Seven years on

It has been rather quiet on the blogging front these past few months as other projects impinge on my time, but every year around this point I take a look at where we stand on the Brexit issue, and given what has happened in recent weeks it would be a shame to break with tradition.

Johnson disappears and so does a lot of support for Brexit

The most noteworthy event was Boris Johnson’s resignation as an MP – an action precipitated by a report from the Parliamentary Committee of Privileges which would otherwise have recommended a suspension from the House of Commons. Never one to accept personal responsibility, Johnson flounced out of parliament, blaming everyone but himself for the circumstances of his departure. His exit nonetheless raised a whole raft of questions surrounding his toxic legacy and the circumstances that allowed him to thrive.

Both of these issues have been well documented on this blog over the past seven years and have their roots in the poisoned well of public debate triggered by Brexit. Quite simply, Brexit was a strategy designed to further the ends of those populist nationalists who largely happened to be members of, or associated with, the Conservative Party. This is not to say that the parliamentary Tory party of 2016 was rabidly pro-Brexit but it became so when the tone of public debate shifted in the wake of the referendum such that those who questioned the wisdom of the strategy were denounced as enemies of the people. It was in this environment that Johnson was enabled to rise to the top, promising his oven-ready Brexit deal despite the fact it was known in 2019 to be a far less economically attractive proposition than that negotiated by his predecessor, Theresa May. The same supporters egged him on to prorogue parliament in 2019, as he sought to subvert due parliamentary process. In so doing, Johnson kicked 21 Tory MPs out of the party who had the temerity to oppose his strategy. Perhaps it was that point that the Conservative Party became spectacularly unmoored.

Admittedly Johnson did win a handsome electoral majority in December 2019, although this was due in large part to the quality of an opposition led by Jeremy Corbyn. Not long afterwards, a combination of the Covid pandemic and apparent lack of interest in the business of governing caused the government to rapidly lose its way. Indeed one of my biggest concerns in recent years has been the lack of effective governance.

As many of those who agitated in favour of Brexit gradually leave the stage, they leave behind a toxic legacy. Following Johnson’s ousting from Downing Street last year and the implosion of the Truss premiership, the gilt has been slowly peeling from the Brexit crown. Since autumn 2022 the survey evidence points to a lead of 20 points for those who believe that voting to leave the EU in 2016 was a mistake. That does not exactly scream “will of the people.”

It's not just Project Fear

Many of the fears of those who pointed out the economic consequences of Brexit are now being realised (I include myself in that camp). It is simply more difficult to conduct cross-border trade in a world where barriers have been erected where once there were none. As of Q123 the volume of UK goods exports was 9.1% below the average levels in 2019 whilst import volumes were down 8.1% (admittedly the figures are volatile on a quarterly basis so we should not over-interpret them). But the OBR has pointed out that the UK’s trade intensity (trade as a share of GDP) has fallen below that in other G7 economies.

The fall in immigration from the EU has also contributed to the UK’s economic difficulties in a material way. Since 2020, there has been net outward migration of EU nationals: no longer can the UK rely on skilled labour from continental Europe to fill gaps in the domestic labour market. Although this has been more than offset by a net inflow of non-EU nationals (+606k in the year-ending December 2022), only 30% of them came to work, with almost as many being granted leave to remain on humanitarian grounds and therefore not immediately eligible to work (most of the remainder came to study - chart above). Labour shortages have contributed to second round inflation effects, following Covid-related supply bottlenecks and an energy price spike, which are making life harder for many. This is not to say that Brexit is wholly responsible for the cost of living crisis but its role cannot be denied.

However, to get a wider picture I have updated my estimate of the hit to UK GDP based on synthetic control analysis which attempts to measure the performance of the UK economy relative to a panel of 23 similar economies that did not experience the disruption of Brexit (chart above). Last year, I estimated that by Q122 the UK had underperformed the control group by 3.5%. This year my estimate suggests that the underperformance gap widened to around 6.5% by Q123 (admittedly better than the double digit figures recorded in 2020 and 2021 but still alarming). The figures are distorted by the pandemic period when differences in the way non-market services were recorded across economies made cross-country comparisons very difficult. Nonetheless, rebasing the figures at mid-2021 (by which time many of the pandemic restrictions were being eased) actual GDP still underperforms the control total by around 2.5%.

These figures have to be treated with caution. Nonetheless they do suggest that Brexit has imposed a sizeable hit to the UK economy. This should come as no surprise: The way that the UK trades with Europe has changed and it is no longer as easy to cross borders as it was prior to 2021. Eurostar services between London and Amsterdam, for example, have been suspended for a time as construction work means there is no space to perform passport and baggage checks in Amsterdam (ironically well reported in the Brexit-supporting Daily Telegraph).

What happens now?

