by Simon Deakin, Graham Gudgin & Ken Coutts, Centre for Business Research, University of Cambridge
- Read the Graham Gudgin, Ken Coutts and Neil Gibson working paper 483: “The Macro-Economic Impact of Brexit: Using the CBR Macro-Economic Model of the UK Economy (UKMOD)”
Economists at the Centre for Business Research, University of Cambridge, have challenged the assumptions of the Treasury in their new forecast for the UK economy and the impact of Brexit in 2017.
The economists have also been working with lawyers at the CBR to explore the possible impact of Brexit. They warn that the UK is in danger of remaining a low wage, low skill country unless it can create the conditions for a reorientation of its economic model post-Brexit.
In a new podcast for the CBR, Graham Gudgin, one of the authors of the new report “The Macro-Economic Impact of Brexit: Using the CBR Macro-Economic Model of the UK Economy (UKMOD)”, and Simon Deakin, Director of the CBR and Professor of Law at the University of Cambridge, discuss how the UK economy is likely to perform in 2017 and what would be the best model for leaving the EU.
Deakin begins by explaining four possible options the UK government could pursue for leaving the EU: re-joining (or remaining in) the EEA (European Economic Area); becoming a member of the EU’s customs union; undertaking a series of bespoke trade deals, such as Switzerland has; or, if none of the above apply, defaulting to the rules of the World Trade Organization. The first of these would mean accepting the free movement of persons, which the current policy of the British government appears to rule out.
Gudgin suggests that, since the policy of migration control is likely to be maintained, the UK will try to negotiate a new trade deal with the EU, perhaps along the lines of the recent EU-Canada agreement. Some argue that this could take a decade or more to achieve, but Gudgin takes the view that since we are starting from an existing free-trade situation, the task is much easier. No quick agreement is however likely and whether the EU and the UK can negotiate transitional arrangements to bridge that gap remains to be seen. Any new trade deal will also have to be conducted within the framework of WTO rules, which will add to the complexity of the negotiations.
“We can sketch out broadly what happens for each of these main options but I think there is a case for more research to be done. It is most unlikely that there will be a trade deal negotiated within two years of triggering Article 50, and as the process of negotiation and deliberation unfolds new issues will arise. These may crop up at sector level, particular industries may have issues that need to be worked through, and individual companies may raise points about their position and if they receive guarantees from government there will be issues of state aids to consider under both EU and WTO law. At the moment we just don’t have a good set of answers to these questions,” says Deakin.
Deakin says new independent research is needed:
“We do need independent research to be carried out on this question because so far most of the research that has been done on this has been by one or other side of the Brexit argument. The government has its own researchers in the civil service and of course this is objective, high quality research; the OBR is doing independent economic forecasting. However, there is a public demand for independent, non-partisan research, conducted outside government and the political arena. Thus there is an important role for University-based research; this should feed into the process of deliberation as Brexit unfolds”.
Gudgin says he hopes the new CBR UKMOD model will be more reliable than the Treasury and OBR ones:
“We have gone to the huge effort of building a new model because of dissatisfaction with what is out there. The official OBR government model is independent of the Treasury but it is not really a forecast in any normal sense. It is really an assumption about productivity growth, they assume labour productivity will grow at about 2 per cent per annum and everything else follows from that. The average growth in productivity over the last decade has been closer to zero. The OBR are continually over-optimistic about productivity growth and as a result they have to massage everything else to fit this overarching productivity assumption. The forecast they tend to massage most is business investment. It is fair enough to make an assumption if one is transparent that this is what it is, but it is not a normal forecast. If the forecast were to be correct the government’s books will eventually balance, inflation may do x and employment may do y, but if you assume something else for productivity then other things will happen. It is really a fairly crude assumption of that sort. The built-in optimism means that Governments have always missed their targets.
“Our CBR UKMOD model is based on economic behaviour in the UK over the last few decades. We estimate equations for relationships such as household incomes and household consumer spending, and we make some assumptions about the future, about world trade, about American interest rates, about oil prices, and our forecasts are clearly conditional on those assumptions but not in the same way as the OBR forecast which is dependent on a single assumption.”
Gudgin explains these predictions in the podcast:
- “2017 won’t be a great year but growth of GDP will be between 1.0 and 1.5 per cent rather than the 2 per cent it would have been without Brexit. It could even be 2 per cent but we don’t yet really know much about company investment intentions. GDP growth is slowing but will not be too bad.
- The sterling depreciation of 10 to 12 per cent will mean inflation will rise to about 3 per cent by the end of 2017. It will be higher than it has been for some years. The big question is will inflation get out of hand and we don’t think it will. Remember most countries have been trying to increase their inflation up to 2 per cent to get their exchange rates down. The UK has done it in one bound.
- The UKMOD equations tell us wages will start to rise as prices rise. We are pretty close to full employment, so workers have bargaining power. The Bank of England published its forecast for wages recently and we agree wages will rise to something like three per cent by the end of 2017.”
Gudgin explains these predictions in the podcast:
Listen to the podcast