We need a Budget next week that shows Britain is open to the world, not closed to Europe

We need a Budget next week that shows Britain is open to the world, not closed to Europe

The UK economy has performed robustly since the Brexit vote, in complete contrast to the scenarios outlined by HM Treasury in their documents prior to the referendum. The Office for Budget Responsibility is expected to report shortly that the UK economy will grow by some 1.6%. This is slightly lower than the rate expected by the OBR in the spring, but is considerably higher than predicted by the Treasury and almost all outside forecasters before the Brexit vote.

It is true that this year the UK economy may underperform the economies of the Eurozone and the United States but this is understandable after several years near the top of the table and is not likely to continue, provided that we manage our affairs appropriately.

Recent good performance by the Eurozone contrasts with its longer term history. Since the first quarter of 2008, while the UK economy has registered cumulative growth of 10% the Eurozone has managed only 5%. Within this total, the experience of some member countries has been much worse. Over the period, the Italian economy has contracted by 6%. If this comparison were made since the formation of the euro in the first quarter 1999, then we find that whereas the UK has grown by 40% the Eurozone has expanded by only 28% and Italy a feeble 8%.

When the UK decided against joining the euro, it was widely argued that this would be an act of irreparable self-harm as the countries of the Eurozone were set to surge forward on a wave of new prosperity unleashed by the single currency. Gravity models predicted a tripling or doubling of UK trade if we joined. Only a few brave souls stood out against this overwhelming consensus, but not for the first time in our economic history a small band of contrary thinkers won the day. For the countries of Southern Europe not a wave of prosperity but a tsunami of unemployment.

It is widely suggested that the Brexit vote has caused substantial weakness in consumer expenditure. This is untrue. This year it should grow by 1.8%. This is lower than last year, which is hardly surprising given that last year’s sharp fall in the pound caused inflation to rise, thereby precipitating a squeeze on consumers’ real income. Inflation has risen to 3% but this is not far from its peak. In the next few months, it may reach 3.2% before starting to head down towards 2% in the second half of next year. This will allow real incomes to rise again, thereby underpinning more robust growth of consumer spending.

Many commentators have viewed last year’s sharp fall in the pound as some sort of disaster. They could not be more wrong; the pound has been overvalued for some time and it needed to fall in order to make the UK more competitive and thereby to improve the UK’s current account position. The Brexit vote proved to be the trigger for this welcome adjustment, the weak pound should help rebalance the economy by slowing the growth of consumer spending and boosting the growth of net exports. Accordingly, this year’s consumer slowdown, far from being some unanticipated disaster is part of the process by which the UK economy returns to full health.

At the time of the Brexit vote, it was suggested that business investment, which accounts for about 10% of the UK’s GDP, would be severely weakened by a vote for Brexit. All that has happened is a moderate level of growth this year but the surveys suggest it will pick up next year. The notion that investment is being held back by Brexit is certainly erroneous. Large parts of the UK economy are unaffected by EU trade. Exports to the rest of EU account for about 12% of the UK economy. This means, of course, that 88% is accounted by things other than exports to the EU. What matters for the 88% is that we run our economy well and that we stabilise the public’s finances, as has happened over the last 7 years. For the 12% the overwhelming bulk of UK exports to the EU will continue anyway.

At the heart of these forecasts is the fiscal reality that by taking a more optimistic view of the growth consequence of Brexit, based on the static and dynamic stimulus from classic free trade and combining this with continued restraint in public spending, then when post-Brexit fiscal freedom opens up, public spending net borrowing (PSNB) moves into steadily increasing surplus from 2021 and the public sector debt to GDP ratio falls to 60% by 2025.

These forecasts quantify what we call post-Brexit fiscal freedom of £135 billion between 2020-2025 and a further £40 billion per annum from 2025 onwards. This includes the £10 billion a year saved by not having to make contributions to the EU budget.

The window of post-Brexit freedom will remain firmly shut to those forecasters who subscribe to the modelling approach adopted by HM Treasury, which has a neo-protectionist approach and inbuilt bias towards a pessimistic assessment of Brexit. It is worth taking a few moments to make some crucial observations about the use of gravity modelling by HM Treasury.

