18 October 2019

Will a vote for the Johnson deal boost the British economy?


The UK government and the EU have finally agreed a new Brexit deal. Of course, Prime Minister May had already got us to this stage and there are still plenty of hurdles to clear. Everything may look different again after Parliament votes on Saturday. But let’s assume that a negotiated withdrawal along these lines is indeed imminent. What would Boris Johnson’s deal mean for the economy?

In the short term, the proposed transition period – perhaps of two years – means that not a lot will actually change on the ground. Indeed, in economic terms at least this would be ‘Brexit in name only’ for some time yet, and the final destination would remain unknown. However, there should still be some positive impact straightaway.

The needlessly prolonged uncertainty since the 2016 referendum has definitely had some negative effect. To be clear, claims that the vote has already cost the UK as much as 3% of GDP (or £60 billion) are fatally flawed, mainly because they assume that all the underperformance since then has been due to Brexit. The US in particular has benefited from a substantial fiscal boost, the euro area was overdue a period of catch-up growth, and UK consumer spending was already looking overstretched.

Nonetheless, there is no doubt that the UK has been held back by two factors. The first is the fall in the pound in the wake of the referendum result. A more competitive currency may have benefits that build over time, but the immediate impact is negative because of the impact on inflation. The second is the hit on business investment, which was initially limited but has increased as the negotiations have dragged on. These headwinds to growth should now be at least partially reversed.

Many Brexit pessimists are sceptical about this, even though sterling has already rallied sharply over the past week. They say that leaving the EU on 31st October will not end the uncertainty, because the terms of the long-term relationship would still be unclear. That much is true. But it will definitely reduce the uncertainty. The imminent threat of ‘no deal’ will have been lifted and there would at least some goodwill left as the two parties head into the next stage of negotiations.

What’s more, the heightened uncertainty is not just about the economics of Brexit itself. There is also the wider political chaos. Leaving with a deal should clear the way, at last, for a General Election, which in turn is likely to restore a Conservative majority. Some commentators have recently been willing to argue that handing power to Labour might be less bad than ‘no deal’. But I suspect that even they would be wary of suggesting that a Corbyn-led government would actually be good for the UK economy.

In the short term, then, the UK should see an immediate economic bounce from Boris’ deal. Admittedly, the global backdrop is challenging. But there are some reasons to be more positive about the rest of the world too, including signs of an easing in trade tensions and the prospect of further support from central banks. (For aficionados of such things, yield curves are starting to normalise and broad money growth is already accelerating again in most major economies.)

As for the longer term, there would still be all to play for. Some commentators have been quick to argue that Boris’s Brexit will leave the UK economy worse off than May’s, mainly because it involves a (relatively) clean break from the customs union. In particular, academics at The UK in a Changing Europe were already claiming earlier this month that Boris’ deal could reduce GDP per capita ten years after Brexit by a (wide range of) between 2.3% and 7.0%, or more than £2,000 per capita a year, compared to remaining in the EU.

But we have also been here many times before. All such studies are heavily dependent on the assumptions made. For example, the government’s long-term economic analysis of Brexit, published under Mr Hammond’s watch last November, relied on estimates of the costs of non-tariff barriers which looked too high even then, let alone as forecasts for what they might be in future as technology continues to improve. That analysis also assumed that even a small increase in frictions has a large impact on activity, so that these additional costs lead to a slump in the volume of UK-EU trade.

The UK in a Changing Europe report should also be challenged. For example, the biggest hit to per capita incomes (nearly 4% of GDP) is assumed to come from a sharp decline in productivity after Brexit. This is highly speculative. In the short term at least, a rebound in investment should actually lift productivity.

In contrast, most estimates of the potential economic benefits of independent trade and regulatory policies are implausibly low. The Treasury analysis factored in a boost of just a few tenths of a percentage points of GDP from these two sources over a 15-year period. Frankly, even if all these results are backed by the most sophisticated econometric modelling, they fail the common-sense test.

But let’s suppose that the pessimists are mostly right, and that the best guess for the long-term economic impact of Boris’s deal is, say, a loss of 3% of GDP. I’m always wary of the argument that this would be ‘a price worth paying’, because those making this point are rarely the ones likely to pick up the bill. Nonetheless, 3% would still be a small hit over a 15-year period when GDP might otherwise be expected to increase by, say, 25%.

Finally, as the Director of The UK in a Changing Europe has acknowledged, Brexit is clearly about more than economics. Former Bank of England Governor Mervyn King put it well when he said that he’d never met anyone who would be in favour of Brexit if they thought the impact on GDP would be less than 2%, but in favour of Remain if they thought it would be more than 5%. However, even wearing my economist’s cap, I would give little weight to long-term forecasts with as much uncertainty as these.

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Julian Jessop is an independent economist