Bob Edlin: Brexit forecasts are getting more optimistic

As the likelihood of Britain leaving the EU without a formal agreement increases, expectations of the impact are more benign.  

Britain’s independent Office for Budget Responsibility (OBR) ran some numbers and chose the scenario (note – not forecast) of a mild recession with a 2.1% drop in GDP in the event of a no-deal Brexit.  It’s a long way from the terrifying 8% crash in GDP scenario (obviously based on different assumptions) put out by the Bank of England last November.

The OBR bases its thinking on the IMF’s Brexit scenarios published earlier this year in its World Economic Outlook [see pages 28 – 31 of the report].  Assuming that no-deal would result in WTO tariffs, an increase in non-tariff barriers (eg, restrictions on financial services), reduction in migration from EU to UK, and higher interest rates, the IMF modeled UK GDP falling between 1 – 1.5%.  If there were also border disruption, GDP might decline 2.5 – 3%.  The IMF also models a respectable economic recovery under both scenarios.

There are a few conclusions which can be drawn from this.  First, extreme disruption is seen as much less likely.  Secondly, adapting to trade on WTO terms isn’t perhaps as bad as was initially bruited.  Thirdly, there are strong incentives on both sides to reduce negative impacts.  All this should help Britain’s newly-minted Prime Minister, Boris Johnson, in his negotiations with the EU.

There is also much of interest in the detail of the IMF’s thinking.  For example the IMF notes that the assumed increase in non-tariff barriers “could be considerably smaller, and the outcome more benign” , if the UK and EU recognise existing product standards (at least temporarily), while at the same time confessing that it is nearly impossible to determine the impact on the UK’s financial sector of EU attempts to restrict its access. It assumes that the UK will benefit from the plan to temporarily set tariffs on 87% of imports unilaterally to zero for a year (but does not allow for the possibility that the British government will come under pressure to renew this free-trade exemption).  It assumes that the UK will not be able to secure temporary extensions of the EU’s existing FTAs with third countries and thus will bear additional costs for the couple of years it takes to negotiate new agreements.  The IMF also explains that some key assumptions, such as the extent of any border disruption or tightening of financial conditions, “are also very uncertain”.

This uncertainty should encourage caution in relying overmuch on forecasts.  The long run impact of Brexit will be determined by its effect on the productivity of the UK and Eurozone economies respectively.  The IMF expects long term output losses of 2.3% in the UK and 0.4% for the EU from a permanent increase in trade barriers, which reduces returns on capital, and thus capital investment.  This is a plausible model to adopt for the EU as its consistent policy is to tighten standards and restrict external providers (even in some cases where there is compliance with its standards).  But the UK has the choice of actually reducing trade barriers and adopting a regulatory and tax regime which encourages highly productive firms and individuals to locate in the UK.  This might just be the default position of a Johnson government.  And that in turn might lead to some serious revisions to the IMF’s forecasts.

Bob Edlin is a veteran journalist and editor for the Point of Order blog HERE.