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Is H M Treasury the Enemy of Brexit? by Graham Gudgin

HM Treasury
Written by Graham Gudgin

The Treasury’s role in spreading exaggerated pessimism about a post-Brexit UK economy continues to undermine, the already low, public confidence in official predictions. The Treasury’s role merits much greater public scrutiny than it gets either in parliament or in the media.

Chancellor Philip Hammond hit back at Boris Johnson this week in his Mansion House speech.  Speaking at the Conservative Way Forward’s summer reception two weeks ago Boris Johnson had described Hammond’s Treasury as the “the heart of remain” and viewed dealing with the Treasury as an “inner struggle”.

Hammond’s response is worth quoting in full. He said that “…as we leave the EU we need to forge a new relationship with our European neighbours that protects those patterns of trade: those business relationships that have been painstakingly built over decades, that maintains low friction borders and open markets. That does not make the Treasury on my watch “the enemy of Brexit” rather it makes it the champion of prosperity for the British people outside the EU but working and trading closely with it”.

What this appears to say is that the UK will leave the EU while retaining the closest trade and customs relationships. This should not be interpreted as support for remaining within the single market and customs union since this is not Government policy as set out in the Conservative Manifesto. It can however be understood to support the nearest equivalent, a customs partnership and regulatory alignment.

Like Jacob Rees-Mogg, Boris Johnson views these arrangements as leaving the UK in something akin to a vassal state, subject to the EU but without influence in setting the rules. Philip Hammond sees himself as ever the pragmatist, and Friday’s statement from Airbus that it ‘could withdraw investment from the UK in the event of deal’ indicates precisely what he is trying to avoid. Johnson admits that short term disruption is likely but sees long term gains.

If this was the full scope of the Treasury position we could regard it as an honest if debatable point of view, but the Treasury has form. During the referendum campaign in 2016 the Treasury published two long reports on Brexit amounting in total to 300 pages. Both outlined some of the most pessimistic predictions published on the economic impact of Brexit.

The April 2016 report on the short-term impact has proved infamously wrong. This predicted that the UK economy immediately after the referendum ‘would fall into recession with four quarters of negative growth. After two years, GDP would be around 3.6% lower…. the fall in the value of the pound would be around 12%, and unemployment would increase by around 500,000, with all regions experiencing a rise in the number of people out of work.

The Chancellor at the time, George Osborne, enthusiastically followed up with the threat of an emergency budget and higher taxes, but in practice public sector borrowing has continued to fall. Even the strongly pro-remain Financial Times economics editor now admits that these forecasts were politically motivated saying “after all, they had a referendum to win”. This rather shocking view, that public servants were employed to fool the electorate, deserves much wider comment. A previous Cabinet Secretary took the view that in his time the Treasury would never have been permitted to publish such a report.

While these short-term forecasts can be viewed as an embarrassment of now only historic interest, the Treasury’s long-term predictions of major economic losses from Brexit continue to play an important role. Large numbers of remain spokespeople confidently assert that a ‘no deal’ Brexit would be economically disastrous. Neither the BBC or most other media ever ask what evidence this assertion is based on, but the Treasury’s May 2016 report must be one of the key elements.

As a member of a (mostly pro-remain) research group that has fully replicated the Treasury analysis we showed that the Treasury report contained serious flaws that greatly increased the pessimism of its conclusions[i]. Firstly, HMT based its calculations of the likely loss of UK trade, post-Brexit, on average trade patterns across the EU. This ignored the fact that the UK is virtually the only EU economy that does more of its trade outside the EU than inside it. Again shockingly, an earlier unpublished Treasury paper showed that the Treasury knew well that this approach would exaggerate its negative evaluation of Brexit.

Secondly, around half of the Treasury’s estimate of the negative impact on UK output came from an assumed knock-on effect of trade losses onto productivity. This was based on a somewhat out of date analysis focussing largely on emerging economies. There is little evidence that there is any modern relationship between trade and productivity among richer economies like the UK.

Tellingly, the Treasury refused to meet to discuss any of these points and has never retracted them nor apologised. It has however dropped the central methodology it used in 2016, the so-called ‘gravity model’. It has instead doubled down on its long-term prediction of losses of 7-8% of GDP using a completely different approach.

These latest predictions were published in the Government’s ‘EU Exit Analysis, Cross-Whitehall Briefing’ note of last January. This repeated the Treasury’s pessimistic prediction without giving much detail on how the predictions were produced, or even letting us know what model was being used. The Economists for Free Trade group subsequently discovered that the Treasury were now using a black-box American model based on a range of unrealistic theoretical assumptions.  Far too little information was given in the briefing Note for anyone to check the calculations.

Unlike the earlier Treasury predictions those in the Briefing Note were published during Philip Hammond’s period as Chancellor. Similarly, HMRC’s claim that leaving the Custom’s Union would cost UK firms up to £20 billion a year in administrative costs alone, received no comment from the Chancellor. This was the case despite the fact HMRC’s embarrassing later admission that the figure included £6.5 billion of double counting.

We can accept Mr Hammond’s sincere belief that he is working in the best interests of the UK economy, especially as far as financial services are concerned. The Treasury’s role in spreading exaggerated pessimism does however continue to undermine, the already low, public confidence in official predictions. It certainly merits much greater public scrutiny than it gets either in parliament or in the media.

[i] http://www.cbr.cam.ac.uk/fileadmin/user_upload/centre-for-business-research/downloads/working-papers/wp493.pdf

 

About the author

Graham Gudgin