Look beyond the Brexit forecasts

The leaked report from Britain’s civil service, apparently showing that the UK would be worse off after the country leaves the EU, can be quietly forgotten. It is based on out-of-date assumptions about a world that has long since moved on.

One might start, of course, by asking why the report has been leaked at all—when it is only a draft that is far away from being presented to ministers, if it should get that far at all. The answer is, of course, that it questions the wisdom of Brexit. But then Britain’s civil-service establishment—traditionally hostile to change, keen to keep the UK a big fish in small pools of any sort—is anti-Brexit to its core. Nothing new there, then.

The thing is, that there’s nothing new in the analysis, either. Whitehall, and its East End branch the Bank of England, are fixated with the current conception of the ‘gravity model’ of trade. This is the idea that the volume of trade a country can do is most strongly related to the size of its trading partners their closeness to it. Not surprisingly, this model concludes that our best bet is to hang in with the EU, because there are some very large economies there (Germany, France…) that are about as close as any country could be. QED.

But as leading economists (and ASI authors) including Professor Patrick Minford of Cardiff, Professor Kevin Dowd of Durham and others have shown, this ‘gravity’ model based on geographic proximity does not fit all the facts. A look over the UK’s trading history reveals that it is wrong, and getting more wrong by the day. In the 19th Century, the UK’s main trading partners were the US, Canada, the West Indies, Argentina, Brazil and China. No near neighbours in that lot. Nor, today, does the gravity model account for the huge surge in the UK’s export services, particularly financial services, all around the globe. Barriers must play a part, some of these were strict quotas and blocks, some others on cost. Costs have been brought down nearby, but have been kept up or expanded elsewhere and we still have substantial transport costs. Transport and related costs are a better prediction of trade potential as Tim Worstall has argued previously. 

And the gravity model does not explain well the fact that we do so much trade with Anglophone countries—even though the US and Canada are much further away than the EU, while Australia and New Zealand are about as far away as any country could be. Often the Anglosphere (and the Brexit analysis is guilty of this) ignores the potential of trade with these countries. Bringing down barriers in countries with a common language boosts trade and investment. Bringing down barriers so those that can speak our language can move, live and build businesses here increases trade (from the USA, to India, Ireland, and Australia). It’s part of the reason EU trade has grown so reliant on the UK: we speak English and they’ve learned it. Proximity as a measurement alone underestimates British and Irish trade by 5 times, and there’s good reason to think we might expect a greater than currently modelled boost in trade with the rest of the world. Our share of trade with the (much closer) EU countries has fallen, from 54% in 2006 to just 43% today and that’s before we’ve even begun making it easier to trade with the rest of the world.

In fact, the traditional model of trade works much better at explaining the flow of imports and exports. That is because it is based on solid realities like comparative advantage—whereby countries buy things from other countries that are comparatively better at producing them. And on historic, cultural, language and trading ties. And the fact that EU-style protectionism—yes, it’s supposed to be zero-tariff free trade, but look at all the regulatory and other barriers that EU countries erect to keep out others' goods and services—just gets in the way of trade.

Remember too, that as road, maritime and air transport get so much easier and more efficient, more entrepreneurs are going out to more distant countries to exploit those comparative advantages and round-the-world ties, while moving goods over long distances has become much safer and cheaper. Meanwhile, worldwide internet connections have made doing deals with and exporting services to people in faraway places very much faster and easier than they were in the days of fax machines. 

Ask a silly question and you get a silly answer. Ask a sensible question and feed it into Whitehall’s theory- (as opposed to reality)- based calculating machine and you will get a very silly answer indeed. Very much worth leaking if that’s your prejudice, because no media reports look beyond the bogus ‘worse off out’ headline. But not exactly QED, Sir Humphrey.