Archive for the ‘Economics of Brexit’ Category

Many voters do not believe economists are impartial

More than half of Leave voters distrust the opinions of economists, and men, older voters and the less educated are more likely to mistrust them. Nonetheless, more than half of all voters  say they want to find out more about the economic effects of leaving the EU. Alvin Birdi (University of Bristol), Ashley Lait (Economics Network) and Mark Cliffe (ING Group) warn that as the General Election approaches economists need to be extra careful to avoid accusations of political bias.

On the surface, it is encouraging that in the run up to an election which is bound to be dominated by Brexit, the ING-Economics Network Survey finds that there is a healthy interest in learning more about the economic effects of the UK leaving the EU. Over half of respondents expressed an interest in increasing their understanding of these effects. This desire is high across the sample but considerably higher among Remain voters (65%) than for Leave voters (49%).

This desire to increase understanding is heartening, but it stems from a troubling lack of knowledge about the impact of Brexit. Indeed, 42% say they do not feel they have a grasp on the economic consequences of the UK leaving the EU, while just under half (49%) feel they did have a grasp of these issues. The lack of understanding seems to be worsening, with 40% of the survey reporting it is becoming harder over time to understand the economics relevant for informed voting in elections and referendums.

face with raised eyebrow
The Twitter and WhatsApp ‘Face With Raised Eyebrow’ emoji. Public domain

It should be said that a knowledgeable electorate is not the only marker of successful democratic participation and political agency. This is especially the case where any shortcomings in relevant knowledge can be rectified through informed and trusted expert opinion. But if trust in experts is lacking there is a risk of undermining this important democratic input.

Sadly, our survey shows a considerable lack of trust in professional economics opinion, particularly among Leave voters. Significantly higher numbers of Leave voters (51%) distrust the opinions of economists on the world economy compared with Remain voters (23%). Worse still, this scepticism has intensified since the EU referendum, even among Remain voters. 45% of Leave voters have become more sceptical, compared with 28% of Remain voters. Most of the rest express either no change in their scepticism or no opinion.

We find that scepticism is also more prevalent among Conservative voters (46% compared with 31% of Labour voters), older people (over 40% of over 50-year-olds compared with just under a quarter of 18-49 year olds), men (36% compared with 31% of women) and the less educated (24% of people without GCSEs are much more sceptical compared with 11% of people with a degree).

Indeed, this lack of trust is underlined by the finding that under a third of Leave voters (31%) believe that economists base their comments on verifiable data compared with over a half (58%) of Remain voters. Similarly, 26% of Leave voters believe such comments are based on political affiliations compared with 13% of Remain voters.

On the eve of an election, much of which will turn on economic issues, the mixture of a perceived lack of economic understanding, a desire to learn more economics and a distrust of those that can provide such understanding is a challenge for democratic participation. The fact that the lack of trust is skewed across political lines underscores both how divisive the EU referendum has been and how the consequences of that division present trust and communications challenges to economists. They need to be extra careful to avoid accusations of political bias in both the tone and substance of their analyses.

Note

The ING-Economics 2019 Network Survey of The Public’s Understanding of Economics is based on an online poll of 1,641 respondents from across the country conducted by YouGov. A previous cohort was surveyed in 2017. The first of a series of reports from the survey concentrates on public understanding, trust in economists and differences between Leave and Remain voters.

This post represents the views of the authors and not those of the Brexit blog, nor LSE.

It’s ridiculous! The disarray of our fiscal system leaves voters short-changed

Our fiscal policies are in disarray, and this will leave voters short-changed. Jagjit S. Chadha (NIESR) explains that fiscal policy planning has just taken a huge retrograde step with the delay in a budget, spending plan and official economic forecast. Furthermore, he argues that whatever government we end up with is unlikely to reach its self-imposed fiscal mandate and that an unfunded spending spree risks unhinging fiscal policy even further.

The fiscal framework adopted in 2010 built on the success of the experience with monetary policy. The basic mechanism, which was replicated to a great degree in the fiscal case, is that a macroeconomic target that suits society is pursued transparently with the support of independent forecasts of whether the target will be achieved. The target and instrument are bound together by a rule that explains how the instrument will respond to the state of the economy. The advantage of rules-based policies is that other participants in the economy can formulate their plans in a manner consistent with the target and if the policy-maker is going to miss the target, there is scope to explain why and how the economy will get back on track. By binding people into a common path of adjustment, it simply becomes easier to meet the target, which should be exactly what society wants anyway.  While monetary policy has more or less been bound by such a framework, our fiscal policy is more or less in disarray.

Image by Andy ThornleySome rights reserved.

The basic approach to rules-based policy led to a number of excellent innovations in monetary decision-making.  We first set a target consistent with price stability and moved from Treasury-determined interest rate-setting through to operational independence of the Bank of England. We have a fixed timetable for monetary policy decision-making, the quarterly production of an inflation forecast, the creation of a transparent decision-making process at the Monetary Policy Committee and a fillip to Parliamentary scrutiny of monetary policy at the Treasury Committee. As well as promoting a strong national interest in interest rate decisions, that might be more than just thinking about the mortgage, it has also focussed the attention of the key institution on meeting its target, which helped us deal with the shock and aftermath of the financial crisis.  All of the above have contributed to nominal stability. Across town the story is woeful.

The fiscal targets have not only been rather opaque and portmanteau but have been changed as often as the instrument itself, the deficit. We have had nearly has as many different sets of fiscal rules in the nine years or so since we adopted rules-based fiscal policy. There are three fundamental problems here that explain why we keep changing targets. First, it is not really possible to write down a socially optimal level of public debt: as it is simply not a fixed point or timeless quantity. The second is that the quantity of debt, per se, does not really matter unless scaled by output and from year to year that is determined by fluctuations in demand and in the long run by the growth in supply potential and so is largely outside the control of the government. And finally that the key fiscal instrument, the year to year budget deficit, is rather complicated as it depends on each of public expenditures, taxes raised and the interest rate paid on debt.  In the language of economics, it is a very noisy instrument rather than the direct control of Bank Rate available to the MPC.

