How the Treasury's model suggests the UK could grow faster outside the EU

Strange as this might sound, under the Treasury’s post-Brexit economic model it’s conceivable that the UK economy could, for a period, grow faster outside the EU than inside.

Let me explain why.

If you were reading this blog yesterday you’ll recall my point that the Treasury had not drawn up a simulation of what could happen to the economy if the UK left the EU and stayed in the single market.

For those who didn’t see that story, a quick recap: back when the Treasury published its analysis of the long-term impact of Brexit, it considered three scenarios of what might happen after Britain left: 1. That it stayed inside the European Economic Area (the EEA or single market), 2. That it left and agreed a bilateral trade deal with Europe (the Canada option) and 3. That it left and simply relied on World Trade Organization rules to trade with Europe and everyone else. The economic impact of each deal was as below:

However, when the Treasury published its short-term analysis yesterday, looking not at where Britain could be in 2030 but how it could do between referendum day and Q2 2018, it only provided two scenarios: a “shock scenario” where growth fell 3.6% and a “severe shock” scenario in which it fell 6%.

As I wrote yesterday, the two scenarios were both based on the presumption that the UK would not join the EEA – in other words the least negative option from the top table above was simply ignored.

The suspicion was that this most conservative option was omitted because the scenario would not result in the scary recession the other scenarios projected.

However, I’ve since been told by government insiders that, in fact, something similar to these two scenarios – the shock and severe shock – could nonetheless apply even if the UK left the EU and then eventually decided to stay a member of the single market. In other words, a small or even deep recession could ensue whatever post-EU path the UK decided to take. This is because there are three factors that could cause a recession: the uncertainty factor (people get scared), the transition factor (people make particular plans because of how they envisage life will be outside the EU) and the financial market factor (the City faces big trouble following Brexit). It turns out the uncertainty factor is one of the biggest elements- and that would apply whatever post-Brexit path the UK takes.

On the one hand, Leave campaigners will see this as a blow. People are generally unlikely to vote for economic pain, after all. However, there is a thin, albeit hollow and technical, silver lining for them, which goes as follows: if the UK leaves the EU, suffers a severe shock and then opts to remain a part of the single market, according to the Treasury’s own models it could actually grow faster for the following decade and a bit than it would had it simply stayed in the EU.

How does this work? Well, 1) let’s presume the UK had that severe shock and shrank by 6% between Q2 2016 and Q2 2018 compared with its path if the UK remained. 2) Assume, too, that the Treasury’s long-term assumption stands, that if the UK took the EEA route then by 2030 it would be 3.8% smaller than if it stayed in the EU. 3) In that case, the economy would need to recoup some of that lost ground in the following years. In rough terms, one might expect that between Q2 2018 and 2030 the UK economy could grow 2.2% faster than it would do if it stayed in the EU.

You can see the point from the line in the below chart, which compares how UK GDP would fare compared with its current expected path (the zero line). As you can probably tell, I jotted in the line myself:

In other words, on the basis of the Treasury models, the UK economy would be smaller in 2030 than if it stayed in the EU, but there would also be what Gerard Lyons, Boris Johnson’s economic advisor, has called a “Nike swoosh” effect as it regained some of that lost ground in the following years. What this means in practice is that the economy would grow ever so slightly faster between 2018 and 2030 than it would if the UK stayed in (perhaps 0.2 percentage points a year, which is pretty small in the grand scheme of things).

Moreover, it’s something of a Pyrrhic victory, since the growth comes from a smaller base and the UK economy would, on this basis, nonetheless be smaller in the long term than if it stayed inside. Plus, Treasury insiders say there’s also a significant chance that if the UK suffered a major recession in the first few post-EU years, then the 2030 end-point could be even worse than it thought in last month’s analysis.

Finally, you could, quite reasonably, retort that this is just proof that you can use an economic model to prove basically anything. Which is quite right. So why are we paying so much attention to them in the first place…? etc etc