Whitehall’s leaked Brexit forecasts are clearly based on outdated trade models

Whitehall’s leaked Brexit forecasts are clearly based on outdated trade models

Free trade with the world or free trade with Europe? That is the question! Or so the latest Buzzfeed-leaked report from the civil service would have us believe.

The report has examined, it would appear from the leaks, three post-Brexit scenarios: continuing in a close ‘Norway’ deal with the EU, doing an EU trade deal à la Canada, and the ‘WTO option’ where we have no EU trade deal but we do trade deals with the rest of the world. All are shown to give bad results, from 2% off GDP with the Norway option to 8% off GDP with the WTO option over the next 15 years. So what we see here is that even the slightest deviation from our current EU membership apparently deals us a bad blow, while not even the most massive programme of trade deals with the rest of the world gives us more than tiny gains.

The battle has raged over models and projections and all such economist-oriented material. But naturally enough, many people mercifully untrained in these arcana find them pretty baffling. So what is it really all about? Remember that behind all the models and projections lies an imagined world to which these models give material body.

On the one side are the current ‘trade economists’ and their civil service followers who believe that ‘border’ formalities can sabotage trade. Trade, in their view, is mainly with neighbours and the larger the better – as there is relatively less border to contend with once you are inside the large market. Trade with far-flung countries and especially small ones is less important because distance creates cost and smallness means the border looms large relative to the size of trade. All this is summed up as the ‘gravity’ principle of trade: gravity is closeness times size and the bigger the gravity the more the trade.

On the other side are many non-trade economists and policy-makers who see a world of ‘comparative advantage’ determining trade and emphasise the way that transport costs have fallen to negligible levels with containerisation, while computerisation of customs procedures and the ‘virtual border’ that is now mandatory under WTO rules have more or less eliminated border costs. Add to that service trade that is not subject to border formalities and is weightless; this trade is particularly large for the UK, now over 40% of our exports. According to this view, trade is diverse and spread across the world, depending on your comparative advantage. Australia mainly exports commodities, as it is resource-rich; Britain mainly exports services, as it is skills-rich and resource poor.

Enter Brexit. Under the Government’s announced policies we will leave the Single Market and Customs Union and strike free trade deals around the world, so getting rid of the EU’s protectionist trade barriers in food and manufactures against other countries. We will also have a free trade deal with the EU if possible, which we could call ‘Canada-plus’, in which trade continues as now with the EU in goods and services; you could also call it a ‘deep and bespoke’ deal as Mrs. May does. We have done the sums on this and it certainly pays the EU to do such a deal rather than have no trade deal: we would in fact do well out of a no trade deal scenario but plainly we would like to do one anyway. So let us assume such a deal happens.

As trade with the EU accounts for only 12% of the economy, you have to be a big believer in the awfulness of any sort of new border arrangement with the EU to think that such a deal will cause terrible costs to trade and the total economy. This is what the leaked civil service work purports to say. Yet what are these costs? Under the Canada-plus EU deal there would be free trade with the UK, so nothing there. Of course, exported cargoes would pay EU tariffs on non-UK, non-EU content and so there must be ‘rules of origin’ determination – so what? Under modern customs procedures cargoes are classified on the customs computers well before they arrive in port and once there they are unchecked! That is the way it works: if you don’t believe me, visit a port and talk to the owners as we have. On such apparently small but vital facts is applied economics based.

Now consider trade agreements with the rest of the world. These will allow better value food and manufactures into the UK that currently attract an average tariff (and other tariff-equivalent) cost of 20% according to widely agreed calculations of tariff and non-tariff barriers. As these new trade agreements accumulate, this 20% addition to the prices of these imported goods will melt away and protection will diminish. This will mean lower consumer prices in our shops and more competition on our home market, which will drive our industry to higher productivity. Competition like this has always been the life-blood of our economy, whether coming from trade or simply domestic competing entrants. Comparative advantage will rule OK. Those who believe this is politically impossible because protected producers will resist (as the CBI did last week) underestimate the toughness of UK democracy: we expect firms to compete and we also help them adjust to the new realities, as we have done consistently since we started ‘supply-side reforms’ in the 1980s. Just now, in this spirit, the Brexit devaluation has been boosting firms in the CBI and elsewhere that will be able to use this breathing space to raise productivity in the longer term.

It is obvious that there are gains from free trade with the rest of the world. But the mechanism I have described is largely absent from the civil service models and those of their allies. We have checked! When you put their ‘gravity principles’ into a general model of trade and the economy that also incorporates the supply-side where comparative advantage counts, Brexit is a success! Even if there are some EU border costs, this remains the case. To believe otherwise, as the civil service and their allied trade economists argue, seems to be a travesty of economic common sense, bordering on obsession.