CEP Work on Economics of Brexit

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Dennis Banks
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1 CEP Work on Economics of Brexit Professor John Van Reenen, Director Swati Dhingra, Gianmarco Ottaviano, Tom Sampson & Jonathan Wadsworth NIESR Conference, May 27 th 2016

2 How will Brexit effect economy? We started work in 2013 after PM s speech. Build a team to think about economic impacts of Brexit Develop appropriate framework(s) Look at different post-brexit scenario

3 How will Brexit effect economy? We started work in 2013 after PM s speech. Build a team to think about economic impacts of Brexit Develop appropriate framework(s) Look at different post-brexit scenario Elements of assessment: Max Net fiscal saving (~0.4% of GDP) absurd

4 How will Brexit effect economy? We started work in 2013 after PM s speech. Build a team to think about economic impacts of Brexit Develop appropriate framework(s) Look at different post-brexit scenario Elements of assessment: Max Net fiscal saving (~0.4% of GDP) Trade Foreign Direct Investment Immigration Distribution Regulation absurd

framework(s) Look at different post-brexit scenario Elements of assessment: Max Net

5 Static Trade Model Analysis Trade creates gains from specialization Build standard modern trade model Gravity relation: Trade between countries increases in economic size & reduces in distance (trade costs from geography, tariff & non-tariff barriers) Allow for product differentiation: e.g. German built car is not the same as Chinese built car Computable General Equilibrium (CGE) model, so can accommodate big policy changes WIOD Data: Divide world into 35 regions & 31 sectors; full bilateral trade matrix (with intermediates) Forward looking Consider different tariff & non-tariff barriers which vary depending on post-brexit negotiations

ography, tariff & non-tariff barriers) Allow for product differentiation: e.g. German built car is not the same as Chinese built car Computable General

6 Static trade model Results (net of fiscal saving) 1. Optimistic (EEA Norway): -1.3% welfare loss EFTA (Switzerland) similar 2. Pessimistic (WTO): -2.6% welfare loss 3. WTO & unilateral tariff liberalization: -2.3% welfare loss Britain Alone (Economists for Brexit, EfB policy) Only 0.3% improvement over pessimistic scenario because tariffs low (~3%) & EU remains our closest neighbour so we still have to trade with them & face bigger trade costs Least politically plausible scenario? (EfB describe their recommended policy as causing elimination of manufacturing sector & big increase in wage inequality)

3% improvement over pessimistic scenario because tariffs low (~3%) & EU remains our closest neighbour so we still have to trade with them & face bigger

7 Why do Economists for Brexit get big positive effects from Britain Alone We get 2.3% GDP loss; EfB get 4% GDP gain Models both CGE, but only ours is consistent with gravity Minford 2 step (i) assume a 10% price fall in goods; (ii) put this price fall into Liverpool Model Step 2: Liverpool Model Ignores gravity & assume always buy from lowest cost country. Means post-brexit higher trade costs with EU don t harm UK exports because we can sell everything to fictional world market Clearly wrong: EU is rich & geographically close block to UK will remain major trading partner. We trade less after Brexit as UK exporters hurt by higher tariff & non-tariff barriers This is major source of welfare loss in everyone else s approach

Liverpool Model Step 2: Liverpool Model Ignores gravity & assume always buy from lowest cost country.

8 Step 1: Where does 10% price fall post Brexit come from? Compares producer prices across countries, argue that EU prices 10% higher & asserts this due to trade protection. Problems: Actually consumer prices with crude adjustments 14 year old data (2002) extrapolated to 2020 Main issue: Cross country price differences due to quality differences (Deaton, 2014) not just regulations Italian made shoe isn t same as a Korean street market shoe Higher EU product standards: Moving to Chinese standards of toy safety would reduce price by lowering quality. Is this what we want after Brexit? Fundamental misunderstanding of Single Market rules. Harmonizing regulations key to modern trade & competition, especially in services.

(Deaton, 2014) not just regulations Italian made shoe isn t same as a Korean street market shoe Higher EU product standards: Moving to Chinese standards of toy safety would reduce

9 Dynamic trade effects So far, our static approach ignores how trade has positive effects on productivity, innovation, management, etc. Since harder to incorporate in quantitative theoretical model we take a simpler reduced form approach 1. Empirical effects of EU on trade relative to EFTA from Baier et al (2008) 2. Empirical effects of lower trade costs on GDP (Feyrer, 2009) Together, imply Brexit negative effects much larger than just static losses: 6.3% to 9.5% fall in GDP Others have used much more sophisticated versions of this (HMT, NIESR, PWC, etc.) & consistent with CEP find bigger effects than static

Empirical effects of EU on trade relative to EFTA from Baier et al (2008) 2.

10 Some other ways in which Brexit effects economy? Foreign Direct Investment Estimate new gravity model of FDI (implies a -22% fall due to Brexit) Use Alfaro et al (2004) to estimate impact: 3.4% GDP fall Structural model of car sector (gravity + FDI choice) Immigration Analysis at local area level of effects of EU immigration on jobs & wages of UK born No negative effects on jobs, wages or inequality Distribution Combine structural static model with spending pattern by household income & demographic groups Pain of Brexit evenly shared. Middle income groups do a bit worse than richest & poorest deciles

4% GDP fall Structural model of car sector (gravity + FDI choice) Immigration Analysis at local area level 2008-2015 of effects of EU immigration on jobs

11 Economics & Economist for Brexit approach 1970s style of macro modelling: frictionless free market world with government only imperfection. Ignores: All product differentiation Statistical reality of gravity in trade Evidence that EU trade creating not just diverting Role of Empirical work in economics Empirical work always imperfect, but biases usually go in either direction. Theory needs to respond to inconvenient economic facts with better models & data, not swept under rug

Ignores: All product differentiation Statistical reality of gravity in trade Evidence that EU trade creating not just

12 Back Up

13 No relationship between EU immigration & unemployment of the UK born Figure 8: Unemployment rates of UK-born & EU immigration Change in UK-Born Unemployment Rate A B % point change in local area EU Immigrant Share local area values Fitted value Source: CEP analysis of Labour Force Survey. Notes: Each dot represents a UK local authority. The solid line is the predicted best fit from a regression of changes in unemployment on the change in share of EU immigrants in each UK local authority. These are weighted by the sample population in each area. Slope of this line is with standard error of 0.05, statistically insignificantly different from zero.

Notes: Each dot represents a UK local authority.

14 Some Further reading CEP BREXIT webpages: Reports Trade FDI Immigration Treasury Report Regulation Distribution Next Week! Blogs

15 No relationship between EU immigration & wages of those born in the UK

16 No relationship between EU immigration & NEET rate of less educated

17 No relationship between EU immigration & wages of less educated

Should We Stay or Should We Go? The economic consequences of leaving the EU. Swati Dhingra, Gianmarco Ottaviano and Thomas Sampson

PAPER EA022 A series of background briefings on the policy issues in the May 2015 UK General Election Should We Stay or Should We Go? The economic consequences of leaving the EU Swati Dhingra, Gianmarco