Crys­tal balls

The Daily Telegraph - Business - - Front Page - Roger Boo­tle

What do econ­o­mists know? Not a lot

How many econ­o­mists does it take to change a light bulb? Let’s as­sume that we know the an­swer. How many econ­o­mists does it take to stitch up Brexit? The an­swer is hun­dreds. Last week we were bom­barded with gloomy prog­nos­ti­ca­tions from the Trea­sury, telling us that our longterm fu­ture would be much worse out­side the EU, par­tic­u­larly if we leave “with­out a deal”. On the same day, we had to en­dure an even gloomier on­slaught from the Bank of Eng­land, telling us that the short-term im­pact would be dire.

How much cred­i­bil­ity should be at­tached to th­ese fore­casts? None. They have been pre­pared by peo­ple with both an agenda and an ap­palling track record of get­ting the big is­sues wrong.

What do econ­o­mists know? The an­swer is “not a lot”. This isn’t be­cause they are das­tardly or in­com­pe­tent. The trou­ble is that the econ­omy is com­plex and the fu­ture is pretty dif­fi­cult to fore­see. You might think that this should breed a cer­tain mod­esty. But no, your av­er­age es­tab­lish­ment econ­o­mist is a strange crea­ture. De­spite re­peated ex­pe­ri­ence of be­ing grossly wrong, they seem to think they can pon­tif­i­cate about the fu­ture, even down to a dec­i­mal point.

The Trea­sury’s as­sess­ment of the post-Brexit fu­ture is es­pe­cially re­mark­able for how lit­tle ben­e­fit is de­rived from free-trade agree­ments (FTAs) with the rest of the world – a mere 0.2pc of GDP. Yet, when the EU it­self looked at the ben­e­fits of con­clud­ing FTAs with th­ese coun­tries it put the gain at 1.9pc. Mean­while, the Trea­sury seems to think that the ben­e­fits of hav­ing an FTA with the EU amount to al­most 3pc.

It has man­aged to pro­duce its bizarre re­sults by mak­ing a se­ries of as­sump­tions that are buried deep in the tech­ni­cal an­nals of its doc­u­ment, where mere mor­tals are not sup­posed to tread. In par­tic­u­lar, it as­sumes that we do deals with only half the world, non-tar­iff bar­ri­ers are only partly abol­ished and then only a quar­ter of this agenda is ac­tu­ally ac­com­plished in the pe­riod un­der re­view. In other words, it pur­ports to show that the gains from a strat­egy of global free trade are min­i­mal by bas­ing its as­sess­ment on the as­sump­tion that we ac­tu­ally man­age to make min­i­mal progress to­wards free trade. Nice one, Cyril!

An­other key eco­nomic ar­gu­ment for Brexit is that it will en­able us to make our own reg­u­la­tions, lead­ing to a less oner­ous reg­u­la­tory bur­den on busi­ness. There is a small gain from this source fac­tored into the Trea­sury as­sess­ment of a no-deal Brexit, but it is nu­ga­tory. In­ter­est­ingly, the gain from this source is about the same un­der a no-deal Brexit as un­der Mrs May’s agree­ment. Go fig­ure!

The study is also re­mark­able for the costs it at­taches to trade “fric­tions”. It tries to es­ti­mate their costs by us­ing all the usual econ­o­mists’ tools. Yet we have di­rect ev­i­dence that such costs should be min­i­mal, in­clud­ing the ev­i­dence from var­i­ous ports, which tell us that they in­spect a tiny frac­tion of car­goes and that doc­u­men­ta­tion is han­dled elec­tron­i­cally be­fore ship­ment.

But I think the most con­vinc­ing ar­gu­ment on this is­sue comes from some ba­sic facts. If “fric­tions” are so sig­nif­i­cant how is it that non-sin­gle market coun­tries ex­port so much into the sin­gle market and in­deed that the rate of in­crease of their ex­ports is greater than that of most sin­gle market mem­bers to other mem­bers?

This should ring a bell. In the de­bate in the late Nineties about whether or not we should join the euro, those ar­gu­ing in favour ad­duced the ar­gu­ment that if we did not join, Bri­tish busi­ness would face sub­stan­tial costs de­riv­ing from “un­cer­tainty and trans­ac­tions costs”. They weren’t wrong in ei­ther the­ory or prac­tice. But they were com­pletely wrong about the mag­ni­tude and sig­nif­i­cance of th­ese costs com­pared to other fac­tors. For “un­cer­tainty and trans­ac­tions costs” then, read “fric­tions and non-tar­iff bar­ri­ers” now. The Bank’s apoc­a­lyp­tic vi­sion of the im­me­di­ate af­ter­math of a no-deal Brexit is even more ab­surd. In the mod­ern world, sup­ply-side shocks have of­ten not had the im­pact that was ex­pected. The rea­son is sub­sti­tu­tion, and sub­sti­tutabil­ity has in­creased, thanks to glob­al­i­sa­tion and the dig­i­tal revo­lu­tion. There are now more al­ter­na­tive sources of sup­ply, more al­ter­na­tive prod­ucts and, be­cause of in­for­ma­tion tech­nol­ogy, we now know more about how to ac­cess those al­ter­na­tives.

In any case, if we do leave with­out a deal this can hardly come as a com­plete shock. We have been mov­ing to­wards this con­clu­sion for months, and if Par­lia­ment votes down Mrs May’s deal, in­di­vid­u­als and busi­nesses will have three months to pre­pare.

The Bank’s study is also pe­cu­liar in that in its worst case sce­nario it puts up in­ter­est rates to 5.5pc. No won­der that house prices fall by 30pc. But I do not re­motely be­lieve that this would hap­pen. In the past, when a sup­ply shock or a fall of ster­ling has caused the in­fla­tion rate to spike up, the Bank has looked through this tem­po­rary up­surge. Quite rightly. I am sure that it would do the same again. In­deed, it may well cut rates.

The Bank’s view on in­ter­est rates is heav­ily con­di­tioned by its view that the pound would fall a long way. This is per­fectly plau­si­ble. But cur­ren­cies fre­quently make fools of us. I can read­ily imag­ine cir­cum­stances in which the pound rises af­ter a no-deal Brexit. Some dis­rup­tion is al­ready ex­pected. If it proves to be less se­ri­ous than an­tic­i­pated then there will be a sense of re­lief in the mar­kets.

But for most market op­er­a­tors, the most im­por­tant fear, far more im­por­tant than Brexit, is a cer­tain Mr Cor­byn. If a suc­cess­fully ac­com­plished no-deal Brexit is fol­lowed by a boost to the Gov­ern­ment’s stand­ing and a fall in Labour’s sup­port, then I could see a sub­stan­tial cap­i­tal in­flow into UK as­sets, caus­ing the pound to rise. Nowhere is such a pos­si­bil­ity re­flected in the Bank’s think­ing. I sup­pose that the mod­els don’t do pol­i­tics. Or re­al­ity.

‘They have been pre­pared by peo­ple with both an agenda and an ap­palling track record of get­ting the big is­sues wrong’

The big­gest risk to mar­kets is not leav­ing the EU with­out a deal, but the prospect of a Cor­byn-led gov­ern­ment

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