The great Brexit trade-off

Two years ago Boris Johnson’s government had just won a thumping election victory promising to “get Brexit done” and on 31 January 2020 the UK’s formal departure from the EU came into force. A lot of water has since flowed under the bridge and little could they have known that two years later Johnson would be embroiled in a fight for his political survival following the publication of the long-awaited Sue Gray report into “Partygate.” Despite having delivered on his signature policy, Johnson’s premiership has today come into question as never before, with even MPs on his own side prepared to stick the boot in (this intervention from Theresa May was priceless).

It is no surprise, therefore, that a very different government report released today has received virtually no coverage. Benefits of Brexit “sets out some of our achievements so far” and outlines how the government plans to “seize the incredible opportunities that our freedom presents.” It is hard to know where to start. So far, according to the report, Brexit has “ended free movement and [enabled] control of our borders”; “restored democratic control over our lawmaking”; “taken back control of our waters; “reintroduced our iconic blue passports” and “enabl[ed] businesses to use a crown stamp symbol on pint glasses”. To use one of Johnson’s favourite phrases, it really is a pyramid of piffle.

The ending of free movement has been such a great success that last autumn it made a significant contribution to the lorry driver shortage that seemed to impact most heavily on the UK. As for control of the borders, all it has done is make life harder for everyone. Queues have been building up at ports on both sides of the Channel as border controls are reintroduced. Restoring “democratic control over our lawmaking” rings somewhat hollow following the shenanigans in parliament in recent months, with MPs prepared to rig the rules to protect their own and apparently failing to follow the guidelines that all other citizens have to follow. Taking control of waters counts for nothing if fishermen cannot sell their catch and there is mounting anger in fishing communities that Brexit has not delivered the promised benefits. If the restoration of blue passports and the crown stamp symbol on pint glasses really are of such importance to the government, far be it for me to suggest that there was nothing stopping either of these things from being introduced whilst the UK was a member of the EU.

The losses from trade

The most obvious problems are manifest in trade flows due to the form of Brexit implemented by the UK. Merchandise exports in November 2021 were 7% below the average level in Q4 2019 with services exports down 9.4%. Despite a rally from the depths of 2020 exports are struggling to get back to pre-pandemic levels. By contrast German exports in November were 6.9% above Q4 2019 levels. However the statistical office reported that German exports to the UK in November 2021 were down 7.9% compared to the same period a year earlier, suggesting that exporters are finding it more difficult to conduct business with the UK. 

This accords with the results from a paper by Fernandes and Winter (2021) looking at transaction-level export data for Portugal which suggested that exporters reduced export volumes and export prices in the UK market after the referendum shock in a bid to remain competitive. As the trading relationship between the UK and EU continues to evolve, the authors note that such behaviour is likely to make the UK a less attractive market for EU exporters with the decline in prices placing an increased squeeze on margins. Their estimates also point to “a high degree of exchange rate pass-through into consumer prices in the UK after the shock, implying rising inflation and living costs."

Aggregate data suggest that in real terms, UK merchandise trade volumes are currently 12% below Q4 2019 levels. According to the CPB World Trade Monitor global trade volumes have surged, with exports up 17% on late-2019 levels. As a consequence the UK’s share of world trade has fallen well below 2019 levels even if there has been a sharp rebound in the most recent figures (chart above). We only have a year’s worth of data and the Covid shock has obviously exacerbated the problem but it is clear that Brexit has got off to a bad start in terms of its trade impact. There is nothing on the horizon to suggest that the trade agreements currently in the pipeline will generate a big enough boost to offset the damage done to trade relationships with the EU.

Business investment has also clearly stalled (chart below) as the uncertainty effect kicked in. Between 2016 and 2019 there was very little growth in investment volumes and although it has come off its 2020 lows, it is still almost 10% below the 2016-2019 average. As a result, growth in the net capital stock slowed in the wake of the Brexit referendum, from around 2¼% per year prior to 2016 to a rate around 1¾% over the period 2017-19.  To the extent that this is a fundamental driver of the economy’s potential growth rate, the evidence does point to an uncertainty shock adversely affecting the UK’s growth rate and is consistent with the OBR’s prediction that Brexit will cost 4% of GDP in the medium-term.

