It’s time the Chancellor came clean about his absurd Project Fear economic modelling

It’s time the Chancellor came clean about his absurd Project Fear economic modelling

This weekend a large number of economists, businessmen, and politicians have signed a letter asking the Chancellor to publish the work underlying his Brexit forecasts. These forecasts have been leaked by Whitehall to support his gloomy views of the future if we sign either a Canada+ trade agreement with the EU or simply leave with a World Trade Deal under WTO rules.

So far, all we have explaining this is some two dozen PowerPoint slides grudgingly given to the House of Commons Committee on Exiting the EU. These merely scratch the surface of the work that must have been done in Whitehall. My fellow researchers and I have been able to make some decent guesses about the economic model that has been used and also the assumptions that have been put into it. This work suggests that the Whitehall forecasts are not credible.

But this is not a proper substitute for a full exposition of Whitehall’s modelling and also its thinking behind its assumptions. With politicians, businesses and the public all having a vital interest in the Government’s choices for Brexit, it is vital that we have a well-informed debate about the consequences of different policies as Parliament moves towards a final vote. In the absence of this, it is unacceptable that the Chancellor and his cronies, such as the OBR, leak these dire projections at every opportunity.

We often hear the excuse that it must all be kept secret because release would damage the Government’s position in negotiating a meaningful Brexit. However, this is manifest nonsense as the Government has, in fact, leaked doom-laden forecasts for every Brexit policy that alters the status quo. The effect of this is to undermine its own negotiating position in any attempt to achieve a meaningful Brexit. It encourages the EU to believe that, in the end, we will always prefer to stay as we are, effectively in the EU.

The truth is more mundane. This Whitehall Brexit analysis is the skeleton inside the Chancellor’s cupboard. To reveal it in all its skeletal glory would be to destroy the Chancellor’s gloomy arguments at a stroke. We have attempted since last December to discuss the Whitehall analysis but officials and ministers have simply refused to engage.

Why has the Treasury got the Chancellor into this parlous state? As we all know, the civil service and manufacturing industry (auto manufacturing in particular) are bitterly opposed to Brexit because it will remove trade protection, the access to Brussels lobbying for regulations and the resulting policies that make life so comfortable for them all – to the discomfort of the consumer, particularly the lower paid. A clean Brexit instead will bring down prices for consumers with a bang, expand our trading horizons, usher in sharp competition from the rest of the world thereby improving productivity, allow the Government to make sensible regulations (especially for newly emerging technologies), control the massive inflow of unskilled workers that undermines our own workers and incentives to train them properly – and it will bring the Exchequer a lot of money.

During the referendum, the Treasury, a variety of quangos and other allies came up with models that ‘demonstrated’ how bad Brexit would be because it ‘worked against the natural gravity’ of our EU trade. However, as Economists for Free Trade argued repeatedly, these models were all treating correlations as if they were causation – a well-known fallacy – and could not be used to predict the causal effects of Brexit. I am delighted that the Treasury and Whitehall have finally dropped these models and that the Chancellor has conceded in his recent remarks to the Lords Economic Affairs Committee that the EFT model ‘is very effective’. He also conceded – as we have maintained – that the disagreement lies in the assumptions used. This is where the Treasury and its allies now take their stand.

Their first argument is that, in order to avoid ‘border frictions’, we must not leave the existing jurisdiction that sets EU standards and we should maintain the same tariffs as the EU, which requires us to remain in the EU Customs Union as ‘rule-takers’. They argue this would allow goods to cross borders without customs inspection and checking ‘rules of origin’ certificates.

These border frictions are said to be very large by the proponents of these arguments.

From our detective work, we have discovered that the Treasury analysis assumes, under WTO rules, that we would face tariff-equivalent costs at the border of around 30%. This figure includes tariffs of 4%, so 26% would be due to these ‘border frictions’. Under Canada+, it is not a lot less; no tariffs but 22% for border frictions. When these assumptions are fed into the model now being used by the Treasury (which is similar to ours in its general approach), not surprisingly they deliver bad results: UK GDP is reduced by 6.8% under WTO rules and 4.9% under an FTA with the EU (eg, Canada +).

The trouble about these assumptions is that they totally disregard the extensive framework of WTO rules surrounding modern trade under which such new barriers would be completely illegal. The WTO mandates ‘seamless’ borders, with all the aids that modern technology can bring in the form of computerised clearance pre-arrival at port.

Furthermore, the WTO outlaws discrimination in standards against foreign suppliers so that if goods conform to a country’s generally set standards (for consumer protection and so on), they cannot be denied entry by establishing special standards for a given importing country. Of course, all UK goods exports currently conform to EU standards, and vice versa. So neither side can claim the day after Brexit that somehow they do not.

Whitehall’s assumptions also ignore how trade actually works. Standards on both sides will no doubt change gradually over time, but this is a quite normal development that exporters deal with constantly and out of their own commercial interest they keep their products conformable. But companies who do not export need not bother.

Therefore, it is correct to assume that, under WTO rules, both sides’ exporters will continue to conform to the other’s standards. WTO rules will bind whether we have no trade deal or we have Canada+. That deals with the Whitehall fantasy of open illegal warfare on standards and border costs.

The Whitehall/Treasury fantasy does not stop there. The civil servants’ second argument is that we will make a complete mess of FTAs with the non-EU world thereby bringing little benefit to the UK economy. Yet this is the core of the Brexit free trade policy, which offers enormous gains to the UK consumer through lower prices and more competition.

How to estimate the effects of this? If implemented well, these FTAs will make large inroads and, in principle, abolish the trade barriers we will initially inherit from the EU. These tariff and non-tariff barriers are massive, estimated by us – consistently with other studies – at around 20% on both food and manufactures. It is well accepted that abolishing such barriers will bring gains in lower prices, greater welfare, higher productivity, and enhanced innovation. In addition, we also will make gains from the reciprocal reduction of barriers against us in the rest of the world.

The usual method to quantify this – which we follow – is to estimate the effects of abolishing our own barriers alone. There is no way of estimating at this stage what other countries will do in return. This estimate, which is the equivalent of estimating the effects of unilateral free trade, gives us a lower bound on the gains from FTAs, since it omits the reciprocal gains. If these assumptions were to be fed into Whitehall’s new model, this lower bound gain to GDP would be about 4% under Canada+ and 3% under a World Trade Deal under WTO rules. One could easily imagine these results could be doubled by the reciprocal gains not included; but of course we cannot estimate them with any precision at all.

What this all comes down to is, if you use the correct assumptions, you get substantial gains from Brexit under either Canada+ or a World Trade deal under WTO rules. It is only if you make the absurd assumptions embraced by Whitehall that you get the large negative effects they forecast.

These assumptions – whose absurdity anyone can understand with a moment’s thought – are the skeleton in the Chancellor’s cupboard. No wonder he refuses to open the cupboard; but we must insist.