Brexit is another Iraq

In March 2003, 149 MPs voted against the Iraq war. They comprised the then much bigger Liberal Democrat party, the then much smaller SNP, 84 Labour MPs, Plaid and the SDLP, and the odd Conservative. Those voting against triggering Article 50 comprised the LibDems, the SNP, 47 Labour MPs, Plaid, the SDLP, one Green and a single Conservative. Is the similarity between these votes just a coincidence? I want to suggest not.

Let us begin by making an obvious point. You may think Iraq is different because so many lives were lost in the chaos after the war. But how many lives will be brought to a premature end because Brexit means we will have to live with an NHS in permanent crisis? Many people have not realised what a disaster Brexit could turn out to be. With a hard Brexit the CEP estimates an eventual cost of almost 10% of GDP each year. [1] That is huge: much bigger than the loss in real incomes already experienced as a result of the Brexit induced sterling depreciation. That alone could mean a 10% cut in money available for the NHS, if the share of NHS spending in GDP remained constant. But it is worse than that. If immigration falls, as the OBR expects it to, and because immigration improves the public finances, the cut in NHS spending could be a lot greater than 10%. Of course it may turn out to be not quite as bad as that, but we need to ask what exactly is the point of taking such a huge risk, just as people now ask what was the point of the Iraq war?

Iraq involved the US and the UK, whereas Brexit is just a UK affair. But think of the following mapping. The Neocons who pushed for the war are like the Brexiteers. May is George Bush, and Corbyn is Blair. Whereas Blair felt he had to go along with Bush, he also must have felt that getting rid of Saddam would be no bad thing. Whereas Corbyn and many MPs feel they have to follow the referendum result, Corbyn may also think that leaving the EU is no bad thing.

Does the referendum not make the two events distinct? The first point to make is that a clear majority of UK popular opinion (and US opinion) supported the war. Everyone of Murdoch’s papers around the world strongly supported it. However a minority of people were passionate in their desire for the war not to happen, with many taking part in the largest demonstration the UK had ever seen.

More importantly, the referendum was advisory, whatever politicians may have said. After an election the opposition does not feel obliged to start voting for all the government’s policies that they used to oppose? The idea that the Brexiteers, if they had narrowly lost, would have said ‘fair enough, we will keep quiet for 30 years’ is laughable. Most people voting Leave expect to be no worse off as a result, and would not have voted Leave if they thought otherwise. In these circumstances, the idea that the 52% majority will remain the ‘will of the people’ for very long is ridiculous.

The most important similarity between Iraq and Brexit is that both were huge decisions that were politically driven and which went against the available evidence. Hans Blix, who had been in Iraq looking for chemical weapons, thought it was a huge mistake. Chicot confirmed that the UK chose to invade Iraq “before peaceful options for disarmament” had been exhausted. Military action was “not a last resort”. The British knew that there were no serious plans for post-war reconstruction and reconciliation, but we joined Bush’s war nevertheless. It was not just a disaster, it was also a widely predicted disaster. Brexit is an almost universally predicted disaster among experts. For both Blair and Corbyn, their own misguided political views overrode expert opinion.

Just as Iraq destroyed Blair’s support among Labour party members, Brexit is likely to do the same to Corbyn. I expect the process will continue steadily over time, as bad Brexit news is greeted by Labour ministers not with a confident and resounding I told you so, but rather with feeble claims that May is enacting the wrong kind of Brexit. As the popular tide turns on Brexit, just as it did on Iraq (a majority of people now think they were always against the war), the opportunity Labour has missed by supporting Brexit will become clear. One difference is that Blair had enough popularity in the country to win a general election after Iraq, but the support of Labour Party members is pretty well all the political capital Corbyn has.

