It was good to see the Bank of England confessing its mistakes in being far too pessimistic about the UK’s economic prospects in 2016. As they seek to correct the record, they need to look again at their so called gravity model for predicting the impact of European trade on the UK economy and the alleged damage leaving the single market could do. The model does not seem to attribute enough significance to common language, which is especially important in service trade.
Their conclusion that the UK will be hit over the longer term by leaving the single market is based on a dubious model and inappropriate data. The model assumes that a country trades more easily with a country it is close to. The Treasury analysed the impact on trade for all the members of the EU post war. Of course the EU had a more positive impact on those who joined early, when world tariffs were higher, than it did on the UK which joined later after world tariffs had come under GATT. More particularly, trade was boosted substantially for relatively poor closed economies in East Europe when they joined and started trading properly with the west for the first time. The UK’s experience of gains from single market membership have been much less than these two different dominant cases used in the data.
The numbers show that the UK growth rate did not accelerate either on joining the EU or on completing the single market. It is difficult from this past evidence to argue that the longer term growth rate will therefore slow when we leave.
We now know that the Treasury vector autoregressive model for the first two years after the Brexit vote was also hopelessly wrong. The establishment now accepts this and is busy changing its forecasts for the period June 2016-2018. It is high time they also acknowledged the weaknesses of the model and the data used for the longer term predictions. Had they applied their gravity model to our trade with the rest of the world it would presumably have said we need free trade deals with all those countries, which in turn requires us to leave the EU.