The most telling chart from the Treasury’s Brexit report

What is the EU? Not all that long ago, we all knew the answer. These days, what constitutes Europe has disintegrated so dramatically that the beginnings and ends of Europe are extremely fuzzy. Consider the following chart from the Treasury’s Brexit report.


Look at where the UK is. Inside the European Union, outside the fiscal compact, outside the euro, outside the countries obliged to join the euro. And not all that far away from Norway and Iceland, which are technically outside the EU.

If I were a Leave campaigner I would make much of this chart. Not only does it show, quite viscerally, that the UK is clearly outside the centre of gravity in Europe, one might also quite reasonably ask how dramatic it would be if the UK were simply one ring further away from that euro core, sitting alongside Iceland and Norway.

Then again, the Remain camp might point out that the UK is already so semi-detached from Europe that, well, why make all the fuss?

Probably right, definitely not accurate. The Treasury on the impact on Brexit

Economics is an art masquerading as a science. Always has been, always will be.

An economic model looks complicated, full of factors and equations, but it is invariably balanced on a bunch of assumptions that are, if not plucked out of the air, then at the very least guesstimates. Art plus science equals economics.

The Treasury’s analysis of the impact of Brexit is a case in point. It is a well-researched, chunky piece of work. It has some of the best inverse gravity modelling known to man. It has many equations which look impenetrable and intimidating. It is shrouded in a cloak of science.


And yet underneath its surface there are a whole load of assumptions and guesstimates.


To understand how and why, consider how those big numbers above (for instance, the 6.2% hit to UK economic growth, £4,300 for each household, by 2030) were forged. It was a long-winded six-step process. By way of explanation, allow me to paraphrase the bottled Treasury argument.

  1. First, trade matters, really matters, to the economy: UK trade flows are now over 60% of gross domestic product. So any fall in trade would naturally impact UK economic growth. This is pretty uncontroversial.
  2. Under any of the three Brexit scenarios they’ve looked at (the UK becoming a. more like Norway, b. more like Canada, or c. more like Brazil/Russia in terms of its economic relationship with the EU) trade and foreign direct investment would fall. This is an assumption. A reasonable one, but an assumption all the same.
  3. If trade falls, so does productivity and with it the performance of the wider economy. Again, this is a reasonable assumption, but there is a question mark over how you model the extent of the impact. The Treasury used a load of academic research based on previous episodes of trade trauma, including the Suez crisis of the 1950s, when the canal was briefly closed, to model this.
  4. Then they plug that resulting number into a broader model of the world economy, supplied by the National Institute for Economic and Social Research.
  5. After that they lop an extra bit of growth off the UK economy to account for what they call the “persistence effect” – the permanent chunk of growth that goes as a result of business firms putting off investment, households cutting spending, because of the fear and shock of the departure. The “persistence effect” means in each of the scenarios modelled in the HMT paper the economy is 1% weaker by 2030. Quite why the effect is the same in every scenario is unclear. It is yet another guesstimate.
  6. Once the Treasury has this growth number, it puts it into its public finance models and calculates the impact on tax revenues and spending. Unsurprisingly, because the economy will be weaker, so will the public finances (to the tune of £36bn in the Canada scenario). Provided you believe the headline numbers, this is totally uncontroversial. What is a little more odd is that in each case, the Treasury has lopped off £7bn to account for the fact that the UK would no longer have to contribute to the EU budget. This is oddly imprecise, given that these scenarios imply totally different grades of relationship with the EU.

You get the idea. There is plenty of detailed, forensic analysis throughout this report. But there are also a fair few unscientific assumptions thrown in to boot.

There’s the presumption that migration won’t be affected at all in any of the scenarios. There’s the fact that the report gives short shrift to the idea that regulations might be cut if the UK leaves. There are those slightly unscientific touches, like assuming the change in contributions to the EU is the same in every scenario, and lopping a seemingly arbitrary extra 1% off the growth impact for each scenario as a result of the “persistence effect”.

Now, economists would reason that all of the above is simply what happens in economic exercises like this. The more specific you get in each case, the more hypothetical your modelling looks, and the easier it is for critics to pick apart, so perhaps better to apply the same numbers and assumptions to each scenario.

However, it underlines that this is not a purely scientific exercise. That £4,300 figure is the product of a cocktail of equations and assumptions, some precise, some unexpectedly crude.

But ‘twas ever thus. Any economic assessment of the impact of some unknown future event will have to incorporate many imponderables. And in broad terms, the Treasury has been relatively conservative. Its forecasts are more pessimistic than those from Oxford Economics, but less so than those from the London School of Economics. It has attempted to measure not just the impact on trade but also on the broader economy (a dynamic rather than a static projection). You can quibble to your heart’s content, but at least the Treasury has been open enough about its assumptions.