Thus the only interesting question is when Corbyn will go, and what the manner of his departure will be. I surprised a few people by saying in an earlier post that he needed to stay on for a while if we were to have any chance of stopping Brexit. My reasoning is as follows. The longer he stays, the greater will be the opportunity for the LibDems to achieve some eye catching victories like Richmond. (In the May council elections, for example.) Only then will it become clear to MPs from all parties that a Brexit backlash is the real threat, not UKIP winning in Labour heartlands. At present they and political commentators are in a Westminster bubble which is strongly influenced by the pro-Brexit press. That bubble needs to be pricked by events. If Labour switch leader and start opposing Brexit too soon, any Conservative losses could be put down to countless factors. It is vital that that a significant number of MPs begin to fear that a Brexit backlash will lose them their seat. Once (and if) that change in perception comes about, what happens next is anyone’s guess.

[1] This estimate is produced by a team led by one of our top applied economists, John Van Reenen, who has just moved to MIT.

How Brexit advocates intend to smear economics

Those who are devoted to Brexit have only faced one real enemy: economics. It is in the DNA of economics that trade is good, and so anything that makes trade more difficult will be costly. On top of this basic insight on which so much of society is built is a host of detailed evidence on the impact of trade agreements and the effect of more trade on the economy. This knowledge had become received wisdom among most MPs, probably as much if not more through their contacts with business.

What Brexit advocates had on their side was the huge advantage of fanatical support from most of the Tabloid press as well as the most widely read broadsheet . It is a schoolboy error to say that because newspaper circulation is declining its influence is also declining. More people may get their news online, but newspapers remain a primary news source online, either directly or indirectly. The broadcast media also tends to take their lead from newspapers. This is why Leave wanted a referendum, because they thought they could win, not because they had any great belief in this form of democracy. [1]

In the referendum itself economists were largely sidelined, and when their arguments did appear via the predictions of organisations like the IMF they were generally accompanied by a matching segment from the tiny band of “economists for Brexit”. For this and other reasons I have discussed at length in earlier posts, the Brexit advocates won, narrowly. But the advocates of Brexit still face a problem. If the news as Brexit happens is all bad, then maybe people will begin to hear about what the overwhelming majority of economists have been saying.

And sure enough, that has been happening. Sterling crashes the moment markets hear about the vote, and this will gradually reduce consumers’ real incomes. The Bank has to cut rates to their lower bound and restart QE. Forecasts of the public finances deteriorate, most recently here. So they needed some way of smearing all these negative medium term economic predictions. When the Bank of England revised up their forecast of UK GDP growth in 2017 from 0.8% in August to 2% in February (see this post), they saw their chance.

They will now claim that economists are completely discredited because they all thought GDP would collapse as a result of the Brexit vote and it hasn’t. Therefore anything they say about the public finances or growth in the medium term can be discounted. Now of course among those that know anything about economics this is nonsense. But most people do not know much about economics, they do not read the FT or Economist, so this kind of propaganda is effective. Don’t be surprised to hear it from political journalists in the broadcast media before long.

So for the record, before this happens, here is why it is nonsense.

1. (And most important) Short term unconditional macroeconomic forecasts are extremely unreliable: always have been and I suspect always will be. They are slightly better than guesswork, but for a central bank that slightly better is well worth having. Predictions about the long term impact of Brexit mainly come from the non-macro part of international trade: gravity equations and all that. Their empirical foundation is strong. The idea that lower immigration will hurt the public finances is also common sense once you recognise that immigrants are young, and therefore will pay taxes that finance their use of the NHS and other public services with plenty to spare. This has nothing to do with macro forecasting!
   
   
2. Actually it is not the case that economists universally thought GDP would collapse. Here is the FT survey: most thought it would collapse, but it was not universal. The FT survey focuses on City economists, not academic economists. One prominent academic economists, Paul Krugman, has always been very dubious about talk of a recession. What is true is that economists universally think Brexit will have bad long term effects.
   
