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Book Review: The Economics of Brexit

October 26, 2017

 

A welcome publication

 

Lost among all the mainstream and social media furore over the ongoing exit negotiations is that thing called ‘perspective’. Not least ‘perspective’ on many of the underlying assumptions that the furore seems to be based upon. One of the biggest ‘assumption’ being that membership of the EU is somehow important for conducting trade and that the long-run prosperity of a society disproportionately depends on a certain kind of political arrangement with 27 particular countries from which, at best, a small minority of economic actors might see the products they export or import move marginally faster across a border or two. A glance at economic history (never mind a thorough study) would tell you both of these ‘underlying assumptions’ are, well, nonsense. Orders of magnitude more important to prosperity are:

 

  • Institutions (Rodrik et al, 2002).*

  • Infrastructure.

  • Policy (whose effectiveness both depends upon and shapes institutional factors).

 

Institutions, infrastructure and policy are central to socio-economic development because together they influence i.e. facilitate and inhibit, directly and indirectly the activities that, in the end, generate a social surplus. Outside of the reductivist world of orthodox political economy this reality has been well understood for a long time. Yet the heterodox schools of political economy fail to get the cut-through into the public discourse that they deserve.

 

This has been true on the issue of the European Union as much as any other issue in political economy. A notable exception to this sad state-of-affairs is Professor Philip Whyman of the University of Central Lancashire (UCLan). DLN had the privilege, in the lead up to the referendum, of posting one of Professor Whyman’s critiques of HM Treasury’s very flawed (putting it politely) analysis of the impact of leaving the EU on the UK economy.

 

Professor Whyman, along with frequent co-authors and fellow academic economists Brian Burkitt and Mark Baimbridge have, between them, been producing rigorous and penetrating analyses of the political economy of the EU from a Post-Keynesian perspective for many years. Building on and taking further the kinds of heterodox critical analysis of European Community membership begun by eminent economists such as Professor Nicholas Kaldor (Thirlwall, 1987).** Therefore, Professor Whyman is perfectly placed to provide a new, comprehensive and rigorous analysis not only of the existing studies into the ‘economic story’ of UK membership of the EU but the possible impacts of Brexit on the UK economy from a heterodox perspective. In the new book, ‘The Economics of Brexit’ Professor Whyman and his colleague Dr Alina Petrescu have done just that. As a result, the book is an essential read for anyone interested in either or both of these topics.

 

The topics in the book

 

Whyman and Petrescu make the two complex topics of the impact of membership and the potential consequences of leaving digestible by dividing the book into themed chapters. Each chapter is focussed on a  key economic issue closely associated with EU membership. These range from the fiscal impact of EU membership on the UK (chapter one) through to alternative trade models for the UK (Chapter nine). Along the way they look at Foreign Direct Investment (FDI), trade, immigration, regulation, growth and productivity and economic policy. In each chapter Whyman and Petrescu are able to cast a critical eye over much of the 'back catalogue' of studies on each topic. As they go along they raise challenging points, exposing how an analytical orthodoxy, sadly, tends to dominate the mainstream discourse on each.

 

Flaws in the analysis of existing work on EU membership and the impact of Brexit

 

Of particular note are the pithy critiques of some of the major studies that, over the preceding two decades or so, have claimed to show (on the one the hand) the supposed ‘benefits’ of EU membership and (on the other) the consequent ‘likely significant costs’ of leaving the EU. The book also looks at studies which have found that EU membership has been detrimental and leaving will bring significant gains. However, the large majority of studies done over the years, and this is reflected in the book, fall squarely in the ‘many benefits of membership’ and ‘costs to leaving’ camps.

 

The authors are able to succinctly explain the limitations of many of the studies heralded, in the mainstream media or in political circles, as important illustrators of the ‘benefits’ of membership and the likely ‘costs’ of ending-membership. As Whyman and Petrescu state:

 

‘…most of the consensus studies have used rather similar models and methodologies [therefore] it is perhaps unsurprising that the…differences [there are] lie in the range of assumptions…[used]…to construct the models and the choice of data…Moreover, theoretical weaknesses inherent in the studies – whether ranging from their neo-classical foundations, the tenuous assumptions underpinning the inclusion of dynamic costs, the length of time it takes to negotiate a FTA or the issues relating to applicability of historical data to gravity modelling – weaken the robustness of the predicted outcomes’.