And if one takes the mass of evidence from economic analysts over the past few months, one overarching lesson is emerging from the statistical clouds. In most scenarios, the UK would probably be worse off in the event of Brexit. Whether that loss is a price worth paying for extra sovereignty is something the Leave camp must  confront. It seems increasingly difficult to argue that people would be better off in the event of the UK’s departure.

But to suppose that the Treasury is able to put a two-decimal place precision on the impact of departure is frankly a little silly. Not that that will stop them.

Why the Bank of England is closer to a cut than you might think

Watching the Bank of England is an exercise in what old Cold War hands used to call Kremlinology. Because Moscow never used to make open statements about its plans, the only way to get a sense of its future actions was to watch the smoke signals coming from the Kremlin, to look at the body language rather than the actions.

When it comes to the Bank of England, the best way to get a sense of its future actions is to run a fine toothcomb over the Monetary Policy Committee’s members’ comments to see which way they’re leaning. And it so happens there has been a subtle shift over the past few months – a shift most economists seem to have missed.

Remember that only a few months ago the Bank’s Governor declared that the next move in interest rates would be up, not down, and that all members of the MPC agreed on that. Then, in February’s Treasury Committee hearing, he subtly changed his position.

Now have a look at these two sentences, the first from the February MPC minutes:

The MPC judges it more likely than not that Bank Rate will need to increase over the forecast period to ensure inflation remains likely to return to the target in a sustainable fashion.

Now compare that with this one from the March minutes (emphasis mine):

The MPC’s best collective judgement is that it is more likely than not that Bank Rate will need to increase over the forecast period to ensure inflation returns to the target in a sustainable fashion.

In other words, the MPC is no longer unanimous that rates will go up over the forecast horizon.

To some extent, this is just a formalisation of what markets are already telling us. Not long ago they (and the Bank) were predicting rates were going up within months. Now they don’t expect an increase in borrowing costs at all, at least until 2021(!) Indeed, they think there is more chance of a cut than an increase.

My understanding is that at least two of the MPC members are strongly considering cutting rates, if wages and inflation do not pick up considerably in the coming months (a look through the cuts and it won’t take you long to guess which ones).

Smoke signals like this don’t seem to have been noticed very widely in markets, and yet the reality is that the MPC is closer than many think to being split on interest rates, with some members voting for a cut, rather than a rise.

All the same, there is a difference between considering a cut and actually doing it (a distinction which seems to have been lost on some day traders who got very excited when I tweeted words to that effect earlier today – and then very angry when the MPC did nothing). The latest minutes (which, significantly, repeat that latter line) hint that until the referendum is out of the way, the Committee is unlikely to do anything to rock the boat.

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But if the economy has not shown convincing signs of pick-up by July, the smoke signals from Threadneedle Street suggest that some members are poised to vote for a cut in rates.

The real story from the Panama Papers: tax havens are already imploding

Somerset Maugham once famously described Monaco as “a sunny place for shady people”. But the truth is that Monaco, along with most of the old, traditional tax havens, is no longer quite as shady. If you really want to hide money, no questions asked, the likelihood these days is you’ll end up somewhere like Panama.

The explanation tells you much about the state of the global tax havens business, a business which is under greater threat than ever before. To understand why, have a look at the enormous cache of documents leaked to the Sueddeutsche Zeitung (and analysed by members of the ICIJ) from Panamanian firm Mossack Fonseca.

For me, the most interesting nugget so far isn’t anything about any of the politicians and oligarchs concerned. It isn’t the proximity of Russian president Vladimir Putin to millions – possibly billions – of mysterious dollars. Nor is it the complexity of the companies these wealthy individuals use to hide their money, or the lengths to which they will go to scurry it away in different countries.

For the fact is that while it is truly fascinating to get this behind-the-scenes glimpse of how this shady branch of the offshore world works, the truth is we knew pretty much all of the above already.

The interesting story is the one told by this chart:

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Mossack Fonseca has been dramatically shutting down companies over the past five or six years. Remember that if you want to hide money away you will usually have to set up a shell company in which to put it. At its peak in 2005, MF was setting up 12,287 companies a year and deactivating 6,339. Last year it set up just 4,341 and deactivated 8,864. Since 2009 the number of companies being deactivated has dramatically outpaced the number being created.

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This is only one piece of evidence for a much broader phenomenon: the sharp, dramatic decline in the use of tax havens for shady purposes.