   
3. As I wrote here in June last year, the macro impact of Brexit involves counteracting forces. The depreciation is partly in anticipation of the loss in trade Brexit will bring, but in the short term it could boost net trade. Consumers could beat (for now) the increase in the prices of imported goods by buying durables immediately. Most forecasters thought these effects would be counteracted by negative effects, and it was reasonable to do so, but a sharp downturn was never a one way bet. In contrast, there is no upside to making trade more difficult with your nearest neighbour. The only question is how bad will it be.

If you think this is all so obvious that the propaganda about economists being hopelessly discredited will not work, I think you need to get out more. The line 'they all got the immediate impact completely wrong so we cannot take their medium term predictions seriously, and who can forecast until 2030 anyway' will be repeated ad nauseam in the press and by Leave advocates. Most political journalists will not know this line is rubbish and full of elementary confusions, because they do not talk to academic economists either directly or indirectly. The one group who could puncture this bubble is business, but at present its voice has been fragmented and therefore weak.  

[1] For those who still doubt the power of the tabloid media, imagine there is a car market with a single best selling car, call it car R. A new rival is launched, car L. It is independently assessed to perform worse, but this assessment is not widely available. But car L gets a year of pre-launch publicity in 80% of the tabloid press, followed by a period of 6 months non-stop adverts for this car coupled with stories about the failings of car R. All discussion of the technical merits of the two cars in the broadcast media involve debates between advertisers for both cars. Now, honestly, are you going to tell me that under these circumstances car L would not capture a lot, perhaps a majority, of the market?

2016 Autumn Statement

Got back from a trip to London to give my lecture (pics above: thanks to everyone at SPERI and New Statesman, plus Beth Rigby for chairing and everyone else for coming) looking forward to not thinking about economics for the rest of the day, only to find the Chancellor had given an Autumn Statement. Luckily the whole thing appears to be a damp squib compared to the expectations raised beforehand, so here are just a few points. On helping the so-called just about managing, see the ever excellent Ben Chu.

Public investment

Remember all the talk beforehand about substantial increases in public investment? What we got is increases of 0.3% or 0.4% of GDP in each of the financial years from 2017 to 2020. These increases give us figures that are slightly above the numbers we saw from the Labour government in the years immediately before the financial crisis. We should be spending much, much more when interest rates are so low.

Fiscal rules

There was also much speculation that we might return to more sensible fiscal rules, now that Osborne’s had been busted. Instead the new Charter for Budget Responsibility is honestly not worth the paper it is written on. We have a target for the total cyclically adjusted deficit (including investment) for a fixed year. Whatever the number involved, this makes two mistakes: having a fixed rather than rolling date, and by including public investment in that target. It is a recipe for panic cuts in public investment a year or two before the target date.

There is also a target of a falling debt to GDP ratio by the same date. I’m at a loss to understand why you need a target for this as well as a target for the deficit. The change in the debt to GDP ratio is after all just the change in debt (which is the deficit) and the change in GDP. So targeting the change in the debt to GDP ratio just adds to the deficit target some things that you cannot control: GDP growth and your position in the business cycle. I knew there would be no zero lower bound knock out, because that would be a clear admission that 2010 austerity was a mistake. But I did hope for something more intelligent than this.

I fear George Osborne has totally discredited the idea of a fiscal rule. Remember that Labour stuck to its fiscal rules for 10 years, before they inevitably fell victim to the largest recession since the 1930s. Yes there was fiddling at the margin, but the important point was that they did have a strong influence on what the Chancellor did. I now suspect that, by breaking a whole series of rules within a shorter period of years, whatever a Conservative Chancellor says has become pretty worthless.

The fuel duty fiddle

There is this great chart in the OBR’s autumn statement document.

