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Analysis
Project Fear ‘got its figures wrong’

Project Fear ‘got its figures wrong’

Britain will still be damaged by Brexit 

by Brian Reading in London

Fri 16 Jun 2017

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Before last year’s UK referendum on membership of the European Union, the Treasury produced dire warnings of an immediate recession if Britain voted to leave. It also predicted that Brexit would cause severe damage to UK growth in the longer term. The International Monetary Fund and the Organisation for Economic Co-operation and Development were equally gloomy. Project Fear’s short-term forecasts were wildly wrong. This does not mean that the longer-term projections will be. But a recent study by academics for the think tank Policy Exchange indicates that flawed methodology exaggerated the potential harm.

Given the parlous state of Prime Minister-for-now Theresa May and her minority government, the spotlight will soon turn to the economy. Things are not looking good. Manufacturers like a falling pound as it boosts exports and makes imports dearer. But reduced consumer spending is another matter. Inflation rose to 2.9% year-on-year in May as the weak pound made imports and package holidays more expensive. Despite low unemployment, wages grew by just 2.1% in the three months to April. This is well below the 2.7% inflation in that month, meaning that disposable incomes have been squeezed. With uncertainty affecting business investment, a slowdown is likely in the second half of this year and into 2018.

Economists from the universities of Cambridge and Ulster carried out an assessment for Policy Exchange of the Treasury’s medium-term predictions about the cost of Brexit. The Treasury had analysed bilateral trade between 200 economies over 65 years using a gravity model. The findings of this analysis were extrapolated and applied to the UK’s trade relationship with the EU, and conclusions were drawn on the impact of Brexit on the UK’s trade with the EU.

The figures, it appears, are misleading. According to the academics, too many insignificant countries with little relevance to Britain’s bilateral trade were included in the global calculation. The 65-year timescale was ridiculously long. When just Britain’s major trading partners are included, and more recent data used, the Brexit cost is cut to a fifth of the Treasury’s figure.

The estimate is open to other criticism, too. Productivity is more likely to explain exports than the other way around. Structural reforms and fiscal and monetary policy figure nowhere in the Treasury’s sums. But the fact remains that Brexit will do transitional damage to UK growth. It will also affect the remaining 27 EU members. Perhaps Brussels negotiators could use the Treasury’s methodology to see what the cost of Brexit would be for the rest of the EU. A deal is needed, not dictated departure.

Brian Reading was an Economic Adviser to Prime Minister Edward Heath and is a Member of the OMFIF Advisory Board.

 

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