Sunday, June 26, 2022
Six years on, there's no plan to deal with the Brexit damage
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

My regular column is available to subscribers on www.thetimes.co.uk This is an excerpt. Not to be reproduced without permission

I can remember vividly June 23 2016, the sixth anniversary of which we have just passed. During the afternoon I gave a talk to some schools in Guildford in Surrey, after which the heavens opened in a storm of Biblical proportions. Perhaps somebody was trying to tell us something. The short train journey back to Waterloo took hours, because of the rain not strikers, though I did get back in time to vote in the referendum.

Damage was done that day, with widespread flooding. Today I want to start by reviewing the damage done to the economy by the decision voters took that day. Polls show that they now think by a significant margin it was a mistake, though it is a little late for that.

Then, in the spirit of constructive engagement, I want to examine what we should do about it. It is not, spoiler alert, about rejoining the European Union, though it was a massive economic policy error to leave. The Labour Party is as scared about saying anything positive about the EU as it is about being caught offering support for striking railway workers. That ship has sailed and will not come back into port for many years.

The experience of the past six years is gratifying for economists, including me, because they have panned out as expected. Apart from an explicitly political Treasury forecast commissioned by George Osborne, most economists did not expect a post-referendum recession. That Treasury short-term forecast, of the mildest recession ever, was wide of the mark.

Other forecasts had two central features. One was that sterling would suffer a sharp fall, which it did, the biggest short-term drop of any major currency in the floating era. The other was that the economy would suffer from many years of attrition as a result of the Brexit vote, slow-burn damage, in other words.

I wrote once that there was a danger that people would lose sight of that damage as other things intervened. Other things have indeed intervened, notably the pandemic and the Russian invasion of Ukraine, so it is important that we do not lose sight. And before anybody says it, while the editor of this newspaper at the time backed Brexit, I and many of my colleagues strongly took the opposite view.

How do we measure the damage? An intriguing and widely accepted method, which has been used by the Bank of England among others, is the doppelganger approach. If that sounds a bit sci-fi, it is quite straightforward. The average performance of advanced economies similar to the UK, but which did not Brexit, is the control. Doppelganger UK reflects what would have happened had we not decided to leave, against which the performance of the actual UK can be compared.

The doppelganger approach has been used extensively by John Springford, deputy director of the Centre for European Reform. His latest update, covering the period to the end of last year, was published earlier this month, and the results are striking.

The headline is that actual UK GDP in real terms was 5.2 per cent smaller at the end of last year than doppelganger UK GDP. The economy has lost 5 per cent as a result of the Brexit vote on this calculation, equivalent to a quarterly GDP loss of £31 billion, or an annual loss of more than £120 billion.

The UK has done worse than its doppelganger in investment, which is 13,7 per cent lower, and goods trade, down 13.6 per cent. The only exception is services trade, in both directions, which is 7.9 per cent up on the doppelganger, but this only offsets a fraction of the declines elsewhere. I shall come back to exports in a moment.

There is a neat symmetry between the 5 per cent GDP loss since the referendum and the Bank’s calculation, revealed ion a recent speech by the monetary policy committee member Catherine Mann, that price levels in the UK are 5 per cent higher than in doppelganger UK. Brexit is not mainly to blame for current high inflation, caused by supply-chain difficulties, the monetary response to the pandemic and the Russian invasion of Ukraine, but prices in the UK are 5 per cent higher than they would have been.

This kind of effect, together with the damaging effect on productivity of Brexit, informed a Resolution Foundation/London School of Economics study last week, which said that real wages will be £470 a year lower, on average, than in the absence of Brexit.

Higher UK prices are partly a function of the dampening of competitive forces as a result of the UK becoming a more closed economy, but have a lot to do with sterling, which has again been coming under pressure recently. Sterling’s average value against the dollar since the referendum, $1.31, compared with $1.57 in the previous six years, and $1.66 in the 10 years leading up to the vote. The represents a devaluation of 17 and 21 per cent respectively.

Against the euro, where the post-referendum average has been just €1.146, the equivalent declines are 8 and 9 per cent respectively, or 17 per cent if we take the period since the euro came into being at the start of 1999.

This big sterling devaluation has not supercharged UK exports, as noted, far from it, but there is a curiosity. Non-EU exports have been weaker than EU exports, just as non-EU imports have been stronger than EU imports. Some of the weakness of non-EU exports may be due to the fact that many exporters, particularly smaller ones, have only a certain amount of bandwidth, and that dealing with the red tape of exporting to the EU has diverted them from the task of exporting elsewhere. There may also be still an echo of the old Rotterdam effect, in which exports destined for the rest of the world go via the Dutch port, though there is not good reason for doing that anymore.

Even so, there is no room to relax about exports to the EU. Official statisticians reported that, in cash terms, UK exports of goods rose to record levels in April. Digging a little deeper, however, and the figure was flattered by Ukraine-inflated UK energy exports. Adjusted for inflation, UK exports to the EU in April remained below pre-pandemic levels.

This brief review has underlined the damage inflicted on the economy by the Brexit vote over the past six years. The question is how to halt the decline. Shortly after the referendum, on July 3 2016, I set out an agenda for doing that and, if I say so myself, it was rather prescient.

Long before anybody had started to use the phrase “levelling up” I said it had to include regional rebalancing, partly via infrastructure spending including the full HS2 but also via a new focus on high-value manufacturing rather than low-productivity services.

To compensate for the big disadvantage of leaving the single market, I suggested that this country could attract inward investment by adopting a 10 per cent corporation tax rate, undercutting even Ireland’s 12.5 per cent. Low tax rates are not the only reason businesses invest in countries, but they help. The UK had to rediscover the secret of being a low-tax, dynamic economy.

We needed a close post-Brexit trading relationship with the EU. And, amongst other things, and this one has really come into its own, there had to be an energy strategy, including replacing the ageing nuclear stations that were coming to the end of their lives.

Some of those suggestions were heeded. There is a regional approach of sorts, though the government has been better at announcing large amounts of infrastructure spending than implementing game-changing projects.
Mostly, though, things have gone backwards. There is no industrial strategy anymore. Corporation tax is already higher under this government than it was intended to be, a cut from 19 to 17 per cent having been abandoned, and a rise to 25 per cent due next year, the exact opposite of what was needed. Foreign direct investment into the UK has not collapsed but little has been done to encourage it. The trade desal with the EU is think and flawed, The government is desperately trying to play catch up on energy.

More than that, in leaving the EU we have paradoxically become more European, with higher sustained levels of public spending and the tax burden heading for its highest since the late 1940s. Instead of low personal taxes, which made the UK attractive in the 1980s, they are rising. There is no plan, no strategy, just a government flitting from one headline to the next and struggling in the face of economic forces it cannot control. The Brexit hangover, sadly, will last.