Economic Forecasting and why we should remain optimistic

As we all know, before the 2016 EU referendum took place a series of projections on the likely impact of a Leave vote were made by the UK Treasury, the Bank of England, the OECD, the IMF and others. Almost without exception, they forecasted dire results.  The Treasury predicted that in short order there would be a 500,000 increase in unemployment, whereas actually unemployment fell and the total number of people in work rose by 400,000. We were told that the UK economy might experience a 3.6% drop in output– as much as the fall in 2008. Actually, the UK economy grew by 1.9% in 2016 and by 1.7% in 2017.

It was not, however, just prestigious organisations which got their predictions so wrong. It was also the bulk of professional economists. No doubt there was some interaction here between their pre-conceived predominantly Remain views and their belief that the economy would falter if there was a Leave vote. Because they generally favoured Remain rather than Leave, most economists seem to have been predisposed towards believing – perhaps almost hoping – that the economic consequences of a Leave vote would be a disaster.

Why, however, even allowing for this, did such big mistakes get made? Economic forecasts are notoriously unreliable, but if you stick your neck out and make them, you need to try to get them right. The explanation for what went wrong, which in turn has a substantial bearing on what we can reasonably expect the outcome of Brexit to be, is that nearly all the gloomy forecasts almost certainly had a built-in bias towards being much too negative.

Why did this happen? It is because economists are used to using data from the past to predict what is going to happen in future. The problem with the Brexit vote was that it took everyone into unchartered territory. No-one had relevant past data on which to rely when forecasting what the economic impact of a Leave vote would be. All sorts of assumptions therefore had to be made which could not be supported by relevant past econometric data.

This is when a crucial bias then crept in.  It was much easier for economists to identify what downside problems there might be than it was to foresee what new opportunities might be created. The result was a tendency for all projections to be too pessimistic. This was because the result of feeding in the costs of all the problems which it was relatively easy to anticipate, while leaving out the relatively unknowable benefits of new opportunities, was bound to tend to conclusions which were too gloomy.

It is, however, not just economists who seem to be suffering from this bias. It appears that many businesses may be caught up with the same syndrome, reinforced by the relatively negative projections coming from organisations such as the CBI. What is actually happening, however, is that new opportunities are materialising as quickly as new costs are incurred, which is why the economy is holding up so much better than the experts predicted it would.

What this tells us is that the UK economy will very probably continue to expand, albeit relatively slowly, whatever the result of the Brexit negotiations. There are side-effects to be expected from both a soft Brexit or a clean break but, absent a last-minute breakdown for which inadequate preparations have been made, a significant deviation from current trends seems unlikely.  Businesses should then plan accordingly and those who voted Leave and who support Brexit as the negotiations proceed should be thankful that they have not been swayed by the bad advice provided by those who might have been expected to know better.

Forecasts always depend on the assumptions fed into the models used to provide them.  If you only see problems ahead, but not opportunities, your guesses at the way the future unfold are not likely to be right – as indeed we saw,   Rubbish in – rubbish out – and this is why those of us who take an optimistic view of Brexit are much more likely to turn out to be right than those who predict doom and gloom.

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Project Fear Mark 2??

The Buzz Feed website has obtained a leaked copy of the leaked Government analysis of different Brexit scenarios which claims that over the next 15 years, the UK would be poorer by 8% under “WTO rules”, 5% poorer under a Comprehensive trade deal with the EU and 2% poorer if we re-joined EFTA, which would allow us reasonably frictionless access to the EU’s single market.

However, this is hardly Project Fear Part 2.  Labour may be pushing for the Government to publish the findings, but they are wasting their time. The report matters not one iota.  Forecasting likely economic developments as far ahead as 2034 is an utter waste of taxpayers’ money.

I can say this with some confidence without having seen the report because government bodies and indeed many distinguished economists – especially if they carry the label “Keynesian” – have terrific form when it comes to making economic predictions which turn out to be utterly and completely wrong – even over a much shorter timescale than 15 years.

