New BfB report shows costs of no-deal have been seriously exaggerated

Here at Briefings for Britain, our economists have repeatedly explained why economic modelling produced by HM Treasury and others on ‘no-deal’ Brexit scenarios (i.e. a switch to trading with the EU on WTO terms) is seriously flawed. Unfortunately, we still hear the same old figures cited time and again by the media and others, with no recognition of the major flaws we have repeatedly drawn attention to.

That is why we are publishing the following short, accessible report, entitled The economic impact of no-deal: A more balanced assessment. The report provides a corrective to some of the extreme assumptions previously used to model the impact of a no-deal Brexit. It outlines some of the more egregious exaggerations about the economic impact of no-deal – especially from HM Treasury, which is no longer permitted to produce new reports on Brexit.

The report is authored by Dr Graham Gudgin, BfB’s co-editor and Cambridge University economist, independent economist Julian Jessop, formerly Chief Economist at the Institute of Economic Affairs, and Harry Western, a senior private sector economic forecaster who writes under a pen name for professional reasons.

The report analyses assessments of ‘no-deal’ scenarios previously conducted by the Treasury and other organisations such as the IMF. It finds that their assessments of such scenarios, where the UK does not conclude a trade deal with the EU and trades with the bloc on WTO terms, are based on such extreme assumptions as to render them implausible.

Similarly, claims that a no-deal Brexit would hit the UK ‘three times as hard’ as coronavirus are found to be both inaccurate and misleading.

Experts of every stripe need to be humbler and more realistic if they want to be taken seriously. Predictions of imminent economic disaster if the UK voted to leave the EU proved to be hopelessly wrong. The more pessimistic modelling of the impact of no-deal is similarly flawed, relying on implausible assumptions to come up with numbers that fail the basic test of common sense. We hope that the report will set the agenda for a more balanced, evidence-based approach towards modelling the economic impact of Brexit.

While it would be better to exit the transition period with a new and balanced free trade agreement in place, this does not mean that the UK should simply accept whatever the EU is willing to offer. Ruling out the option of walking away would significantly weaken the UK’s bargaining position and reduce the chances of getting a good deal. The UK should not be afraid of shifting to trading with the EU on WTO terms: the costs of doing so have been greatly overestimated while the benefits are often overlooked. Moreover, the difference between trading with the EU on WTO terms or via a basic free trade deal are modest.

Main findings

The report’s main findings are as follows:

• Exiting the Brexit transition period with a balanced UK-EU Free Trade Agreement (FTA) in place would be preferable to a ‘no-deal’ exit, in which the UK trades with the EU on WTO terms. However, most modelling of the economic impact of the latter is far too pessimistic. In terms of both short-term and long-term economic impact, the difference between an FTA-based Brexit or no-deal is relatively small.
• Taking a no-deal option off the table would also significantly weaken the UK’s bargaining position and reduce the chances of getting a good deal. Furthermore, restraints imposed by an overly-restrictive EU FTA could dampen the benefits of increased future trade agreements with third party nations.
• Studies suggesting that a switch to trading with the EU on WTO terms would result in a huge long-term hit to GDP are fundamentally flawed – for five main reasons:

1. 1. They exaggerate the costs of Brexit. Predictions of a collapse in UK-EU trade are based on implausible assumptions on both the costs of non-tariff barriers, and the sensitivity of trade to an increase in these costs. This is compounded by implausible assumptions about the knock-on effects on productivity, and the impact on migration.
   2. They under-estimate the benefits of Brexit, including the gains from lowering trade barriers with the rest of the world and better regulation at home.
   3. The costs in point (i) are further exaggerated by comparing WTO terms with a rosy view of what would have happened in the future if the UK had remained a full member of the EU. Such counterfactuals assume that significant reductions in intra-EU barriers to trade will take place in the future, and count the ‘loss’ of these hypothetical future gains as a ‘cost’ of Brexit.
   4. The baseline as described in (iii) is not only fictitious, it is no longer relevant. The UK remaining in the EU is no longer an option. The only relevant baseline against which no-deal should now be considered is a UK-EU FTA.
   5. Finally, the extrapolation of costs is unrealistic. Most studies simply extrapolate the results over a period as long as 15 years, when almost anything could happen. This ignores, for example, the likelihood that technological progress will reduce the costs of non-tariff barriers over time, or the possibility of concluding a new FTA with the EU within a few years even if the transition period ends without one.

• Similar points apply to the many pessimistic assessments of the short-term economic impact of no-deal. There is history here: the 2016 Treasury analysis grossly exaggerated the immediate costs of a vote to leave the EU. There is still more than a whiff of ‘Project Fear’ about warnings on such issues as the impact of no-deal on the supply of medicines, the risk of severe disruption at ports, and the impact on the cost of food.
• Recent attempts to compare the long-term impacts of no-deal and Covid-19 are misleading. If anything, the impact of the pandemic strengthens the case for retaining no-deal as an option, both by reducing some of the potential costs and increasing some of the benefits.