The costs of Brexit

That was the theme of a presentation in Wellington on Monday, organised by the research institute Motu, by visiting British economist Richard Harris.  Harris is a professor of economics at the Durham University business school, but had apparently spent some time at Waikato early in his career.

The presentation was promoted as an update on the Brexit negotiations, seven months into the two year Article 50 notice period.  Of course, it takes not much more than a cursory glance at your British media outlet of choice to know that things are not going that well, not helped by the tenuous hold on office the current government has.   Competing agendas all round don’t help either.  Plenty of people in the British government –  and the Opposition –  didn’t want to leave.  For them, minimal change from the status quo would be the best outcome. But for those who actually favoured Brexit that solution would, understandably be anathema –  the goal for many of them was to restore the UK’s freedom of action to that of a typical sovereign state.    And on the other side, some countries face pretty bad outcomes if there is a hard British exit.  For others it isn’t much of an issue. For some it might even be an opportunity, to attract multinationals –  including in the financial sector – that have operations currently based in Britain.    And although everyone knows that rising trade barriers comes at a (likely) cost to all countries, the EU doesn’t want any other countries –  or regions –  getting the idea that leaving the EU was a serious option.

Harris’s presentation helped me see more clearly where the EU “divorce bill” demands are coming from, and put the numbers in some sort of context.  At present the UK pays a net 14.6 billion pounds a year into the EU, and the sort of numbers observers like the FT think the EU might accept are only the equivalent of two or three years’ “membership fee”, in a club that apparently operates five year budgets.  At present though, as the FT observes, a number acceptable to Brussels would be “deadly” in Westminster.

It was also interesting to see some numbers on how restrictions on trade between the UK and the rest of the EU would rise if there is no trade deal and the two sides fall back to trading on WTO terms.   On goods, tariffs would rise from zero at present to around 4.4 per cent on average.   On services, where barriers are mostly non-tariff, the restrictions would rise from a tariff-equivalent of around 2 per cent to something nearer 8 per cent.   In principle, the UK could offset this to some extent by securing early trade agreements with other countries –  including countries that the EU does not have deals with –  but good deals, with significant countries, aren’t likely to be secured easily or quickly.  As various commentators have noted, the EU-Canada trade agreement took eight years. New Zealand is already among several countries objecting to early EU/UK proposals to divvy up agricultural import quotas.

Even though there is a lot of talk about smoothing the customs barriers between the UK and rest of the EU –  including on the Ireland/Northern Ireland border –  to faciliate, for example, the value-chains in manufacturing that rely on the seamless movement of goods, there doesn’t seem to be any great optimism as to whether any of these schemes can be made to work well.   That matters, even more than to the UK, for Ireland in particular, which has a very large share of its trade with the UK (and not just with Northern Ireland).  The Irish have been making opportunistic bids to try to semi-detach Northern Ireland from the rest of the UK.

It was pretty clear that Harris hadn’t voted for Brexit, and didn’t support it now.  But he had a pretty hard-headed assessment: the decision had been made and there was no imaginable way it was going to be reversed.   He couldn’t see how effective deals could be in place in March 2019, and even talk of transitional periods beyond that had all sorts of (technical and political) problems.  He envisages a pretty “hard Brexit”, and is very gloomy as to how the UK will cope.

In fact, that was one of the odder aspects of his talk.  He presented a (familiar) chart showing that in the 20 years to 2007. British productivity growth had been faster than that in most other major advanced economies.  But since 2007 there has been no productivity growth at all in the UK.  No one quite knows why, or even how much of what we see might be measurement and how much genuine.  Performance has been poor recently, but that has nothing apparent to do with Brexit.

And yet Harris used this record to claim that if Britain was to take advantage of Brexit, it needed to have a high productivity economy to benefit from comparative advantage.  He said it twice, so it presumably was an intentional statement.  But Stage 1 economics students learn that everyone has a comparative advantage: economy B might be better at producing all sorts of different goods that economy A (that’s absolute advantage), but comparative advantage just tells you that economy A will nonetheless be occupied producing the things it is relatively less bad at producing.     Misunderstanding that point didn’t fill me with confidence in the rest of the presentation, although I’m guessing he just meant that one might be more optimistic about British economic outcomes –  in or out of the EU –  if it was managing decent productivity growth now.

