Measurement Without Theory: On the Extraordinary Abuse of Economic Models in the EU Referendum Debate

The Treasury has published two reports on the economic consequences of a decision by the UK to vote to leave the European Union in the Referendum on 23 June. Together, the reports predict that each household in the UK will be worse off (in terms of a lower gross domestic product) by £4,300 or more by 2030. This prediction is grossly exaggerated for two main reasons. First, the Treasury assumes that the government will not respond to what it calls the ‘extreme shock’ of leaving the EU – a shock that is assumed to last for two years, which is longer than that caused by the Global Financial Crisis – and so will stand by while the economy dives into a recession with GDP falling by up to 6% over the next two years (relative to where the economy would be if the UK remained in the EU) – equivalent to losing 50% of our trade with the EU, even though we will still be in the Single Market during this period. This is simply not credible – had the government responded in the same way during the GFC, the consequences for the economy would have been catastrophic.Second, it assumes that the UK, the fifth largest economy in the world, will be unable to negotiate more favorable trading arrangements than currently exist with either the EU or the rest of the world – which has three times the GDP of the EU and nine times its population and is growing much faster than the stagnant EU economy. As a result of this assumption, GDP is predicted to be lower by up to 7.5% p.a. by 2030. This prediction comes from combining the outcome from a short-term model (called a vector autoregressive (VAR) model) which is used for the first two years after leaving with a long-term model (called a gravity model) which is used to project GDP between 2018 and 2030. The reason that the models are switched in 2018 is because this is the maximum time allowed to negotiate an exit from the EU under Article 50 of the Treaty on European Union. The specific gravity model used by the Treasury is centred on the EU: this model predicts that the UK would actually be better off not only staying in the EU but actually joining the euro – although the Treasury does not acknowledge this. Had the Treasury used a different gravity model centred on the rest of the world – which it certainly should have considered – it might well have found that the UK would be better off leaving the EU. Most of the other economic models that have examined the economic consequences of Brexit – and which have been entirely ignored by the Treasury – find that it will make little difference to the UK’s economy whether the UK stays in or leaves the EU. This is consistent with both Greenland’s experience of leaving the EU in 1985 and Ireland’s experience of ending currency union with the UK in 1979 – neither of which is considered in the Treasury reports.