Taking a macroeconomic perspective, Paul Welfens reflects what the findings of his book ‘An Accidental Brexit’ mean in light of new developments in the Brexit negotiations. He argues that if the true economic consequences had been known, the referendum would have turned out differently and shows the potential pitfalls of the ‘Global Britain’ approach to international trade.
The joint statement by PM May and President of the European Commission Juncker on 8 December declared: there is a basic agreement on the ‘Exit Treaty’, including a UK payment of £35 to £39 billion and the British promise to avoid a hard border regime in Northern Ireland. Hence, Stage II of the negotiations can start in the near future. An exit treaty opens up options to avoid a No-Deal Brexit which would bring a net welfare loss of approximately 16% of UK real income as estimated by the European Institute for International Economic Relations (Discussion Paper 234).
Economic consequences of Brexit
This figure already includes, as a gain, the assumed removal of UK import tariffs on agricultural products which could raise real income by 1% plus a UK-US transatlantic trade & investment agreement that could bring a rise of 2%. The income loss – in the sense of lower income growth relative to the benchmark of the UK remaining in the EU – would be spread over more than a decade and thus will not be felt dramatically in 2018/19. However, in both coming years, the inflation rate could be close to 3% due to a high devaluation of the Pound – as already seen in late 2017. The US stock market rally, the inflation-induced real wage reductions 2016/17 in the UK, the EU27 economic upswing, and global growth will all help the UK to avoid a recession in 2018/19, but the growth rate will be much lower than was expected in 2015. A comparison of the 2016-2020 forecast of the Office for Budget Responsibility implies – looking at the forecasted figures from Nov. 2015/Nov. 2017 – that Brexit is already responsible for an output loss of more than 4% in 2016-2020.
Even if one assumes a sectoral free trade agreement between the UK and the EU27, the income loss faced by the UK is at least 10%, a figure also found in the Treasury study (2016) on long-term UK benefits of EU membership. However, in the 16-page information brochure which the Cameron government mailed to all households in England during 11-13 April 2016, not a single word was mentioned regarding this key finding on the potential cost of Brexit. Had voters received the message that they could face a 10% income decline through Brexit, standard UK popularity functions – showing the link between disposable income growth and government popularity – imply that the result of an orderly referendum in 2016 would in fact have been 52.1% for Remain.
The message of Brexiteers is often that economists are good at analysing history, but bad at forecasting future developments; actually, this is to suggest that one should not believe in studies showing a clear negative output effect of Brexit. This conjecture is about as convincing as saying that meteorologists are good at analysing history, but bad at forecasting the weather – but this view is nonsense. Everyday, millions of people watch the weather forecast, which, admittedly, is sometimes wrong, but more often than not rather accurate for the coming days. Economists are not always good in forecasting short-term business cycle dynamics – medium-term and long-term modelling is, however, more reliable. Anything less than 12% medium-term real income loss from Brexit would be a big surprise for the UK; for the lower strata of society, this figure is a disaster and the government has such a tight budget that there is no hope of being in a position to easily increase transfers to poor households. A decade of modest growth and high inflation would be critical for median income households and poorer strata.
With modest growth, the UK government will face increased pressure after 2018 to reduce corporate tax rates – as an impulse to stimulate the investment-output ratio that has started to decline strongly in 2017. There will also be a new wave of excessive banking deregulation in the UK which, along with US deregulation under President Trump, will lead to excessive deregulation pressure for the EU and hence, sooner or later, to the next Transatlantic Banking Crisis. This holds unless the EU and the UK would agree upon continued EU-UK joint banking regulation which is not a likely outcome from the divorce negotiations in Brussels. This topic should urgently be put on the negotiation agenda.