 

Whyman and Petrescu are equally unequivocal about some of the flaws in a lot of the analyses (by the orthodox economics profession) of the specific influence of EU membership on the quantity of trade between the UK and the rest of the EU. For example, they point out how the UK’s trade with the founder members of the European Economic Community (as was) and the other countries who joined at the same time as the UK (1973) has been on a declining trend since the millennium. The trade chapter goes onto describe, after summarising a series of studies, that: ‘…the evidence suggests that European trade integration has produced considerably less benefit for the UK than for the majority of EU member states’. It is perhaps at this point that the authors could have added to the evidence base they cover on the trade debate by touching upon the voluminous work of Michael Burrage, who has undertaken extensive comparative analysis of the UK’s trade performance compared with that of non-EU developed countries vis-à-vis the founding (excluding the UK) members of the Single Internal Market (SIM). Burrage’s work reinforces the points made by the authors. Using OECD and World Bank data it shows how non-member countries have significantly outperformed the UK in export growth to the SIM despite not having the so-called ‘advantage’ of being inside it (Burrage 2016).  

 

Nevertheless, minor quibbling aside, the chapter on trade finishes with Whyman and Petrescu helpfully pointing out how a number of the studies seen as ‘proving the risks to trade of leaving the EU’ use numerous questionable assumptions about the future trajectory of EU policy in order to make their case, e.g:

 

One regular feature of studies examining the trade impact of Brexit concerns the EU’s ability to realise additional future trade benefits, through either a further reduction in trade barriers more rapidly thanby the world as a whole, or the negotiation of preferential trade agreements with other nations…The inference is that, not only would the UK suffer the consequences of lower current trade benefits as a result of Brexit, but that it would miss out on these future predicted benefits’.

 

It could be convincingly argued that by building such assumptions into a model and claiming these (highly arguable) hypothetical future gains as part of the ‘costs’ of leaving the EU in the cost-benefit evaluation somewhat ‘muddies the waters’ to put it mildly for those who see and hear the results about potential ‘economic losses’ but do not look into or have explained to them the details of the modelling and some of its shaky foundations. Whyman and Petrescu are alive to the potential for such approaches to provide over-estimates of particular consequences. As they openly state:  

 

It is difficult to assess the viability of these hypothetical scenarios. It is worthy of note that, to date, the SIM has been established for a quarter of a century and has not been very successful in securing…unfettered trade in services…[while]…recent eventswould seem to have deferred, if not permanently derailed, the TTIP…[therefore]…whilst Brexit would mean the UK does not benefit from any…potential benefits [which might in the future derive from either], they are unlikely to prove to be as significant as presented in many of these studies…’.

 

To compound the ‘selective assumptions’ behind many studies, Whyman and Petrescu expose about potential future gains foregone as a result of leaving the EU, they highlight further questionable practices. They find that:

 

  • Research frequently: ‘…ignored the other side of the balance sheet, which concerns the potential for trade expansion in the rest of the world’.

  • Most studies don’t take into account any currency depreciation nor phenomena such as ‘stickiness’ or ‘path dependency’ in economic interactions e.g. ‘There is some evidence to suggest that trade linkages are highly persistent once they are established…’ implying that despite ‘new barriers’ resulting from a new trading arrangement with the EU existing economic relationships may persist between UK and EU businesses and consumers. This latter phenomenon would be consistent with the marginal degree of demand elasticity for UK imports, among EU Member States, identified in recent World Bank research by two economists, one from the World Bank the other UNCTAD (Kee and Nicita, 2017).

  • Domestic policy reform, is also largely forgotten. As Whyman and Petrescu point out, the ‘…studies tend to ignore [economic policy]…Nevertheless, it is here…Brexit has the potential…to realise its greatest benefits’.

 

Leaving these factors out of any analysis while including what are, in-fact, no-more than speculative gains from possible future EU policy might, if you were suspicious, lead the reader of this book to think the researchers behind some of the studies analysed were, ummm, ‘over-egging’ things somewhat in their modelling.***

 

Essential reading

 

Whyman and Petrescu have undertaken vitally important analysis in this book. The book is lengthy, but this is not to its detriment. It is very readable. As a result of its concise critical summaries of much of the existing research on each topic, the reader will come away from the book much better informed (than when they began it), whether that be on the possible impacts of the UK’s exit from the EU on FDI and immigration into the UK, the fiscal and funding impacts and the consequences for regulation and productivity. To add further to  the comprehensive nature of the book, it goes onto provide a:

 

  • Helpful overview of economic policy options available to UK Governments, should they wish to use them, once the UK leaves the EU.

