Reviewing the Treasury's "shock"(ingly bad) scenario for a Brexit

At the risk of this becoming "Economics with a C", or more bizarrely "Referendum with a C", I want to just take a few moments to analyse the Treasury's latest report "The immediate economic impact of leaving the EU". After all, the Brexit debate could change the UK's security position through virtue of an altered economic position. So what is this report?

Well, "not worth the paper it was written on" would be a good starting point. It's an analysis produced by the Treasury with the help of Professor Sir Charles Bean, who is noted only as an advisor to the Treasury. For some reason they left out mentioning that he was once a special advisor to the European Parliament Committee on Economic and Monetary Affairs. How careless of them. After all that could potentially be seen as a significant conflict of interest for what is supposedly an independent report, but then I don't think anyone that read this report would have seriously believed for a second that it had any kind of independence about it. Moving on from that, what does the report actually say?

Well it's supposed to be an investigation into what will happen to the UK economy post-Brexit. A forecast really, though nobody seems to dare call it a forecast even though that's precisely what it is. What else do you call an attempt to predict the future? Well apparently this an analysis, not a forecast, which is odd because I'm fairly certain you can't analyse in detail something which has not happened yet. Now as you might expect it's all doom and gloom. It tries to predict, sorry, analyse, two different economic scenarios following a Brexit; shock and severe shock. 

No, I'm not joking, the report genuinely has just assumed that either one or the other of these two things will happen, with no thought of an alternative.

And that really is where the whole thing breaks down. It is based entirely on a series of inter-locking assumptions, many of which are highly questionable. It repeatedly uses the phrase "following the shock of a vote to leave the EU" as if it is pre-determined that a vote to leave the EU will instantly create a shock. It's rather like writing a report that begins "what will happen after the meteorite strikes the Earth..." and then assuming from that point onwards that a meteorite has indeed struck just because you've asserted that it will. Most of the macroeconomic assumptions are based off this idea, with gloomy headlines about managing the transition to a less open and competitive economy.

If you want to know why economists keep fucking up their forecasts, this is a prime example of how it happens. They frequently pick an end point having made a lot of highly dubious assumptions and then try to draw a line that connects the starting dot to the dot they've positioned at the end, which naturally leads to a line that looks very odd because its path has been pre-determined and has to wind its way through a series of increasingly bizarre twists and turns in order to make the numbers fit the end argument. For example the Treasury seems to have no satisfactory explanation as to why the UK economy would shrink by 0.1% in the first quarter post-referendum and then keep shrinking at the exact same rate for the next three quarters afterwards before beginning to recover. It's almost like someone took the Office of Budget Responsibility (OBR) projected UK growth figures over the same period (0.6% growth per quarter) and just went "erm, let's take 0.7% off shall we?". So the UK economy magically contracts in that first quarter by 0.7% compared to current growth predictions, but then remarkably it immediately stabilises to 0.1% contraction for the next few quarters, and then magically begins to start growing again at a decent rate after that. 

If it looks and sounds like someone has just generated a minus figure using a calculation and then simply applied that same figure to all the OBRs forecasts for the next few years then that's probably because that is exactly what appears to have happened. There is no other explanation for their insanely neat and tidy forecast. Why does the economy suffer such a severe contraction immediately for example, but then just kind of dribble along in a nice controlled manner after that? Where are the knock on effects on growth caused by that big drop at the beginning? Over four quarters the economy loses 2.8% growth compared to current estimates, including a prediction of 500,000 job losses in the shock scenario or 800,000 in the severe shock scenario, yet magically the economy pops back into life and starts growing again steadily at the other end as if the previous four quarters had never happened.

