Defying Gravity: A critique of estimates of the economic impact of Brexit
The models used to assess the economic impact of Brexit were misleading, according to new analysis published today by Policy Exchange. At the time, the projections made by the Treasury, OECD and IMF were used by the then government and Remain campaign to argue that the British economy would face a significant and permanent loss of income in the event of a vote to leave. A careful analysis of the gravity trade economic models used to generate these pessimistic projections suggests that the impact of Brexit on our economy will be much less significant than the economic consensus constructed at the time of the referendum.
Dr Graham Gudgin, Policy Exchange’s new Chief Economics Adviser and the co-author of the report, said:
“As we start formal negotiations to leave the European Union, now is a good time to reflect on the predictions which suggested that the British economy would collapse immediately in the event of a Brexit vote.”
“The forecasts for the impact of Brexit on international trade undertaken by the Treasury, OECD and IMF were based on ‘gravity models’, which predict the amount of trade between countries based on account factors like the size of trading economies and the distance between them. We have replicated the Treasury’s gravity model results and examined them in detail and we believe that they were overly pessimistic.”
“The Treasury’s models did not take into account that not all economies are created equal and the UK is a significantly larger and stronger economy than many of the smaller countries which were given equal weight in the model. We therefore estimated an alternative gravity equation based on data for the 60 largest UK export partners, which account for close to 100% of UK exports and include all 28 EU members. The result is that the measured impact of EU membership on goods trade for all EU countries on average falls from 115% to 90%.”
“Most important is the fact that the Treasury and OECD estimated the average potential trade loss across all 28 EU members, and did not take into account that the UK has a very different trade relationship with the EU. In our analysis the estimated loss of UK trade is only 23%. This is consistent with the declining importance of the EU in UK trade over the last 20 years. The overall conclusion is that the effect of leaving the EU on economic growth, while negative, will be small, and any associated knock-on impacts will similarly not be large.”
“We concluded that the gravity model approach lacks the degree of precision needed to make a definitive estimate of the impact of EU membership on trade. In particular, estimates need to focus on the UK itself if they are to have relevance to the Brexit negotiations. A smaller economic impact is in line with our view that the small average external tariff of the EU, together with the fact that most UK firms are already compliant with EU regulations, will mean that the impact will be more limited than the Treasury estimated.”