Monday, July 4, 2016

Brexit and long-term growth in the UK

A central tenet of those advocating that the UK remain in the EU has been that the UK economy would experience more robust growth within the EU that it would outside the EU, ostensibly because the UK trades extensively with EU member states, and this trade would be impaired permanently were the UK to leave the EU.

This view, or something similar, was ubiquitous throughout the debate. In fact, most proponents of the UK remaining in the EU didn't feel a need to provide any support for this argument. And even many people advocating that the UK should leave the EU didn't bother questioning this view. They often simply accepted that slower growth would result but concluded that this slower growth was a price worth paying for the competencies that would be reclaimed by the UK once it left the EU.

But is this view really so obvious?

Let's consider the thirty-four OECD member states as a set of countries with economic characteristics not too dissimilar from those of the UK economy. Over the past five years, the average annual real growth rate among these countries has been 1.56%. Of these, the average annual growth rate of the twenty-one countries that are also members of the EU was 1.01%, while the average annual growth rate of the thirteen non-EU member states was 2.45%. For comparison, the average annual growth rate of the fifteen OECD member states that are also part of EMU was 0.77%.

The impression is similar when the comparison uses ten years of data rather than five. In particular, the average annual growth rate of the thirty-four OECD countries over the past ten years has been 1.42%. Of these, the average annual growth rate for the EU member states was 0.90%, while the average annual growth rate for the non-EU member states was 2.27% Again, the subset of member states that were also part of EMU showed the worst performance, with an average annual growth rate of  0.70%.

Clearly, these comparisons are too simplistic to be used as the basis for an argument that the UK economy is likely to perform better outside of the EU than it would inside the EU. For example, this simple comparison doesn't take population growth into consideration, and it's well-known that many European countries have lower population growth rates than do countries in other parts of the world. On the other hand, with an EU unemployment rate of 8.8% (10.3% in the Eurozone), it seems implausible that European growth has been suffering due to a lack of available labor.

These simplistic comparisons also suffer from clear methodological issues. For example, it could be argued that average annual growth rates should be weighted by GDP or by population rather than using a simple, unweighted arithmetic average.

But the point of this simple comparison is not to persuade people that the UK economy is likely to grow more quickly outside the EU than inside. Rather, it's to suggest that we shouldn't simply accept the assertion that the UK economy will experience slower growth outside the EU. Given that average growth among OECD economies outside the EU has been better than average growth of OECD countries inside the EU over the past ten years, there's considerable room for skepticism here.

My view is that the relative performance of the UK economy outside the EU will depend largely on the choices made by the British people in the next few years. Already, Chancellor Osborne has indicated his intention to reduce the corporation tax rate in the UK to 15%, and this seems like an excellent start. Other key choices will involve the regulatory environment for financial services, which had been a traditional strength for the UK. And of course the new trade agreements negotiated with the EU will play an important role.

If the UK emphasizes its role as a leading global exporter of services (particularly financial services), I believe that increased trade with the US, China, India, and Africa can more than offset any reduction in trade with EU member states. And with a streamlined decision-making structure, the UK is in a position to institute another round of economic reforms that would build upon the reforms of the 1980s, helping to boost productivity beyond levels that otherwise could have been achieved within the EU.

Of course, there are some serious challenges ahead. In addition to resolving leadership issues in the Conservative party, the UK needs to negotiate its exit from the EU and new terms of trade with the EU. And then there are issues involving Scotland and Northern Ireland. Given these challenges, and particularly the associated uncertainty, I believe slower growth in the UK is virtually inevitable over the next few years.

But the simple statistics considered here give some reason for optimism that the UK economy can thrive outside the EU over the longer term, and my hope is that political leadership in the UK, with the support of the electorate, will use this opportunity to undertake a set of reforms that might not have been possible otherwise.