Nobody really knows. Labour has ruled out returning to the European single market and the customs union, promising instead a “pragmatic” relationship with the EU. Obviously it is trying to win back voters in its core seats where it lost out to Boris Johnson’s promise of an oven-ready deal. But the polling evidence suggests that closer relationships with the EU would not be a vote loser.

Brexit remains an emotive subject. Economically, it poses additional costs at a time when global inflationary pressures are rising, along with interest rates; productivity growth remains sluggish; the fiscal position is less than ideal and the demographic profile is not supportive of a decent medium-term economic rebound. Some of its strongest proponents continue to claim that a “true” Brexit has not yet been tried so it is no surprise that it has failed to yield any benefits yet. Such people are the equivalent of flat-earthers who would not recognise facts if they were presented in a gift-wrapped box. They are, however, increasingly a minority who will probably be left howling at the moon as the political pendulum swings back towards the centre while the likes of Nigel Farage represent a no-trick pony.

However, nobody has the stomach to overturn the events of 2016 for fear of the bitterness it would unleash. It will take a new generation of politicians, untainted by events of the past decade, to find a rapprochement with the EU. By the time that happens, a future generation of historians will likely judge Johnson and his ilk as harshly as those of us who predicted much of the disaster he unleashed.

Don't do dumb stuff

A decade of distress

On 23 January 2013 David Cameron gave his (in)famous Bloomberg speech during which he announced his intention to hold an in-out referendum on the UK’s membership of the EU. The intervening decade has been a difficult one. Looking back over all this time, the speech might be viewed as the starting gun for a process which led us through four prime ministers, including the incompetent Boris Johnson and the hapless Liz Truss, and the steady erosion of trust in the political process.

However, in some ways what Cameron said in 2013 needed to be said. We should remember that at the time the euro area was in the throes of a debt crisis which came very close to scuppering the single currency project. He called for enhanced European competitiveness by extending the single market; a flexible structure which "can accommodate the diversity of its members"; allowing "power … to flow back to member states" and enhanced democratic accountability and fairness so that “whatever new arrangements are enacted for the eurozone, they must work fairly for those inside it and out." There was in 2013 a growing sense that the EU was disjointed and unsure about how to proceed and it was important to ask the right questions which would allow it to get back on track. Moreover, as I wrote at the time, “the speech also gave a reasoned and rational account of the benefits of staying within the EU, notably the enhanced influence which it gives the UK on the global stage, and the benefits to jobs and growth arising from the huge FDI inflows which have come from the EU.”

But Cameron’s relationship with the EU was fractious. He was not a committed player and was unable to reach an agreement with the other members that would allow him to land the killer blow to knock out his domestic anti-EU opponents. Consequently, he left the door open to the “fruitcakes, loonies and closet racists” associated with UKIP who went on to run a campaign that knocked the Remainers for six. Unfortunately, the promises made by those intent on winning the Brexit referendum at any price now lie in ruins. Who can forget the pledge to use the £350 million per week that would be saved by not having to contribute to the EU budget to improve the NHS? Not only was that figure a gross distortion (pardon the pun) but it ignored the fact that part of any funds not sent to Brussels would have to be devoted to those areas that the EU previously funded. Consequently the NHS got very little extra cash, despite being protected from the worst ravages of George Osborne’s misguided austerity programme. It is hard to imagine that the NHS could be in worse shape than it is today without actually collapsing. Admittedly the pandemic placed great strains on the system but the fact that it was underfunded long before Covid struck has been a bigger contributor to its current dire predicament.

No shelter from the fallout

The fallout from the Brexit process has had a profound effect on Britain – on its unity, identity and its place in the world. Having taken a close-run, non-binding referendum and imposing a winner-takes-all outcome the government failed to unify the electorate around a strategy to take the UK forward. In the process of trying to square the circle of unreconcilable promises, the government wasted three years of time and effort failing to tackle the mounting economic problems of the day and did a lot of damage to the public perception of parliament. Admittedly, the pandemic blew everything off course but by then the zealots had taken over in Downing Street as moderates within government were either marginalised or exiled from the Conservative Party altogether.

Perhaps one of the most pernicious aspects of the Brexit saga is that it has enabled politicians to lie with impunity and not face any sanctions. As a consequence they have been able to ride out crises that would previously have been a resignation offence as former Chancellor Nadhim Zahawi’s latest trials and tribulations testify and further exemplified by the position of the chairman of the BBC whose close relationship with senior politicians has raised questions about a conflict of interest. Faced with a cost-of-living crisis not seen in decades (even the 1970s were not this bad as wages more than kept pace with inflation) public trust in government has collapsed. It is all very reminiscent of the 1990s when John Major’s government lost public trust following its handling of the ERM crisis and spent almost five years limping towards a heavy election defeat.

