The evidence suggests Edinburgh will rise above Brexit forecasts

The evidence suggests Edinburgh will rise above Brexit forecasts

by Douglas Lowe
article from Wednesday 25, April, 2018

IF YOU HAVE ever wondered what the European Commission’s understanding of the UK’s negotiating position is it is best represented by the FT in the diagram below. For the UK to avoid all the “Xs” the only model acceptable is that of Canada or South Korea.

In Canada’s case, the EU-Canada Comprehensive Economic and Trade Agreement, or CETA, which abolishes trade barriers, allows mutual recognition of many professions, and intellectual property rights and regulates certain investment disputes. Back in March the UK set out its requirements for several “options”, concessions and exemptions, such as segmenting the single market, privileged access for the City of London and bespoke customs arrangements. The FT describes these as “have your cake and eat it demands” (surely, “eat your cake and have it”!). Time will tell – and there is not much time – as November is considered the latest date to conclude the negotiations if ratification is to be concluded by March 2019.

A “Canadian” trade deal, even “plus, plus” will restrict trade in goods and even more so for services. The effect of such restrictions will be much greater initially than later as adjustments are made and new trade patterns develop. The extent of the long-term damage to 2030 to the UK economy has been widely assessed with even wider conclusions; some “surprisingly” seem correlated with the political bias of the forecaster. Most estimates are of GDP in 2030 compared to an assumed “normal” growth in the UK economy of circa 2.3 per cent. The FT summarises 10 such “Estimates of economic impact of a FTA” (on GDP (sic!)) from which I exclude the pre-referendum Treasury’s – 6.5 per cent forecast and both extreme forecasts, given by LSE/CEP and Economists for Free Trade. The seven remaining central forecasts shown an average loss of 2.75 per cent by 2030 or 0.20 per cent per year compound. Twelve years of 2.3 per cent growth would result in a UK GDP increase of 31.4 per cent but a 0.20 per cent reduction per year could reduce this to approximately 28.7 per cent.

NIESR, one of the seven forecasters cited, forecast a 2.50 per cent reduction in GNP by 2030, but also forecast that, as a result of lower population growth, the loss of GNP per head by 2030 would only be 0.8 per cent. The FT affirm that in the table referred to above all the figures shown in the chart relate to total GDP, as the subtitle indicates rather than GNP per person.

Cambridge Economics in a separate study “Preparing for Brexit” used a different “method” from NIESR, OECD, and HM Treasury to forecast the difference in GVA by 2030 from leaving the EU under different scenarios and their results were similar to those of NIESR, quoted above. An analysis of Cambridge Economics’ report by Dr Graham Gudgin of Cambridge allows the per capita GVA figure to be derived from the gross GVA figure by combining the estimated percentage reduction in population growth to 2030 of 2.2 per cent with the percentage total GVA reduction in growth of 2.7 per cent, to give a reduction in GVA per head in 2030 of only 0.5 per cent. The same arbitrary adjustment to the OECD and HMT forecasts – which forecast the most unfavourable outcomes gives per capita reductions of 2.9 per cent and 4.0 per cent respectively, assuming a FTA.

How accurate and how relevant are the forecasts? They cannot all be accurate, as they are widely varied! Moreover, as shown above, earlier forecasters missed the Great Depression and the Great Recession. History is not kind to “establishment” forecasters who have tended to be profoundly wrong at such critical junctions, having made what Roger Bootle calls “serious errors of judgement” on the effect of policy changes for almost 100 years. In 1931 the Treasury, the Bank and almost all the established economic forecasters agreed that if the UK left the Gold Standard - if, in today’s jargon, we “crashed out” we would fall over a “cliff edge”. Per contra this policy change preceded a substantial period of economic growth as Keynes, a lonely exception, had forecast. A Government Minister, Sidney Webb, in echoes of today’s debate, said “No one told us we could do that …!” Nearly 50 years later there was widespread opposition to the Thatcher reforms from the establishment and, particularly, the CBI. As with Keynes earlier, there was some support for the reform, but the majority opposition crystallised in the famous letter of criticism written by 364 economists to the Times. The Thatcher reforms transformed the UK economy from a laggard to a leader in relative economic performance.

