No, Robert Chote, it is not clear that Brexit harmed the economy

No, Robert Chote, it is not clear that Brexit harmed the economy

In an interview for the new edition of the New Statesman, Robert Chote – who chairs the Office of Budget Responsibility (OBR) – has entered the murky waters of blaming the Brexit vote for “harming growth”, claiming the economy is “weak and stable, rather than strong and stable”. He asserts that “…in terms of the net effect on GDP, the hits to demand have outweighed the boosts”. But truth to tell, this may, or may not, be true. Clearly, we do not know what would have happened to the economy if there had been no Brexit vote in June 2016 – we do not know the counterfactual.

Granted, the OBR produced forecasts back in March 2016, which suggested GDP growth would be 2.0% for 2016 (outturn currently estimated to be 1.9%) and 2.2% for 2017. Arguably, this is as near as we can get to a no Brexit-vote counterfactual picture. Current expectations are for 1.8% growth in 2017 (we will know the ONS’s first estimate on Friday 26th January, which will probably be revised up subsequently) which is, arguably, not a million miles from the OBR’s March 2016 forecast.

But there is more. All economic forecasters, not least of all the OBR, know that economic forecasting is an imprecise art. Indeed, since the Brexit vote the OBR’s forecasts for GDP growth for 2017 have, to put it kindly, fluctuated. In November 2016 gloom descended and they downgraded their growth forecast to show 1.4% for 2017, they then revised it up to 2.0% in March 2017, as the economy seemed to weathering the Brexit vote well, and then revised it down to 1.5% in November 2017. I respect the OBR, but may I humbly suggest that with such a forecasting record, caution and modesty should be the order of the day. Economic models can only tell us so much about the way the economy functions.

More constructively, let us analyse what has actually happened to the economy over the last two years. GDP growth in the 2016 Q1 was poor (see chart 1 below), but it perked up in 2016 Q2 and through the second half of 2016. How much the strength in the second half had to do with the Bank’s premature easing of monetary policy in August 2016 is subject to much speculation, but my speculation is that, overall, it was fairly modest. The economy had momentum in the middle of 2016 and the labour force was robust.

Granted, the economy showed weaker growth in the first half of 2017 as household consumption growth weakened significantly, doubtless reflecting the squeeze on real earnings following the post-Brexit vote depreciation of the currency and the subsequent rise in inflation. (And I suspect some residual seasonality in the figures, there seems to be a pattern of weak first quarter data.) This is all understood. Consumption did, however, pick up in the second half of the year. Meanwhile gross fixed capital formation (capital investment) remained solid in 2017 in spite of fears in some quarters that a Brexit vote would lead to a “collapse”.

And, of crucial importance, net exports (a vital component of GDP) have shown some improvement, with exports benefiting from the (much-needed) more competitive currency and a pick-up in global growth (which has been much as was expected by the IMF prior to the Brexit vote). In 2016, the trade balance in goods and services deteriorated, acting as a drag on growth, but in 2017 the turn-round in the trade balance should contribute to growth. Arguably, the currency was overvalued prior to the vote, doubtless supporting household consumption but to the detriment of the external sector. And economic growth in 2017 can be seen as in a post-depreciation adjustment phase, achieving a much-needed and long overdue rebalancing from the household sector to exports.

Now, we can argue until the cows come home as to whether Brexit’s “hits to demand” have outweighed the “boosts”. Perhaps they have, perhaps they haven’t. To repeat, we don’t know what would have happened if there had been no Brexit vote (perhaps household consumption would have slowed in any case?), and we never will. But one thing is fairly clear, economic growth now seems to be better balanced than it was when the currency was overvalued.

There are two other points to make. Firstly, I am not claiming that the economy is problem–free. Analysts are rightly concerned about the weak productivity growth since the Great Recession, though with plentiful labour resources it is hardly surprising that employers favoured labour-intensive means of production (hence poor productivity growth). As the labour market tightens, the unemployment rate is now down to 40-year lows and net immigration is slowing, employers will have to switch to other ways in order to grow their businesses – and productivity will rise.

And, secondly, rightly or wrongly, Mr Chote’s comments risk being seen as political and, more specifically, a continuation of the dreaded “Project Fear”, which lurked the land prior to the referendum and has done so much to undermine people’s trust in seriously important institutions, including HM Treasury.

It is worth remembering the Treasury’s scandalous “analysis” of the immediate impact of a Brexit vote, released in May 2016. May I conclude by quoting some highlights?

“The analysis in this document comes to a clear central conclusion: a vote to leave would represent an immediate and profound shock to our economy. That shock would push our economy into a recession and lead to an increase in unemployment of around 500,000, GDP would be 3.6% smaller, average real wages would be lower, inflation higher, sterling weaker, house prices would be hit and public borrowing would rise compared with a vote to remain”.

“The analysis also presents a downside scenario, finding that the shock could be much more profound, meaning the effect on the economy would be worse still. The rise in uncertainty could be amplified, the volatility in financial markets more tumultuous, and the extent of the impact to living standards more acute. In this severe scenario, GDP would be 6% smaller, there would be a deeper recession, and the number of people made unemployed would rise by around 800,000 compared with a vote to remain. The hit to wages, inflation, house prices and borrowing would be larger. There is a credible risk that this more acute scenario could materialise”.