It shows how Conservative Chancellors keep postponing rises in fuel duty. One obvious question is why. But the OBR is also concerned about whether this makes a mockery of its forecasts. Each year they are obliged by parliament to continue to assume that in all subsequent years the government will raise fuel duty after each ‘one-off’ cut. And almost each time the Chancellor announces a ‘give away’ for motorists: they will postpone any increase ‘just for this year’. You can see why they do it: it allows the papers to write favourable headlines. But if they really are going to go on doing this, it means that really their policy is to have no increases in fuel duty. Fiscal forecasts based on the assumption that they will increase fuel duty will be much too optimistic. The government is fooling parliament and the public, but the OBR cannot do anything about it because of the restrictive rules it is forced to operate under.

The cost of Brexit

The big news was of course the higher levels of borrowing. As this table shows, a significant part of that is due to the fiscal costs of Brexit.

Surprise surprise - there will actually be less money available for the NHS and other public services after leaving, rather than more. It is as if that red Leave bus just crashed and rolled over so it is now upside down. The two big factors are lower productivity growth and lower immigration. The OBR has, unsurprisingly, followed their own previous analysis (immigration) and the consensus economist view (productivity growth).

I can almost guarantee that the Sun and Mail will make no mention of this - or if they do it will only be to rubbish the OBR. So, following the theme of my lecture, I really hope that the broadcasters’ nightly news programmes pick this up. Channel 4 news did do so, but I didn’t watch the others (let me know in comments).

The NHS and squeezing the public sector

Not a penny more for an NHS in crisis. Make no mistake, as this blog has shown before, the current crisis in the NHS is simply because it has been starved of resources for the last six years. I really wish Labour (it has to be them, because they are the only party who the media will take any notice of) would run a campaign that busted the myth of a ‘protected’ NHS. But what Hammond’s refusal to do anything about this shows is that this government is continuing the squeeze of the public sector begun by the Coalition. Here is the relevant chart from the OBR. 

In the long run ... our children are adults

One of the annoying aspects of the Brexit debate is that every piece of macroeconomic news, every survey or data point, is interpreted as evidence one way or another about the economic costs of Brexit. The problem with this is partly that Brexit has not happened yet, but more fundamentally the important costs of Brexit were always long term. The Treasury’s analysis of the permanent costs of Brexit looked 15 years ahead, because that is the kind of time period over which the full impacts will be felt.

That has another annoying implication, which is that it will be very difficult to ever know what the actual costs of Brexit will have been. GDP being 6% lower after 15 years (the Treasury’s central estimate based on a bilateral trade agreement) will have a noticeable impact on economic growth, but who knows what the counterfactual is? As I have noted many times, the trend growth in UK GDP per capita was a remarkably steady 2.25% until the financial crisis, but since then productivity growth has collapsed, so who knows what it might have been without Brexit.

It is true that with rational expectations the future will have an impact on the present. That is why the exchange rate fell sharply on news of the vote. As I keep pointing out, unless those in the markets change their minds, that depreciation makes every UK resident poorer, perhaps forever. Equally if everyone anticipated that their future income will be lower they should reduce consumption now. But one reason the vote went the way it did is that many people did not believe that Brexit will have a long run negative impact on their standard of living.

We can make the same point in a more concrete way by thinking about the problem facing the OBR as it makes its forecast before the Autumn Statement in November. Those expecting to see something dramatic in these forecasts may be disappointed, partly because Brexit is likely to actually occur in the middle of the OBR’s 5 year forecasting period. Where the OBR will have to come clean about their view on the long term impact of Brexit will not be until next summer, when it does its 50 year ahead projections.

While these long term costs were always what really mattered, I have the impression (see also Paul Krugman) that the campaign spent much more time talking about short run impacts. As I have argued, these could be significant but are much more uncertain because they are more complicated. (How much will the depreciation boost net exports, for example?) So why was there so much focus on the short term in the campaign, and why did some (mainly politicians) start talking about Brexit creating a short term crisis?