The UK joined the ERM enthusiastically supported by the economic establishment, possibly as a Trojan Horse for the Euro: the Delores principle – make the institutional change and policy, permanence and practicality follow! This proved a disaster from which the UK was rescued when it was forced out of the ERM in September 1992. With the Trojan horse reduced to kindling the Treasury and the establishment revealed their true colours with a full cavalry charge for the Euro, strongly supported by the City. The euro has been a disaster as many of its promoters have gallantly admitted and, indeed, given the absence of political unity, rather than unifying the EU, it undermines it.

Prior to the EU referendum the “Remain” campaign was supported by most of the economic establishment, who, together with the Treasury, forecast an economic downturn unless Remain won. Indeed, the Treasury forecast a recession with GDP falling quickly by 3.6 per cent. 

The HMG forecast uses a different modelling system from the one used by the Treasury pre-referendum, possibly because the Treasury one was so obviously wrong! The model ‘GTAP’ used by HMG has been used by other economic forecasters where the results show small - 0.8 per cent - long-term UK benefits from unilateral free trade and greater benefits from multilateral free trade arrangements. In spite of using the same model a key difference been the Treasury and other forecasters using the same Treasury model is the assumption of “friction” at the borders. The non Treasury view is that such friction is overstated as the World Bank showed that, between 15 developed countries in 2016, 98 per cent of the trade required no physical inspections and for the remaining 2 per cent the median clearing time was one day. In such instances there is virtually no “friction”.

Given the complexity, the multiplicity and the inconsistency of all the forecast no defensible position can be taken on the precise effect of Brexit by 2030! Economic forecasting in the short-term is unreliable and over 12 years arguments over ± 0.25 percentage point differences in GNP seem surreal. However, it is self-evident that the adjustment in the economy from the present EU membership to any new trading relationship cannot be made without upset and destruction in some areas, in some industries and to some people. Almost without exception the long-term “costs” of leaving the EU are measured in real GNP, but the effect will be experienced largely in GNP per head, not total GNP and such a qualification would significantly reduce the forecast economic “cost”.

In contrast to the wide range of forecasts for the consequences of leaving the EU, forecasts for the UK economy vary little. GDP growth was 1.7 per cent in 2017 and is expected to increase marginally to at least 1.8 per cent in 2018 by the Bank, Oxford Economics and NIESR but to be below that level by the IMF, OBR, and the EC, and the OECD forecasts only 1.2 per cent. In 2019 forecast growth is at or below 2018 forecasts with the OECD and the EC falling back to 1.1 per cent, but from 2020 growth forecasts are at or above current levels. These forecasts do not suggest that the economic consequences of leaving the EU will be significant.

Scotland’s growth continues to lag UK growth and in 2016 was only 0.4 per cent but is expected to reach 0.8 per cent in 2017, just under half of the UK’s 1.7 per cent. Over the next five years the EY ITEM Club expect Scottish growth to be 1.7 per cent, 0.3 percentage points below the 2.0 per cent forecast for the UK. Scotland is far from uniform, as the economic crisis in the north east exemplifies. However, as London and the South East is to the UK, so is Edinburgh to Scotland. The ONS Regional gross value added (“GVA”) figures show that in 2016 (the latest available), whereas the UK had a growth in GVA per head of 2.8 per cent, and Scotland had a lower growth of 2.4 per cent per head, the City of Edinburgh had a GVA growth per head of 2.9 per cent. Edinburgh’s total growth in GVA was 4.5 per cent, the fourth highest performing city in the UK after London, Cardiff and Greater Manchester. The growth total of GVA in Edinburgh was 1.53 times that of Scotland whereas the growth of GVA in London was 1.38 times that of the UK. In spite of an indifferent UK economic performance and of a poor Scottish one, Edinburgh’s economy is booming.

The uncertainty posed by leaving the EU is at times confounded with an economic downturn but the evidence and the forecasts suggest that leaving the EU will at worst have only a marginal effect on the growth of GDP. Even with a lower growth environment some localities, including Edinburgh, will continue to enjoy average growth significantly above the UK average.

This article is an extract from Douglas Lowe’s Chairman's Statement for Caledonian Trust PLC of March 2018. For the full statement please refer to Caledonian Trust PLC Interim Statement Half Year to 31 December 2017, here.

Diagram courtesy of the Financial Times, full article can be viewed here.

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