  • Tour de force of eight different trading models that the UK might choose to take up after it leaves the EU, including both the European Economic Area (EEA) and World Trade Organisation (WTO) options, among others.    

 

However, perhaps the most important ‘takeaway’ for the UK political debate and future public policy is the expose of numerous ‘frailties’ in the methodologies of many of these studies that claim to show the so-called ‘benefits’ of EU membership and the ‘costs’ of leaving. The book illustrates how, at best, some of the research undertaken is ‘incomplete’ (e.g. the nature and scope of the data used does not adequately support the analytical weight placed upon it) and, at worst, it appears others ‘build-in’ an exaggerated negativity. Both these types of flaws are then reflected in their ‘conclusions’. Sadly, outside academic books like ‘The Economics of Brexit’ such nuances rarely get highlighted. Instead of interrogating the ‘guesstimates’ of such research, their results are reported largely uncritically in the media. Further, and more worryingly, these studies play a significant role in shaping the contours of the debate within the political class and business. It’s unfortunate that it is in the methodology that a considerable portion of the debate needs to be had because, predictably but to the detriment of public debate and policy making, the media, political and business class are never going to ‘dive into’ these complexities.

 

The book ends with the author’s providing their own thoughts on the likely short and long-term impact, on the UK economy, of leaving the EU. Having critically reviewed most of the existing evidence on the issue they are well placed to provide a reasoned projection about the prospects of the British economy beyond March 2019. With the credibility of having examined a wide range of the existing literature behind them, they are able to present estimates clearly based on strong rationales and consequently, their forecasts are more convincing than most.   

 

Imperative this book is widely read

 

Many will be heartened to find that there are alternative voices out there engaging in this issue, bringing a different (and frequently better) analytical frame to the debate on the possible implications of leaving for the imaginable futures the UK can choose once it has left. As a result of the breadth of its analysis and use of a heterodox framework for that analysis this is an important contribution to the debate over the economic future post-the UK leaving the EU. As such, this book deserves to be read cover-to-cover by policy makers across Whitehall, MP's and peers. At the very least it will open some people’s eyes to their own lazy assumptions about the economics of Brexit and the studies they rely on to inform themselves about those economics. In the end human cognitive biases may mean most will dismiss its findings because they are inconvenient. Nevertheless, the intellectually honest ones will be forced to acknowledge that the orthodox economics profession has at best made some questionable decisions about how it has analysed EU membership and the consequences of leaving and at worst has been disingenuous with some of its claims. 

 

Bibliography

 

Burrage, M. ‘Myth and Paradox of the Single Market: How the trade benefits of EU membership have been mis-sold’. (2016).

 

Kee, H. L and Nicita, A. ‘Short-Term Impact of Brexit on the United Kingdom’s Export of Goods’, World Bank Policy Research Working Paper 8195. (2017).

 

Rodrik, D., Subramanian, A and Trebbi, F. ‘Institutions Rule: The Primacy of Institutions over Geography and Integration in Economic Development’, National Bureau of Economic Research Working Paper 9305. (2002).

 

Thirlwall, A. P. ‘Nicholas Kaldor’. (1987).

 

Notes

 

*Institutions is a term that can narrowly describe legal and political institutions and associated norms of behaviour. In political economy this is often how it is used. Nevertheless, a more comprehensive definition used by heterodox schools of political economy would also encompass: cultural and social institutions (i.e. wider societal norms and structures) and the levels of social capital (trust and solidarity) in society.

 

**Other Post-Keynesian and radical political economists that raised concerns in the 1960s and 70s about the supposed economic ‘gains’ from membership of the (then) European Community, included: Richard Kahn, Roy Harrod and H. D. Dickinson.

 

***The studies also fail to take account the fundamental (i.e. deep causal) role of institutions and infrastructure in their accounting of the sources of capital accumulation and the growth in the social surplus.

 

 

 

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