We recently pointed out that David Cameron had been caught on camera admitting that the first 18 months since the Brexit vote had not been anything like the disaster he had anticipated.  You don’t need long memories to recall Gordon Brown’s claim that there would be no more boom and bust – only a few years before the Great Recession erupted during his premiership. Going back to 1981, no fewer than 364 economists wrote a letter to the Times stating that Sir Geoffrey Howe, the then Chancellor of the Exchequer,  would cause mayhem if he raised taxes in the middle of a recession. It turned out that the controversial 1981 budget, far from exacerbating the recession, laid the foundation of the UK’s economic recovery under Margaret Thatcher.

What is more, it is asking the moon to expect civil servants to come up with a study showing Brexit to be beneficial. Steve Baker MP found himself in trouble for claiming that Treasury officials are conspiring against the government on Brexit, but like it or not, the Treasury has been reported on good authority as being keen to keep us in the Customs union, even though Civil servants are meant to implement, not decide policy.

John Mills is therefore correct in sharing our scepticism when commenting on the claim in the new report that “Officials believe the methodology for the new assessment is better than that used for similar analyses before the referendum.” He says  “The whole piece rests on the above assertion. There is no description of the previous methodology or of the changes that make this analysis better. Is the methodology different from the one used previously to “prove” that the UK economy would tank if it did not join the Euro?”

Let us apply a bit of common sense to the UK’s economic prospects instead of listening to the so-called “experts”. In the shorter term, a slight dip in economic growth is likely in the post-Brexit period as things settle down, even if a satisfactory exit solution is agreed with the EU. Fisheries and agricultural  products are not covered by Single Market legislation and trade with the EU may be reduced here (although the fishing industry can begin its revival as soon as we leave, assuming Fishing for Leave’s proposals are eventually accepted by the government.) The delay in providing any guidelines about what deal the Government is expecting is causing firms to hold back on investment decisions and some firms in the City are already contemplating relocating staff to other locations. The City of London may see a slowdown in growth given the EU is none too keen to strike a trade deal involving financial services.

There is also the question of trade with those countries with whom the EU has negotiated trade deals. The EU is most reluctant to let the UK continue to participate in these deals post-Brexit and if new deals are not negotiated in time (or the countries in question do not agree to continuing to trade with the UK on the same basis), the economy may suffer here. As it happens, most of the UK’s most important trade partners outside the EU, including the USA, China and Japan have not negotiated a full-blown trade deal with the EU, although the EU has made more limited mutual recognition agreements with these countries, which we may need to replicate quickly.

All these factors do suggest that even the smoothest of Brexits could well see a slowdown in growth in early 2019, although this is a long way from saying a recession will occur. The UK economy has proved far more resilient than the promoters of “Project Fear” expected. Of course, if we crashed out of the EU, the consequences could be far more serious.

In the longer term, however, there is every reason to expect the UK to perform at least as well outside the EU as if we had remained a member state – if not better.  It will be far easier to reorientate our trade away from the sclerotic EU to the up-and-coming economies of Asia from outside the EU.  The massive deregulation advocated by some Brexiteers in the run-up to the referendum vote is not realistic, given how many  regulations originate from global bodies such as the WTO or the ILO, of which we will still be members. Some regulations could be scrapped or re-written if they originate from Brussels and are not in our national interest. We would also have the option to cut taxes to boost the economy in a way which would not be possible as an EU member state. VAT could be scrapped, for example.

Then thee is the issue of freedom. A strong correlation exists between freedom and prosperity. Freedom is a relative term, but being able to make our own laws, being able to remove those people holding real power via the ballot box if we don’t like them and our common law legal system will put us higher up the freedom index once we leave the EU. How tyrannical the EU is likely to become remains to be seen. Vladimir Bukovsky, the former Soviet dissident, said of the European Union, “I have lived in your future and it didn’t work.”  We are, of course, a long way from the gulags, the persecution of Christians and the extreme censorship of the former USSR, but a number of EU officials have made clear their disdain for real democracy. To quote one example, when the European Constitution was rejected in two referendums in France and the Netherlands,  Valéry Giscard d’Estaing, the former French Prime Minister, said “Let’s be clear about this. The rejection of the constitution was a mistake that will have to be corrected.”