Harris did present the results of a couple of modelling exercises that have been done on how large the real economic costs of Brexit might be.  They usefully highlight that the costs won’t just fall on the United Kingdom –  indeed, one of them envisages job losses (transitional presumably) twice as large for the rest of the EU as for the UK (the EU is of course much larger).    There are losses in this scenario because, even with full free trade with the rest of the world (which won’t happen any time soon), there are typically fewer profitable trade opportunities with places further away than with places close to home (one of NZ’s problems).

In one paper (by Vandenbussche et al), it is estimated that the level of British GDP will fall by 4.5 per cent in a “hard Brexit”.   What I hadn’t realised –  or thought about before –  is that Britain might not be the biggest loser.  In this particular model, Irish GDP would fall by almost 6 per cent, and that of Malta –  with close historic ties to the UK –  would also fall by 5 per cent.    If a 5 per cent loss of GDP seems large, no one really knows the likely absolute magnitudes. Harris quoted estimates from another study by Dhingra et al: they in turn had bad and less-bad scenarios, but the central estimate of lost GDP for the UK was around 2 per cent.

There is a pretty widespread view among economists that these costs, whatever the precise number, are both large and avoidable.  Of course, they might be avoidable, if Brexit was to free up Britain to adopt far-reaching microeconomic reform and liberalisation.  Sadly, that doesn’t seem remotely likely at present –  and of course, many of the costly restrictions the UK imposes now (eg land use restrictions) are entirely home-grown.

Instead, economic elites lament the choice to exit the EU and wish, longingly, that it could be reversed.  That sentiment is perhaps particularly evident in places like the IMF and the OECD –  and Harris cited quite a bit of material from the latter organisation, which has an institutional bias away from the national in favour of the multinational.

I suspect, by the tone of the questions, and the sympathetic murmurs when Harris made particular points, that there weren’t many people in Monday’s seminar who were sympathetic to Brexit.  I am.  Were I a Brit, I’m pretty sure I’d have voted for it –  although, in truth, I’m not sure I’ve ever voted in New Zealand for a programme that might reduce GDP per capita by 4 per cent.  But Brexit has just never seemed primarily like an economic issue, and that seems to be the difference between the public –  polls suggest they are still pretty evenly divided as they were last June –  and most economists.

And so I stuck up my hand and suggested that if we’d been doing this sort of modelling 60 years ago, as territories pondered the possibility of independence from Britain, the results would surely have shown that, for almost all of them, they would be worse off economically than if they’d stayed with Britain.  (And that modelling would never have allowed for the gross mismanagement that followed in many of the newly independent African countries in particular).  And yet if they had been presented with estimates of a 5 per cent loss of GDP, how many would have turned down the chance to be independent – to be free?  Even now, decades on, few probably regret the independence choice –  Somalis might be an exception.   The essence of my point of course was along the lines of why shouldn’t Britons today make a similar choice about the EU.  (And, of course, a 4 per cent loss of productivity sounds big, but it is the loss of 2 or 3 years productivity growth in normal times, invisible over a 50 year horizon.  Adding another week’s annual leave probably reduces GDP per capita by a couple of per cent.)

I’ve made this point here previously, but I was interested in how Harris was going to respond to it.  His response was to acknowledge that many Scots had certainly favoured independence, even at an economic cost – although of course they, like the Quebecois in the 1990s – decided to stay part of the larger country.  But then he fell back on avoidance, arguing that the issues were different for India or Zambia, as their cultures had been squelched by the British etc, and no one could suggest that anything of the sort could be said of Britain and the EU.  Had I had the chance of a rejoinder, I’d have noted that my points would have applied to the choices New Zealand, Australia, and Canada (and Ireland –  although the cultural issues were a bit different) had made to progress towards full economic and political independence.  It may well have come at a cost, but few then –  and fewer now –  will have regretted the choice.  And in all three countries the predominant population was English.  Probably few Slovaks regret their divorce from the Czechs.

