February 9, 2018 / 11:19 AM / 6 months ago

Breakingviews - Hadas: Brexit trial could go worse than expected

LONDON (Reuters Breakingviews) - The infighting and reality-dodging that surrounds Britain’s exit from the European Union can seem like a grim comedy. However, it is no laughing matter that members of the government consider it their patriotic duty to criticise and ignore advice which doesn’t validate their view. Expert economists, however, have not stopped estimating just how bad it will be. And rather than exhibiting bias against Brexit, if anything they show too much optimism.

Demonstrators supporting Brexit protest outside of the Houses of Parliament in London, Britain, November 23, 2016.

There is no serious economic debate over whether leaving the European Union will initially cause some damage. It will take time to compensate for the deterioration of relations with Britain’s most important trading partner. The legitimate questions are how much harm will be done, and for how long.

To answer those questions, the experts turn to models of how trade works in modern economies. The models all follow similar rules, so they come up with roughly the same estimates. The leaked preliminary numbers prepared for the government’s Department for Exiting the European Union are typical.

Over 15 years, government economists predict damage as small as a 2 percent cumulative loss of GDP, or a minimal 0.1 percentage point decline in the annual GDP growth rate. Such a loss would barely be noticed, but it requires the UK to remain inside the EU’s customs union and single market – a political anathema to the wildest Brexit enthusiasts.

The worst predicted outcome occurs if Britain gets no special deal with the EU, which some Brexit enthusiasts actively prefer. In that case, the country’s GDP would be 8 percent lower at the end of 15 years than if full membership continued.

This equates to an annual growth rate hit of about 0.6 percentage points, a bit more than a quarter of most economists’ estimate of the sustainable GDP growth rate. That is not pleasant, but it is far from disastrous. The British people would still continue to become steadily and substantially richer. Arguably, increased British sovereignty is worth that amount of sacrifice in potential prosperity.

However, the economists are too optimistic, because their models miss a few important things about Brexit.

First, they extrapolate from historic changes in trading patterns, which almost always increased the efficiency of production. As economies become more integrated, bad systems are basically replaced by good ones, already good systems by even better ones. When economists apply these precedents to Brexit, they basically reverse the effect from positive to negative.

But going backwards is likely to do more than simply remove the gains from trade integration.  It will take a lot of energy for the British to set up less efficient trading networks – whether the country becomes more self-sufficient or trades more with more distant countries. After all, the old pre-EU production systems are long gone, as are the British skills needed to deal with increases in economic isolation and regulatory complexity.

Second, Brexit will change far more than trade relations. It will put a wedge between the UK and the rest of Europe in every part of the culture. This matters for the economy, which is built from what sociologists call institutions – legal systems, regulators, universities, industry groups, research institutes and financial networks. The de-Europeanisation of British institutions is likely to create all sorts of problems, small and large.

Of course, a Brexit-in-name-only would bring less institutional disruption than a no-deal Brexit. Still, the cumulative effect of subtle disruptions would be significant. The institutional cherry-picking from the EU side has already begun. European agencies are leaving London. Anecdotal evidence suggests the UK, perceived as unreliable and immigrant-hostile, is losing out in regional research projects and supplier searches.

Whatever the post-Brexit arrangements, business people will see the post-Brexit UK as a country with an unreliable governing class. It will take a decade of renewed national reliability for the mistrust to dissipate. Meanwhile, both existing businesses and aspiring entrepreneurs will be tempted to look for safer locations to do business, across the Channel or around the world.

A harder Brexit would make everything worse. Regionally integrated industries such as cars, pharmaceuticals and aerospace would shift investment away from Britain. Fewer talented foreigners would come to what would clearly be the European periphery, and more rising British stars would move to be closer to the centre of the world’s largest economic bloc. British wages would presumably fall, keeping costs more competitive, but such serious wounds to the economic infrastructure do not heal easily.

The greatest threat may be a fog of isolationism settling on the British Isles. In the global economy, the sharing of international best practice raises national standards in everything from biotechnology to road design. A purely British path is necessarily an inferior one.

Those arguments are known, and well aired. But they are not well modelled, because their effect, never encountered before, does not lend itself to spreadsheets. However sincere Brexit proponents are about Britain embracing the world, the goal is simply incompatible with their desire for vastly increased national economic sovereignty. The costs of going it alone are likely to be far higher than they, and even the economists who disagree with them, seem to realise.

Breakingviews

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