And so it is hardly a surprise that targets have been missed and rules changed. Indeed we do not even have a clear timetable for fiscal events. We have shifted the date of the budget from spring to autumn and now are poised to move it back again. Currently, government departments are having to work with a one-year spending plan, rather than the three-year version that was promised. And to add insult to injury, the Office for Budget Responsibility that is responsible for modelling the government’s fiscal plans has had its forecast shelved at the last minute. These independent forecasts would have allowed the electorate to understand whether the government would have hit its self-imposed targets, which the same government had decided on the day the previously announced budget had been cancelled to drop anyway, in favour of another set of rules. Yes: it is that ridiculous.

Fortunately, NIESR published its own analysis the previous week, which explained that the government would not reach its fiscal mandate and that an unfunded spending spree risked unhinging fiscal policy as well as missing the chance to set right the shortfalls in sustained public investment in physical and human that are required.  Indeed the muting of the OBR also means that other parties do not feel the censor of an open discussion of their spending plans with a required explanation of accompanying plans for their funding – also known as taxes in grown-up circles.  Where does this all end?  It ends with increased risk of a further official downgrade of our fiscal position by the ratings agencies. In case you missed it, Moody’s took the first step on 9 November by changing the outlook on its rating of the UK’s debt from “stable” to “negative”.

Will Johnson’s Brexit deal bring choppy waters to Holyhead?

The new Withdrawal Agreement would mean the Irish Sea will become a border between Welsh ports and the Republic of Ireland. This will mean big changes for Holyhead. Andrew Potter (Cardiff Business School) looks at the likely problems and how they could be minimised.

As 2019 draws to a close, the logistics industry is once again digesting a new potential scenario for moving goods between the UK and EU, thanks to the Withdrawal Agreement agreed in October and which will be enacted if the Conservatives win a majority in the General Election. Within Wales, there has been significant discussion by both politicians and the media about what this might mean for ports, and particularly those serving the Republic of Ireland.

The most important port in this discussion is Holyhead, with over 440,000 trucks travelling to or from Dublin in 2018. These are roll-on roll-off (RoRo) movements, often time sensitive and always accompanied by the driver. Consequently, this makes Holyhead the second largest RoRo port in the UK after Dover.

Bringing back a border

The main thing to note is that the new agreement would effectively make the Irish Sea a border between Welsh ports and the Republic of Ireland. This differs from the previous version of the Agreement and occurs because the UK would move away from both the Customs Union and the Single Market.

holyhead
Holyhead. Photo: Chandler Abraham via a CC BY 2.0 licence

Consequently, there would be a requirement for more checks at the port of departure and/or arrival. These extend beyond just customs and include animal welfare, driver licencing and insurance and product conformance, and therefore involve various government agencies. More often than not, these checks will involve little more than a review of paperwork, but the volume of vehicles through Holyhead mean that delays would seem likely.

Further, 40% of the traffic through Holyhead is actually using the UK as a landbridge, rather than going by sea between Ireland and mainland Europe. Therefore, these movements will generally be subject to two sets of checks as they enter and leave the EU. It is also unclear what the circumstance will be for traffic from Northern Ireland that currently passes through the Republic of Ireland on its way to Holyhead.

The impact on Holyhead

What this means is that it will take longer for vehicles to pass through Holyhead, leading to queues and delays. The first few days would likely be the worst, and over time a ‘new normal’ situation would emerge. However, given the nature of products and that the driver is the biggest cost in road haulage operations, these delays may encourage a switch to unaccompanied vehicles where the trailer travels alone and is collected from the port at the other end. In this instance, ports such as Liverpool become more attractive given their existing services and when time is less important in decision making.

For landbridge traffic, the option of bypassing the UK completely by sea could become more attractive, although the impact on Holyhead and other Welsh ports is likely to be determined more by what happens in Kent and the English Channel crossings. For the traffic from Northern Ireland, taking one of the shipping routes from Belfast or Larne would seem to be far superior given the UK commitment to not have checks on such flows.

Consequently, the impact on Holyhead will likely be a reduction in freight volumes over time, especially given both the time sensitive nature of the freight movements and the competition from other Irish Sea ports such as Liverpool. As the port is a major employer in Anglesey, the impact would be felt throughout the local community, and along the north Wales coast more widely.

Solutions

Despite the above, there are steps that can be taken to mitigate some of these potential impacts. Within the port itself, there may be the opportunity to reconfigure the layout to ensure that vehicles can flow through more effectively and, where backlogs may occur, allow space for trucks to park up and wait. For the wider supply chain, ensuring that all paperwork is done correctly and that drivers are fully briefed on what they need to carry with them will make a big difference. After all, the checks in themselves will only add very small amount of extra time and it will be those with the wrong paperwork that really cause major backlogs. But supply chains are complex and, given the 25 years of Single Market membership, many firms and individuals are unfamiliar with these requirements. Therefore, training and briefing sessions from across industry and government are required.

Here, the Withdrawal Agreement offers something that will help these preparations – time. With a transition period to the end of 2020 (and potentially longer), it will be possible to all organisations involved in cross-Irish Sea movements to plan how to change their processes with a degree of certainty as to what the future will look like.

The only uncertainty for now is whether the new Withdrawal Agreement can survive the current political environment.

This post represents the views of the author and not those of the Brexit blog, nor LSE.

A missed opportunity? Revisiting the euro referendum that never was from a historical perspective

In 1997 all the main parties promised a referendum on whether Britain should join the euro, but eventually Labour ruled out membership. Anti-euro campaigners went on to hone their arguments in the 2016 referendum. Stuart Smedley (King’s College London) suggests that this may have been a missed opportunity for the government to tackle Eurosceptic narratives.

Early historical accounts of the United Kingdom’s engagement with the process of European integration categorised the failure to join the European Coal and Steel Community and European Economic Community at their launch as representing ‘missed opportunities’. These decisions, it was argued, denied Britain a leadership role in Europe, which accession to the EEC in 1973 only partially rectified. With time, however, this historical interpretation came to be challenged as more measured assessments of these decisions emerged.

