(Updated on 4th Jan to correct all values expressed as % of GDP and to add job estimates)
Change Britain, the pro-Brexit outfit some members of which are behind, amongst other things, the NHS Brexit bus debacle, released a study claiming “that a huge £24 billion a year prize is on offer if the UK Government pursues a ‘clean Brexit’ and decides to leave the EU’s single market and customs union.” The full report does not seem to be available on the website but a brief summary is presented highlighting the basis of this claim. It is good news in the sense that it is the first detailed estimate of the economic impact of a clean (i.e. hard) Brexit I have seen from the pro-Brexit camp.
If you don’t want to go through the full analysis below, here’s the key points:
- Change Britain does mention that a hard Brexit will result in a decline in trade with the EU and, consequently, total GDP. They ignored the point in their analysis and claimed that the new trade deals the UK could sign with non-EU countries, will result in increase in GDP. The analysis below will show that even this possible increase will not match the probable decrease in GDP from leaving the EU. Once we add this up, a total of 233,000 jobs could be lost, compared to a gain of 400,000 estimated by Change Britain in a complementary analysis.
- The benefits of getting rid of EU red tape are equivalent to 0.07% of annual GDP. Whether this independence is worth jeopardizing goods and services exported to the EU, worth 12% of the UK’s GDP, remains a value judgement.
- Because the UK exports services as much as it exports goods, future prosperity will depend on level of integration (with EU and non-EU countries) beyond the scope of free trade agreements, which tend to focus mostly on trade in goods and tariffs. Enabling trade in services largely depends on ensuring freedom of mobility of people and capital, therefore the UK will need to harmonize its regulations to that of other countries or block of countries (through things like TTIP or, heaven forbids, the EU single market). Leaving aside for a moment the important aspect of political feasibility and desirability of this, the matter of fact is that if the UK is to keep a strong export-driven service sector, it will need to give up some sovereignty (to the EU or anyone else) in order to remain competitive.
The post-truth analysis
When you have got partisanship, opinions and passion who needs an expert? Experts are so 2015, right? In this case, I’d like to give you my post-truth analysis: half as a professional economist and half as a pro-EU progressive (who is about to move to London in February, hopefully before Article 50 is triggered). So now that you know all of my biases, let us debunk the analysis.
The analysis of the analysis
The £24 billion a year prize from leaving the EU, equivalent to 1.2% of GDP, is calculated as follows:
- UK net contributions to EU budget: £10,353 mil (o.46% of GDP, based on 2016 from ONS). Following the link on their website, I could not find the figure in the source they cited. Based on fact-checked Treasury figures, the more likely impact will be around £8,473 mil – unless their higher figure is the result of converting the 2015 EU contribution from the 2015 euro amount using today’s exchange rate, which has dropped significantly because of the Brexit referendum.
- Scrapping EU red tape (net): £1,220 mil (0.07% of GDP). This figure represents the net impact (benefits minus costs) of the 100 most cumbersome regulations for British businesses. Change Britain excluded regulations that Britain will be bound to because of international agreements that will remain after Brexit, as well as those regulations that are also government priorities. A big argument of the pro-Brexit campaign has been to take back control by rejecting EU intrusion in domestic affairs. Guess what, that control is only worth 0.26% of GDP, and that’s without taking into account the bureaucratic cost of preparing for the great disentanglement (a leaked memo estimates that the civil service will need to hire up to 30,000 employees to deal with the over 500 Brexit projects)
- Predicted impact on exports: £12,294 mil (0.67% of GDP). This assumes that the UK manages to negotiate free trade agreements with India, Mercosur, China, Canada, Korea and the USA. The table below summarizes the expected impact based on the Change Britain study vs. the length of negotiations for similar agreements.
Key statistics on free trade agreements (FTAs)
|Negotiations started||Agreement signed||Years||Reference|
|India FTA||1,500||0.08%||10/2003||8/2009||5.9||ASEAN-India FTA|
|Mercosur FTA||1,800||0.10%||5/2010||12/2016||6.6||EU-Mercosur FTA (not concluded)|
|China FTA||200||0.01%||11/2004||4/2008||3.4||NZ-China FTA|
|Korea FTA||3,200||0.17%||5/2007||10/2009||2.5||EU-Korea FTA|
|USA FTA||3,800||0.21%||4/2001||1/2004||2.8||US-Australia FTA|
Source: Change Britain and a variety of sources for the timelines (mostly Wikipedia)
Barring a sudden influx of post-truth optimism, there are a number of issues with these assumptions:
- The feasibility of concluding all of these agreements quickly is very slim. Also, it must be noted that the UK lacks the large bureaucratic infrastructure to negotiate trade deals, given that for the past thirty years all trade negotiations were handled by Brussels. There are approximately 600 trade negotiators in the EU and 300 in Canada but apparently close to zero in the UK civil service.