Harris’s fallback was that “the EU was always only an economic club, and it remains an economic club”.      That was the conceit of many in Britain.  It was never the vision of the founders of the EU, or of those driving it today.  The very treaties envisage an ‘ever-closer union”, and even today newspapers such as the FT are full of talk of plans for closer banking or fiscal unions, even talk of an EU finance minister.   New entrants to the EU – although not Britain, Sweden and Denmark –  are obliged to commit to enter the euro.  And –  as a matter of conscious and deliberate choice –  being part of the EU means individual nations surrender the right to legislate for themselves in many areas.  That is a (lost, or foregone) freedom that many Britons seemed (and seem) willing to pay some price to reclaim.  If you don’t value the nation state –  or you aspire to some mega European state –  you’ll think that choice irrational.  But most people do seem to value the nation state –  and not just in the UK.    And the British exit polls last year suggested that it was just those sorts of “chart one’s own destiny” considerations that counted with those voting to leave.

Nearly half (49%) of leave voters said the biggest single reason for wanting to leave the EU was “the principle that decisions about the UK should be taken in the UK”. One third (33%) said the main reason was that leaving “offered the best chance for the UK to regain control over immigration and its own borders.” Just over one in eight (13%) said remaining would mean having no choice “about how the EU expanded its membership or its powers in the years ahead.” Only just over one in twenty (6%) said their main reason was that “when it comes to trade and the economy, the UK would benefit more from being outside the EU than from being part of it.”

In the end, who knows whether it will matter much.  All the modelling assumes that the EU itself carries on much as it is.  A pessimist – perhaps an optimist –  might wonder whether the EU itself will last in its current form for much longer.  Public opinion in other EU countries seems to ebb and flow.   The next recession –  whenever it is –  is just going to accentuate the tensions already apparent in many countries, given that few EU countries have any material “fiscal space” and the ECB is likely to go into the recession with interest rates already at or below zero.  Perhaps in the end Britain will prove to be a pathbreaker –  something the eurocrats and EU-oriented elites must fear very deeply.

Harris concluded with a couple of slides making the point as to how little trade New Zealand firms/individuals and those in the UK now do.   He was inclined to the view that, therefore, what happens around Brexit doesn’t really matter to us.   I’m not sure he is right there –  even setting aside wishful thinking about full free trade between us, including in agriculture.    Even in the transition, a disruptive hard Brexit is the sort of event that could –  in the wrong circumstances –  matter for the world economy in 2019.  And for a small country, looking to materially increase its export orientation, we should certainly be hoping that a country of the size and sophistication of the UK can make it –  and prosper –  alone.  If they can’t, it wouldn’t bode well for us.

22 thoughts on “The costs of Brexit

  1. Britain should re-establish its leadership of the Commonwealth. As a sporting event it is certainly still quite popular. I think many countries whose population still have long lost happy memories of the British Empire and its hey day and many countries still have British administration processes and Westminster type of government. It is quite surprising that the Britain of today behave more like a faithful pet to the US and taking baby steps to be independent of mother Europe, rather than the awe inspiring British Empire that we expect of Britons.

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  2. The people in Britain must look on in horror at developments across the ditch, the insanity of a virtual open door to third world criminals and Islamic extremists beggars belief.
    The EU elites are committed to the creation of a true super state and the elimination/emasculation of the nation state in Europe. They have begun the establishment of an EU military (controlled by?), one can easily envision the day when it’s guns will be turned on the citizens wanting independence or were there is strong rejection of totalitarian edicts from Brussels. Currently no EU country can fire on it’s own people, I’m sure this new military will have no such constraints. http://www.businessinsider.com/eu-countries-agree-mega-army-2017-11?IR=T
    There is rising anger against the EU establishment and more than a possibility of civil war as a result, EU reaction to the Catalan independence movement are indicative of it’s antidemocratic and totalitarian trajectory.

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  3. One vivid sub-text of the article is that the loss of sovereignty is economically beneficial. Acceptable even. Which just happens to parallel the as yet unresolved flaw in the TTPA

    Liked by 1 person

    • It needn’t be that way. Genuine unilaterial free trade, and (say) mutual recognition of regulatory standards around service provision, and you can have almost all the gains that are really on offer.

      Of course, in some sense, any interaction with other people – internally or externally – limits one’s choices/freedom of action in some sense, while opening up other new opportunities.