Obviously it is still very early in the post-Brexit period and until the pandemic effect has fully unwound we will not be in a position to make any definitive assessment. But on the evidence so far many of the downsides which we warned about appear to be making their presence felt. In Johnson’s foreword to the Brexit report he noted that it will allow the UK to “seize the incredible opportunities that our freedom presents and use them to build back better than ever before—making our businesses more competitive and our people more prosperous.” The problem with much of the Brexit bluster is that it assumes the UK will have sufficient control over its future to realise these possibilities on its own. It makes no allowance for the fact that other governments may not want to play ball. Those who run businesses take a much more realistic view about what Brexit means for them and government boosterism cuts no ice. And even in the unlikely event there are considerable upsides, it is highly probable that on the basis of recent events Johnson will not be in office long enough to enjoy them.

Hiding in plain sight

They say that if you are going to lie then you might as well lie big by distorting the truth in plain sight, and by so much that people cannot possibly credit that what you are saying is false. Yet when it comes to the economics of Brexit, that is exactly what is happening. All the downsides that the government was warned about are not perceived as problems: They are now being sold as features of the new system as the economy transforms from one model to another. You have to hand it to Boris Johnson for being able to deliver his closing message at this week’s Conservative Party conference with a straight face. Indeed, I have to regularly check the calendar to make sure that it is not 1 April because the British electorate are now being taken for fools.

As a former journalist, Johnson is without a doubt a great wordsmith as his conference address demonstrated. But a journalist is meant to engage in a modicum of factual reporting: Johnson’s journalism career as a reporter from Brussels was more akin to a purveyor of fiction. His speeches as prime minister are often no different. To quote the blond bombshell himself, “after decades of drift and dither this reforming government, this can-do government, this government that got Brexit done … [is] dealing with the biggest underlying issues of our economy and society, the problems that no government has had the guts to tackle before, and I mean the long-term structural weaknesses in the UK economy.” I don’t want to be overly pedantic but the Conservative Party has held office for 29 of the last 42 years (almost 70% of the span since 1979). If there has been “drift and dither” surely they have to take some responsibility for that?

To quote Johnson further, “we are not going back to the same old broken model with low wages, low growth, low skills and low productivity, all of it enabled and assisted by uncontrolled immigration.” That is an astonishing statement – and it is wrong. The evidence suggests that economic migrants tend to be better educated than the host population. In 2016 the Rand Corporation reported that “In England and Wales, for example, 23% of the working-age, native-born population has no qualifications. This compares with only 13% of migrants from [EU12] countries.” Education and training should in theory show up in total factor productivity growth – the intangible factors which are external to labour and capital inputs. Reducing the education input by turning away better educated foreign workers ought to make productivity worse in the long run and there is some evidence from the official data to suggest that between mid-2018 and end-2019 TFP actually deteriorated (chart below).

Even before the conference, business was not happy about being lectured by government on how to deal with the reduced flow of EU workers upon which they have heavily relied. Simon Wolfson, CEO of Next plc and also a prominent Brexit supporter, has argued strongly that the UK needs to import labour. As he noted in a newspaper article, “the only thing Brexit decided was that the UK must determine its own immigration policy. The vote did not decide what that system should be; nor did it determine that only those on one side of the Brexit debate should have a say going forward.”

Johnson’s answer to the queues which have built up outside petrol stations is to pay tanker drivers more in order to alleviate the underlying labour shortages. You don’t have to be an economist to work out that a pay rise not backed by productivity improvements is inflationary. Perhaps we should not expect anything more serious from a prime minister who is known for his “f*** business” message (there was a lot more truth in that quote than we knew). Beneath the bluster, there is a more serious underlying point. Brexit was meant to set UK business free to connect with more rapidly growing parts of the world and liberate it from the constraints imposed by the EU. It was after all, heavily backed by the free market lobby. What the government has instead done is to impose additional red tape by raising tariff barriers with the EU where previously there were none, and is now telling business how to operate. As Johnson put it, companies must not “use immigration as an excuse for failure to invest in people, in skills and in the equipment the facilities the machinery they need to do their jobs.” It’s a message worthy of a Soviet May Day speech in Red Square.

