Trying to make sense of the economic forecasts around Brexit

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In May 2016, one month before the British public voted to leave the EU, Her Majesty’s Treasury, under the leadership of the Chancellor of the Exchequer George Osborne, put out a detailed analysis of the immediate economic impacts of leaving the EU in which the Chancellor wrote: 
“The analysis in this document comes to a clear central conclusion: a vote to leave would represent an immediate and profound shock to our economy. That shock would push our economy into a recession and lead to an increase in unemployment of around 500,000, GDP would be 3.6% smaller, average real wages would be lower, inflation higher, sterling weaker, house prices would be hit and public borrowing would rise compared with a vote to remain.” 

Was he right? No, inflation did increase, and the sterling did get weaker, but unemployment fell, and GDP still grew, albeit at a smaller pace. What went wrong? Politics and uncertainty. 

Let us first take a look at the origins of Brexit: When did it start? 

The first referendum on UK membership of the EU wasn’t in June 2016 but in June 1975, only two years after the UK joined the European Communities. The result was in favour of remain and the question only came back in the limelight 40 years later in the election of 2015 when the promise of a new referendum was included in the Conservative party manifesto. The Conservatives won that election and under the leadership of James Cameron a referendum was held in June 2016 and the Leave side won the referendum. 

How to explain this different outcome? 

In both cases the Prime Minister called the referendum to appease the rebels in their party, in both cases governments campaigned for Remain and touted the economic advantages of staying in the EU. 
What fundamentally changed was the political landscape, the desire for sovereignty and the fear of war. 
On the 16thof April 1975 Margaret Thatcher said in her speech opening the Conservative referendum campaign “It is not surprising that I, as Leader of the Conservative Party, should wish to give my wholehearted support to this campaign, for the Conservative Party has been pursuing the European vision almost as long as we have existed as a Party.”
She would later denounce the European Community and characterise it as a bureaucracy and a super-state centralising power in Brussels. 

Why does this matter? 

The Brexit process wasn’t started by economists, nor is it run by economists. It is run by politicians and, in the UK cabinet, ministers are bound by convention to always publicly support the government’s policies, including the Chancellor of the Exchequer. Therefore, we cannot be certain that the information provided by government agencies paints a fair picture of the economic realities. 

Did independent institutions do better?

Yes, but their predictions were not as accurate as usual. If we look at the National Institute for Economic and Social Research and the OECD, they both predicted more accurately the weakening of the sterling and the rise of inflation but they also both predicted a much sharper fall in GDP growth than what actually happened. Both wrongly predicted rising unemployment and falling of average real wages in the short term and both overestimated the decrease in the GDP growth rate. 

If politics alone do not justify the erroneous predictions, what else?

The term “uncertainty” appears 310 times in the 90 pages analysis of HM Treasury about the immediate impacts of Brexit, 50 times in the OECD 37 pages analysis, and 80 times in the NIESR 13 pages paper. The Confederation of Brexit Industry considers Brexit uncertainty “utter kryptonite for investment” and many studies have linked uncertainty to lower GDP and to higher unemployment, yet we did not see rising unemployment after the vote to leave and GDP growth wasn’t hit as hard as anticipated. This doesn’t mean that Brexit uncertainty didn’t affect the UK economy. By looking at businesses alone we can see that the CBI Business Optimism Index plummeted through 2017 and 2018 with the CBI saying that by the end of 2018 80% of UK businesses had cancelled or delayed investments because of Brexit uncertainty.

Making predictions is never easy and if making sense of the different analyses of the economic impacts of Brexit is so difficult it is, in the end, because no one really knows exactly what is going to happen. Everything relies on exponentially multiplying hypothetical scenarios with new information coming up every month. In addition to that, the multiple geopolitical conflicts and crises impacting the UK makes it even more difficult to know what caused which problem. 

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