Is Britain better off outside the EU?
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Is Britain better off outside the EU? Over the past four days, three economic research groups have attempted to answer that question.
All recognise the question is difficult because no one knows what relationship the UK will be able to strike with the rest of the EU if it votes to leave, or whether links to other countries will change.
Economists do not generally claim these models provide a clear answer, but they do claim to offer insight into the magnitude of the issue and the importance of the assumptions.
All of the three groups — the Centre for Economic Performance at the London School of Economics, CBI/PwC and Oxford Economics — provide a range of likely outcomes depending on the relationship Britain strikes with the EU if it leaves. None are estimated using the same techniques. All suggest that leaving the bloc will have a significant cost for British households, although under certain assumptions, those costs can be contained, they suggest.
For the Centre for Economic Performance, drops in trade with the EU “is likely to cost the UK economy far more than is gained from lower contributions to the EU budget”. The CBI/PwC report concludes that leaving the EU “would cause a serious shock to the UK economy”, while Oxford Economics thinks that “our scenario modelling does not give much cause for optimism about the impact of Brexit”.
The form of Brexit they each say is least costly is the one that most closely mimics Britain’s existing relationship with the EU.
Just as important as the conclusions are the assumptions that underpin each model, since they generally take a generalised view of changes under different Brexit scenarios, rather than modelling specific issues, such as the benefits arising from not having to comply with the EU working time directive or the costs for British companies of complying with “rules of origin” regulations if the UK leaves the EU’s customs union.
Two of the modelling exercises are long-term (CEP and Oxford Economics) while the CBI/PwC study seeks to include the immediate effects of the decision to leave, as well as the long-term implications; so they are not directly comparable.The trick to understanding the models and the results is to look for the underlying important assumption and assess its credibility. Normally, this will be about trade costs and the precise relationship Britain strikes with the rest of the EU. In each of these studies migration, regulation and third party trade deals are relatively small factors in comparison.
Centre for Economic Performance
The CEP found Brexit to be costly in all scenarios because it would complicate trade deals between the UK and the EU. The lowest costs come if the UK strikes a free trade deal with the EU and simultaneously eliminates all its tariffs on goods on imports from the US, China and other countries. The highest estimates come from an attempt to include the long-term effects of a lower efficiency economy that had less competition from EU nations.
The key assumptions
The CEP report’s main conclusions depend on an estimate of non-tariff barriers that it assumes would be erected even if the UK secured a free-trade agreement with the EU. Academics have estimated that non-tariff barriers between the EU and the US are equivalent to a tariff barrier of 14.7 per cent. This research assumes UK EU trade would be hit by a new non-tariff barrier of 2 per cent, reflecting rules of origin regulations, anti-dumping regulations and more difficulty in services trade. There is no migration or regulation assumption in this report.
Vote Leave called the report ridiculous, suggested CEP should not be trusted because it had received EU funding and the authors were “the same economic sages who said we would better off scrapping the pound”. The campaign said it was wrong to claim trade with the EU would fall, citing reports that suggested the EU would sign a free-trade agreement with Britain after Brexit.
The criticism is wrong, since the CEP also assumes a free-trade agreement. The CEP’s results stem directly from what are modest assumptions on the size of non-tariff barriers.
The report finds that Brexit would be very damaging for the UK economy over the next five years, but after that, Britain could repair much of the damage, as long as it struck a free-trade agreement with the EU and other large trading partners including the US. If it did not secure these agreements, the situation would remain much worse. The big losses come at first from uncertainty created by Brexit; the longer term costs are offset by gains from a looser regulatory environment.
The key assumptions
The most important assumption is that the uncertainty would increase the cost of corporate debt by 0.5 percentage points and equity by 0.2 percentage points. This is akin to an unwarranted rise in interest rates, hitting investment and consumption and leading to severe weakness in the first five years. The CBI/PwC report assumes no increase in tariffs and minor increases in non-tariff barriers, particularly in the service sector. There is a reduction in population from more controls on unskilled EU migration to the UK. It assumes the UK could save £12.6bn from looser regulations, but does not specify which government policies would change.
Vote Leave said the report was “skewed” to give negative results and yet employment was still higher in 2030 than today in the CBI/PwC scenarios. It also said this was not neutral analysis and that both organisations “receive large sums from the European Commission”. It says the report “deliberately underestimates the economic gains that will be secured by removing EU regulation”.
The weakest part of the CBI/PwC report is its crude estimate of the effects of uncertainty. These are unknown and could be higher or lower. Most of the other assumptions are extremely cautious, particularly the implicit one that short-term uncertainty causes no long term damage to the economy.
The report found that Brexit harmed Britain’s economy in eight of the nine scenarios it modelled. The costs of leaving become large in scenarios without a deep free trade deal signed with Brussels and with populist measures, such as controls on immigration and leaving regulation unchanged. Only in the scenario that closely mimics EU membership is there a gain to households. Generally, Oxford Economics says taxes would have to rise to offset the costs of Brexit.
The key assumptions
Trade also drives the Oxford Economics results. If Britain joins a customs union with its largest trading partner, including in services, Oxford sees little damage, but that would prevent the UK from signing trade deals with third parties. The costs of trade rise in all the other modelling scenarios. The second dimension of the Oxford Economics research is the degree to which Britain is a liberal rather than a populist nation after a vote for Brexit. Its only favourable scenario is one in which migration continues as normal, Britain gets rid of regulations on workers and stays in an EU customs union.
Vote Leave says, “another day, another pro-EU campaign report”, again accusing Oxford Economics of being funded by the EU and having authors who previously worked for it. It says the estimates of costs are “disingenuous” because the report “admits that GDP will be greater in 2030 than it is today if we Vote Leave”.
The Oxford Economics report is opaque about how exactly it incorporates trade costs. But its numbers are similar to other studies, so its modelling is not outlandish. Its weakest aspect is the lack of credibility of the proposition that after voting for Brexit, Britain will negotiate a settlement with the EU that basically keeps everything the same.
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