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Abu Dhabi, UAETuesday 11 December 2018

As EU divorce nears, UK's 'Project Fear' alarmists may be on the right track

Estimated level of UK GDP could drop between 3.2 per cent and 6.7 per cent by 2030, depending on the option chosen

Boris Johnson could be mistaken in his belief that economic damage from Brixit will be minimal. EPA
Boris Johnson could be mistaken in his belief that economic damage from Brixit will be minimal. EPA

Latest figures show the warnings of economic self-harm Brexiteers such as Boris Johnson derided as "Project Fear" are fast becoming real, while the promises of a Brexit dividend are still too remote even to assess.

Most studies seek to calculate the economic impact of the various degrees of Brexit. The UK Treasury puts the damage at as much as 6 per cent of gross domestic product. Bloomberg Economics analyst Dan Hanson estimates that the level of UK GDP could drop between 3.2 per cent and 6.7 per cent by 2030, depending on the option chosen.

Such estimates are controversial. We don’t know the shape of the Brexit deal, including what arrangements will be put in place to keep trade flowing. And Brexiteers complain such exercises tend to use assumptions that favour negative results.

Yet it is possible to make some unbiased judgements about the costs of the vote itself to date. Doing so is useful as those unhappy with the prospects of a compromise Brexit deal advocate more extreme alternatives, such as leaving without one.

In November 2017, four academics affiliated with the Centre for Economic and Policy Research - led by German associate professor Benjamin Born - modelled how the UK economy would have grown had the referendum gone the other way. Their approach was to create a synthetic UK economy using the attributes of 30 OECD countries, including the US and Canada, whose GDP between 1995 and 2016 most matched that of Britain.

This month, they increased their estimate of the cost of Brexit to 2 per cent of GDP, or about £35 billion (Dh169.39bn), from 1.3 per cent. The researchers’ new output cost is £350 million a week, the exact amount the Leave campaign claimed Brexit would save for use in the National Health Service.

Other attempts to measure the costs of the referendum all produce losses. An FT average of several models back in June arrived at a Brexit cost of around 1.2 per cent of GDP by the end of the first quarter of 2018.

The economy would be doing better if voters had chosen to stay in the European Union

Note: the Remain model is based on attributes from other wealthy nations.

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But models based on historical growth will tend to understate the costs of Brexit, especially since 2017 and the first half of 2018 saw such robust global growth. Most advanced economies other than the UK grew more quickly than they had before 2016. Using arbitrary control groups such as other G7 economies has limited predictive value, too. Japan’s aging population makes it an odd reference point for the UK economy, for example.

The Centre for European Reform’s John Springford has taken the Born-led model a step further. The CER approach uses not just GDP, but also other attributes of 22 advanced economies - including the inflation rate, openness to trade, investment ratio and how well-educated the population is - to create a doppelganger UK that most closely matches the country’s economy before the referendum. Based on that methodology, the CER puts the cost of Brexit at 2.1 per cent of GDP.

Lower growth means lost income for the government, meaning it has to borrow more to meet its spending goals. Whitehall’s own analysis showed that 1 percent of lost GDP resulted in £11bn of extra borrowing. So Springford’s calculation of a gap of 2.1 percent would equate to £23bn of additional borrowing, or £440m a week. Even with the model’s margin of error, it’s a striking result.

“If Britain had voted to Remain, our analysis suggests that the UK government deficit would largely have been eliminated by Brexit day” on March 29, Mr Springford says. “If Theresa May fails to land a deal by then, the costs to both the economy and the public finances will be even greater.”

If the UK remains in the customs union and achieves a trade deal with minimal barriers, tariffs or otherwise, the economy could recover lost ground in time. And for committed Brexiteers, whose minds haven’t been changed in the intervening two years, the economic toll doesn’t matter. They voted for “control”, for sovereignty over laws and borders above all.

But those costs mean choices right now, as Chancellor of the Exchequer, or Finance Minister, Philip Hammond works on a budget that must deliver on Theresa May’s promises to end austerity and help the worse off and somehow stick to fiscal prudence. They also limit the degree to which Labour leader Jeremy Corbyn can deliver on his sweeping pledges to nationalise industries and enlarge the welfare state.

And they provide the closest thing we have to an arbiter of who was right during the campaign.

Bloomberg