I can't tell you what kind of economics this is, but it's most certainly not based on any kind of realistic and detailed assessment of the UK economy. This can be backed up by two points inside the document itself. One is where the Treasury tries to make sweeping assumptions about the nature of household spending. This is worth pointing out simply because people are difficult to predict and a frequent mis-step made by economists is to try and predict how people will behave. They assume that every household is well versed in economics and will make the "right" choice, or at least the choice that the economist desires. Frequently though the general public lacks both the information required to make such decisions and the understanding of economics on such a large scale. As a result they tend to act very differently to the way the models say they will, not least because many people simply have different personalities, circumstances and outlooks. Not everyone views warnings of a year long recession as a time to trade in their car for a more economical model and start hoarding money in a savings account. Frankly a lot of people are so poor that "saving" in the economist's sense of the word is simply not possible.

The second point is the fact that the Treasury's assessment makes no attempt to model any kind of monetary or fiscal policy reaction by the government and the Bank of England. For those not sure, "monetary policy" relates to the control of the money supply by targeting the rates of interest and inflation, whereas "fiscal policy" relates broadly to things like taxation and investment by the government. And just to clarify, yes, that means the Treasury's analysis is based on the idea that the government would simply sit on its arse and do nothing while the walls crumbled around them in these shock scenarios. Apparently they wouldn't like to comment on what a future government might do in response to the shock, despite the fact that a) unless there is a coup in the making already, then the future government will be exactly the same as the current one, and b) they're more than happy to make a bunch of massive guesses about the economy based on bizarre numbers, dubious assumptions, and looking out as many as 15 years into the future. I would posit to anyone reading this that it would probably be easier to predict this governments and the Bank of England's future fiscal and monetary policy than it would be to try and make a prediction about what a post-Brexit economy might look like in 15 years.

Now just sit back and digest that for a second. They're making a prediction about a shock effect on the economy which entirely rests on the idea that the government and Bank of England would make no effort to intervene. None. So what's the point in even making an analysis like that? You're basically saying this; "here's what will happen in a future scenario that will never actually happen". You might as well write an economic forecast for Narnia or Middle Earth for all it's worth.

This whole matter is complicated by the Treasury's insistence in only looking at the negatives. For example when talking about a potential drop in the pound it goes to great lengths to mention only the bits about imports becoming more expensive and the effect this would have on household spending. It declines to point out that exports would also become more affordable for foreign customers (there's a reason why some of the top exporting nations in the world have significantly weaker currencies than ours). At the same time the Treasury attempts to have its cake and eat it.

Why? Because it ignores the simple fact that the day after the referendum, even in the event of a vote to leave, the UK would still be a member of the EU. This is an important point that keeps getting swept under the rug for some reason. Until the UK actually agrees some kind of deal with the EU (or not, as the case may be), it will remain a member of the EU. It will continue to be bound by the EU rules and regulations, as will other member states in regards to the UK. Part of the Treasury's assumption is based on the idea that prices will immediately rise due to tariff increases on trade with Europe, while seemingly ignoring the fact that tariffs and other trade barriers would stay exactly as they are. I say "seemingly ignoring" because the only other possible explanation is that they're simply too stupid to realise this and that the whole document was devised off calculations on the back of a packet of fags by some unpaid intern. Though given the state of the document that's looking increasingly likely as a possibility.

They also make the assumption that businesses from outside the EU would be uncertain about the tariff and regulatory regime, which would cause the UK problems in the short term. But again, look at the above. The UK would remain a member of the EU. Nothing would change overnight. The UK would exist and trade as it always has done until a new deal was signed, by which point the details would be a lot clearer. And given the time it will take to agree a deal with the EU it's not like there will be no advanced warning about the kind of regime that will exist in the future, not least because I suspect in the event of a vote to leave Cameron will attempt to take the path of least resistance and sign a deal that ties the UK as closely possible to the EU without being in it, which is the worst of all possible outcomes. Countries the globe over will simply continue to be able to trade on the same terms as they do now, the complete opposite of what the Treasury is saying. Or in other words, the Treasury is telling out right, bare faced lies.

