One of the key issues in the context of the UK’s EU referendum is the effect a Brexit would have on the country’s economy. Iain Begg assesses the economic claims that have been made so far in the campaign, noting that there have been misleading figures put forward by both sides of the debate

Begg, Iain

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London – The Gherkin & Canary Wharf. Credits: Harshil Shah / Flickr5/9/2016The economics of Brexit: which side should we believe?blogs.lse.ac.uk/europpblog/2016/05/09/the-economics-of-brexit-which-side-should-we-believe/One of the key issues in the context of the UK’s EU referendum is the eﬀect a Brexit would have onthe country’s economy. Iain Begg assesses the economic claims that have been made so far in thecampaign, noting that there have been misleading ﬁgures put forward by both sides of the debate.Two recent assessments of the economics of Brexit, from the Treasury and a new group callingitself Economists for Brexit, come to diametrically opposed conclusions. They add to an array ofclaims and counter-claims, many of which come up with apparently ﬁrm predictions, but have subtlediﬀerences that make direct comparisons diﬃcult. Voters are entitled to be confused and to wonderwhether anyone can be believed.The Treasury study can be interpreted as representing the government standpoint. George Osborne, the Chancellorof the Exchequer, quoting from the lengthy analysis by his oﬃcials of the likely long-term impact of leaving the EU,tells us that the average household would be worse oﬀ by £4,300. The ﬁgure is the mid-point of a range of estimatesbased, in turn, on three diﬀerent scenarios about how the UK’s trade relationship with the EU would evolve after aBrexit. The underlying projection is that GDP would be 6.2 percent lower and the headline ﬁgure is obtained bydividing that GDP loss by the number of households.The Chancellor is ﬂatly contradicted by the new group who argue that ‘Brexit will result in a better economicoutcome than remaining in the EU’. They do not provide the same sort of precise ﬁgure as the Chancellor, but one ofits members, Patrick Minford, refers in the new document to a previous analysis published in 2015 in which he andhis co-authors ‘identiﬁed 3.2-3.7 percent of GDP in ongoing costs’ of continuing membership of the EU. They alsopoint to potentially very dramatic longer term negative eﬀects on UK GDP, resulting from what they portray as thelooming threat of unfunded pension commitments in many core EU countries.To understand how such diﬀerent answers can bearrived at for ostensibly the same question, it isimportant to look both at the methodologies employedand the nature of the assertions made. It is routine foreconomists to use sophisticated models to generateprojections of future developments in the economy.Typically, these models rely on a range ofassumptions about what would happen in theabsence of whatever change is under discussion.This ‘counterfactual’ is then used as the benchmarkagainst which to assess how the change will aﬀectthe economy.In the Treasury exercise, the main focus is on howtrade enhances GDP and they use a technique oftenused by applied economists for this purpose – the‘gravity’ model – which starts from the empiricallywell-founded proposition that trade will be moreintense between countries geographically close to one another. Key assumptions are that the UK maintains itsaccess to non-EU markets, but has diminished access to the EU, that there is a reduction of foreign directinvestment into the UK and that there is a diminution of competitive pressures which results in slower UK1/3productivity growth. These can be considered reasonable assumptions.The three scenarios examined by the Treasury are:what has become known as the Norway/EEA model, despite it having been rejected by the Prime Minister, inwhich the UK largely retains access to the European single marketthe bilateral trade model in which a trade deal between the UK and remainder of the EU is negotiated, as isthe case today for the EU with Turkey and with Canadathe WTO model in which the UK has the same access to the EU market as other members of the World TradeOrganization, one consequence would be tariﬀs on some UK exportsAccording to the Treasury projections, UK GDP would be lower than it would otherwise be by 2030 under all of thesescenarios, but least under the ﬁrst model and most in the WTO variant. In each case they present a range, reﬂectingdiﬀering assumptions about the intensity of the eﬀects on key outcomes, such as on productivity. In all cases,because GDP is lower, there is a negative eﬀect on tax revenue which means that the public ﬁnances deteriorate bymuch more than the gain from the UK no longer having to pay towards the EU budget.The approach of the eight ‘Brexeconomists’ is to assess a range of eﬀects on UK economic prospects, includingregulation, the trade regime, immigration, the position of the City of London and the public ﬁnances. The part of theiranalysis which is most directly comparable with the Treasury projections is in a chapter which uses the University ofLiverpool ‘rational expectations’ model to assess the eﬀects of Brexit. Such models assume that economic actorsadapt quickly to the new environment and, as a consequence, can rapidly exploit new opportunities. Keyassumptions are that prices fall, beneﬁting consumers, there is a windfall gain from lower regulation and there is animmediate gain to the public ﬁnances from no longer having to contribute to the EU budget.Questions also arise about the numbers being quoted and how they are ‘spun’. In the Treasury projections, theheadline ﬁgure of a loss of £4,300 is criticised for being ‘per household’, when it is not a measure of householdincome and for implying (though it was never actually said) that people will be worse-oﬀ. It is more common to referto GDP per head of population, but despite what some critics have argued – see, for example, Andrew Neil’sentertaining interrogation of a Minister – there is nothing intrinsically wrong with using households. Clearly, though,the latter results in a higher headline ﬁgure for the simple arithmetical reason that the aggregate loss is divided by asmaller number: the equivalent ﬁgure for GDP per capita is £1,800.Because the ‘loss’ projected by the Treasury is relative to what would have happened and GDP would be expectedto rise by perhaps 2 percent per year, taking it to 30 percent higher by 2030, the eﬀect of Brexit would be to lower itto 27 percent higher in the best case and just 20 percent higher in the worst case.Similarly, the 4 percent gain projected by the Economists for Brexit would mean boosting GDP growth to 34 percentby 2030. However, the economists provide only limited evidence to back their claims, some of which rely more onassertion than on hard data. For example, while recognising that there could be threats to London’s pre-eminencein ﬁnancial services, they quickly dismiss them even though the City itself has repeatedly stressed the risks. Thereport also states that the deregulation that will follow a Brexit is modelled as ‘a fall in the employer rate of nationalinsurance by 2%’. Even if is accepted that some forms of regulations will change, there is no explanation for why itshould be worth this amount.In summary, both reports are only as good as the assumptions they make and the real question voters should askthemselves is ‘are these assumptions credible’. Those of the Treasury are at least broadly in line with many otherassessments; those of the ‘Brexeconomists’ will raise more eyebrows. Even so, the Chancellor’s highlighting of aloss of £4,300 is misleadingly precise.The opening sentence of the Economists for Brexit paper states that ‘a lot of economic nonsense has been talked2/3so far in the Brexit debate’. Indeed; but the bad news is that much more will follow before June 23.Please read our comments policy before commenting .Note: A version of this article originally appeared at UK in a Changing Europe. The article gives the views ofthe author, not the position of EUROPP – European Politics and Policy, nor of the London School of Economics.Shortened URL for this post: http://bit.ly/1T6t8Uw _________________________________About the authorIain Begg – LSE, European InstituteIain Begg is a Professorial Research Fellow at the European Institute, London School of Economicsand Political Science, and Senior Fellow on the UK Economic and Social Research Council’sinitiative on The UK in a Changing Europe. 3/3

The economics of Brexit: which side should we believe?

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