Solving the Mystery of the Brexit Bounce

In the run-up to the EU referendum on June 23rd, you could hardly move without hearing prophecies of doom from the Great and Good of the terrible consequences should Britain vote to leave.

IMF Chief Christine Lagarde predicted the impact on the UK economy would range from “bad to very, very bad”. George Osborne, then Chancellor of the Exchequer, forecast a severe recession which would oblige him to add 2p to the basic rate of income tax to save Britain’s public finances. Mark Carney, Governor of the Bank of England, warned of a “material impact” on growth if Britain voted to leave the EU, adding for good measure that it could lead to a 3% hike in mortgage interest rates. Not to be outdone, Scotland’s very own Cassandra, Nicola Sturgeon, predicted after the Brexit vote “a lost decade” with “deep and severe consequences”, no doubt only restraining herself from foreseeing plagues of frogs and locusts and darkness across the land by a wholly statesmanlike concern not to trigger panic.

And in case anyone should – heaven forfend – suspect for a moment that these forecasts might possibly be driven by a self-serving agenda on the part of these estimable individuals, they could find reassurance from a supposedly neutral third party. For were they not supported by very thorough and detailed technocratic forecasts prepared by high powered economists at that most august of all British institutions – Her Majesty’s Treasury? And no-one could possibly question their impartiality and political independence, could they?

Well, yes they could – and did.

Writing to the Financial Times on April 19th in a letter reproduced on this site, I cautioned that the Treasury’s warning of the “permanent economic damage” that a vote to leave the EU would cause the UK “continues a worrying trend, first seen in last year’s referendum on Scottish independence, towards the politicisation of the Treasury.” I cautioned that this threatened to undermine the fundamental principle of the civil service’s political neutrality. “Instead,” I wrote then, “the Treasury is slowly metamorphosing into an instrument of pro-government propaganda supporting the established order.”

Nine months on, my concerns were echoed last week by the Bank of England’s Chief Economist, Andrew Haldane. He raised the question of whether there needs to be a fundamental reassessment of conventional forecasting assumptions and methodologies. For his pains, he suffered the outrage of certain members of the UK’s political and economic establishment.

In my judgement, this criticism is wholly unfair. Mr Haldane deserves credit for having the courage to go against a complacent consensus which has clearly been undermined by the robust performance of the UK economy since the Brexit vote, contrary to the overwhelming weight of opinion from those who now criticise him.

So why were their forecasts so badly wrong?

Firstly, it seems almost tautologous to state that, if most UK electors voted to leave the EU, it was because, on balance, they believed that they personally would be better off if the UK was no longer constrained by the EU’s rules and regulations. This in turn could be expected to feed through to an increase in their confidence once Britain voted to leave, not to a collapse in confidence as assumed in the Remainers’ doom-laden forecasts. So there was a fundamental inconsistency at the heart of the Remainers’ forecasting assumptions.

The more arrogant proponents of the Remain case (of whom there seem to be quite a few) seem to imply that those who voted to leave were either too stupid, or too ignorant, or quite possibly both, to appreciate the dire consequences of their actions.

The problem for the Remainers is that their narrow opinion of the EU’s merits is contrary to the conclusion of every great economist, from Adam Smith to John Maynard Keynes, that a move away from protectionism towards free trade will improve economic welfare. Their conclusion has been borne out by experience in all places, at all times. I can’t think of a single leading economist of the past who had a contrary view – not David Ricardo, not John Stuart Mill, not even the iconoclastic Joseph Schumpeter. And if they’re right, then any threats associated with leaving the EU will be hugely outweighed by the opportunities created by an open, freely trading structure, hopefully with zero tariffs, achieved by new British agreements with rapidly growing nations in Asia, Africa and Latin America, as well as our old friends in the Commonwealth and North America.

So the increased confidence seen since the Brexit vote is entirely consistent with the Rational Expectations Hypothesis, as consumers and investors alike anticipate better times ahead outside the EU.

January 11th 2017

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