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  4. The EU is a flawed institution. A common currency and common monetary zone needs the backing of powerful Finance Minister controlling a Treasury with the ability to impose taxes and expeniture for all of the EU. Common currency zones otherwise do not last. If Europe does not have a functional Treasury then the next economic downturn will impose impossible to resolve tensions across Europe.

    A powerful Finance Minister/Treasury needs to be partnered with an executive team and in liberal Western countries this executive team needs to have a democratic mandate. They need to be appointed and be accountable directly to EU citizens.

    As the EU currently stands it is one of the broken legs of liberal democracy. Trump and the US in my opinion being the other.

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  5. “Instead, economic elites lament the choice to exit the EU and wish, longingly, that it could be reversed. That sentiment is perhaps particularly evident in places like the IMF and the OECD”

    And here … The dance of the Economic Elites. A UK based economic elite, sponsored by an NZ group of economic elites, reviewed by an economic elite whose audience are NZ economic elites talking about Econocrats and econocracy

    Definition. .. econocracy . A society in which a wide range of political goals are defined and valued in terms of their effect on the economy. The economy is believed to be a distinct system with its own logic. This system requires experts to manage it and so economic policymaking increasingly becomes a technocratic process

    They forget … what it’s all about … this has overtones of Scrooge McDuck and Flintheart Glomgold sitting in their Money Bins, unaware of the plight of the homeless, the garage dwellers, car sleepers, rough sleepers, the damage to what once was, what we had … our heritage … what made New Zealand …

    Just the other day our scribe here asked
    “Is there really no political figure, in our entire political system, willing to stand up for the interests and values of New Zealanders, for our heritage as one of the longest-established democracies in the world”

    ————————————————
    The Quest Of The Grail Knight Katherine Paterson’s revision of Wolfram van Eschenbach’s “Parzival”

    Parzival leaves the castle, to begin his quest …….. ??

    The gate was open and the drawbridge down. He galloped across, but when he got to the end of the drawbridge, someone yanked the cable so abruptly that Parzival was nearly thrown, horse and all, into the moat. Parzival turned back to see who had done this to him. There standing in the open gateway was the page who had pulled the cable, shaking his fist at Parzival. “May God damn the light that falls upon your path!” the boy cried. “You fool! You wretched fool! Why didn’t you ask the question?”.

    “What do you mean? .. Question?” Parzival shouted back at the page. “What question?”
    ————————————————

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  6. I found this post really interesting and hope you will return to Brexit as it develops.

    When I was a child the UK devalued the pound and the Irish did likewise twenty minutes later. I remember at the time thinking the Irish being a small country dependent (at that time) on the UK didn’t have sovereignty and with similar thinking concluded the concept of the EU was good. Now I interpret the same event quite differently – that 20 minutes and that decision was theirs – they had the opportunity and the right to choose a different exchange rate but on the basis of what was best for them decided to copy the UK.

    When Brexit was interpreted by some as proof of deep seated racism in Britain I asked who would want New Zealand to be an Australian state. I was rather surprised to discover there are New Zealanders who really don’t care.

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    • I could imagine voting for NZ to join Australia, as (I suppose) the Scottish bit of my ancestry could imagine voting to stay part of the UK. But I could never imagine to voting to join a common union with Chile, or with Spain, or France. or Poland. There might be economic motives for those positive votes, but only in a context of enough shared culture, and sense of “how things are done here” that i could be comfortable with the prospect of the (uncertain) future outcomes and policy choices.

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      • Under Australia’s constitution, NZ remains a state of Australia. All NZ needs to do is to have a referendum and decide by majority vote if they want to join Australia. Your ancestors turned down Australia’s desperate attempts to get NZ to join and Australia even left us with a path to join writing us into their constitution for the future.

        I wonder if this existing lot of Australian politicians would give credence to what their founding constitution allows for or as we have seen the likes of Malcolm Turnbull that just ignores their founding constitution. I wonder if an Australian court would have to back us if we decided that we did want to join Australia?

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      • We have discussed it before but your answers have not been anywhere close to satisfactory. A founding constitution is usually the backbone of interpreting law and a judge could easily interpret a legal challenge in NZ’s favour

        Liked by 1 person

  7. Alasdair Scott (IMF European Desk) gave a similar presentation on Brexit at UoA. A keys point: whether or not Britain can retain its financial passport to the EU will be critical to the economy. That, unfortunately for the UK, looks unlikely.