I suspect (and this is just a guess) that one reason is that talk about long run costs had little impact in the media and on voters. (This is what the polls suggest: voters seemed more prepared to agree that there might be short run costs to Brexit.) To an economist that seems odd, because the economics behind the long term impact is much more solid than what might happen in the short run. Of course Keynes had a famous phrase about all being dead in the long run, but as Simon Taylor points out he made that comment to counteract a tendency for some to dismiss problems like unemployment caused by recessions as unimportant because it will disappear in the long run.

One suggestion I have seen links the lack of traction over long run costs to the fact that Leave voters tended to be older, and therefore that they did not care too much about the long run. I think this is unfair: most of those older voters also have children who they care about.

I suspect the problem came from a basic misunderstanding that was deliberately encouraged by the Leave campaign, which is to see all economic analysis as an unconditional macroeconomic forecast. The retort ‘who knows what will happen in 15 years time’ resonates if that is what you are familiar with. Too many people who should have known better, or perhaps chose not to know better, failed to make the distinction between conditional and unconditional forecasts. We had the ridiculous charge that the Chancellor should not have said people will be worse off in 15 years time, because with normal growth in absolute terms they probably will not be.

To see how nonsensical this framing is, think about the advice any doctor will give you that by smoking you will be worse off. Society does not collectively shrug that off by saying who knows what will happen in 10 or more years time. Except of course some teenagers do say this and come to regret it. Nor, by the way, do people tell medics that they failed for decades to predict that smoking would kill people so why should we take any notice now. We are completely familiar with doctors giving us conditional forecasts, but for some reason some in the media kept trying to view any analysis of long term Brexit costs as another unconditional macroeconomic forecast. [1]

One implication of this is that the consequences of Brexit may never become obvious, particularly to those who voted to Leave. Of course economists will do the best they can with the data, but I doubt very much that their analysis will get through to most people. One of the many sad aspects of the Brexit decision is that those who helped make it possible will never be held responsible for their actions.

[1] Note also that these long term Brexit costs essentially came from empirical studies with fairly common sense theoretical content well grounded in evidence. 

Brexit, economists and journalists

What does a macroeconomist say when confronted with evidence that output has stopped growing since Brexit, but that retail sales growth is strong and employment is holding up? The first thing they would probably say is that monthly figures are erratic, and we really should wait and see (although the Bank was right to cut rates as a precautionary measure given the negative evidence we already have). Second, they might also say that a short term burst in the consumption of consumer goods made overseas is quite a sensible response to the collapse in sterling, as there is often a lag before an exchange rate fall is passed through into higher prices in the shops. Buy your washing machine now before the price goes up. Third, they might note the collapse in sterling has (for good economic reasons) preceded the negative impact of Brexit on trade, and trading firms might benefit from that in the short term. The real worry about the short term impact of Brexit is a collapse in investment, as firms put projects on hold until the nature of the Brexit deal becomes clear, but it is very difficult to guess how large that effect will be. But finally they would also note that if the depreciation in sterling we saw as the vote was announced is permanent, that means every person in the UK is poorer as a result. That has to be reflected in lower consumption eventually.

What does a journalist say confronted with the same evidence? If they voted for Brexit they say economists forecast Armageddon, and it has not happened. They say “ it is obvious that the sky has not fallen in as a result of the referendum, and those who said it would look a bit silly.”

This is an old trick. Completely exaggerate what the other side says, and then cry victory when that exaggerated fiction does not come to pass. I remember 2013, and how the first sign of UK growth (growth in income per head that was at best on trend, rather than above trend as you would expect in a recovery) was proclaimed as vindication of 2010 austerity. When I pointed out that this argument made zero economic sense, I was referred to statements by someone or other that said growth would never happen under austerity. Of course they did: when governments are doing stuff that is causing serious harm and appear not to be listening it is human nature to overstate your case.