Yet in light of the outcome of the 2016 referendum, it is worthwhile revisiting the ‘missed opportunities’ thesis and using it as a frame through which to analyse domestic aspects of Britain’s European integration policy. One decision in particular stands out as being worthy of such treatment: the failure of Tony Blair’s Labour government to hold a referendum on joining the single European currency.

On the face of it, this may seem like a sensible policy choice. It appeared highly likely that a referendum would have led to the British public rejecting the euro. Indeed, referendum voting intention polling on the subject showed a consistently strong lead for those who would vote ‘No’ – even when the public were presented with a hypothetical scenario in which the government recommended a vote in favour.

However, through an analysis of the Blair government’s policy towards the euro, campaign material produced by anti-euro campaign groups, as well as historical opinion poll data, it becomes apparent this was arguably a ‘missed opportunity’ – and that Labour perhaps should have held a referendum on the principle of British membership of the single currency.

Alongside the Conservatives and Liberal Democrats, ahead of the 1997 general election Labour promised that any decision to join the planned single currency would require the consent of the British public. For Labour, a referendum would be the final stage of the path towards adopting the euro, but it would only have been held if Cabinet and Parliament had provided their approval. Labour also insisted that any decision to join would have to be ‘determined by a hard-headed assessment of Britain’s economic interests’. As a result, in October 1997 Chancellor Gordon Brown set out the five economic tests that would have to be satisfied.

Yet the five tests, along with the National Changeover Plan announced in 1999, seemed to signal that the government was making preparations to adopt the single currency – and thus to hold a referendum. This speculation was fuelled further by the Eurosceptic press. But Labour did not help themselves. Indeed, it was not until June 2003 – five and a half years after they were initially announced – that the five tests were reassessed. During that time, Europe sustained a high level of public salience. According to Ipsos MORI’s Issues Index, prior to the 1997 general election a record 43% of British adults mentioned Europe as an important issue facing Britain (this was the highest level of importance it would achieve until February 2017). While concern declined after Labour entered office, between 1998 and 2000 Europe’s average monthly importance matched that for unemployment – the dominant issue of the early 1990s – and was only bettered by health and education. Furthermore, Europe’s salience only receded after the 2003 assessment of the five tests, an event which made it clear that Britain would not be joining the euro.

Anti-euro campaign groups subsequently took advantage of this situation, launching a form of proxy campaign in which their views went largely unchallenged. The most prominent organisations established were Business for Sterling (whose early Head of Research was a certain Dominic Cummings) and New Europe. These groups would then merge to form the ‘No’ campaign in 2000. With the support of prominent business organisations, including the Institute of Directors (IoD), these groups expressed doubts about the economic case for adopting the single currency. Intriguingly though, they did not outright reject the euro’s purported economic benefits. Instead they merely argued against adoption ‘for the foreseeable future’ on economic grounds.

But the questioning of the economic case appeared to be a means to lend greater credibility to the far more emotive reasons they gave for rejecting the single currency. The crux of their arguments against the euro related to control and identity – two themes that not only resonated with the public, but further embedded themselves in popular discourse about the EU and variations of which were returned to with great effect in the 2016 referendum.

The idea that adopting the euro would see Britain lose control over key aspects of economic policy was one that featured heavily in the campaign groups’ literature, examples of which can be found in the LSE Archive’s ‘Eurosceptic’ collection. The ‘No’ campaign even produced a leaflet that used a pair of handcuffs to depict the effects of the currency, which they claimed would ‘lock’ Britain into economic policies that would be heavily to its disadvantage.

‘No’ campaign leaflet, undated but probably 2000 or 2001 (LSE/EUROSCEPTIC/11/3)

Arguments about control tapped into a belief strongly evident among the British public. Eurobarometer surveys conducted in 1995, 1996, 1998 and 2001 found that between six in ten and two-thirds of British adults felt that joining the single currency would ‘imply that Britain will lose control over its economy policy’. Unsurprisingly, this view was held by an overwhelming majority with a negative view of the EU. But even those who considered Britain’s EU membership to be a good thing were more likely to accept this argument, with around half doing so in 1995 and 1996.

Public opinion in Britain on whether the euro will or will not… (Source: Eurobarometer)

 1995199619982001
Imply that Britain will lose control over its economic policy
Will %666462 59
Will not %21222017
Don't know %13141824
Imply that Britain will lose too much of its national identity
Will %666362
Will not %262822
Don't know %91013
Note: Data are based on the author’s own calculations and have been taken from the following Eurobarometer files in each year: EB44 and EB44.1 (1995), EB45.1, EB46 and EB46.1 (1996), EB50 (1998) and EB55 (2001). Data have been filtered to adults aged 18 and over in Great Britain in order to reflect those of voting age. Percentages may not total 100 due to rounding.
In 2001, the question used was altered to ask the extent to which respondents agreed or disagreed that the euro will lead to various outcomes. For the purpose of this post, in the table above those answering ‘Totally agree’ and ‘Somewhat agree’ have been combined as have those answering ‘Totally disagree’ and ‘Somewhat disagree’. Strictly speaking though, 2001 data is not directly comparable to that shown for previous years.

Anti-euro groups also sought to portray the euro as another step towards undermining the sovereignty and identity of nation states. In a 1998 booklet, Business for Sterling labelled the currency as ‘a political project [that] flows from an ambition to create a single political and economic entity in Europe’. Meanwhile, in a pamphlet authored by the economist Sir James Ball, New Europe described the euro as ‘a key element in the march towards some form of European Federal State’ and that it was ‘a gross deception for the British government to pretend otherwise’.

The most similar notion tested on Eurobarometer related to the idea that adopting the euro would ‘imply that Britain will lose too much of its identity’. A clear majority felt this would occur, with around two-thirds doing so. Among those with negative opinions of Britain’s EU membership, the size of the majority agreeing with this statement was again substantial. In contrast, although around half who believed EU membership to be a good thing disputed the idea in 1996 and 1998, comfortably more than a third accepted this argument regarding the euro and national identity.