The immediate future

Quite where we go from here is difficult to say. The genie cannot easily be put back in the bottle but given the increasing realisation that the current form of Brexit is a mistake it is incumbent on the government to do all it can to mend fences with the EU. Doubling down on the current strategy is not going to get the electorate back onside, given the wide margin in opinion polls of those who think voting to leave the EU was a mistake (chart above). Issues that need to be addressed include the terms of the Trade and Cooperation Agreement between the UK and EU, which allows for tariff free trade for a wide range of goods but does not address the issue of regulatory harmonisation, which is a key element in agreements designed to increase trade flows. The issue of the Northern Ireland border has yet to be settled with the Northern Ireland Protocol Bill seeking to unilaterally override parts of the protocol that governs some aspects of trade in goods between the province and Great Britain.

Businesses face the prospect of considerable disruption in the face of government action/inaction on a number of legal matters. For example, the UK ‘Temporary Permissions Regime’ which allows EEA-based financial services to maintain their ‘passporting’ rights into the UK market, expires on 31 December 2023. If this is not extended or amended, there is the risk that financial services trade could be severely disrupted. Then there is the prospect that the Retained EU Law Bill, which passed unamended through the Commons last week, will intensify business uncertainty. In brief, this allows the government to revoke certain retained EU law at will, undermining the position of many businesses which continue to trade with the EU.

Simple fixes that the government could make include extending the Temporary Permissions legislation and deferring the introduction of the Retained EU Law Bill in a bid to kick it into the long grass. Similarly, postponing debate on the Northern Ireland Protocol and accepting that the current arrangements will have to remain in place for a while, will take some heat of tensions with the EU. None of this is to say that the UK is about to reconsider its position on EU membership. For one thing it is unlikely that the EU would be thrilled about a UK application anytime soon, nor is the electorate likely to have the stomach to rerun the debates of 2016 once again. Needlessly picking fights with the EU on issues we were told were settled two years ago will not get us anywhere, however.

But it is evident that the political class needs to address the elephant in the room that the current form of Brexit will not make the UK better off. That the Conservatives cannot or will not do so is perhaps understandable, given that so many members of the government were pro-Leave. Labour’s position is less forgivable. It continues to deny the extent of the problem for fear of upsetting the anti-EU media ahead of an election, despite recent polling evidence. At the very least politicians owe it to us to take a leaf out of the Obama playbook on foreign policy: “Don’t do stupid sh**.” Whilst in some ways this may be sound advice that comes too late, the next best option is don’t make it worse by ignoring the problem.

Six years on

It is hard to believe that it is six long years since the British electorate narrowly voted in favour of leaving the EU. In the interim, many things have changed. The economy has most certainly taken a turn for the worse and although not all of the problems are Brexit-related, there is indisputable evidence that it has imposed significant costs. But for all the economic problems, changes to the political landscape have been even more dramatic. A referendum that was designed to lance the boil of Euroscepticism within the Tory Party and heal divisions within society has had completely the opposite effect: British society is polarised as never before and there are no signs of a healing in prospect as the UK’s reputation for good political governance sinks ever lower.

Assessing the hit to the economy

I recently dug out some analysis I conducted in 2018 based on a model simulation of Brexit costs which suggested that after eight years “real GDP will be 4.5% below the no-Brexit baseline level (falling to 4% after 15 years).” Analysis conducted two years later by the OBR came to the same conclusion. So where do we stand now? In order to provide an answer, I updated the synthetic control analysis I reported a year ago which tracks UK output in terms of  GDP outcomes in a control group of 23 similar countries to assess how the UK might otherwise have been expected to perform. Although we should not place too much emphasis on the exact magnitudes, the analysis indicates that the economy has underperformed. The results, shown in the chart below[1], suggest that as of Q1 2022 UK output was around 3.5% below the control value. Even without allowing for inflation (the figures are measured in 2019 prices) this amounts to around £1.5 billion of “lost” output per week. What was that about saving £350 million per week?

Nowhere is the hit to the economy more evident than in trade which has been impacted by the imposition of barriers to cross border flows. Brexit cheerleaders pointed to the fact that exports to the EU in April rose to a record high. They were less vocal about the fact that imports also reached a record high as the trade gap with the EU continues to widen. In any event, nominal trade flows have been boosted by the recent surge in inflation: latest data suggest that the volume of exports to the EU is still around 10% below previous highs.

However, a true picture of the UK’s economic position is only realised by looking at a comparison with other countries. Here is where it gets interesting. German data (based on my own seasonal adjustment estimates) suggest that merchandise export volumes in April were 9% below the 2019 average versus a decline of 11.7% in the UK. A similar analysis suggests that French goods exports volumes are 16% below 2019 levels. In fact, the UK’s performance relative to world trade trends (measured by the CPB’s World Trade Monitor) is not significantly worse than either France or Germany (chart above). The French and German data may be biased down by a reduction in trade with the UK. In 2014, for example, the UK was Germany’s third largest export market: by last year it had slipped to eighth. We thus need more time to assess whether the UK’s trade figures have suffered permanent Brexit damage. But it has impacted on cross-border activity, with bigger queues at border crossings and a rise in bureaucracy. And the UK has still not signed trade agreements with the US or China. There are no trade positives flowing from the decision to leave the EU.

