For an economist, it’s rare that events occur enabling us to directly test our economic theories and assess them against outcomes. Britain’s Brexit vote last year was one such moment. As the formal Article 50 process for EU withdrawal begins today, it’s worth re-examining the consensus view on what a “Leave” vote would mean. Those warning of impending doom today are many of the same people who predicted a decision to exit would bring immediate economic slowdown.
The Economists for Brexit group of which I was a founding member was busy refuting anti-Brexit reports pre-referendum. Britain’s Treasury led the way, claiming GDP would be 6.2 per cent smaller after 15 years if Britain exited the EU and single market (replaced with an EU-UK bilateral trade deal, as Prime Minister Theresa May now desires). Importantly, they forecast the mere act of voting to leave would trigger an immediate 4-quarter recession with 500,000 people losing jobs, higher inflation and lower house prices. There would be a “profound economic shock.” The IMF warned that a path towards leaving the single market would mean a recession in 2017. The OECD predicted a “major negative shock.” An Economists for Remain letter signed by 12 Nobel Laureates likewise said “a recession causing job losses will become significantly more likely.”
Yet the UK economy has proven robust. Immediate financial market turbulence following the unexpected vote quickly subsided. Far from contracting at the Treasury’s forecast 0.4 per cent annualized rate, the economy is currently growing at 2.8 per cent per year. The employment rate for 16 to 64 year olds is at its highest ever level, 74.6 percent, with unemployment at just 4.7 percent. House prices are currently increasing at 6.2 per cent per year. Annual broad money growth was 6.6 percent in January – suggesting robust nominal GDP growth through 2017. Even after Theresa May pledged to leave the single market and customs union, forecasters were revising growth estimates upwards for 2017.
The economic consensus did forecast correctly the pound’s fall on a trade-weighted index (around 13 percent decline), as did the Economists for Brexit analysis. This will raise the UK inflation rate. But even the recent uptick in inflation to 2.3 percent is in part driven by increasing commodity prices affecting U.S. and German inflation rates too. The flipside has been strong export order books, highlighted by the Confederation of British Industry’s buoyant survey last week. What happens to the pound in the longer term of course depends on the economic fundamentals, but what is clear is that so far the doom-mongers have been wrong on the macroeconomic impact overall.
Some disingenuously claim they called it wrong because Article 50 was not triggered straight away, or because the Bank of England took action after the vote. But this makes little economic sense given the forward-looking nature of consumers and investors, and the lags with which monetary policy operates.
No, the faulty forecast really came about because forecasters made a host of negative political assumptions in their modelling. They implied that many of the positive pro-market policies that have taken place since the 1970s alongside EU membership would be reversed. They assumed Britain would choose to maintain EU-level tariffs on the rest of the world and fail to agree any new trade deals. They assumed an independent Britain would change no EU regulations. They assumed that Britain’s gross contribution to the EU budget, and other powers in everything from agriculture to clinical trials, would be no better used domestically.
On every major issue, they looked solely at the potential downsides of Brexit and not the opportunities. Britain in the EU was considered the peak of economic dynamism. Thinking they’d be worse off after Brexit, the British Treasury and others believed consumers and investors would tighten their belts now. The faulty forecast of an “immediate recession” stemmed directly from the assumptions the Treasury made.
Most consumers and investors have so far shrugged off the vote though, suggesting the public believe Brexit will have little long-term economic impact. Theresa May has made strong commitments to pursue free trade (despite the lazy comparisons between Brexit and Trump) and the British Chancellor has floated the idea of moving to a Singapore-like economic model if no deal with the EU is reached. If the UK were to pursue free trade unilaterally, my Economists for Brexit colleague Professor Patrick Minford estimates GDP gains of as much as 4 percent in the long-term. Incidentally, his near-term forecast, deriving from this assumption, was much closer to outturns than the pessimistic consensus.
Even the EU Commission itself seems to think that the single market adds just 2.1 percent to EU-wide GDP overall, and you'd think that this figure would be lower for the UK given the market in services is less complete and Britain's instincts on regulation tend to be on the liberal end. Factor in the ability to review damaging regulations on clinical trials, agricultural and financial services, and there is room for optimism for a post-EU Britain.
As Article 50 is triggered, it is time for economists to remember that there are many more options stemming from policy freeoms than many of them considered during the campaign. Brexit is a supply-side shock to the economy. Whether it is a positive or negative one depends on how Britain uses the trade, regulatory and spending powers it repatriates from the EU in the long-term. All agree that a country more open to trade and investment will, other things given, be more prosperous. The fact that some economists are so sure Brexit will be damaging reflects their own priors rather than economics.