It is therefore clear that anti-euro groups grasped the mood of public opinion in Britain regarding the single currency. Yet with no referendum called, their arguments went largely unchallenged. To confound matters, Labour’s prevarication over holding a vote and the policy measures taken regarding the single currency fuelled speculation and uncertainty, which these campaign groups made the most of.

Having developed arguments that struck an obvious chord – and with veterans of the anti-euro campaign engaged in the Leave campaign – the anti-euro groups’ narratives would be reimagined to great effect in the 2016 vote on Britain’s EU membership. And for this reason, Labour’s decision not to hold a referendum on the single currency can even be seen as a missed opportunity with significant long-term consequences.

This post represents the views of the author and not those of the Brexit blog, nor LSE.

Three years on: the UK is paying a high economic price for its decision to leave the EU

How has the Leave vote affected the UK economy, ask Swati Dhingra and Thomas Sampson (LSE) in this second of two blogs based on the CEP Election Analysis briefing on Brexit. It summarizes CEP research on how the referendum outcome has affected the UK economy since 2016. The first blog, which reviews work on the potential long-run economic effects of different forms of Brexit, can be found here.

The full economic impacts of Brexit will not be known for many years. But three and a half years after the referendum, we can assess how the Brexit vote has affected the UK economy since June 2016. The vote has already had economic impacts because economic behaviour depends upon both what is happening now and upon what people and businesses expect to happen in the future. The referendum changed expectations about the future of the UK’s economic relations with the EU and the rest of the world. Not only is Brexit likely to make the UK less open to trade, investment and immigration with the EU, but it has also increased uncertainty. Researchers at the CEP and elsewhere have studied the effect of the Brexit vote on the value of the pound, output, prices, trade, wages and investment.

Sterling

The immediate economic impact of the Brexit vote was a depreciation of sterling. On referendum night, sterling saw the biggest one-day loss that has ever occurred in the four major currencies of the world since the collapse of Bretton Woods. Between 23rd and 27th June 2016, sterling declined by 11 per cent against the US dollar and 8 per cent against the euro, and it has remained around 10 per cent below its pre-referendum value.

Image by Images Money, (CC BY 2.0).

Output

A broad indicator of economic performance is the growth rate of GDP. While the UK started with a steeper growth trajectory, it has fallen behind other G7 countries since the referendum (Figure 1). The Brexit vote is estimated to have reduced UK’s GDP by between 1.7 and 2.5 percentage points lower, or between £1,300 and £2,000 per household in pound terms (Born et al. 2019).

Figure 1: GDP Growth in the UK and Other G7 Countries 2012-19

Source: CEP calculations, updated from De Lyon and Dhingra (2019). GDP values are deflated by country-specific GDP deflators. Other G7 countries include France, Germany, Italy, Japan and the United States.

Prices and the cost of living

Consumer Price Index (CPI) inflation rose dramatically from 0.4 percent in June 2016 to 3 percent in January 2018. Breinlich et al. (2019a) study whether this increase in inflation was caused by the Brexit depreciation. If the sterling depreciation is responsible for higher inflation, we would expect product groups where consumers buy more imported goods, such as food and clothing, to have experienced bigger price rises than groups less sensitive to import costs, such as restaurants and hotels. And this is exactly what Breinlich et al. find. After disentangling the effect of higher import costs from other factors that affect prices, Breinlich et al. estimate the Brexit vote increased consumer prices by 2.9 percentage points in the two years following the referendum, which equates to an £870 pound per year increase in the cost of living for the average UK household. It would be wise to view the precise magnitude of this effect with some caution, but the cost is undoubtedly substantial.

Trade

By making UK exports cheaper, the depreciation of sterling following the referendum could, in principle, give UK firms a competitive advantage in foreign markets leading to higher exports. However, real export growth has not increased since the depreciation, compared to other G7 countries, as shown in Figure 2a. For firms with global supply chains, currency depreciations also raise import costs, mitigating the competitive advantage of the depreciation for exporting. The growth in real imports into the UK has been broadly similar to that in other G7 countries, as shown in Figure 2b. The nominal value of imports has risen, but this is largely because of a rise in import prices due to the sterling depreciation. Analysis by Costa et al. (2019) finds that the rising cost of imported inputs has dominated the potential revenue gains from exports brought about by the depreciation.

Figure 2: Real exports and imports in the UK and other G7 countries, 2012-19

(a) Exports       

                                                                    

(b) Imports

Source: Updated CEP calculations from De Lyon and Dhingra (2019). Trade values deflated by country-specific producer price indices (PPIs). Other G7 countries include France, Germany, Italy, Japan and the United States.

Wages and employment

The increase in inflation due to the Brexit depreciation has not been accompanied by faster income growth. As shown in Figure 3a, higher inflation after the referendum led to a decline in real wage growth. Real wages dropped from a pre-referendum annual growth rate of 1.1% to less than 0.1% after the referendum. Research by Costa et al. (2019) sheds more light on the causes of this real wage stagnation. After the referendum, workers in sectors that saw bigger increases in the price of their intermediate imports experienced slower wage growth and reductions in job-related education and training. Comparing sectors in the top and bottom halves of the intermediate import-weighted depreciations, Figure 3b shows real wages in the top half of sectors were growing at 1.3% annually before the referendum and this dropped to -0.6% after the referendum. This is a slowdown of 1.4 percentage points, compared to less exposed sectors in the bottom half, which saw an increase in their annual real wage growth from 1% to 1.4% after the referendum. While wages had been growing in the pre-referendum period, real wages have stagnated since then and this effect is more pronounced in sectors that have been hardest hit by rising costs from the sterling depreciation.

Rising import costs have not translated into job losses or reductions in hours worked, except paid overtime hours which have seen reductions since the referendum. Overall, the drop in training opportunities and anaemic wage growth at a time of high employment rates raises serious alarm of a deepening of the productivity slowdown that has plagued the UK economy for years.                          