- How do you deal with a problem called Donald: if the Trump administration officially designates China a currency manipulator, politically it would be difficult for the UK to sign a trade agreement with both China and the USA. Granted coherence is not Donald’s strongest suit, but rushing to sign a FTA with the UK might be a lot from a man who has publicly promised to dismantle the North American Free Trade Agreement. Canada and Mexico are likely to close ranks in on Trump (see their recent visa liberalization). If Trump decides to weaken NAFTA and sign a FTA with the UK, one could expect the Canadians to be less than enthused about signing an agreement with the UK as well. So it looks like a China-US-Canada impossible triangle is lurking. Finally, timelines for a FTA with the US will be long. The 3 year timeline for the US-Australia FTA happened against the backdrop of Australian support to the war on terror. NAFTA took years to sign, ratify and over a decade for all of its provisions to fully come into effect.
- Negotiating a trade deal with India is notoriously difficult: it was Indian opposition that derailed the last round of global trade negotiations and PM May’s visit to the country seems to have tied the negotiations to the future of the ever shrinking number of visas issued to Indian workers and students. Hard to see how to square that with the pro-Brexit immigration control promises.
- You could have already gotten a lot of this at no additional cost: had the UK stayed in the EU or opted to stay in the customs union, it would already benefit from the Canadian and Korean FTAs, which represent half of the gains from new trade deals that the Brexit camp is projecting.
What is missing from the analysis.
First, it does not take into account the negative impact of trade losses by losing access to the European single market. Secondly, it counts the savings from EU membership as an increase in GDP – this is misleading.
Without extensively nitpicking the study presented by Change Britain, its main flaw is that it does not weigh the gains from a hard Brexit against the loss in European trade arising from losing access to the single market. Thankfully, the US Congressional Research Services compiled estimates from a variety of studies. The table below summarizes the impacts on UK GDP by 2030 of hard Brexit and of signing a FTA with the EU. I have also added a study from the London School of Economics.
Estimate of the impact of signing a FTA agreement with Europe compared to current EU membership scenario
|Highest estimate||Lowest estimate||Mid-point estimate|
|HM Treasury **||-7.60%||-4.60%||-6.10%|
|Confederation of British Industries**||-5.50%||-3.50%||-4.50%|
Even assuming that all the benefits from cutting red tape and new FTAs are accrued as quickly as the loss of trade from the EU materializes, this would leave the UK 4.4% poorer than when it was in the EU. Update: Change Britain estimates that “2,503 new UK jobs [are created] for each €-billion of extra-EU exports”. A contraction of 4.4% of GDP would be equivalent to € 93.4 billion loss, or 234,000 jobs. This is against 400,000 additional jobs created by new trade opportunities that they estimated in a follow-up post to the one analyzed here.
Source: Change Britain’s estimates of gains from leaving the EU vs average of estimates of impact from leaving the EU
Source: own analysis based on mid-point estimate of GDP loss from five scenarios and Change Britain’s estimate of gains from leaving the EU (excluding value of EU contribution, see below).
The cost of admission
Of course there’s the matter of the 0.46% of GDP that Britain contributes to the EU budget. Even if the government spent all of this on the economy, it would not translate directly into GDP (the reasons are a bit tedious, but in a nutshell, for the contribution to translate into GDP it would need to be spent on locally-sourced goods and services and the expenditure needs to go mostly towards salaries and profits. For instance, spending the full 0.46% to give a raise to NHS staff will stimulate GDP more than importing foreign-produced equipment for defense or infrastructure purposes). Because the EU contribution is a budgetary measure (the government could theoretically pocket the amount), the gains from not paying the EU contribution should be measured against the losses from tax revenues that would result from the GDP contraction after leaving the single market. These effects are difficult to disentangle, but a simple correlation analysis of the 1998-2014 trend shows that when GDP goes down by 1% in a given year, total government debt goes up by 2.56% (i.e. the annual deficit in that year is equivalent to 2.56%).
