The key difference between the May plan, which was three times rejected by parliament, and the Johnson plan is that May’s plan sought as close an alignment with the EU as possible and suggested that “the United Kingdom will consider aligning with union rules in relevant areas.” However, the Johnson plan seeks a relationship that is “as close as possible” to current arrangements. On the surface, this may not appear much different but it does open the possibility that there could be more significant regulatory divergence in future than is currently the case. This implies significant non-tariff barriers for trade because there will be extra costs for business as the UK operates its own customs regime. Moreover, even though Johnson is seeking a free trade agreement, this may still require customs checks to ensure compliance with rule of origin requirements, which will raise trade frictions between the UK and EU.
Quantifying the impact of trade barriers on trade is a highly imprecise exercise since they can be divided into tariff and non-tariff barriers. The former are relatively straightforward to deal with but the latter are not. The good news is that an FTA implies no tariff barriers. But we then have to deal with non-tariff barriers. The simulation analysis assumes that they are 50% of those between the US and EU (i.e. smaller), but they are non-zero because FTAs imply a higher degree of trade friction than a customs union. Services trade continues to be ignored in the government’s plans, and in the absence of any other option, services tariffs are assumed to be set at WTO levels. More contentious is the assumption that the UK loses out from future reductions in intra-EU trade costs, which in this analysis fall 40% faster than trade costs in the rest of the world in the ten-year simulation horizon.
Putting all the numbers together points to a 2.5% reduction
in income per head over a ten-year horizon compared with staying in the EU,
versus a 1.7% reduction in the case of May’s plan. Allowing for the dynamic
feedback effects whereby lower trade adversely affects productivity – the
economic literature generally assumes a 1% decline in trade reduces income per
capita by around 0.5% – the overall effects of the Johnson plan result in a
6.4% medium-term (10 year) decline in incomes per head relative to staying in the EU
versus 4.9% in the May plan. Further allowing for lower immigration numbers, as
Brexit plans advocate, results in still bigger declines in incomes, amounting
to 7% in the worst case scenario versus the no change baseline (chart).
It is important to note that the simulation analysis does
not indicate that the economy will contract by these amounts, only that it will
be smaller than might otherwise have been the case. In the analysis outlined
above, the Johnson plan broadly implies that the economy will grow 0.7
percentage points per year more slowly than it would had the UK stayed in the
EU. In a case where the economy is assumed to grow at an annual average rate of
1.5%, this would imply a reduction to an annual rate of 0.8% which is an
economic draught we are likely to feel. However, we would be well advised to
treat the numbers with a pinch of salt. Modelling exercises of this type are
fraught with uncertainty and highly dependent on the conditioning assumptions.
Just as I have been dismissive of the results of Brexit-supporters who claim
that their simulation analysis will lead to better outcomes, so we should treat
the analysis of Remainers with similar caution.
Brexit supporters can claim that this kind of analysis does not account for the benefits that would come from a lower regulatory burden. In principle, there are indeed positives from such an approach. Reducing the corporate tax burden is one such option. However, the UK already has one of the lowest corporate tax rates in the EU, with a rate of 19% versus 29.8% in Germany, and with a view to cutting it to 17% by 2020. Increased pressure on public finances will make it difficult to cut further (each one percentage point reduction in the corporate tax rate reduces revenue by around 0.1% of GDP) – as I have pointed out before.
Another area of interest is the labour market where the suggestion has often been made that the UK would benefit by getting rid of the working time directive which places limits on the number of hours worked. But the UK already has the least regulated labour market in the EU, according to OECD data, and evidence produced by the UK government in 2014 suggested that the limits on the number of hours worked “had little discernible impact on total hours worked across the economy, but a small positive impact on employment.” It is thus unlikely that the UK would be able to generate a significant competitive boost from further deregulation – much of the low-hanging fruit has already been plucked.
Irrespective of whether we are looking at May’s deal or that cobbled together by the Johnson government, it is very hard to see how leaving the frictionless trade area of the EU leads to improved economic outcomes. It certainly will not be because of improved trade performance. All the empirical analysis of trade suggests that gravity effects still hold – large countries which are located closely together tend to trade more with each other. Countries which are further away do less trade because transport costs make it less attractive (here). Nor is it likely that the UK can deregulate on the same scale as it did in the 1980s – those one off gains have played out. None of this is to say that Brexit will necessarily be an economic disaster. But we will all likely be slightly poorer which is not what people voted for in 2016.
Brexit supporters can claim that this kind of analysis does not account for the benefits that would come from a lower regulatory burden. In principle, there are indeed positives from such an approach. Reducing the corporate tax burden is one such option. However, the UK already has one of the lowest corporate tax rates in the EU, with a rate of 19% versus 29.8% in Germany, and with a view to cutting it to 17% by 2020. Increased pressure on public finances will make it difficult to cut further (each one percentage point reduction in the corporate tax rate reduces revenue by around 0.1% of GDP) – as I have pointed out before.
Another area of interest is the labour market where the suggestion has often been made that the UK would benefit by getting rid of the working time directive which places limits on the number of hours worked. But the UK already has the least regulated labour market in the EU, according to OECD data, and evidence produced by the UK government in 2014 suggested that the limits on the number of hours worked “had little discernible impact on total hours worked across the economy, but a small positive impact on employment.” It is thus unlikely that the UK would be able to generate a significant competitive boost from further deregulation – much of the low-hanging fruit has already been plucked.
Irrespective of whether we are looking at May’s deal or that cobbled together by the Johnson government, it is very hard to see how leaving the frictionless trade area of the EU leads to improved economic outcomes. It certainly will not be because of improved trade performance. All the empirical analysis of trade suggests that gravity effects still hold – large countries which are located closely together tend to trade more with each other. Countries which are further away do less trade because transport costs make it less attractive (here). Nor is it likely that the UK can deregulate on the same scale as it did in the 1980s – those one off gains have played out. None of this is to say that Brexit will necessarily be an economic disaster. But we will all likely be slightly poorer which is not what people voted for in 2016.
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