Figure 3: Wage growth, 2012-18

(a) Nominal and Real Wage Growth In All Sectors                      

   

(b) Real Wage Growth in Sectors at the Top and Bottom of Import Cost Exposure

Source: Office for National Statistics and CEP calculations based on Costa et al (2019). Wage growth is the percentage change year on year in the three month average of Average Weekly Earnings – Regular Pay. Real AWE is Nominal AWE deflated by CPI. The dashed vertical line shows the date of the referendum (June 2016).

Investment

Uncertainty makes businesses less willing to invest in risky new projects. Bloom et al. (2019) find that firms that report experiencing higher Brexit-related uncertainty have had lower investment and productivity growth since the referendum. They estimate that anticipation of Brexit reduced business investment in the UK by 11 percent in the three years following the referendum. The Brexit vote has also started to affect investment flows into and out of the UK. Reduced openness makes the UK a less desirable investment destination because it increases the costs of using the UK as a base for serving EU markets. CEP research by Breinlich et al. (2019b) shows that the Leave vote led to a 17% increase in new investment projects by UK firms in the EU by March 2019, but did not affect UK investment outside of the EU. Looking at flows in the opposite direction, Breinlich et al. find that the referendum reduced new investment projects by EU firms in the UK by 9 percent over the same period. Together these estimates suggest that Brexit is making the UK a less attractive place to do business.

Final words

It is too soon to evaluate the accuracy of forecasts that estimate the potential long-run effects of Brexit and as time passes, new evidence will continue to provide fresh information on the response of the economy to Brexit. However, even before Brexit has happened evidence on post-referendum changes in output, prices, trade, wages and investment shows that the UK is paying an economic price for its decision to leave the EU.

This post represents the views of the author and not those of the Brexit blog, nor the LSE.

John Van Reenen: ‘A lot of promises are just smoke and mirrors’

As director of LSE’s Centre for Economic Performance (CEP) up to 2016, British economist John Van Reenen led a team of academic researchers who produced detailed analysis of the consequences a divorce from the European Union would have on the UK economy. They predicted a fall in GDP, employment, direct investment, wages and productivity. Of these indicators, only employment contradicted the forecasts. Van Reenen, who is now professor of economics at MIT, defends the work of economists on Brexit as consensual and accurate, but competing against lies. He spoke to LSE Business Review managing editor Helena Vieira on 22 November at LSE, and commented on the election promises the parties had made until then. “A lot of promises are just smoke and mirrors”, he said.

Economists were criticised after the referendum results for not knowing how to communicate with the public. Is there anything that you would have done differently?

I think the communication part is probably true in general. What you just said, economists are not as good at communicating as, say, natural scientists, like we read in that interesting blog post saying that economists use jargon, which makes it harder to communicate well with the public. That’s definitely an issue for the profession. On the referendum, though, the criticism that I thought I heard of economists and the government was that they said we were exaggerating the costs, the downsides of Brexit. We weren’t being positive enough. I thought the criticism was less because we’re not being clear. I thought there was a lot of clarity. The profession as a whole spoke really clearly that Brexit was going to cost people, arguing about how much it was going to cost, and I thought that this was said reasonably clearly. Now, did that penetrate through to the public consciousness? Brexiters were kind of saying, ‘just ignore the economists, they’re talking rubbish’. Or you have the more traditional broadcast, the BBC, who would put one of the 99 per cent of economists who said Brexit was going to cost us, against one person representing the one per cent, meaning Patrick Minford, who would say that Brexit was going to be wonderful, and then tell the viewers to make up their minds, which I think is a serious problem. There is such a professional consensus that Brexit would cost people financially. You might think it’s good for other reasons, but financially, economically, it was going to be extremely costly. Then having a so-called balance where you have one person representing one per cent versus one person representing 99 per cent, which is a consensus, that’s no balance. It’s like having one climate change denier up against someone saying climate change is happening, which it is, or having an anti-vaxer saying vaccination leads to autism, which it doesn’t, versus somebody saying vaccines are not going to give you autism. So it seems to me one of the big problems with the traditional broadcasters was that they were pursuing a false sense of balance where there was an unusually strong professional consensus of what the impact was likely to be.

“… most Leavers thought they would be better off financially, which was against the professional consensus of economists… we are living in a world now where blatant lies are just not shut down. “

You also had a very large part of the press that was overwhelmingly anti-Europe, giving only positive views of Brexit. Now, some may say that people heard the economists and then decided that they were going to vote for Brexit even though it was going to cost them financially, because they wanted other things like sovereignty or less immigration. That’s a perfectly reasonable choice to make. You might say, ‘that’s going to cost me 1000 quid a year, but I’ll have fewer immigrants and feel that I’ve got more sovereignty’. However, if you look at surveys, that was not what people were thinking. It seems that most Leavers thought they would be better off financially, which was against the professional consensus of economists. Economists were unable to persuade people. But I think the bigger problem was just the way in which the mainstream media was using false balance, and the rest of the print media was very sceptic. It was very difficult for the profession to get its opinion across, no matter how clearly they were speaking. Another point is that economists were struggling to convey to people the idea that being in the European Union is like being in a club: you pay a membership fee, and in return you get five to ten times the benefits, because you have open trade and fewer trade barriers. That’s the offer that the European Union gives to Britain.

If you think about the campaign on the back of the bus that Boris Johnson drove around, the problem was the statement that we would save £350 million to be used in the National Health Service, which is just a blatant lie. We don’t give the EU anything like £350 million. The membership fee is not £350 million, because with the rebate, the money doesn’t even leave, even before you get into the economic advantages, which are the other kinds of benefits. The whole thing was a complete lie. Disputing that is not about economics. It’s just a clear statement of fact. Despite that, we know that a majority of Leavers believe that number. So, if you can convince people of just a complete blatant lie, when the economists were trying to raise the debate to a higher level, then the problem is much bigger. It’s not just an economist not being able to communicate or get the message across. I think it’s a fundamental problem that we are living in a world now where blatant lies are just not shut down. They perpetuate themselves and they are used deliberately by populist politicians to get what they want.

“Technology is still pushing towards globalisation, while the politics and trade policies are pulling in the opposite direction.”