    RE your hypothetical vote for Brexit: You appear very keen on self-determination. Would you suggest that Texas secede from the US? Auckland from NZ? In other words, where do you draw the line when it comes to geographic self-determination?

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    • To me, it is mostly a question of “shared identity”. As i said in response to another commenter, personally i could imagine voting to join Australia, or (were I a Scot) for voting to stay in the UK (or not). I don’t have a view on Texasm but in general I’d favour alllowing regions to opt out of existing countries if they choose (subject perhaps to a 60% majority on say a 60% turnout). That applies to Quebec, Catalonia, Scotland ….or even Western Australia where secession occasionally appears again on the agenda

      Of course, it has also been the trend in recent decades, as external trade barriers have come down there are many more countries than there were.

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      • Interesting concept for a country – a common culture. It explains PNG and maybe Belgium and now time for Kurdistan? The trouble with culture is it is a vague concept. When Paul Spoonley talks about multi-culture he talks about sport and food but surely it has more to do with values but values are too vague to discuss in a speech. Food isn’t. However the food of my youth is no longer the food eaten in the UK so that cultural aspect changed. Another problem is defining cultural differences which are more distinct than class differences.

        Your common culture concept is attractive by instinct but weak when contemplated. If it was culture then it would be Northern Territory and Cape York looking for independence.

        Maybe a mix of factors interacting: culture and common history/myth, economic and geographic. Of course historical accident, inertia, fear of change and loss of status at the top (whatever happened to the East German government elite?) explains the current situation. Potential changes will be triggered by changes in those four factors plus the intellectual attraction of globalism. Or is that another myth?

        Then there are issues with fragmented sovereignty; the Isle of Man has independence but foreign policy belongs to the UK. Been that way for a long time. From wikipedia: “”The Cook Islands is a self-governing island country in the South Pacific Ocean in free association with New Zealand.””. Supreme authority in some matters but not in others.

        As you can tell I’m confused. Simple ideas like ‘country’ and ‘money’ become very hard to grasp the more I think about them.

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      • I guess by common culture I mean something about shared identity and willingness to trust. As you suggest, some of that is about historical accidents – any sort of national identity for Belgium must surely fit that bill. A concrete question is who are you willing to pay to support when times are tough. Brits – or Germans, or anyone else – aren’t willing to pay unemployment benefits for Greeks (and probably vice versa).

        I’m increasingly pessimistic about what common culture/identity means at all – historically it was encapsulated in some mix of shared experience and shared religion – which leaves me pretty pessimistic about the world. But that’s a topic for another time/place.

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      • Your thinking echoes David Goodhart’s comment about the unwillingness to pay social welfare costs when the underclass appears to be a different ethnicity (‘Them’ and ‘Us’). In the USA they emphasise Afro-Americans & Hispanics as being different and poorer. That made it easier for the Tea party. The more I think about immigration the more I come to two conclusions:
        1. it is like Paracetamol – really beneficial in small doses and dangerous in large doses
        2. there is a strong class issue – those who support our unusually high immigration rate are looking for people to man the checkouts in their supermarket, provide cheap child and elderly care for their family members, work in their restaurants and generally. The genuine ‘skilled & business’ immigrant is too rare as is proved by figures about average wages immigrant/non-immigrant.
        The third reason could be the need to prop-up the property market but I’m not that cynical.

        15 years in NZ and the place is changing me. When I arrived I voted ACT. I doubt I would have ever stepped off the plane if I had had a premonition that I’d become a socialist.

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  8. 1) The EU doesn’t want the UK to leave & don’t want to be seen to be easy on the UK otherwise other states will get the same idea. They are playing hardball

    2) I doubt the UK negotiating team really want the UK to leave either. Multinationals are already pulling out as are the banks

    3) I haven’t seen a workable solution to the Irish border posted yet

    4) UK public opinion has turned against Brexit

    5) The UK parliament will get a final vote

    Its not a done deal yet.

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  9. ‘Brexit’ vs. ‘Grexit’: assuming the later remains a word rather than action, be interesting to follow the fortunes of these two countries over the next decade or so – should give a good steer on sustainability of the EU….

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