Britain’s public finances would deteriorate by £30bn a year in a “relatively benign” no-deal Brexit scenario, the Office for Budget Responsibility said on Thursday as it dipped its toes into the vicious debate over crashing out of the EU.
With Boris Johnson claiming the costs of a no-deal Brexit would be “vanishingly small”, the independent fiscal watchdog directly contradicted the frontrunner in the Tory leadership race, saying the public finance consequences would be “significant”.
Mr Johnson is threatening EU leaders that if he becomes prime minister he will take Britain out of the bloc without a deal on October 31 unless he is able to rip up Mrs May’s withdrawal agreement.
Robert Chote, chair of the OBR, repeatedly stressed the watchdog’s figures were based on a “mild” no-deal Brexit scenario and were not a forecast of what would happen. He added that the figures assumed no disruption at British ports, a relatively short recession and few permanent scars to the economy.
The OBR took the economic section of the scenario directly from an April forecast by the IMF to assess how vulnerable Britain’s public finances were to these possible events.
Although many observers incorrectly viewed the watchdog’s report as a no-deal Brexit forecast, Mr Chote said the OBR had entered the Brexit fray because it was mandated to stress test the public finances against realistic risks facing Britain.
Mr Chote said that since the OBR produced a similar report two years ago, the risk of a no-deal Brexit had increased.
In the scenario tested by the OBR: Britain would face EU tariffs on exports to the bloc; would impose tariffs on imports; migration to the UK would fall; and there would be additional costs from completing customs declarations and goods being checked as they entered the EU from the UK.
The scenario assumed the pound would drop another 10 per cent, with falling equity prices, and the Bank of England would cut interest rates close to zero and extend cheap funding to banks; but under the scenario no other policies would change initially.
It assumed that the main effect on the economy would be a sharp drop in business investment leading to a mild recession about the same size as that in the early 1990s, with a 2.1 per cent drop in real gross domestic product in 2020 and an economy 4 per cent smaller than assumed in the OBR’s most recent forecast from March by mid-2021. With the downturn assumed to have few permanent effects in the scenario, the economy would recover strongly from 2022 onwards.
The recession would hit tax revenues, even with increased customs duties from UK tariffs and cheaper debt interest payments, the OBR said, with the net cost about £30bn a year.
Asked whether the annual £30bn cost of the no-deal scenario was small compared with the £39bn “divorce bill” that Britain has agreed to pay the EU (some of which it might not pay in a no-deal scenario), Mr Chote was at pains to point out the difference between permanent losses and temporary effects.
“There is a world of difference between a hit to the economy and the public finances, which is an ongoing one over time versus a relatively large, but one-off sum,” he said.
With higher borrowing, net public debt under the OBR’s scenario rose by 12 per cent of national income compared with the previous forecast in March.
A more disruptive no-deal Brexit scenario would have bigger effects on the public finances than this scenario Mr Chote added, something that was immediately seized upon by Philip Hammond, the outgoing chancellor, who has repeatedly said no deal would cost £90bn a year.
Mr Hammond, who has sought to rein in spending pledges made by the Tory leadership candidates during the two-month campaign, said the analysis confirmed his view that even a mild no-deal Brexit would represent “a very significant hit to the UK economy, a very significant reduction in tax revenues and a big increase in our national debt”.
Without siding with the chancellor, Mr Chote was clear that he thought Mr Hammond’s figures were much more plausible than those of Tory backbencher Jacob Rees-Mogg, who said on Wednesday that a no-deal Brexit would boost the public finances by £80bn a year.
Mr Rees-Mogg’s figures were based on an Economists for Free Trade paper “that is clearly a view at one end of the spectrum” and based on assumptions that were “not widely shared” in the economics community, Mr Chote said.
Should we be worried about debt levels?
Amid all the gloom over no-deal Brexit risks to the public finances, the Office for Budget Responsibility also looked at the possibility it was fretting too much about public debt.
The possibility that the OBR was exaggerating the risk was raised by Olivier Blanchard, former IMF chief economist, who is president of the American Economics Association.
He pointed out that the current growth rates of most advanced economies were consistently higher than the interest rates on government debt. This meant growth would enable governments to service debt easily and, when it matured, the debt would be a smaller burden on the economy than when issued. This suggested governments could take on much more debt without danger.
The OBR was not so sure, however. It accepted that at the moment growth rates were higher than interest rates, but said that evidence from the past 100 years showed this was often reversed and it would not be prudent to assume current trends would persist.
The fiscal watchdog added that if governments went on a spending spree because interest rates were very low there was a risk that financing rates might rise. “If markets begin to fear default, this increase [in interest rates] can be sharp,” the OBR said.
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