And social media is partly responsible for that too, because it allows anyone to publish what they want.

I think that conventional media, though, is also to blame. But yes, the problem gets even worse with social media where people can increasingly just hear what they want to hear. There was another problem with the narrative, which became, ‘well, economists got it wrong, they said things were going to be bad and look, things aren’t so bad’. Incredibly, the economic forecasts were extremely accurate. My work was on the long-term impacts. But people who looked at the short-term impacts, for the next two, three years, were predicting between one and three per cent fall in GDP compared to being in European Union. That’s exactly what’s happened. There has been a fall of about two to three in GDP, relative to staying in the European Union. So those forecasts actually turned out to be relatively accurate. Now, the forecasts for employment weren’t so good. Employment is higher, but the forecasts of falling direct investment, falling wages, falling productivity, all those were right. The fact is that economists have done incredibly well. Chris Giles in the Financial Times has a nice summary of this. So, I do think there is a real problem between the kind of perception, on the mass media side, and what actually economists were saying and have been saying. That’s a real fundamental problem. And I’m not sure extra media training for economists is going to solve that problem. I think it’s a more structural problem with the nature of society and the media at the moment.

“… whether nationalisation is good or bad is not the main thing. A company can be efficient in the public sector, and it can be inefficient the private sector. What matters is the competition that it faces and how well regulated it is.”

There has been talk about the end of globalisation. A recent article in the FT says that the ECB president, Christine Lagarde, is recommending that EU countries focus more on expanding domestic demand than on exports. Is this a relevant factor in this Brexit saga?

It’s clear that after having many decades of globalisation and decreasing trade costs, we’re at a moment in politics in which there is a big backlash against that. Most vividly with the kind of Trump-China trade wars, with barriers being erected by Trump against China and other countries, including the European Union. That’s all over the world and includes, as you say, the Brexit saga, but also more generally, it’s becoming very hard to get trade deals through. We are living in a moment when that element of globalisation, trade liberalisation, is in retreat. So that could be a reason for wanting to focus more on domestic integration, European integration and so on. But what goes against that is that technology is still making global communication and global trade easier, because it’s reducing many kinds of trade costs. If you think about the advances in communication through faster broadband… When you came in, I was having a Zoom call with one person in Cambridge, Massachusetts, somebody else in Princeton, somebody else in Chicago. It’s almost like being in the same room. And developments in technology communication are going to continue reducing the cost of interaction, trading with other people. Technology is still pushing towards globalisation, while the politics and trade policies are pulling in the opposite direction. We’ll have to see which one wins out at the end. It does seem that people are looking more inwardly, becoming more nationalistic, trying to put up more barriers to immigration as well as trade. My sense, and my hope as well, is that it’s a kind of temporary thing because the underlying nature of integrating people all over the world is very strong. We saw similar things in the 1920s and 1930s, when we had a long period of globalisation the 19th century, and then a retreat into nationalism, and the first and second world wars, so I hope it doesn’t lead to that kind conflict as it did then.

“It’s harder and harder to find new ideas. It takes more and more efforts to push the frontier of knowledge forward… If we want to have the rates of growth we had in the past, we have to make bigger and bigger investments in research.”

Moving on to productivity… Nokia argues in a white paper that 5G will solve the productivity paradox because up until now, we have we’ve had improvements in personal communications, but with 5G, machines will be able to synchronise and industries will become more efficient, which will raise productivity exponentially…

In the history of humanity, productivity growth is the foundation of our income growth and the improvement of our well-being. Technological improvements are behind that. Technology has improved over the course of the last couple thousand years, and particularly in the industrial revolution in the last 300 years. There’s no reason why that won’t continue. That’s the foundation of productivity growth. The question is, for the last hundred years or so, we saw GDP per worker in the UK going up by one or two per cent a year. Will that continue, will it slow down, will it speed up? What we’ve seen certainly since the global financial crisis is that there has been a particularly severe slowdown of productivity growth in Britain. But technology is still carrying, and so productivity will bounce back. Will it bounce back to the rate of the last hundred years? Will it bounce back to the rate it had starting in the 1970s in the UK? Those were pretty good years, in fact 30 years when we kind of caught up with our major peer countries, like Germany, the US and France.

From a global perspective, one of the worrying factors is that productivity growth has stayed the same or slowed down despite the fact that we’ve been putting more and more resources into research and development. More and more people, like me, are involved with doing research and development. But that hasn’t led to fast productivity growth. Most of the main economic models say that when you put more resources, you should get more growth coming out but that hasn’t happened. Take one example: people always talk about Moore’s law, predicted by Gordon Moore, the CEO of Intel, that every 18 months to two years, the number of transistors that go into a silicon chip more or less doubles. That has led to this fantastic productivity growth in semiconductors, which go into computers, which then go into networks and 5G and everything else. If you look at semiconductors, productivity is growing by 35 per cent a year, amazing. But over the last 30 or 40 years to get that 35 per cent growth productivity, there has been an 18-fold increase in the number of workers in semiconductors. So you increased the number of people 18-fold, but productivity is going to stay the same. So why is that? It’s just because it’s harder and harder to find new ideas. It takes more and more effort to push the frontier of knowledge forward. There are diminishing returns to knowledge. There are diminishing returns to everything else. The more effort you put in, the more you get out, but the extra hour of effort doesn’t create as much new stuff as the first hour did. So I think that it’s getting harder, as we get more and more knowledge, to push that frontier forward. Now, there’s no reason why we can’t keep on putting more and more people into research. There’s only about one or two per cent of people who are doing research. So we’ve got a long way to go. But it shows you that you don’t get something for nothing. If we want to have the rates of growth we had in the past, we have to make bigger and bigger investments in research. In the long run, that’s how we have to solve the problem. In the shorter run, these innovations — 5G, artificial intelligence, robotics, quantum computing, new forms of drug engineering, genetics — all these things are improving productivity. Often, the effect takes a long time, because you have to figure out how you transfer these new ideas into products and services, which really do create value for people, and that requires lots of experimentation. You know, an analogy would be with electricity. The historian Paul David pointed out that it took decades for the invention of electricity to have an effect on productivity, because people had to completely redesign the way they ran factories, to know that they could run them 24 hours a day, they could make it in different ways. So there’s a lot of experimentation, a lot of learning, change of management, change of organisation, change of worker skills, to make best use of the new technology. These things take a long time and a lot of experimentation, so maybe that’s going to happen soon. It might not happen quite as quickly as many people wish it would.