Given that we will be free from all this, it is inevitable that Brexit will have a positive effect our prosperity. It is ironic that the young people, who were the strongest supporters of remaining in the EU, are likely to be the biggest beneficiaries of our leaving it. Mrs May has insisted that, in spite of these government studies, we will indeed leave the EU.  Mind you,  it would be a serious cause for concern if she had been influenced by it for, as one government minister said “It also contains a significant number of caveats and is hugely dependent on a wide range of assumptions which demonstrate that significantly more work needs to be carried out to make use of this analysis and draw out conclusions.”

In other words, it isn’t worth the paper it was printed on.

 

Still eating his words in 14 months’ time? Let’s hope so

The consequence of the Brexit vote  “wasn’t as bad as we thought.” David Cameron’s off-the-cuff comment to steel tycoon Lakshmi Mittal was caught on video, as you can see here. However, he did actually say, “it’s a mistake not a disaster. It’s turned out less badly than we had thought but it’s still going to be difficult”.

Over 18 months since the Referendum the UK economy has performed well. The  official guidance to voters, in a letter sent by HM Treasury to each and every household, said that on a Leave vote, “Britain’s economy could be tipped into a year-long recession. Further, at least 500,000 jobs could be lost and GDP could be around 3.6% lower following a vote to leave the EU than it would be if we remained in the EU.”

The reality is that unemployment has fallen to a 43-year low of 4.3%, GDP has continued to grow and exporters are doing well, with September 2017 being the best month ever  Project Fear has looked very discredited and even one of the two men driving it has finally admitted the truth.

The last part of Cameron’s statement is also true as well, unfortunately. The next 14 months are going to be difficult and the difficulties for the government are already mounting as opposition from Tory MPs in particular to the proposed “transitional deal” is beginning to grow.  We have outlined many of its unsatisfactory features on this website and are pleased that our concerns are now being voiced within the corridors of Westminster.  Readers may enjoy this exchange between Jacob Rees-Mogg MP and Brexit secretary David Davis, whose jocular manner cannot disguise the discomfort he clearly felt as Mr Rees-Mogg put him on the spot.

We yet remain hopeful, even if the conflict over this issue is likely in the short-term, that David Cameron will still be eating his words in 14 months’ time.

Mrs May’s trashing of the Successful Nobo Industry

Notified Bodies (Nobos), together with Designated Bodies (Debos) and Assessment Bodies (Asbos), are one of our country’s least known success stories. Yet they could easily largely disappear, together with thousands of well paid jobs and millions if not billions of pounds in export earnings, if Mrs May persists in her determination to take this country out of the Single Market and European Economic Area (EEA).

A wide range of products – from equipment used in explosive atmospheres to toys – are required by EU product law to undergo third party conformity assessment and/or testing by suitable independent accredited organisations (Nobos) in order to be placed on the market in the European Union (EU) and often by extension the EEA. This is to ensure that they meet EU legal requirements, which often includes compliance with specified requirements in European Standards (ENs).  This assessment, depending upon the relevant EU product legislation and ENs may require continuing surveillance (of manufacture) and testing of the product by the Nobo.  Certification can also be time limited as well, requiring reassessment after a number of years.  Over the years, the EU has increased the scope of its legislation, which may in part originate elsewhere in world bodies or agreements and it carries out periodic updates of existing product legislation.

In turn, the Nobos need to be resident in the EEA, Switzerland or Turkey, be accredited with relevant competence(s) and are listed on the EU’s NANDO database.  Each Member State also has an accreditation organisation which regularly checks the competence of Nobos to carry out assessment and testing work. The UK-based list of Nobos includes famous and respected names such as British Standards Institute (BSI), Lloyd’s Register, the National Physical Laboratory and The Vehicle Certification Agency. There are also many other less well known, smaller organisations in the private and public sectors.

Through mutual recognition, a product with a conformity certificate issued by an accredited Nobo in one Member State is accepted in all the others without further assessment or testing.  Sometimes, however, a product may undergo further assessment as part of an overall system, but this is not intended to repeat previous work.