There is a dark secret hidden in HM Treasury and unseen outside until exposed by Patrick Minford. There was not and is not any HM Treasury gravity model of UK trade. Brexit was never modelled in the fullest sense and this has profound consequences.

It also assumed that on leaving the Customs Unions the UK would apply the common external tariff to EU goods. This would be a lunatic thing to do as it would harm consumers directly through higher prices and indirectly from damaging knock on effects to the general economy. Fortunately, after a year’s work, Professor Minford and his research team at Cardiff University have done what the Treasury ought to have done, and what does this tell us? The gravity modellers did not do their jobs properly. If they had adopted a full model with full free trade effects they would have emerged with a positive instead of a negative Brexit story.

This leads to forecasts which provide headroom for fundamental change in fiscal policy and the first thing to do as a matter of prudence is to allocate sufficient funds to prepare us to leave the EU without a trade deal. The Chancellor has so far made £250 million available this ought to be increased to £500 million with a contingency fund of £2 billion for other matters that may arise. This will probably not be needed and can be added back to sums already referred to.

This year’s Budget could mark a real opportunity for a turning point in the conduct of fiscal policy in the UK. Brexit provides the chance to signal to the world that Britain is open for business and that this Government is going to make the UK one of the most competitive economies in the world. The question is how to use this new-found freedom, and inevitably people will differ accordingly to their political principles as to whether they focus on tax cuts or expenditure. However, in my view, the priority must be to show that Britain is open to the world, not closed to Europe.

Most importantly, from 29th March 2019 all tariffs on goods imported from anyway in the world should be zero rated immediately if the UK has no domestic production on any significant scale or if the tariff rate is below 15%, in which case domestic producers have already benefited through the fall in the pound to compensate them for the removal of tariffs. Many of the tariffs in the Customs Union protect inefficient continental manufacturing or agriculture that has no benefit for the UK consumers or businesses. In the long-term, protections harms the businesses they purport to help so other tariffs ought to be phased out. This will help the poorest consumers most as the highest levies are applied to food, clothing and footwear, which take a larger percentage of the lowest income.

There are two further essential opportunities for which the money can be used. The first is proof of the country’s commitment to business so the corporation tax rate ought to be reduced to 10% by 2025 and could be reduced on the 31st March 2019 in the event that the EU seeks to impose tariffs or non-tariff barriers on the UK once we have left. We should not retaliate by applying tariffs that would make us poorer but applying tax cuts that would make us richer. The second thing that ought to be done is to meet the demands of Simon Stevens, the head of NHS England, the necessity of which I accept both because of what he has said and what I am hearing locally. Indeed at the last election I thought that the challenge of 2022 would be for the Tories to show that the NHS really is safe in our hands.

Although I did not want the £350 million figure used, it was used and the electors believe a promise was made. Politicians cannot hide behind the small print like some disreputable businesses do, but must recognise that the commitment is accepted in broad terms not in pettifogging detail. We promised £350 million for the NHS so we must deliver it. This is £18.2 billion a year, just under half the Brexit growth dividend from 2025, but the money is needed sooner so in 2019/2020 the cash boost needs to be there as far as possible. This puts pressure on the Government not to spend too much on speculative future EU commitments and it is the crucial reminder that any money paid out to the EU is money that cannot be spent on domestic priorities.

In addition to the fiscal measures, regulation must escape the anti-competitive dead hand of Brussels. The City is the world’s leading financial centre and post-Brexit we must make it even more attractive and enhance its competitive edge; Solvency II, the AIFMD and MiFID II all reduce competition. The economic history of the world shows that freedom works and we want to free the City to thrive even more. In the wake of the financial crisis, this may make some people nervous but there is no link between the quantity of regulation and financial stability. The key to ensuring financial liability lies in the quality of regulation.

The alarmist reports of tens of thousands of jobs being at stake across the City are poo-pooed by the Chief Executive of Deutsche Bank, who said the estimates of job losses from moving clearing would be 74 not 74,000. London could become an even greater success in the future with Britain outside the EU. Free from the EU’s pursuit of a financial transaction tax, which would simply see business flooding away from London, and free from the thousands of pages and millions of words of prescriptive choking regulation, the City of London could carry on doing what it is best at.

This is an edited extract of a speech delivered at the launch of Economists for Free Trade’s Budget for Brexit.