating the need for an army of technocrat negotiators and for yet more of those supra-national tribunals that so proliferate, eviscerating democracies and sapping consent for globalism.

Prof Minford says the hide-bound political class has yet to give such clear blue sky proposals a serious airing. “It is so unfamiliar. It takes a mental somersault to break free of mercantilist thinking,” he said.

Economists for Brexit – now Economists for Free Trade – certainly got off on the wrong foot last year by suggesting that the UK would be positively richer under such a model. This invited a blizzard of criticism.

My own view has always been that there will be a negative shock from Brexit and withdrawal from the single market, with effects on GDP at best neutral by 2030 with the right policies.

Professor John Van Reenen, a trade expert at MIT and a vocal critic of the Minford plan, says retreat to the WTO would cost roughly 2.5pc of GDP compared to remaining in the EU, with losses rising over time to 8.5pc due to productivity effects.

He agrees that unilateral elimination of barriers is the best WTO variant since it at least mitigates damage to supply-chains entering Britain from the EU. “It offsets some losses but the politics of all this would be very hard,” he said.

Clearly there would have to be income support for farmers and the rural way life – as a cultural choice – and temporary measures to shield the car industry and key sectors from sudden trauma.

Prof Van Reenen said that if Britain wishes to take this leap into the dark, it should at least try to use the allure of zero-tariffs to generate goodwill and secure at least some concession on market access for goods and services. Smithians disagree: reciprocity is not strictly necessary, and should not become the obsessive focus of talks.

As for models used by trade economists, these cannot reliably predict what would happen in an overthrow of the existing economic order. The variables are too big. Nobody knows how investors would react, or what other countries would do. We are in the realm of psychology.

Brussels might try to portray the move inaccurately as ‘dumping’ but the EU would be in the odd position of erecting barriers where none existed before, in effect retreating into unilateral protection vis-a-vis an open Britain.

The claim that the EU had to do this to defend the sacred acquis and the integrity of the Union would in such circumstances be humbug, inviting a good intellectual trashing.

Such a trade plan is certainly a high-risk venture. It might lead to a sterling crisis and a deeper break- down in confidence. But it might equally be a powerful catalyst for renewal. It deserves proper study.

What is clear is that if the final document presented to Britain looks anything like the EU papers circulating this week, no sovereign state can accept it. We will need a Plan B. It should be crystal clear, on the table, fully-loaded, with the trigger cocked.

REFERENCES

Dowd, Kevin (2016) ‘Lies, Damn Lies and the Treasury’s Brexit Reports’, downloadable www.economistsforbrexit.co.uk

Economists for Brexit (2016), Oral evidence by Martin Howe, QC, and Professor Patrick Minford to the House of Commons International Trade Committee. Downloadable from www.economistsforbrexit.co.uk.

Minford, Patrick (2016a) ‘The Treasury Report on Brexit: a Critique’, downloadable www.economistsforbrexit.co.uk

Minford, Patrick (2016b) The Brexit Consensus Bug, downloadable www.economistsforbrexit.co.uk Minford, Patrick (2016c) Reply to LSE, downloadable www.economistsforfreetrade.com

Minford, Patrick and Edgar Miller (2017) ‘What shall we do if the EU does not play ball?’, downloadable from www.economistsforfreetrade.com.

Minford, Patrick, with Sakshi Gupta, Vo Phuong Mai Le, Vidya Mahambare and Yongdeng Xu (2015) Should Britain leave the EU? An economic analysis of a troubled relationship, second edition, December 2015, pp. 200, Edward Elgar.

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