Recently the European Commission has published guidance for manufacturers and Nobos for after 29th March 2019 Notice to stakeholders withdrawal of the United Kingdom and EU rules in the field of industrial products.  After this date Nobos registered in the United Kingdom (as a ‘third country’ outside the EU and EEA) will lose their EU Nobo status and be removed from the EU’s database.

A manufacturer (or supplier) of a product requiring third party conformity assessment after 29th March 2019 will have to use a Nobo based in the EEA, Switzerland or Turkey in order to place a new or modified product on the EU market.  When placing a new or modified product on the UK market, the manufacturer is likely to opt for an EEA- or Switzerland-based Nobo for all conformity assessment to prevent duplication of work and costs. After all, Mrs May intends that after Brexit (if it ever happens instead of EU Vassal State status) UK legislation (presumably including product legislation) will follow EU legislation.

UK-based former EU Nobos could then see much of their work disappear quickly, including any work related to putting products on the UK market.  The Annex to the EU’s Notice to stakeholders withdrawal of the United Kingdom and EU rules in the field of industrial products lists the EU product categories covered. This, however, may be just the ‘tip of the iceberg’ since, depending upon the EU product legislation, components making up a particular product may also need some form of independent conformity testing and inspection.  Manufacturers or suppliers may also like to use a ‘one stop shop’ approach developing a longer term relationship with one Nobo to cover a wide range of their independent conformity, testing and quality assessment requirements, not merely to comply with EU product legislation.

A further blow to UK based Nobos is that without the potentially larger market provided by the EU, some investment decisions, say for testing facilities, may not be justified or even feasible.  In the current climate of uncertainty, prudent UK-based Nobos could already start transferring work and jobs to other EEA members in order to retain existing EU based customers.  They may also consider working through an EU-based Nobo who will ‘rebadge’ their work and obviously charge for so doing. This would in turn undermine their unique selling proposition – competitiveness.

It is possible that this impending loss of EU accreditation by Nobos can be successfully resolved by the Department for (not) Exiting the European Union.  However, at the moment, this does not look promising given that some of the inaccurate and uncompromising statements in the EU’s Notice to stakeholders withdrawal of the United Kingdom and EU rules in the field of industrial products relating to Nobos may not be legal under EU law; Nobos are not solely within the EU.

Third party testing and certification appears to have a very promising future worldwide. It provides confidence that safety, environmental impact and energy consumption have been independently assessed.  It may be essential when assessing some of the products of the future, such as autonomous or driverless cars. Sadly the UK is potentially going to face a huge handicap if Nobos cannot viably operate here through political decisions of the government.

The potential loss of UK and EU markets for UK based Nobos would not arise if Mrs May had not made such a rash decision in ruling out any ongoing membership of the EEA after Brexit.  She could have decided instead after Brexit on 29th March 2019 to re-join the European Free Trade Association (EFTA). This provides a breathing space. enabling us to remain in the EEA (whilst outside the EU) under different conditions which, for example, allow unilateral control of immigration (see Chapter 4, Schedule 112 The Safeguard Measures in the EEA Agreement).  Will she have the courage after 29th March 2019 to face people from these UK-based former EU-accredited Nobos who have worked hard over the years to build expertise, facilities, reputations and long-term relationships with customers and yet face unemployment, because of her premature rejection of a useful “holding position” without any consideration of an alternative?

The financial settlement – it will be a long-term gain

THE FINANCIAL SETTLEMENT

The Prime Minister has stated that the financial settlement and any payment thereof would depend on a satisfactory overall agreement which meets the objectives of the Florence Speech, including a trade arrangement.

THE PRESENT POSITION

When going into negotiations with the EU for a ‘single financial settlement’ it is necessary to consider the current established financial relationships between the UK and the EU.

These come in two parts:

The UK’s EU budget contribution (after rebate) amounts to around £13.5 billion per annum.  That is about 20% of the total net savings of the UK economy.  It is also a legal obligation of EU membership and exists in perpetuity.  Any sum spent by the EU in the UK is not an obligation but is a matter of EU policy.  Since 1973 the total net UK contribution to the EU budget at 2017 prices is about £500 billion and, at present, the perpetual obligation adds to this every year.  (The last time it was fully worked out was for the period 1973-2010 when it amounted to £379 billion at 2010 values.)

