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Press Release
5th January 2017
A new economic forecast for 2017 for the UK economy from the Centre for Business Research
of the University of Cambridge expresses optimism but says Brexit uncertainty must be
addressed
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 MacroEconomic 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 two 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.
Deakin explains: “Nearly every European country is either in the single market or in the customs
union. For example, Norway, via the EEA, is in the single market but not the customs union; Turkey is
in the customs union but not the single market. There are a number of other options. Switzerland is
not part of the European Economic Area, but has a number of bilateral trade deals with the EU. These
are conditional on Switzerland allowing free movement of labour (which a recent Swiss referendum
vetoed) and capital. Countries in the single market, including those in the EEA, must conform to EU
rules and regulations regarding product standards, labour laws and environmental protection, among
other things. Customs union membership implies internal free trade and a single external tariff, but
countries outside the EU which are in that position, such as Turkey, cannot make their own trade
deals with third countries. If we went for that option post-Brexit, we would not be bound by all the rules
of the single market but we couldn’t do our own trade deals with third countries.
“If we were in the EEA we couldn’t avoid rules on free movement of labour or capital. You either
accept the four freedoms, the movement of goods, services, people and capital over borders, or you
don’t; you can’t cherry pick. The UK could try for a Swiss style option where you try to have free
movement but then modify it somewhat, but the Swiss have had to sign up to most aspects of free
movement in order to get access to the single market. To get around the rules of free movement of
labour and capital it is highly likely the UK would have to be outside the EEA. We could still sign up to
the customs union, Turkey isn’t subject to the rules on free movement of labour, for example, nor is
the EU required to accept free movement of persons from Turkey into the EU, but then we wouldn’t
have the freedom to do trade deals with third countries, which the UK has said it wants to have; that is
why the International Trade Department was brought back.
“WTO rules do not require member states to accept free movement of labour, they do, however,
contain some rules on issues like state aids, to prevent distortions of international trade. The WTO
also have rules on how migrant workers may be treated in host states which are not that dissimilar to
those operating in the EU’s single market, and are highly contentious for the same reasons. WTO
rules on these issues are generally not as strict as EU laws and do not form part of UK domestic law.
International law obligations cannot be enforced in the same way as EU laws can be. However, the
WTO option is not a blank slate for the UK.”
Deakin goes on to say that as things stand there is uncertainty over what Brexit might mean, even if it
is possible to identify some of the main features of each of the principal options: “As a lawyer and
someone interested in institutional analysis I would say there is quite a lot of uncertainty at the
moment about how these options will work out institutionally. Lawyers can say what the general
framework is for each of these four options, EEA, customs union, Swiss option, WTO, but until we
know more about how the government will wish to conduct its negotiations with the EU and about the
EU’s position going forward it is hard to make predictions. There are many issues we don’t have a
clear answer to.
“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.”
Deakin says a transitional agreement with the EU would need to be a one-off bespoke arrangement
as there is no provision for such an agreement within EU treaties: “We are bound by EU law until we
leave, we are bound by international law to maintain the treaties that we have signed up to until we
withdraw from them. Until the European Communities Act is repealed we must apply EU law
domestically and even after the so called Great Repeal Act, which the government has promised to
bring in, is implemented, many of the same provisions will be replicated within UK law.
“There is talk of a so-called transitional agreement and that could involve staying in the EEA, while
things are worked out, but there is no obligation on the side of the EU to offer us a transitional deal.
This would have to be a bespoke arrangement as it is not provided for at the moment under the EU
treaties. It remains to be seen if that sort of soft landing is possible, let’s see what is put on the table
after negotiations between the UK and the EU begin. Whatever happens, we need to understand the
institutional impact of Brexit in order to get a better understanding of what its economic effects will be.
“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 agrees with Deakin that better research and economic forecasting models are needed. He
thinks that in reality the only option for the UK to leave the EU, other than the WTO fall-back, is under
the terms of the so called Canadian model.
“There are probably only two practical options. One is a free trade agreement along the lines of the
one Canada has just signed or else no agreement on trade in which case you fall back on WTO rules.
The impact of both of those is pretty uncertain. We have looked very carefully at what the Treasury
has said about this and we find its work very flawed and very partisan. It is not objective. I agree with
Deakin that we need some more objective economic work on this, the whole debate has been
coloured by a lot of hyperbolic discussion.
“The Treasury said there would be four quarters of recession, we have had six months since the
Brexit vote, we should have been in recession by now, but we are not. Things are maybe a bit
delayed but the whole succession of investment announcements we have had from Nissan, Microsoft
and others suggests that companies are taking a much more sanguine view of this than the Treasury
and others have suggested.
“We have looked at the Nissan deal in terms of what degree of currency depreciation you would need
to offset the 10 per cent tariff that motor manufacturers could face under WTO rules and the answer
to us is that it looks like a 15 per cent depreciation of sterling would offset a 10 per cent tariff. We
have already had a 12 per cent depreciation so we are pretty well there. This may have been what the
government was relying upon: it is the currency depreciation that bridges that gap. “
Gudgin says that the EU has not been very good at agreeing free trade deals with third countries:
“Theresa May has said very clearly that there will be control over migration and she rightly recognises
that was the key point in the referendum. The EEA and Swiss bilateral treaties all depend on free
movement of labour. It shows just how difficult even the Swiss approach is. The Canadian model is a
free trade agreement which any country can have with the EU, but historically the EU has not been
good at having free trade agreements with others. It doesn’t have a free trade agreement with China
or the US, and some people such as the Economists For Brexit see the EU as being a highly
protectionist organisation. If the EU has a free trade agreement with Canada, good heavens, they
surely can have one with the UK.”