Exactly the same no doubt happened over Brexit. But most economists, most of the time, have been absolutely consistent. The real damage that Brexit will do is medium/long term, and results from the straightforward fact that making it more difficult to trade with our immediate neighbours will harm growth. How much harm varies depending on the type of Brexit (which is still to be determined) and which study you look at, but in most cases the impact is large and permanent, and we will not know exactly how large for years. Economists also said there would be noticeable short term disruption caused by uncertainty about the exact nature of Brexit, but how large that short term impact would be is very difficult to estimate, and it was of secondary importance compared to the longer term costs. They did not talk about Armageddon, and they did not talk about the sky falling in.    

The lesson of all this is that the reporting of economics in a good deal of the UK press is hopelessly biased by politics. Of course academic economists are not immune from this failing (and it is a failing), but most try not to succumb. Any group that is so consistently misrepresented in the press, and whose advice is so consistently ignored, would organise some form of resistance and defence. Just how much harm has to be done to the UK economy before academic economists do the same?

  

Brexit harm denial and the exchange rate

There seems at the moment some confusion in the Brexit camp: is all the bad news just wishful imagination by Remainers, or is it real but caused by Remainers. Some specific thoughts on the extraordinary Telegraph editorial are here, but one event that was not in anyone’s imagination was the depreciation in sterling as the result became known. Brexiters tend to think markets know what they are doing, so they have resorted to all kinds of arguments why this depreciation was not really bad news.

First, the reason why it is bad news. A depreciation in sterling makes everyone in the UK poorer, because the goods we buy that are made overseas or sold in world markets (oil) will cost more. That this depreciation happened as a result of the vote is beyond dispute. So what do Leave apologists have to say in response? So far I have heard the following.

The depreciation has a good side, because it gives a boost to our exporters.

Economists say never reason from a price change, but instead ask why prices have changed. There are two possible reasons why sterling may have depreciated immediately the vote was announced. The first is that markets think UK exporters need to become more competitive in the longer term to offset the impact of Brexit, because Brexit will make it harder to export to the EU. In short, we are poorer because of Brexit.

Now it is true that markets are anticipating a future event (Brexit has not happened yet), so in theory there will be a short term boost to exports as firms benefit from the depreciation now, but the costs of Brexit come later. But that brings us to the second reason for a depreciation: markets believe Brexit will cause an economic downturn in the UK, implying lower levels of UK interest rates. (In this they have been proved correct). The fact that they were expecting lower interest rates even though exporters get a short term boost tells you that this boost is at best just going to make things a bit less bad than they might otherwise be.

Either way, any short term benefits from the depreciation do not offset the fact that we are all poorer as a result.

Sterling was overvalued anyway

This is an argument put forward by Daniel Hannan. The idea is that a depreciation was going to happen anyway. It is an argument that makes no sense. Suppose you think the price of coffee is too low because markets have underestimated future demand from the US. An unexpected blight then wipes out half the coffee trees in Latin America, and the price shoots up. It is ludicrous to then say no problem, the price was too low anyway. The markets are still underestimating future demand from the US, and when they realise this the price will rise further still.

Sterling is only back to where it was ….

Imagine your earnings vary from month to month because of bonuses. Your boss cuts your basic pay, and tells you not to worry because when you add in the average bonus it is still going to be higher than when bonuses were really low. If you think that actually means your pay has not been cut, then you will be convinced by this argument.

It is just a temporary problem before things become clearer

This argument might just work, but only if you admit things that Leavers tend not to admit. First, it seems reasonable to assume that the short term economic downturn is because firms do not yet know what kind of Brexit we will get, and are putting things on hold until they do. Putting things on hold causes the Brexit Bust, which means the Bank cuts rates, which depreciates sterling. Now move forward to the date where things become clearer, and suppose the outcome is much better for trade than it might have been. (Basically we stay in the single market and accept free movement of labour.) The economy then recovers, interest rates rise, and sterling appreciates. If that happens (and it is a big if), all we need to do is ask who was responsible for all this uncertainty and the temporary damage it caused.