‘Global Britain’ and new trade deals
The May government has argued that Global Britain will be the key to maintaining high growth. Global Britain should bring a new network of free trade agreements, but the only relevant element will be the envisaged US-UK trade and investment partnership. An EU-Japan deal has been reached in December 2017 so that the UK might also benefit from this if some grandfathering rights can be established post-Brexit. A free trade deal with China is unrealistic since this would wipe out large parts of the British industry. A trade deal with India is also not very likely since the Indian government will ask for more visas for Indian workers which will not find much sympathy in parts of the UK government and the British public at large after so much anti-immigration rhetoric from Cameron and May. Trade deals with other small countries, while possible, are not really economically relevant. British exports to the EU amount to 12% of the UK’s national income, the share going to the US only to 2.5%. Hence, if there is no broad free trade agreement between the UK and the EU27, the export dynamics of the UK will be subdued for many years to come. Another reason why Global Britain cannot work is that the US has started to undermine multilateralism as well as the role of the World Trade Organization – an institution strongly needed for free trade policy initiatives. President Trump has blocked the re-election of judges for the Appellate Body of the WTO which will be effectively dysfunctional from late 2019. Prime Minister May has been silent about this shocking institutional dismantling of multilateralism – Brexit makes the UK so dependent on the US that May appears blind to such developments.
Brexit will come on the basis of a disorderly referendum. Not only did Cameron’s brochure suppress the information regarding significant income losses to be expected according to the Treasury analysis. A normal result – without the lies of Boris Johnson about EU contributions – would have been close to 55% Remain. Boris Johnson repeatedly pointed to the red bus of the Leave campaign claiming that £350 million per week was sent to the EU, and that this amount would be better spent on the NHS. However, only the net British EU payments of about £170 million per week is available for the NHS or other UK budget lines after Brexit since UK government payments will largely replace current EU payments to British regions, firms, universities, etc. that so far benefit from Brussels. The head of the UK Statistics Authority, Sir David Norgrove, emphasised this in an open letter to Johnson on 17 September 2017. In it, he claimed that Johnson’s wilful confusion of gross payments and net payments constituted a ‘clear misuse of official statistics’.
In Shakespeare’s Hamlet one can read that honesty is a scarce resource and indeed it still is. PM Cameron was arguing since 2012 that there was too much immigration, which he considered – as did May in her White Paper on Brexit (January 2017) – to be a burden for the UK. The OECD, however, showed in 2015 that immigration had a positive net budget effect for the UK. So why Cameron’s burden claim? He was mainly looking for a scapegoat as his government, facing a record 10% deficit-GDP ratio after the banking crisis, had to cut the budget deficit. Cameron’s cut of budget transfers to local authorities reached a shocking 3.5% of GDP in five years – thus an underprovision of local public services occurred. When people asked ‘who is to blame?’ the answer was: ‘Immigrants’. Thus, both Cameron and May ignored the facts and have played a cynical rhetorical game. The EU Commission, on the other hand, was not bold enough to at least send a blue bus with correct net national contribution information to all countries of the EU in early 2016. A general EU-wide information campaign would not have interfered directly with the UK campaign but could have provided clarification for all EU citizens.
Taking back control?
The EU27 is likely to lose the UK as a member country unless there is a second EU referendum in 2018 – in the context of a fair information policy of government. There is no strong political voice for Remain as the leader of the Labour Party is not committedly pro-EU membership, considering the four freedoms of the EU single market to bring too much competition. Many people will wake up after Brexit to just how much more competition the UK really has to face under the Global Britain approach.
The Leave slogan ‘take back control’ is strange and misleading as the UK’s gross domestic product is one quarter of that of the EU27, so that international deals, e.g. in the field of trade, will be more difficult for it to obtain individually than under the EU28 umbrella. Moreover, the depreciation of the Pound to be expected means that the economic weight of the UK will fall by a fifth. Depreciation will raise the share of foreign ownership in the UK capital stock, meaning more foreign influence rather than less.
Prof. Dr. Paul JJ Welfens is President of the European Institute for International Economic Relations (EIIW) at the University of Wuppertal and Chair in Macroeconomic Theory and Policy as well as Jean Monnet Chair for European Economic Integration. He is a Senior non-resident research fellow at AICGS/Johns Hopkins University and author of the book An Accidental Brexit (London, Palgrave: 2017).
Note: The views expressed in this post are those of the author, and not of the UCL European Institute, nor of UCL.