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Ignore the Brexit scare stories - they have no basis in sound economics

Officials are making up the menacing numbers because they believe that the UK should remain in the EU for non-economic reasons. British citizens should resolve the Brexit issue based on their values

Ashoka Mody
Thursday 06 December 2018 13:29 GMT
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No-deal Brexit will mean 'lost jobs, lower wages and higher inflation' warns Bank of England governor Mark Carney

The Bank of England’s prediction that civilisation will end with Brexit is merely an effort to outdo in shrillness similar analyses by the Treasury and the IMF.

All official agencies, trapped in an echo chamber, are competing to paint the grimmest picture of economic consequences of a British exit from the European Union. They are straining so hard because their projected costs of exit have no basis in economic theory or empirical findings.

“I don’t understand how you can get that kind of cost without making some big ad hoc assumptions,” tweeted Nobel laureate Paul Krugman.

When he uses the expression “big ad hoc assumptions”, he is saying the Bank is making up the numbers.

Mervyn King, who headed the Bank between 2003 and 2013, says he sadly “concurs” with Krugman’s assessment.

Krugman goes a step further: “I have worried in all this about motivated reasoning on the part of people who oppose Brexit for the best of reasons.”

Translation of “motivated reasoning”: officials are making up the menacing numbers because they believe that the UK should remain in the EU for non-economic reasons, which they cannot or are unwilling to defend.

The economics is straightforward. When trade barriers between the UK and the EU go up, British producers will sell less to the EU and will sell more within the UK and to the rest of the world.

No trade economist believes that the long-term cost of this shift in sales patterns is any more than 0.5 per cent of GDP. Throw in 2 to 3 per cent of GDP as temporary disruption costs. Estimates higher than that are ad hoc.

And ad hoc estimates can go either way. Britain’s trade with the EU is down to about 45 per cent from 60 per cent in 2000. Brexit will speed up that already rapid shift.

Scholars associated with the Federal Reserve Bank of Minneapolis, uncontaminated by motivated reasoning, conclude that stepped-up trade and investment with more dynamic economies outside the EU will give British producers greater access to cutting-edge technology and force them to become more productive. Such gains, in their view, will likely offset the costs of lost trade with the EU.

Thus, on balance, the net gains or losses from Brexit should be modest. The UK’s lacklustre growth since the Brexit vote is almost entirely due to the government’s gratuitous austerity.

It is important, therefore, to ask what Europe’s real purpose is. The EU’s beginnings can be attributed to a speech in 9 May 1950 delivered by French foreign minister Robert Schuman.

The goal, Schuman said, was to create “common foundations for economic development as a first step in the federation of Europe”. Hopes of a federation quickly evaporated, and Schuman’s political vision fizzled into empty words such as “ever-closer union,” “unity in diversity”, and Emmanuel Macron’s obscure “European sovereignty”.

However, the idea of a “common foundation for economic development” proved more durable. The Treaty of Rome concluded in 1957 provided shared economic benefits that lasted nearly a quarter of a century. Then even that momentum ran out as more integration provided limited benefits.

The most grievous effort to overdo economic integration was the establishment of a single currency. The repeated warnings that this project could go badly wrong were heard in Britain, and John Major negotiated an “opt-out” at Maastricht in 1991 when the treaty agreeing to the single currency was negotiated.

Oddly, Tony Blair’s government flirted with the idea of the euro. Economists fell in with the new political mood. In 1999, Britain’s “top academic economists” polled heavily in favour of the UK joining the eurozone.

At the University of California, Berkeley, economist Andy Rose published an article claiming countries that adopted the euro would exponentially increase their trade with each other, which would make them all more prosperous.

Adair Turner, then director general of the Confederation of British Industry, urged British business to embrace the single currency and lobbied in favour of it. Some years later, the Treasury, under Gordon Brown as chancellor, conducted a series of studies, which found that the euro was a bad idea.

But Brown left the door open – merely concluding that the euro was not right for the UK at the time. It was only after Swedish citizens decisively rejected the euro in a September 2003 referendum that Blair gave up. He recognised that a UK referendum, which he had promised, would lead to his political humiliation.

In 2015, after an important study had established that the euro produced no trade gains, Andy Rose published a mea culpa. He acknowledged that his earlier analysis improperly extrapolated from the experience of smaller monetary unions of mainly poorer countries, and did not apply to the eurozone. By then, the grim costs of the extended eurozone crisis were evident. The euro created no obvious benefits but carried all-too-real risks.

True, unlike the euro, open borders generate recognisable trade benefits. But the benefits are overstated, and the adverse distributional consequences are too often swept under the rug.

By much the same logic as Krugman used in his recent tweets, the Harvard economist Dani Rodrik explains that economic welfare changes only modestly when countries with extensive trade relationships increase or decrease the extent of their international trade.

Rodrik, therefore, tenaciously highlights the troubling fact that contemporary trade agreements disproportionately help the most successful.

“Trade agreements,” he writes, “are driven overwhelmingly by a business-led agenda. The implicit economic model is one of trickle-down: make investors happy and the benefits will eventually flow down to the rest of society. The interests of labor—good pay, high labor standards, employment security, voice in the workplace, bargaining rights—get little lip service.”

The EU is the world’s most advanced form of “trade agreement” and, hence, comes with all the ills that Rodrik underscores. Well-heeled lobbyists representing business interests influence nearly 75 per cent of EU laws.

No, that does not mean that we need to roll back international trade. It does mean that although the transition costs are real, staying in the EU does not create obvious long-term economic and social gains.

It is possible, of course, that some economists and officials in the UK and the EU use the cover of an economic calculus but they truly wish to promote the deeper message of Schuman’s May 1950 declaration: “An organised and living Europe is indispensable to the maintenance of peaceful relations.”

Perhaps, the real intent of the scary estimates of the economic costs of Brexit is to emphasise that only the EU can credibly support global peace, promote democracy, and champion human rights – that these values and goals override claims to national sovereignty. If that is the motivation, now is the time to make that case transparently.

Sticking to unfounded economic numbers creates the suspicion of another troubling possibility. Travelling in rarified circles, political leaders, business people, and academics merely tell one another farfetched stories, which live in their minds and shape their analyses.

As Krugman wrote in a brilliant 1995 essay, “People believe certain stories because everyone important tells them, and people tell those stories because everyone important believes them. Indeed, when a conventional wisdom is at its fullest strength, one’s agreement with that conventional wisdom becomes almost a litmus test of one’s suitability to be taken seriously.”

British leaders must pull themselves out from the spell of storytelling and focus on their urgent responsibilities. At home, they must heed the real message of the Brexit vote: citizens being left behind by globalisation are clamouring for more protection. Prime minister Theresa May seemed briefly to recognise the primacy of that task. But she was sucked quickly into the Brexit negotiations vortex.

On Brexit, British citizens and their leaders must decide what kind of nation they want to live in. The debate must pit the value of sovereignty against the risks to global peace. Such a debate is of the utmost importance for Europe, with its history of horrific wars, especially now when ugly forms of nationalism are gaining alarming numbers of adherents. Unfortunately, instead of dealing head-on with this monumentally important challenge, which must guide the Brexit decision, global leaders are peddling frightening economic scenarios.

The Remain or Leave decision is an opportunity for Britain’s citizens to express and reaffirm their true values. Failure to protect the most vulnerable at home and redirect the Brexit debate to a higher purpose will leave underlying tensions simmering.

Ashoka Mody is visiting professor of international economic policy at Princeton University and former deputy director of the International Monetary Fund’s European and Research Departments. His new book is Eurotragedy: A Drama in Nine Acts

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