Gudgin and his colleagues Ken Coutts at the CBR and Neil Gibson at the University of Ulster have
completed a new forecast: “The Macro-Economic Impact of Brexit: Using the CBR Macro-Economic
Model of the UK Economy (UKMOD)”.
Gudgin explains these predictions in the podcast:
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“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 3 per cent by the end of
2017.”
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.”
Deakin ends the CBR podcast by saying the Supreme Court judgment can’t stop Brexit whatever the
judges decide, and that going forward the critical issue for researchers is to explore the legal
uncertainties of what Brexit actually means for matters such as tariffs, regulations and rules of origin
for products: “What we should be doing now is take a step back from the sound and fury of the
referendum debates and making the best objective assessment that we can of how we go forward
from here. We need to take a keen analytical look at all the different Brexit options and see how they
would play out in economic and institutional terms.
“The UK Supreme Court when it decides the Article 50 case won’t be deciding whether or not Brexit
occurs, and MPs have recently voted by resolution to support the triggering of article 50 in any event.
The Supreme Court case will have implications for the UK’s Constitution and in particular for the
relationship between Westminster and the devolved parliaments and assemblies. The Article 50 case
is extremely important for the UK’s Constitution but not as important for Brexit. The key issue around
Brexit is: what will the UK’s trading position look like one year or ten years after the UK leaves? That
is the critical issue on which lawyers and economists now need to work together.
“The current government position on immigration rules out an EEA style deal, and its position on the
need to have our own trade deals with third countries rules out staying inside the customs union. If we
are to have a Canadian type free trade agreement with the EU, then it would still have to be within the
framework of WTO law. Until we make preferential trade agreements with third countries we must
conform to the WTO’s most favoured nation principle, which means that we won’t be able to apply
different tariffs to goods imported from the EU from those we apply to goods imported from third
countries. This may turn out to be a considerable constraint on our freedom of manoeuvre post-Brexit.
“Doing trade deals isn’t easy. The EU has a poor record on doing these deals and it is likely to take as
long to get a trade deal between the UK and the EU as it did with Canada, which means waiting up to
a decade, or maybe more. What happens in the meantime? There will be a great deal of uncertainty
about that. Tariffs are a key issue and rules of origin are another. We then have to think about how
the UK may diverge over time from the EU in regulatory terms if we are no longer part of the EEA or
bound by single market rules. Will this divergence add to costs and set up trade distortions? We
agree there will be a Brexit, but on what terms will it be and what are the economic implications of
these different institutional options? This is the area of uncertainty.”
Deakin says that the biggest issue for the British economy post-Brexit is to ensure that leaving the EU
is seen as an opportunity to provide better and more sustainable jobs and does not trigger a race to
the bottom:
“There is always uncertainty in a market economy but the issue here is whether we have some ‘bad’
institutional uncertainty, that is going to affect investment plans. The argument that uncertainty will
lead to lower growth may have been overstated before the Referendum vote by the Treasury and
subsequently, but I am more worried about the long term effects of Brexit. Are we going to be able to
move the UK from being a low wage, low productivity economy to one in which we have not just a
high employment rate as we currently have, but full employment with decent work? That to my mind is
the bigger issue facing the UK and is more important than whether we stay in the EEA, for example. I
would like to know where Brexit is taking us on this issue. Are we heading towards a low regulation
economy and even more precarious and low-paid work, or can we use the opportunity of Brexit
fundamentally to re-orientate the British economy, so that it provides sustainable growth and decent
work?”
Gudgin ends the podcast by saying the CBR UKMOD model has not found the larger economic
impacts of Brexit that the OBR model has: “Uncertainty may be helping us a little bit, because there is
uncertainty about the bad things as well as the beneficial aspects. There are some companies that
will depend upon being inside the EU and quite a lot of those are in finance and professional services,
which will eventually need an office inside the EU and in London, but this will end with a whimper
rather than a bang. We can’t find the big impacts of Brexit that the OBR found. There is a big
underlying question here, just how independent are government economists or advisors? We are
going to have to look at this at some point.”
Deakin ends by saying: “The CBR has always tried to bring together lawyers and economists so long
as we have been a research centre, for nearly 25 years. In doing this interdisciplinary work we are
building upon a longer history of the Department of Applied Economics in Cambridge.”
Footnotes:
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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) can
be found at http://www.cbr.cam.ac.uk/publications/working-papers/2016/
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In this CBR analysis, the analysis by HM Treasury of the potential impact of various outcomes
for trade outside the EU is examined and found wanting. Instead the actual experience of UK
export performance is examined for a long period including both pre- and post- accession
years. This suggests a more limited impact of EU membership.
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The CBR scenario assumes half of the trade loss of the Treasury. The results are presented
through comparing these scenarios with a pre-referendum forecast. In the milder Brexit
scenario there is a two per cent loss of GDP by 2025 but little loss of per capita GDP, less
unemployment but more inflation. In the more severe, Treasury-based scenario the loss of
GDP is nearer five per cent (two per cent for per capita GDP), inflation is higher and the
advantage in unemployment less.
End.