Other assumptions made? That all businesses would be affected equally. In reality only around 6% of UK businesses actually export goods to the EU. Now that figure masks a number of businesses that are suppliers to other UK firms that export to the EU and rely heavily on that business, but it does give a good indication of the fact that really not that much of the UK economy is actually dependent on the EU. The UK economy has a highly advanced internal market and combined with non-EU trade is more than capable of looking after itself. Proof? Look at the state of the EU right now in terms of growth and unemployment figures across the continent. And then look at the UK. Even as Europe struggles to get to grips with the Eurozone crisis which - despite not featuring much in the media anymore - is still well and truly happening, the UK has continued to grow. Because although the UK does plenty of business with the EU and a slowing down in one can cause problems for the other, fundamentally the UK's economy is not tied exclusively to Europe. The Treasury's document assumes a gross over reaction by the bulk of the economy, including a lot of businesses that would not immediately be affected (or indeed expect to be affected at all to any great degree) suddenly having a massive collective panic attack.

As indicators the Treasury has tried to point to a slow down in the commercial property sector as an example that the country is getting spooked and businesses are slowing their investment. In the process of rushing to make this dire warning it seems the Treasury either rather blithely or, rather deliberately, overlooked a survey of members of the Royal Institution of Chartered Surveyors (RICS), which back in April noted that a buy-to-let rush at the beginning of the year had now subsided ahead of changes to stamp duty. It's chief economist has also gone on record as saying that he and his members expect house prices to continue rising irrespective of the referendum result (and thus counter to a central claim by the Treasury in this report) due to that old and true rule of economics; supply and demand (remember what I said earlier about making assumptions about what people will do to make your model fit vs reality?). The only people that really need to worry are the owners of properties in London with a value in excess of £1 million, which credit rating agency Moody's says might be affected to due to a reduction in demand from wealthy Europeans (though treat Moody's with a pinch of salt as they don't exactly have a great record at, err, rating credit worthiness as it turns out). Everyone also seems to acknowledge that the housing market in the south-east might be a bit overheated as it is and that eventually that mini-bubble is going to resolve itself one way or another.

The Treasury also tried to back up its claims with a couple of very vague boxes on the aviation and car industries. They didn't really say anything much about them other than to highlight their size and issue some vague warning about jobs and uncertainty. This was amusing for several reasons. Firstly because just last year the Chief Executive of Airbus stated that he had no intention of pulling manufacturing out of the UK if the country voted to leave the EU. So scratch that one off. In the car industry, bosses of companies such as Vauxhall, Bentley, Opel, Honda, Toyota and Nissan - who between them account for the bulk of UK car manufacturing - have all said that a referendum would not cause them any problems they haven't already accounted for. They've known for a long time that a referendum would be coming at some point and have made their investment decisions with this already in mind. Those decisions being to stick with the UK, Brexit or not. Basically they all seem quite sanguine about the future, understanding that the UK offers a range of advantages over other countries that go beyond mere matters of potential tariffs (not least the fact that a trade war on cars is absolutely not one that the EU wants to get involved in). Then there's the small matter of how difficult and expensive it actually is to set up a brand new plant somewhere else, assemble the needed supply chain, and then recruit and train a workforce from scratch.

I agree with the Treasury only in the sense that I think some suppliers to these industries will take caution in the run up to the referendum. They will be less certain about the true position of their large customers and their future production levels and will act accordingly. This is simply a byproduct of their place in the food chain and the fact they don't have enough hard information to work with so will naturally have to tread with a little caution until they know more. It's unavoidable on their part and I fully accept that. There will be other businesses that feel the same and will likely undergo hiring freezes until they know more about what is to come, but this is hardly the "shock" predicted by the Treasury. I did find it amusing though that the Treasury persisted with its line about regulations and the dire warning that the EU will become a different beast altogether for aviation, automotive and maritime industries to deal with. I laugh because a lot of aviation and maritime standards are set internationally and because I remind you again that the UK would remain a part of the EU until such time as a new deal is struck. If after that the EU wants to impose new, tighter regulations such as on noise or pollution then it can. It will only drive more transiting aviation traffic from the US to the middle east and Africa (and vice versa) into UK airports for their stop overs.

