A critique of treasury estimates of the impact of Brexit

Post-Brexit options for the UK: combining legal and economic analysis

by Graham Gudgin, CBR Research Associate, University of Cambridge (in association with Ken Coutts of the CBR, and Neil Gibson and Jordan Buchanan of the Ulster University Economic Policy Centre)

Gudgin tells Boni Sones why he thinks the Treasury over-estimated the short-term economic impact of the UK’s vote to leave the EU and why he thinks his new economic model is a better bet in determining how the economy will fair in the mid to long term.

While commentators and pundits still believe that the long-term impact of Brexit will be economically damaging to the UK, Gudgin’s modelling takes to task the traditional economic “gravity model” which says that the volume of trade between two countries is directly proportional to the sizes of their economies and inversely proportional to the distance between them.

He finds the treasury and OBR forecasts wanting and is optimistic about the UK’s trade prospects, and its GDP growth in the mid to longer term.

Graham Gudgin’s key quotes:

  • “We have now looked at all the 120 countries, over 65 years, the Treasury model used and scrutinised an enormous amount of data and replicated what the Treasury did. That is the first thing, that there is no or very little difference in our results. Then we vary it and we look at sub samples of the data or we look at different periods and we also look at the UK specifically which the Treasury never did. The Treasury just looked at the average impact on Trade of all 28 EU member countries and they didn’t think to ask if this actually applies to the UK. When you look at this specifically it looks as if it doesn’t, the UK does a lot less trade with the EU countries than they do themselves presumably because of our different histories and geography. You half the impact or less. So instead of saying we will lose 45 per cent of our goods trade with the EU when we leave we think we will lose perhaps 20 per cent or less, and that is a guess because no-one has ever left the EU. And the gains you get by joining aren’t necessarily reversed when you leave because companies have built up distribution networks and they have invested in their brands. We don’t know but we are fairly confident the Treasury was way at the top end of the impact of leaving.”
  • “Small trade and minor trade flows are less than one million dollars a year, that is nothing. When we looked at a sample of the top 60 UK export destinations, and they include all the EU 28 countries, it gives you a different result. Which is the right way of doing this? Different samples, different time periods give you different results and therefore it is not a good guide to what will happen. None of that appeared in the Treasury report, their equations don’t appear, and we have asked them to let us see these and it has never agreed. The public have a right to know how this is done and the Treasury is not telling us.”
  • “Our (UKMOD) models are more accurate. The CBR model is relatively new, fairly Keynesian but the forecasts we did for 2016 last year, published at the end of 2015 were better than all the other 38 different forecasts. Ours seemed to be more accurate. The OBR which the Treasury relies on, is odd, the GDP forecasts are almost an assumption about productivity and nothing else, but productivity has grown very little over the last 10 years, but it is assumed it will come back to a pre banking level, and then everything else has to fit that. We can say that is one assumption, but there are lots of other assumptions, so here are a range of possibilities but instead the OBR model is seen as the gold standard. What they do is legitimate as long as people know what it is.”
  • “Sterling has fallen, there will be more inflation, if wages don’t keep up people will buy less, and that will have a damaging depressing impact on the economy as a whole but if they do keep up, they will keep purchasing.”
  • “The fact that productivity has hardly risen in the last ten years is called the productivity puzzle. To have a puzzle in a scientific discipline that is 200 years old is not very impressive but it is a puzzle. In our model we can predict it but not fully understand it. It is related to migration. Over the past 15 years we have created about 3 million extra jobs in the UK, but that has been associated with a rise of about 85 per cent of people born from abroad, and a high proportion of these work on or at the minimum wage. That is not great for productivity, rich countries wouldn’t do it.”
  • “GDP could fall for a number of years and if migration is falling then that GDP is spread among fewer people so GDP per head could be doing something different and we think that could in fact start to rise. The level of GDP by 2030 could be higher than it would have been.  The fall in sterling is important, and it is a move to a more natural and sustainable level. That will generate more exports and help the economy to grow faster, it has been helpful.”
  • “We are reasonably optimistic about the impact of Brexit. Our gravity model work shows the negative impact on trade will be less than the Treasury said, and when we feed that into our macro-economic model with the lower exchange rate we think things don’t look bad at all. Even at the worst, in the early years of the next decade, GDP will only be one per cent less, and then grow to above, and GDP per head will remain higher throughout. Most people aren’t going to notice much difference.”
  • “We will be able to do our own trade deals, but in many cases it won’t really matter, the EU doesn’t have a trade deal with the US nor do the UK. We will carry on trading and we should look towards the East and countries like India. When we joined the EU in 1973, it slowed down on almost the day we joined but the Commonwealth markets on which we relied have grown faster, and focusing in that direction will do us good.”
  • “A lot of the jobs lost will be jobs taken by migrants in food processing for example  so the impact on the wider economy will be minor.”
  • “The Treasury has let the OBR do its forecasts. Why was the Treasury doing this, why wasn’t there more consultation, and why haven’t they been more open about their equations and methods? These are all questions that need to be addressed.”

Listen to the podcast

In a new podcast on the Post-Brexit Options for the UK: Combining Legal and Economic Analysis Graham Gudgin a Research Associate at the Centre for Business Research discusses his new paper – A Critique of Treasury Estimates of The Impact of Brexit.

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