The think tank and business community did not respond positively to the message they heard from Johnson. The free market Adam Smith Institute, which has traditionally been a supporter of the Tory agenda, described it as “bombastic but vacuous and economically illiterate ... It’s reprehensible and wrong to claim that migrants make us poorer.” The similarly free market Institute of Economic Affairs noted: “Boris Johnson’s rhetoric is always optimistic and enterprising, but insofar as there were actual policies behind it, they seemed to involve yet more state intervention and spending.” The CBI commented, “what businesses urgently need are answers to the problems they are facing in the here and now … The economic recovery is on shaky ground and if it stalls then the private sector investment and tax revenues that the prime minister wants to fuel his vision will be in short supply.”

We always have to take conference speeches with a huge pinch of salt. They are designed to appeal to the party faithful and are not a platform for delivering policy prescriptions. But even against this low benchmark, Johnson’s vision of the post-Brexit UK economy was heavy on the feelgood factor and light on the specifics of how it can be realised. But maybe this is to miss the point of what Johnson is trying to do. As the Frankfurter Allgemeine Zeitung noted, maybe he “is not striving for Thatcherism 2.0, but for an almost Rhenish capitalism, with a caring state at the top. A Tory government under Johnson no longer wants to see itself as an extension of business, but as a "people's government" that also seeks conflict with business.”

There is no doubt that in order to deal with the economic challenges which lie ahead Johnson will have to get a large slice of the electorate onside. Whilst his economic position looks very difficult today, and it is one which has felled prime ministers in the past, we should not dismiss Johnson’s ability to generate a feelgood factor when there is little to feel good about. He is a political phenomenon. Admittedly economics is not his strong point but this has never been a hindrance to those seeking high office, as the Brexit referendum showed.

15 rounds with reality

Leon Spinks was a former world boxing heavyweight champion who gained the title in 1978 by inflicting only the third ever defeat on an ageing and complacent Muhammad Ali. Ali regained the title later that year and Spinks went on to an undistinguished career which saw him win only 26 of his 46 professional fights. The moral of the story is that it is possible to trigger an upset if the opposition is complacent, as Ali was, but success on that one day will not guarantee future success if you merely got lucky and fail to prepare properly for the challenges which lie ahead.

As queues build up outside filling stations as lorry driver shortages hamper deliveries of fuel, I was reminded of the Spinks effect in a Brexit context. The Remain campaign was clearly complacent in the conduct of its 2016 campaign, allowing Leavers to win a narrow points decision. But the Brexit cheerleaders have clearly failed to prepare for what comes next, and even though it is possible to blame Covid for the magnitude of the problem, it is hard to avoid the view that after going 15 rounds with reality, the economics of Brexit is now getting the pasting that all the knowledgeable pundits said would happen.

Government ministers have been out in force on social media telling us that there is no fuel shortage. The new culture secretary Nadine Dorries reinforced the message in a Tweet in capital letters, thereby convincing people of the exact opposite. There may well not be a fuel shortage, but there is a delivery problem and people increasingly do not take the government on trust. And as I pointed out at the start of the pandemic, “If you believe that a major problem is about to be visited upon you … a sensible forward-looking economic actor will make some sort of contingency rather than trust to luck.” 

But the bigger point is that this is not just about fuel shortages. It primarily concerns the British government’s blithe dismissal of the economic consequences of Brexit that they were warned about. What was dismissed for years as Project Fear has now become reality. And before people get on my case about the fact that Covid is really to blame – as the government is trying to tell us – I invite you to point me in the direction of media stories around the EU of empty supermarket shelves and fuel shortages elsewhere.