“The illusion is that you can raise taxes and I won’t have to pay anything (…) the terrible companies making high profits and the rich people [will have to pay]. But unfortunately there aren’t enough rich people to raise that kind of money.”

Now on to the upcoming elections. What is at stake here?

The biggest thing in the UK elections is certainly Brexit. If the Conservative party gets the majority, then they will push through Johnson’s plan. That will lead to more years of uncertainty because it will take many years to negotiate a very difficult trade agreement with the European Union. It will be very rancorous. The Johnson plan will increase trade costs between Britain and the rest of Europe. We’ll probably be battling with slower growth than we would have had before, which will obviously mean less money for hospitals and schools and the police. So the Conservative government is promising to spend lots of money, when the negative Brexit shock will mean that there is less money we can afford to spend.

On the other hand, if Labour wins or forms a coalition with some of the other remain parties, that will give us an opportunity for a second referendum. That could lead to cancelling Brexit, which would produce a big economic bounce, something like a £50 billion bonus to public finances. So that’s a huge difference economically, whether or not someone leaves or stays in the European Union. All the other things are secondary to that simple binary choice: do you vote for a policy towards Brexit, which will lead to more uncertainty and make the country poorer than it would have been, or do you have a chance to remain and actually gain a huge economic benefit from doing that? That’s the main thing.

What did you think of the Labour manifesto?

It’s pretty radical, very much like the 1983 manifesto, promising a lot of nationalisation, very large increases in public spending. To me, whether nationalisation is good or bad is not the main thing. A company can be efficient in the public sector, and it can be inefficient the private sector. What matters is the competition that it faces and how well regulated it is. The public sector doesn’t solve all the problems. You still have to think about how that company is managed. How you set up the incentives for them to invest sufficiently in the future and charge reasonable prices to consumers. But that’s equally true for the private companies. Nationalisation is not the main issue. The problem is that it’s going to be a big distraction, because you’re going to have long arguments on what the appropriate form of nationalisation is and everything else. My personal view is that it is preferable to regulate these companies better in the private sector. And what you really want to do is create structures for better long-run investments, and to lessen policy uncertainty.

Labour’s policies will cost some 80 billion pounds a year by the end of the next Parliament. That’s a lot of money. Some of that is spending on investments. One of the big failures of the UK is its inadequate long-term investment. So, I think borrowing more money to pay for investment is perfectly reasonable, like pouring money to buy a house. We need to make a good choice of investment like we need to we make a good choice for a house. You want to be careful about how you make the investment. There’s nothing wrong in borrowing a lot if you’re investing a lot. But borrowing a lot of money to pay for current consumption, like higher wages for public servants, is not sustainable. The money has to be paid back at some point. In order to pay for it, you have to raise taxes. Again, nothing wrong with that. There are plenty of countries that collect high taxes and have high spending like Sweden, the Scandinavian countries, Germany. But the illusion is that you can somehow raise taxes and I won’t have to pay anything. Everything’s going to be fine because somebody else is going to have to pay the taxes, it’s going to be the terrible companies making high profits and the rich people. But unfortunately there aren’t enough rich people to raise that kind of money. And if you want to have better public services, everybody has to be prepared to pay more taxes, not just the top one or five per cent. You have to prepare yourself to have your taxes put up. The Labour party has to be honest about that and realise it’s not just the top five per cent who will pay more taxes, really, because we’ll have to have a lot of people paying more taxes. An increase in taxes for firms, which is again, perfectly reasonable to do, is not costless. Because, you know, when you put up taxes on firms, either they put prices up, so consumers pay, workers will pay with lower wages or shareholders will get lower returns. The big shareholders are actually pension funds that are managing investments for people. So, people will get less return on their investment. Again, that may be something that you’re happy to live with. But the idea that nobody pays for this, it’s money from the sky, is just an illusion.

The Tories are also talking about increasing spending.

Yes, the Tories are the same. They also won’t be honest, they’re quite dishonest with how they’re going to pay for this additional spending just to install things they have already announced, like new hospitals, which turned out not to be building new hospitals, turned out to be just thinking about building new hospitals. So, a lot of that is just smoke and mirrors. I think the Liberal Democrats have been kind of more open about this. It’s the only party that is currently planning not to increase debt as a proportion of GDP. The other parties are promising lots of spending without actually saying how they’re going to pay for that. The Tories are indeed also promising tax cuts as well, which is going to make things even harder to manage.

Is there still hope that Brexit is not going to happen?

Absolutely. If the Conservative party doesn’t get the majority, then we’ll be in the same situation as we are now. I think the only reasonable democratic solution to that, now that people have an idea about what the choices are, is to allow them to have a say on those choices. People were voting back in 2016 without really knowing what they were voting for, both on the Remain and the Leave side, really. Now there is a clear deal and you want to give people the choice. Here’s the deal, you know what it is. Do you want this deal, versus carrying on being in the relationship we’ve enjoyed for the last four, five decades as a member of the European family? Most polls, 90 to 95 per cent of them, have suggested that Remain is going to win, which wasn’t true of the previous referendum. It does seem to me that there has been a shift towards Remain as people got more knowledge about what’s going to happen.

This blog post gives the views of the interviewee, not the position of LSE Brexit or of the London School of Economics and Political Science. It previously appeared on LSE Business ReviewFeatured image credit: Courtesy of John Van Reenen. Not under a Creative Commons licence.

