I recently gave evidence to the House of Commons International Trade Select Committee on the economic effects of trade policy, alongside my Economists for Free Trade colleague Professor Patrick Minford.
As written evidence, I submitted a report titled “How bright are the prospects for UK trade and prosperity post-Brexit?” In it I demonstrate the ways in which the Treasury has overestimated the costs to the UK of leaving the EU by failing to take into account the regulatory burdens of staying in the Single Market or the benefits from reducing tariffs by leaving the Customs Union.
The Treasury overestimates the costs of leaving the EU
The Treasury’s model predicts a 7.7 per cent reduction in GDP in the event of “no deal” in which the UK retained the existing EU Common External Tariffs with the rest of the world, while the EU imposed these same tariffs and non-tariff barriers (NTBs) on trade with the UK. Of the 7.7 per cent reduction in GDP, 1 per cent is due to the new tariffs on trade with the EU and 5.8 per cent is due to the imposition of NTBs. The model also predicts that the maximum facilitation (max-fac) solution preferred by Boris Johnson for avoiding a hard border in Northern Ireland would wipe 1.8 per cent off GDP.
I strongly reject the Treasury’s predictions for a number of reasons. First, NTBs are illegal under World Trade Organisation (WTO) rules which forbid any form of discrimination on standards between home and foreign products or between the foreign products of different countries. So around 75 per cent of the projected reduction in GDP is due to the imposition of illegal NTBs. This will not happen.
Second, even if there will be new and unavoidable frictional costs, the Treasury has grossly overestimated them. Of the projected 5.8 per cent reduction in GDP due to the imposition of NTBs, 1.3 per cent arises from frictional border costs. Yet if the same border costs as in the EU’s trade deal with Switzerland are applied to the UK, these amount to just 0.12 per cent of GDP, more than ten times lower.
The Treasury underestimates the costs of staying in the Single Market
The Single Market is concerned with standardising regulations in the EU. According to Professor Jacques Pelkmans (“The Economics of Single Market Regulation“, 2012) who also gave evidence at this session, regulation is the EU’s core business. Most EU Single Market regulation is risk regulation, covering issues such as safety, health, environment, and consumer protection. While accepting the need for “good” regulation and less “red tape”, Professor Pelkmans also accepts that regulations can be used to raise rivals’ costs and create barriers to competition from third countries.
Since the primary purpose of trade is to make consumers better off, Professor Pelkmans concedes that the Single Market has not been fully successful to date. That is because of local incumbents having market power, discriminatory local regulations, subsidies, transaction costs like languages, and home bias. The evidence for this is that price convergence has been low (the same good should sell at the same price in different parts of the Single Market, but there are still significant price differences) and most firms do not participate in the Single Market.
Federik Erixon and Rosita Georgieva (“What is wrong with the Single Market?“, 2016) argue that:
The more Europe’s economy grows dependent on services and the digital sector, the less Single Market there will be in Europe. Given the vast complexity of regulations in Europe, and the increasing layers of bureaucracy they entail, it is difficult to see how improvements could be made without a vast overhaul of the structure of regulations and the design of the Single Market. As reforms are moving closer to areas like digital services, energy, and advanced business services, it is evident that the improvements that can be made in Europe’s integration is less about classic Single Market reforms and more about building adequate market institutions and advance structural reform.
It is clear from evidence such as this – from strong supporters of the Single Market concept – that the Single Market does not really exist, especially in services. Given that the future of the UK economy is services – 80 per cent of UK GDP is in services, yet only 5 per cent of UK GDP is exported to the EU as services – we should not be worried about leaving the Single Market. The regulatory burden of remaining in the Single Market is equivalent to 2 per cent of GDP. We can reduce this cost by preparing to simplify regulations, while keeping them “good”; simplify product/service standards so they do not impede competition; and building digital services, energy, and advanced business services for the global economy where all future growth is.
The Treasury underestimates the benefits from reducing tariffs by leaving the Customs Union