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Which trade economists to believe
02 Apr, 2019

The ones who say Brexit will be worse, obvs

Most economists say that Brexit would make us worse off than if we Remained. Some don’t. London4Europe Committee member and former HM Treasury senior civil servant Michael Romberg looks at the evidence with the help of Josh De Lyon of the Centre for Economic Performance at the London School of Economics.

Almost every mainstream economist says that Brexit would lead to slower growth than if we stayed in the EU.

That reflects some basic statements that pretty well every economist believes. More trade is good for the economy because it encourages competition and specialisation, which in turn boost productivity. Increasing barriers to trade harms the economy. Whatever the Global Britain rhetoric, through leaving the single market Brexit is above all an exercise in protectionism.

Moreover, most mainstream economists’ views of the short term effect of the Brexit referendum vote have turned out to be reasonably accurate. While that is not an assessment of the effect of Brexit, rather of the decision to have a Brexit, it is an encouraging sign of the quality of economic forecasting.

 

Not everyone thinks Brexit will be harmful

There are two main teams of economists who think that Brexit will bring benefits or at least not big harms.

 

Economists for Free Trade

The political basis for EFT’s forecasts is the unilateral dropping of all tariffs. Minford’s own expectation is that it would more or less eliminate UK manufacturing. It may therefore be politically unlikely to happen. But let’s run with it – economically it is likely to be better than some alternatives. But EFT come up with unexpectedly high benefits.

The reason why different economists come up with different answers is often because they use different models of the economy. You have to use a model because the whole economy is too complex to understand.  So all models simplify by leaving things out. The question is what do they leave out.

A critique by a team at the LSE led by Professor John van Reenen makes that clear (it provides links to the Minford research).

First, EFT disregard “Gravity”, which is just economists’ word for distance. It is one of the key factors that explains why some countries trade more with each other than others. It is not the only one – cultural similarity, relative wealth and others are also important. But distance makes a big difference. Ireland is the UK’s 5thlargest export market even though its population is less than 5m and Belgium the 8thlargest (population 11m).

Then EFT disregard quality. That works if you believe that all product regulation is harmful or pointless. Then, dropping EU standards on say lead in paint in children’s toys will let you buy cheaper toys. However, if lead in children’s toys is actually a problem then the costs of dropping regulation would show up either in the expense of shops or consumers testing for lead or in sick children.

So EFT’s model ignores some basic realities. Just ask yourself. If I tell you that a supermarket in Birmingham is selling low grade bread for a penny less than the standard loaf in your local supermarket would you buy there? EFT’s model says that you would.

 

Centre for Business Research

Unlike EFT, most of CBR’s modelling does not predict economic gains from Brexit, but smaller losses than most economists forecast.

The main point made by CBR is that the “gravity” (ie distance) model for trade used by most economists relies on average figures; but they hold that UK’s pattern of trade has an unusually low proportion of intra-EU trade compared with other EU members.

Gudgin’s team - while noting that UK growth which had been slower than that of the EU6 before accession became faster after accession - also challenges the prevailing view that EU membership boosted the UK’s economic performance. Unlike most economists, Gudgin’s team believes that “ no aggregate link exists between trade and productivity for advanced open economies ”.

You can read the Gudgin papers here: December 2016, June 2017, September 2017, January 2018 and 2018 (slides)

The Cambridge debunkings of the work of HM Treasury and the rest of the economics profession are normally in turn debunked by other economists. For example, Professor Alan Winter of the UK Trade Policy Observatory points out that in practice: “The gravity model has a great deal of predictive power”. It is not just that gravity models are used by most economists but they are one of the strongest empirical facts in economics. The relationships in the data are very clear. If you wish to follow it up, the standard reference work for gravity models is “Gravity Equations: Workhorse, Toolkit and Cookbook” by Head and Mayer in the Handbook of Economics (2014)

I asked Josh De Lyon of the Centre for Economic Performance at the London School of Economics to explain his concerns with the CBR work. He writes:

“It is very clear why the Coutts et al. (2016) model produces such small effects for the economic loss from Brexit. They arbitrarily assume small inputs into their model.

“Specifically, the model does not predict changes in trade, business and household investment including Foreign Direct Investment, household consumption, interest rates, government spending, and migration. These are all entered by the authors as inputs to the model.

“The model therefore requires hugely important assumptions on the nature of economic changes expected in the economy post-Brexit. Given that the authors arbitrarily assume smaller changes in these key variables than are predicted by rigorous economic models, it is unsurprising that the model produces a smaller expected cost of Brexit.

“For example: They assume a ‘loss of EU trade from 2022 building up within 3 years to 10 per cent, with slow replacement in non-EU markets’ and a ‘reduction in imports from EU but half replaced by imports from non-EU countries.’

“These crucial assumptions are not based on any economic model. In fact, the team proclaim that the loss in trade has been ‘arbitrarily assumed’.

“In comparison, even when ignoring any impact of trade on productivity, the Dhingra et al (2017) model estimates that the effect of Brexit is a 25 per cent fall in UK trade with the EU. When including the link between trade and productivity, Dhingra et al. (2017) predict a long run fall in UK exports to the EU of 43 per cent in a hard Brexit scenario.    

“In the 2018 paper, the team at CBR ‘replicate’ some gravity models from the literature. Briefly, the reason their estimates are different from those produced by mainstream economists is because the team at CBR choose to omit certain fixed effects and therefore bias their results.

“Also, they restrict their sample to just two years which means the estimates lack power and are therefore volatile. Trade flows are fairly consistent over time so it would be more sensible to extend the sample to a longer period, as is done in most of the literature.”

So, in short the problem with the CBR work is that it takes as input assumptions numbers that ought to be computed by the model. The assumptions are different from those used by mainstream economists. Hence the radically different results.

 

Conclusion

The beliefs of mainstream economists are more likely to be accurate than those of the two main groups of economists who have come up with arguments that Brexit will be either beneficial or less economically harmful than generally believed.

 

 

I am enormously grateful to Josh De Lyon of the Centre for Economic Performance at the London School of Economics for sharing his work on the CBR model and reviewing this article. Remaining errors in my text are nonetheless down to me.

 

The London4Europe blogs page is edited by Nick Hopkinson, Vice-Chair. Articles on this page reflect the views of the author, not necessarily of London4Europe.