Correlation (not causation!) between change in UK GDP and change in government debt
Source: own analysis based on GDP and UK total debt in pounds, source data World Bank database for the period (1997-2014)
One needs to be careful when extrapolating the correlation. But as a very rough estimate, if by 2025 GDP is 4.4% smaller, then government deficit could be 11.3% (= 4.4 x 2.56) larger. One needs much more sophisticated tools than that to do a proper analysis. Unfortunately, Change Britain did not provide their own estimates so we’ll have to go with the Treasury estimate of £36 billion loss in revenues, after taking into account a zero contribution to the EU budget. That is equivalent to around 7.6% of GDP. Because the Treasury analysis uses a counter-factual scenario (all things being like what they were before the referendum, excluding access to the EU single market), the estimate excludes the benefits accruing from the hypotherical additional FTAs.
Beyond the tactical critique
I am hoping to write a follow-up post on the politics of Brexit, so this concluding arguments will be about economics. By this, I am not implying that economics should trump politics, it’s just that politics deserve a detailed discussion of its own.
The matter of the fact is that tariffs on goods have been declining globally. This is thanks to negotiations through WTO and the rise of regional trade agreements like the EU, ASEAN and NAFTA. Because the UK at the moment faces the same external tariff as the EU, its average tariff rate is 1.6% (i.e. a weighted average of categories by country of origin by rate applied). The EU has the lowest applied rate but other major economies also have low rates. As a consequence, the margin for improvement in tariffs post-Brexit are very tight: for most of the things that the UK will want to buy, it will realistically pay low tariffs, maybe slightly above what EU countries pay, if the US and Australia are a good benchmark of the UK’s negotiating power going forward.
Tariff rate applied, unweighted mean (%)
Source: World Bank database
The UK exports £225.5 bil worth of services (and £284.9 bil worth of goods) according to the UK Pink book (2016, Chapter 9). Trade in services is equivalent to 12.3% of GDP – service exports to the EU are equal to 4.9% and service exports to the rest of the world are equal 7.5% of GDP. In order to promote exports, the UK needs to pay attention to the service sector if it wants to bring in some additional revenues to its economy after it leaves the EU.
The problem with enabling trade in services is that it needs a level of trade integration beyond what is traditionally offered by free trade agreements. Even a relatively expansive FTA like the Canada-EU Trade Agreement (which took 7 years to negotiate) only has limited provisions concerning services and does not cover financial services. The main obstacles to trade these days are so-called non-tariff barriers, things such as different regulatory requirements, health and safety standards, etc.
Non-tariff barriers to the EU are significantly lower for the UK than say Canada and Korea, both countries that recently signed a FTA with the EU. In the graph, the value of 97 for the UK in 2014 means that it cost 97% more to sell from the UK to the EU than it would cost to sell within the UK itself. Whereas the UK faces significantly lower non-tariff barriers of trading with the EU than Korea or Canada, the UK faces significantly higher cost of trading with European countries that are not in the EU, in line with Korea and Canada.
Non-tariff barriers for UK, Canada and Korea – by trade partner
Source: Non-weighted average of non-tariff barriers estimates from World Bank UNESCAP Trade Cost Database (2016 release).
Recapping the analysis so far:
- The possible increase in UK’s GDP from signing free trade agreements with other countries is unlikely to match the probable decrease in GDP from leaving the EU single market and opting for a free-trade agreement. The net of the two effects is a contraction of 4.4% of GDP, equivalent to 230,000 jobs lost.
- The benefits of getting rid EU red tape are equivalent to 0.07% of GDP. As a comparison, the value of goods and services exported by the UK to the EU is equivalent to 12% of the UK’s GDP.
- Membership in the EU has meant that non-tariff barriers faced by the UK are half as costly as those faced by countries like Canada and Korea that have currently signed a FTA with the EU. If the UK wants to become an export-led powerhouse, it will need to give up some sovereignty to negotiate with other countries on issues of mobility of labor and capital.
In the end, none of this matters right? The experts were wrong in predicting a recession right after the referendum vote, so surely this is just some more scaremongering. So why should we care about the numbers now?
The analysis by Change Britain only came months after the campaign and it is patchy and subject to a long list of objections. It is not even based on Change Britain’s primary analysis, but instead it relies on third party studies, such as Open Europe or the European Commission. If Change Britain wants to lead this sort of momentous change, the least they owe their constituencies is a better attempt at preparing for the change.
There’s of course the political angle. But that deserves a post of its own.