The Treasury also talked a bit about trade. Here it made some interesting and quite ridiculous claims. Again it tried to push the idea of tariffs without acknowledging the UK's continued presence in the EU. It completely ignored the possibility of reducing tariffs and other barriers by the UK which is one of the prime advantages of withdrawing from the EU in the long run. It made the mistake of assuming that because the UK is a smaller economy than the EU that it would have a tougher time striking a deal, again ignoring the body of evidence that already exists that smaller countries generally find it easier to cut trade deals due to their more focused economies (see the China/Switzerland, China/New Zealand free trade agreements as examples. You can't look at the EU's FTA with China because it doesn't have one...)

The Treasury also went on to make the absurd claim that the UK would struggle to sign deals because other countries were already busy negotiating with the EU. Maybe it's because the UK has been out of the Free Trade Agreement business for a while and as such has lost the corporate knowledge, but remarkably most countries don't just have one guy sitting in an office somewhere working on all his countries FTAs by himself. Generally a country, especially one with a bit of cash to spare, can afford to hire teams to deal with the day to day detail of each negotiation, which then needs to be bumped up to the ministerial level for approval before signing and ratifying. That's a slight simplification, but it's vastly closer to the truth than the idea that the rest of the world would be too busy to sign terms with the UK because they were still preoccupied splitting hairs with the EU. Indeed most countries - miraculously if you're to believe the Treasury and the Remain campaign - manage to negotiate with multiple potential partners all at the same time. I can't help but be excited by the potential coup that would take place if the UK could manage to complete Brexit and still conclude some trade deals with countries before the EU did. 

And it's worth noting that despite claims that the UK would have to return to the drawing board and renegotiate deals with countries that already have agreements with the EU, what is actually more likely is that the UK could simply use these existing deals as a framework to continue trade and sign a new deal. It would disadvantage neither the UK nor the countries in question to do so as these are the terms under which they trade already. The advantage of course from the UK's perspective is that with its new found freedom and no obligation to protect certain EU industries from foreign competition, the UK could add sweeteners to the existing agreements in order to get these deals pushed through and in place ready for when the UK finalises the details of a Brexit. In can also of course just unilaterally reduce current tariffs charged by the EU in order to open up its markets and reduce prices for consumers, embracing the concept once again of being a trading nation, something which the Treasury seems very disinclined to mention in its biased forecast... err, I mean, independent analysis. 

It's also interesting to note that among the Treasury's gloomy predictions on trade there is no mention of the number of countries such as Mexico that have already come forward and said they would look to actively secure an FTA with the UK in the event of Brexit. Funny that isn' it? You'd have thought the country's very own treasury department would have taken something as important as that into account when it produced this impartial and independent economic forecas... analysis. It's almost like they didn't want to draw attention to it. Just as a side note, I wonder how those investigations into alleged Conservative electoral fraud are coming along.

Next chuckle comes from the Treasury's claim that there would be uncertainty over the UK's legal and regulatory framework. Odd, considering that every directive that has ever been passed down from Brussels is turned into law by parliament. And while the EU has many powers, it cannot simply undo UK law. So the day after a referendum the law and regulations of the land would remain exactly as they are, until a formal Brexit, at which point those laws and regulations already in place would continue to exist until such time as the UK government decided to alter them. In fact, far from their being any uncertainty over the UK's legal and regulatory framework, nothing could be clearer. The status quo will prevail until such time as the UK opts to change it.

And that, pretty much is that. That really is all the Treasury had to offer; a bunch of nonsense and scaremongering built on a model of dubious merit, fuelled by assertions of dubious validity, and taking into account nothing but negatives. There are maybe a handful of lines in the whole thing that have any kind of reality to back them up, but otherwise the entire thing is a waste to time, paper and taxpayers money. I'd be interested to know whether this thing is even legal under UK election law as to me it seems very much to be a use of state (i.e. taxpayer) funds to produce a biased, politically motivated document, on a similar line to the leaflet they pushed out a while back. How can this possibly be seen as anything else? What it most certainly is not is a balanced and impartial study of the economy post-referendum.