Economic consequences of Brexit are overwhelmingly negative

The economic consequences of Brexit are overwhelmingly negative, estimate Swati Dhingra and Thomas Sampson (LSE). The more the UK distances itself from the EU’s economic institutions and policies, the greater will be the increase in trade barriers and the higher will be the costs of Brexit, they claim. This is the first of two blogs based on the CEP Election Analysis briefing on Brexit. It summarizes CEP research on the long-run economic effects of different forms of Brexit. The second blog will analyse how the referendum outcome has affected the UK economy so far.

Since the UK voted to leave the European Union in June 2016, Brexit has dominated UK politics and economic policy. Three and a half years after the referendum, the UK is yet to leave the EU, there is no certainty over if or when Brexit will take place, and the shape of future UK-EU relations is yet to be determined. Building on methods from earlier work on international trade, the CEP has developed a state-of-the-art model of international trade to analyse how Brexit will affect UK trade and living standards. This model has been used to study how different options for UK-EU trade relations after Brexit would affect the UK economy by analysing how changes in trade barriers affect UK trade, output and income levels in the long run.

Leaving the EU will introduce new costs of trade between the UK and the EU that make it harder for UK firms to do business with the rest of Europe. However, the extent to which trade barriers increase will depend upon the nature of the post-Brexit relationship the UK agrees with the EU.

Table 1 summarizes the model’s forecasts for four scenarios: (i) soft Brexit – UK remains in the EU’s single market, but not its customs union; (ii) Theresa May’s deal – UK leaves the single market, but maintains a customs union with the EU; (iii) Boris Johnson’s deal – UK leaves the single market and the customs union and agrees a free trade agreement with the EU similar to the EU-Canada agreement; (iv) hard Brexit – future UK-EU relations are based on World Trade Organization (WTO) terms.

For each case we estimate the predicted effect of Brexit on UK income per capita ten years after the deal is implemented relative to an alternative scenario where the UK remains in the EU. We report both estimates from our static trade model and estimates that adjust for the effect of trade integration on productivity. Trade integration can raise productivity through increased competition, or stimulating innovation, but these effects are not included in the static model. The estimates that adjust for productivity changes are around two and a half times as large as the static estimates.

Table 1: Effect of Brexit on UK income per capita

Source: CEP calculations. See Dhingra et al. (2016), Levell et al. (2018) and Bevington et al. (2019) for details. Pound values calculated at 2018 prices using data from the ONS and rounded to the nearest hundred pounds.

Economic consequences of Brexit are negative

Table 1 shows that in all cases Brexit leaves the UK worse off economically than remaining in the EU. The worst-case scenario is a Brexit on WTO terms, which is estimated to reduce income per capita by up to 8.1 per cent. This is roughly double the cost of either a soft Brexit that keeps the UK in the single market, or a deal that maintains a customs union with the EU. The more the UK distances itself from the EU’s economic institutions and policies, the greater will be the increase in trade barriers and the higher will be the costs of Brexit.

The estimates in Table 1 do not account for the effects of Brexit on fiscal transfers between the UK and the EU, or for possible gains to the UK from striking new free trade agreements with countries outside the EU. However, even under optimistic assumptions, these effects would be much smaller than the costs shown in Table 1. The UK is a net contributor to the EU budget, but fiscal savings from Brexit are likely to be at most 0.3 per cent of UK income (Dhingra et al. 2017) and the government estimates new trade deals would increase UK output by at most 0.2 per cent (HM Government 2018).

Image by Marco Verch, Creative Commons 2.0.

 

Boris Johnson’s Brexit deal

The Conservative party is proposing that future trade relations with the EU should be based on a free trade agreement similar in scope to the EU-Canada deal. This would entail the UK leaving the single market and customs union, while maintaining tariff-free and quota-free trade with the EU for all (or almost all) products. Leaving the EU’s customs union would require the introduction of customs checks at the UK-EU border. In addition, goods would have to satisfy rules of origin requirements to qualify for tariff-free entry, and trade would be subject to the threat of anti-dumping duties and countervailing measures. Likewise, leaving the single market would lead to the introduction of new checks to ensure goods and services exports comply with the EU’s legal standards, and regulatory divergence will further increase trade costs if businesses need to split production lines for different markets.

We estimate that under a Brexit based on Conservative proposals, UK income per capita ten years after the deal was implemented would be up to 6.4 per cent lower than in an alternative scenario where the UK remains in the EU. The costs of a Boris Brexit are lower than for a WTO Brexit, but between one-third and one-half larger than for a soft Brexit or for Theresa May’s deal. This reflects the fact that Johnson’s deal envisions a future in which the UK is less integrated with the EU than under May’s deal.

Labour’s Brexit policy

Labour’s Brexit policy is ambiguous but involves seeking a soft Brexit that keeps the UK in a customs union with the EU and perhaps also in the single market. Once negotiated the deal would be put to a referendum, though it is unclear whether Labour would campaign for or against its own deal. To get an idea of the likely economic effects of Labour’s policy, we have analysed two options that maintain relatively high levels of economic integration with the EU. We find that the costs of leaving the single market while remaining in the customs union (May’s deal) are similar to the costs of leaving the customs union while remaining in the single market (Norway option). Under both alternatives, the UK is better off than under the Conservative party’s preferred option of a free trade agreement Brexit. In this sense, Labour’s Brexit policy is preferable to Conservative policy from an economic perspective.

Other parties

The Liberal Democrats, Scottish National party, Green party and Plaid Cymru advocate cancelling Brexit and remaining in the EU. Since all the Brexit options under consideration leave the UK worse off than if it stays in the EU, remain is the best policy in terms of Brexit’s effect on average income per capita in the UK.

There is a broad consensus among economists that leaving the EU will, in the long run, reduce UK living standards. But the magnitude of the economic costs will depend on what form Brexit takes. Our analysis finds that Conservative proposals for future UK-EU relations to be based on a free trade agreement would result in around a 50% higher drop in income per capita than a soft Brexit. Remaining in the EU would be the best economic policy while leaving on WTO terms would be the most costly alternative.

This post represents the views of the author and not those of the Brexit blog, nor the LSE.

Powered by WordPress | Designed by: index backlink | Thanks to insanity workout, car insurance and cyber security