The second part of the current relationship is that there is UK exposure to the liabilities of the EU and its entities such as the ECB (European Central Bank), EIB (European Investment Bank), etc.  There is no corresponding EU exposure to UK liabilities such as those of the Bank of England.  The UK also has ‘joint and several’ liability for all EU debts.

In comparison with the UK situation, non-EU EEA countries, such as Norway, have no exposure to EU liabilities nor do they contribute to the EU general budget (contrary to what is often asserted).

It should be noted that this study addresses only financial and fiscal matters.  There are other costly economic effects of the UK-EU relationship, such as food costs, migration costs, etc. which are not referred to here.  There are also some benefits in the internal market relationship.

The present financial situation is described more precisely in a pre-referendum study:

UK Membership of the EU – The Threat to the Balance Sheet.

THE UK’S NECESSARY FINANCIAL ASPIRATION

It is, therefore, prudent and a financial necessity that the UK ceases to hand over 20% of its net savings to the EU in perpetuity with virtually no influence of how these savings are spent (only a tiny fraction is spent on investment in the UK).

It is also urgent for the UK to extract itself from the partly one-sided exposure to the liabilities and contingent liabilities of the EU as soon as possible.  Adopting the position of the EFTA/EEA states which have no responsibility for EU liabilities would be prudent finance.

THE ‘FINANCIAL SETTLEMENT’ AS AT DECEMBER 2017

The fundamental two aims of stopping EU budget contributions with the consequent erosion of UK savings/investment and extracting the UK from EU liabilities are on the table and in the Joint Report of 8th December 2017.

These are the two core financial benefits of departure.

It is important to understand that the EU referendum was about the long-term future and not about the details of departure, not all of which are favourable.  Further, if the referendum had been won by Remain, both the half-a-trillion pound hit to UK savings would have increased every year by some 2 or 3%, and the UK would still have been responsible for its share of EU liabilities.

These will cease over the next five years, although in a somewhat unsatisfactory and messy settlement.

THE FINANCIAL SETTLEMENT – THE QUANTUM

Michel Barnier is quoted in The Guardian (19/12/2017): “He [Barnier] would not confirm British estimates that the final Brexit bill – the UK’s outstanding obligations to the EU – would be no more than Euro 45 billion (£39 billion).”

This was hardly unreasonable of Barnier because at least two of the principal subjects of financial discussion, the UK’s stake in the EIB and EU pensions seem to have been left as ongoing yearly matters and, therefore, it is difficult to form capitalized totals thereof in any meaningful way.  Pensions will be paid when this amount falls due.  This means the UK could still be paying pensions up to 2100 although the amounts will be insignificant by then.

It has also been agreed that the UK will continue its normal financial relationship with the EU until the end of 2020, that is, making budget contributions and collecting the rebate.

Some questions arise over the following (the references are to the Joint UK EU Report of 8/12/17):

  • It is not stated that the UK will receive its rebate for the year 2020 (it is normally repaid one year in arrear).
  • Item 61, “The UK will contribute its share of the financing of the budgetary commitments outstanding at 31st December 2020 (RAL).” The ‘rebate’ is not mentioned but even if the UK agrees to pay its share of RAL then this should be subject to the rebate (paying a share of the RAL is a political concession by the UK).  The whole point of the RAL is that money has been spent or authorized above the EU budget although Item 67(b) appears to negate the rebate in RAL matters.
  • Then there is ambiguous phraseology over the balance sheet. “The UK will contribute (para 62) its share of the financing of the Union’s liabilities incurred before December 2020 except for liabilities with corresponding assets and assets and liabilities which are related to the operation of the budget and the Own Resources division.”  The English is poor and obscurantist.  The clear fair method is for the UK to establish its share of the EU balance sheet (assets and liabilities) and pay its share of the net amount if there is an excess of liabilities over assets.  This is the method recommended by the Institute of Chartered Accountants. (some of the net may be subject to the rebate).
  • The European Investment Bank (EIB): The UK has agreed (item 74 onwards) that it will not receive any profit from the activities of the EIB but will participate in a share of any losses entailing Extra Capital calls.  This is a poor negotiating decision.