While we’re at it, there’s a real danger here of tarring everyone with the wrong brush. There are plenty of legitimate uses for offshore jurisdictions, both for individuals and for businesses. You might be a company with intellectual property which is really international and should not be rooted in any specific country, you could be a worker who gets their salary in one country and mostly lives in another, you could be worried about the financial stability, or the threat of a government coup, in the country you’re working, and so want to keep the money elsewhere. Though the offshore world is used by people avoiding and evading tax, and sometimes hiding money gotten through ill-gotten gains, that is not its purpose.

But the key point is that either way, there have been a whole range of measures introduced over the past five years or so which have, gradually, clamped down on tax havens, which help explain the decline in those charts. There are measures being pushed through the G20, there are rules being imposed by the OECD and, most of all (since in international treaties nothing much matters unless the US is involved), there is the FATCA regime imposed by Washington. Through a whole variety of levers – largely clamping down on secrecy over ownership and over sources of money – the ability of tax havens to shelter money altogether from tax authorities has been dramatically diminished.

Most offshore regimes have been pretty diligent in imposing these new rules, including Switzerland, the Channel Islands and even, to a lesser extent, British overseas territories such as the British Virgin Islands. The upshot is that it has become far, far more difficult to hide away money. Witness the FIFA scandal, witness the Petrobras scandal in Brazil, witness the Malaysian development fund scandal. The common factor is that money which might hitherto have remained hidden in Swiss bank accounts has now been upturned and exposed. Anyone wanting hide money away offshore will still, at some point, want to get their hands on that money, and that normally means channelling it back through UK or US banks, and here, too, banks have been forced to impose yet more checks on who owns the money and the companies.

However, when you talk to people in the offshore industry, they will tell you that there are still one or two countries which are resistant, which are doing everything they can not to impose these regulations. At the top of that list is Panama – though the interesting thing to note from today’s leaks is that even there, activity is starting to dry up.

Steeling ourselves for trouble

Here’s a nugget that goes at least some of the way towards explaining the current woes of the British steel industry: in the past two years alone China has produced more steel than the total cumulative output of the UK since the industrial revolution.

Or consider this: at today’s rate of production, it would take 68 years for Britain to generate the steel China churns out of its mills in a single year.

Take a moment to digest these facts, because you simply cannot understand the pressures faced by the British, or for that matter every country’s steel industry without considering China.

Steel is, of course the critical ingredient in modern manufacturing and construction. If you are making something – anything – the chances you will need steel to make it with, whether that’s a car, a rail line, a can of food or a skyscraper.

And to start with, China was a positive story for Britain’s steel industry. As it expanded over recent decades it initially didn’t produce enough steel of its own to satisfy its seemingly limitless domestic appetite for steel – from Chinese construction to Chinese cities desperate to expand, to Chinese manufacturers pumping out goods around the world.  It became an important destination for UK exports.

However, gradually the country has built its own steel industry – and what an industry. Since 1980 China has gone from producing 5% of the world’s steel to making more than half of it – just over 800m tonnes.

Now, with Chinese demand tailing off in the face of their own economic slowdown, that steel needs somewhere to go, and where it’s going is everywhere. The Chinese are accused of “dumping” that excess steel on global markets, selling it for less than it costs to make. As a result, the steel price has collapsed in recent years, wiping out margins for UK steel manufacturers and contributing to the industry’s recent problems. Making matters worse is the fact that thanks to EU emission rules, UK steelmakers face what they describe as punitive energy costs.

For an industry which cannot compete on price (even if some of the UK’s steel products are of a higher quality than many other producers) the inevitable result is closure.

Based on the above you might feel rather depressed about the industry’s prospects. However, there are at least some chinks of light (albeit rather faint). The most important is that China is starting to cut back its production. Last year Chinese steel output fell for the first time in a quarter of a century. Indeed, hopes that this reversal could continue have pushed the steel price higher in recent months, helping to repair margins. The EU is also pushing ahead with anti-dumping measures, increasing tariffs on steel imports from China although, say critics, nowhere near enough to offset the impact of China’s influx.

So there is still hope for UK steel. Over the past half century the industry has become a kind of economic football, nationalised by Labour in 1949, privatised by the Conservatives in 1952, nationalised by Labour in 1967, privatised by the Conservatives in 1987. So what happens next is anyone’s guess – though one would presume the Tories would be reluctant to do what Labour have done repeatedly and plough on with a nationalisation, temporary or otherwise. But it will be a tough decision.

A few decades ago the world’s steel market was comfortably dominated by one giant which produced about double what the US, the next biggest contender, did. That giant was the Soviet Union; after the Berlin Wall fell, so did its steel output, leaving more room for everyone else to compete. Remember that the economic backdrop is unpredictable – nowhere more so than for steel.