What they said

To put some flesh on the bones of what Leavers said, it is worthwhile visiting the BrexitCentral archive of articles written by prominent supporters of the Leave movement to remind us of what they promised, how Brexit could be delivered and why the Remainers were wrong to oppose them. It represents a litany of all that was wrong with the debate – a group of believers preaching a misleading message to those who were already committed to the cause. But it is important to remind ourselves of the economic benefits that Brexiteers promised would flow from leaving the EU, and equally importantly, what would not happen in order that they be held to account. 

In November 2017, for example, David Davis told us to “stand firm in the face of the onslaught of Project Fear propaganda.” The article was a one-sided view of the gains to be derived from a go-it-alone trade policy which dismissed all the evidence on the other side of the ledger. Davis reminded us of the “hysteria over the rationing of food and medicine.” The empty shelves and strains on an underfunded NHS are evidence that Brexit has made a bad situation worse.

The economist Graham Gudgin told us “why a UK-EU customs union remains a terrible idea” arguing amongst other things that “there is not much evidence that a customs union would be more beneficial for UK-EU trade than a standard free trade agreement.” The likes of Gudgin have been less forthcoming on the question of why the UK looks set to drop out of Germany's top 10 trading partners for the first time since 1950. Julian Jessop, another Brexit supporting economist, noted in 2019 that “some have seized on the one-liner that ‘low income groups will be disproportionately affected by any price rises in food and fuel’. Equally, of course, these groups would disproportionately benefit from any reductions in the prices of food and fuel.” Try telling that to poorer households bracing themselves for a double digit rise in domestic fuel bills next month. Peter Lilley argued that “EU economic policy has held the UK back and cost us £82 billion over two decades.” It’s barely worth even responding to such trite nonsense, but suffice to say that my analysis using synthetic control methods pointed to a GDP loss in excess of £100bn in the 3 years following the vote to leave the EU.

One of the central tenets of Brexit economics was that the UK would be free to sign trade deals with third countries which would allow the UK to tap into more rapidly growing markets. Key to this was the prospect of a trade deal with the US. Brexit ultra, Iain Duncan Smith wrote that “achieving a Free Trade deal with the United States alone would be equivalent economically to achieving Free Trade deals with the entire world … This is because the vast US economy could supply virtually every good that the UK currently imports.” Brexiteer economist par excellence, Patrick Minford, wrote in 2019 that “Boris Johnson has already made it clear he will urgently look for a trade deal with President Trump.” This week Johnson visited the US, holding talks with President Biden who played down hopes of a UK-US trade deal, whilst the US Ambassador to Britain recently told Sky News that a comprehensive UK-US free trade deal is “not the be-all and end-all”.

It’s just not happening

The Brexiteers made great play of the fact that forecasts which portrayed a gloomy economic future were made by institutions such as the Treasury whose forecasts, in the words of David Davis, ”have almost never been right and have more often been dramatically wrong.” Words of contrition from those who peddled this view have been conspicuous by their absence. And in one of the great ironies of the current situation, the government is being forced to issue temporary visas to lorry drivers from other EU countries to alleviate domestic shortages. Remember they need us more than we need them? In any case this will not resolve the underlying problems, as the road haulage industry has made clear, and presupposes that they would want to come given that shortages are a Europe-wide problem.

There should be no doubt in anyone’s mind that Brexiteers lied about the economic benefits – their own words provide the most damning evidence. That the opposition Labour Party is unable to hold the government to account, given its preoccupation with internal political battles, is nothing short of a scandal (and the subject of another post). However, not all Brexit supporters were as deluded as the ultras. Gerard Lyons pointed out that “if we left the EU in a stupid way then there would be no dividend.” Well, we did so there isn’t.

Much like the unfortunate Leon Spinks, whose early career represented a triumph of hype over ability, the economics of Brexit is being tested by reality and found wanting. But Spinks was the one who ultimately paid the price. In the case of Brexit there are 67 million of us taking a good beating.