12 June 2018

Remainer scaremongering is still built on dodgy economics

By David Blake

I recently gave evidence to the House of Commons International Trade Select Committee on the economic effects of trade policy, alongside my Economists for Free Trade colleague Professor Patrick Minford.

As written evidence, I submitted a report titled “How bright are the prospects for UK trade and prosperity post-Brexit?” In it I demonstrate the ways in which the Treasury has overestimated the costs to the UK of leaving the EU by failing to take into account the regulatory burdens of staying in the Single Market or the benefits from reducing tariffs by leaving the Customs Union.

The Treasury overestimates the costs of leaving the EU

The Treasury’s model predicts a 7.7 per cent reduction in GDP in the event of “no deal” in which the UK retained the existing EU Common External Tariffs with the rest of the world, while the EU imposed these same tariffs and non-tariff barriers (NTBs) on trade with the UK. Of the 7.7 per cent reduction in GDP, 1 per cent is due to the new tariffs on trade with the EU and 5.8 per cent is due to the imposition of NTBs. The model also predicts that the maximum facilitation (max-fac) solution preferred by Boris Johnson for avoiding a hard border in Northern Ireland would wipe 1.8 per cent off GDP.

I strongly reject the Treasury’s predictions for a number of reasons. First, NTBs are illegal under World Trade Organisation (WTO) rules which forbid any form of discrimination on standards between home and foreign products or between the foreign products of different countries. So around 75 per cent of the projected reduction in GDP is due to the imposition of illegal NTBs. This will not happen.

Second, even if there will be new and unavoidable frictional costs, the Treasury has grossly overestimated them. Of the projected 5.8 per cent reduction in GDP due to the imposition of NTBs, 1.3 per cent arises from frictional border costs. Yet if the same border costs as in the EU’s trade deal with Switzerland are applied to the UK, these amount to just 0.12 per cent of GDP, more than ten times lower.

The Treasury underestimates the costs of staying in the Single Market

The Single Market is concerned with standardising regulations in the EU. According to Professor Jacques Pelkmans (“The Economics of Single Market Regulation“, 2012) who also gave evidence at this session, regulation is the EU’s core business. Most EU Single Market regulation is risk regulation, covering issues such as safety, health, environment, and consumer protection. While accepting the need for “good” regulation and less “red tape”, Professor Pelkmans also accepts that regulations can be used to raise rivals’ costs and create barriers to competition from third countries.

Since the primary purpose of trade is to make consumers better off, Professor Pelkmans concedes that the Single Market has not been fully successful to date. That is because of local incumbents having market power, discriminatory local regulations, subsidies, transaction costs like languages, and home bias. The evidence for this is that price convergence has been low (the same good should sell at the same price in different parts of the Single Market, but there are still significant price differences) and most firms do not participate in the Single Market.

Federik Erixon and Rosita Georgieva (“What is wrong with the Single Market?“, 2016) argue that:

The more Europe’s economy grows dependent on services and the digital sector, the less Single Market there will be in Europe. Given the vast complexity of regulations in Europe, and the increasing layers of bureaucracy they entail, it is difficult to see how improvements could be made without a vast overhaul of the structure of regulations and the design of the Single Market. As reforms are moving closer to areas like digital services, energy, and advanced business services, it is evident that the improvements that can be made in Europe’s integration is less about classic Single Market reforms and more about building adequate market institutions and advance structural reform.

It is clear from evidence such as this – from strong supporters of the Single Market concept – that the Single Market does not really exist, especially in services. Given that the future of the UK economy is services – 80 per cent of UK GDP is in services, yet only 5 per cent of UK GDP is exported to the EU as services – we should not be worried about leaving the Single Market. The regulatory burden of remaining in the Single Market is equivalent to 2 per cent of GDP. We can reduce this cost by preparing to simplify regulations, while keeping them “good”; simplify product/service standards so they do not impede competition; and building digital services, energy, and advanced business services for the global economy where all future growth is.

The Treasury underestimates the benefits from reducing tariffs by leaving the Customs Union

It is crucial that the UK is free to set is own tariffs outside the Customs Union. However, EU (tariff and non-tariff) barriers on trade in food and manufactures raise their prices by 20 per cent. If these barriers were reduced from 20 per cent to 10 per cent, the UK would be better off and GDP would rise by 4 per cent.

However, the various current proposals for “customs partnerships” and “customs agreements” essentially mean that we are stuck in the Customs Union with these high trade barriers.

While we do need a good trade deal with the EU, the one currently on offer is not good enough. This is a standard free trade agreement with only limited provisions for trade in services. Services would be provided “under host state rules”, meaning complying with different rules in different member states. This would be disruptive for certain sectors – financial services and broadcasting – which currently operate in the EU under domestic rules.

The UK, by contrast, should seek a much more ambitious agreement in services either based on mutual recognition which would allow reciprocal access or based on the acceptance that the regulatory regimes are sufficiently equivalent or aligned. In particular, trade in financial services should be covered by “the principle of mutual recognition and reciprocal regulatory equivalence”.

Another key concern is the EU’s “level playing field” demand. The EU has made it clear that, while it might be willing to consider a “balanced, ambitious and wide-ranging free trade agreement”, this is only “insofar as there are sufficient guarantees for a level playing field”. In particular, the EU wants an agreement to cover “competition and state aid, tax, social, environment and regulatory measures and practices”, preventing the UK from competing “unfairly” against the EU. In other words, the EU does not want the UK to escape from the protectionist “European model”. This is worse than a standard “no compete” clause when a senior employee leaves a company. The EU wants to put the UK on permanent gardening leave. It would effectively prevent the UK from achieving regulatory autonomy or from pursuing an independent trade policy – and needs to be rejected.

The prospects for UK trade and prosperity are very bright post-Brexit

We need to ignore both the Treasury’s scaremongering and attempts by the EU and its supporters in the UK to keep us in the EU in all but name. The EU itself recognises that more than 90 per cent of future global economic growth will take place outside the EU.

The UK’s prospects for trade and prosperity after Brexit will be inversely related to the size of the tariffs on international trade that the UK itself sets. The lower the tariff barriers, the brighter the prospects will be. By leaving both the Single Market with its regulatory excesses and the Customs Union with its high tariffs on imported goods, UK GDP would increase by 6 per cent – in marked contrast to the Treasury’s dire and exaggerated predictions of a 7.7 per cent reduction in GDP. As a comparison, we note that Australia’s trade liberalisation policy – which began in 1986 – increased Australia’s GDP by 5.4 per cent.

Professor David Blake is a Professor of Economics at the Cass Business School and a member of Economists for Free Trade.