In the domestic economy it is a different story with the latest reading, for the first quarter of 2022, showing that the volume of business investment is 9.5% below its pre-Brexit referendum levels. Whilst the extent of the decline has been exacerbated by the pandemic, even before 2020 there were signs that corporate investment activity had tailed off (chart above). This is despite the government’s introduction of a ‘super deduction’ in 2021, designed to boost capital spending until 2023. Although the latest Bank of England Decision Maker Panel, based on data through May 2022, indicates that Brexit-related uncertainty has fallen to its lowest level on record with just 1.2% of survey respondents citing it as the biggest source of business uncertainty, it should be interpreted with care. To the extent that Brexit is expected to result in a permanent 4% loss of output, the capital stock is likely to adjust accordingly. Moreover, since uncertainty reflects indecision as to whether projects should go ahead, a decision to abandon capital investment plans will be reflected in a reduction in uncertainty just as much as the decision to go ahead. Scepticism is warranted that investment will bounce back any time soon.

Can’t work, won’t work

Whatever the damage inflicted by Brexit on the economy, its impact on the political landscape has been even more profound. Much of what has happened in the last six years bears repeating as politicians continue to gaslight us as to the process which got us here. The campaign was built on lies (here or here) and it is questionable whether it ever represented the will of the people given that only 37% of eligible voters were in favour of it. The Vote Leave campaign broke funding rules which, according to one legal expert, would have invalidated a legally binding plebiscite (the referendum was merely advisory). Nor was leaving the EU Single Market ever on the ballot paper and Theresa May’s time in office was characterised by efforts to placate the Brexiteers in her party rather than find an agreement that minimised the damage to the UK.

Under Boris Johnson, things have got worse. His government prorogued parliament in 2019 in order to avoid scrutiny of his Brexit Bill and was only prevented from doing so by the courts, and in 2020 the government threatened to break international law. Johnson’s government ripped up Theresa May’s agreement with the EU and replaced it with one which placed a customs border with Ireland (north and south) in the middle of the Irish Sea, despite his promises to the contrary. He fought the 2019 election on the basis that his deal was “oven ready” – so much so, in fact, that even now the government is desperately trying to rewrite the Northern Ireland Protocol, claiming that they signed it under duress.

These are not the bitter ramblings of a disaffected Remoaner. The fallout from the referendum matters profoundly for the conduct of democratic processes. The government called a referendum which allowed voters to directly participate in a democratic decision but gave them no direct say in the terms of departure which is profoundly undemocratic. Worse still, Brexit is the Conservatives’ signature policy and it is failing to deliver on its promises. A defining feature of the current government’s approach to Brexit is persistent victimhood – only this week The Sun reported that “Britain is failing to reap the benefits of Brexit because of the defeatist mindset of ruling elites” citing a report by the Centre for Brexit Policy. Never mind that Brexit has been passed into law, that the government won an 80 seat majority at the last election on the back of its Brexit promise and that its key members were educated at some of the country’s elite institutions – it’s always somebody else’s fault.

This goes to the heart of the problem: Brexit was only ever a campaign – its existence was defined by the journey rather than arrival at the destination. Having got what it wanted, the Conservative government cannot make Brexit work because it involves trade-offs they promised we would never have to make. Partly because it is chasing shadows in trying to implement its Brexit policy, it has taken its eye off the ball on almost everything else. As Samuel Earle wrote in the New York Times, “the truth is that Conservatives gave up on governing long ago – a fact that accounts both for Britain’s current mess and Mr. Johnson’s appeal in the first place.”

There is no appetite to reopen the debates of recent years, which explains why the Labour opposition has avoided talking about the problems caused by Brexit. However it need a realistic plan if it wants to form the next government. Aside from a pledge to “make Brexit work which is, make sure we've got a better deal that works” it is far from clear what the alternatives are.

Brexit was supposed to lead the UK to a new economic nirvana. Instead, as Samuel Earle put it, “each one of [the government’s] proposed solutions, offered in the name of national renewal, has made the situation worse … An economy predicated on low productivity and low investment, buttressed by a self-defeating lack of seriousness about Britain’s condition” is now where we are. Six years ago, economists warned this would happen. What was derided as Project Fear is now reality.

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[1] It is notable that UK GDP fell by more than most countries during the initial stages of the pandemic but subsequently rebounded much more sharply. One possible explanation for this are differences across countries in the way non-market services are measured in the national accounts. Here for an explanation.