Straws in the wind

Apart from signs of possible movement in the stalled negotiations with the EU on trade, events are beginning to push into reality those matters which have previously been merely the subject of rhetoric and speculation.

Whatever plans the government has, it will have to start giving practical information to businesses in the early new year about its intentions. In our extended article The Complexities of Brexit, we pointed out the urgency of the situation for chemical manufacturers, farmers, food producers and other businesses which have long production cycles or investment programmes which reach into the post Brexit era.

Whilst trade associations like to avoid publicity which might upset the government and to conduct their negotiations in private, the urgency of the situation is pushing these matters into the public sphere. Two articles from City AM of 22nd November demonstrate this.

EASYJET PLAN COULD SHAKE UP SHAREHOLDINGS by Rebecca Smith

EASYJET yesterday set out plans which could force UK shareholders to sell their stakes after Brexit, as it prepares to comply with foreign ownership rules.

Under EU law, the airline needs to ensure majority control and ownership by EU nationals after Britain leaves in order for it to keep operating intra-EU. Yesterday it unveiled plans to amend its articles of association which currently give directors the power to limit the ownership of the firm’s shares by by non UK nationals. Easyjet intends to change this so they apply to non EU shareholders, which will exclude UK shareholders once the UK has left the EU – giving it the power to force UK shareholders to divest their shares if need be.

The airline will put the changes to shareholders at its annual general meeting in February, saying the switch-up will ensure that Easyjet is able to remain EU-owned and controlled at all times after the UK has left the EU.

The carrier said it has “no current intention” of using the proposed powers……

BREXIT BREAKTHROUGH NEEDED BY EARLY 2018 TO HELP BUSINESSES.

By Jasper Jolly & Alys Key

THE GOVERNMENT must secure a Brexit transition deal by the end of the first quarter of 2018 before businesses implement “no deal” contingency plans, according to the head of the Institute of Directors (IoD).

Speaking at the lobby group’s annual dinner last night, IoD director general Stephen Martin said businesses “are concerned about what happens if a breakthrough is not made at the next round of talks in December”.

He said “It’s as simple as this – we are now only 16 months away from leaving the EU. We need the discussion to move on to our future trading relationship and critically what happens when the Article 50 timeline runs out in early 2019.

But he praise IoD members for their “determination” in preparing for every Brexit eventuality, saying that businesses have upheld their end of the bargain and now need the politicians to “deliver” for them.

IGNORANCE ABOUNDING IN HIGH PLACES

A colleague, who has been quietly lobbying trade associations for months, decided it was time to speak to his MP. During the course of their discussion, he mentioned EFTA (The European Free Trade Association) and was astonished to find that this shadow minister did not know what it was. He had never heard of it. Over many years of campaigning, we have often been surprised at the lack of knowledge by MPs of all parties concerning the European project. A national referendum and over a year’s intense debate on the result appear to have been insufficient to disperse the fog of ignorance on even such a basic matter as this.

It is not just politicians either. At a private meeting of senior business people, not one participant raised a hand when asked if they had ever downloaded and skim-read an EU Free Trade Agreement. Former civil servants at the meeting said that this was also true of ministers they had served.

Mind you, half an hour of reading the sort of leaden prose which the EU produces is enough to sap the will to live! Considering the very definitive statements made by leading spokesmen and media personalities, it would be interesting to know how many of their very emphatic opinions were based on direct acquaintance with the text. The Devil is always in the detail.

A WIND OF CHANGE

Commenting on a report of this meeting, our good friend John Ashworth of Fishing for Leave wrote “I haven’t been home long from three days in London and I too can’t say what I have been up to, but I can confirm there is a wind of change. I have a lot of work to do now, but I am happy with the three days, never satisfied enough. But movement is at last happening, so to all readers, keep the pressure up.

“The two factors which had the most effect on them were, on the one hand, a most extraordinary level of ignorance and, on the other, an almost complete inability to listen. If anything, the stories that have leaked out on these aspects are somewhat under-stated” – yes, spot on”.