09 November 2021

The UK in a changing Europe: The Chancellor and Treasury need to re-engage with Brexit

 As her Chancellor, Philip Hammond, told us ‘.. there was never any doubt that the overwhelming majority of people in the Treasury saw a hard Brexit as an economic catastrophe, as did I – a potential economic catastrophe to be averted.’

Since her fall, the Treasury has ceased to be a player on the main Brexit stage. Michael Gove persuaded Sajid Javid to open the wallet to pay for no deal preparations.

His successor, Chancellor Rishi Sunak, said next to nothing about Brexit while the pandemic raged.

He has made some moves on divergence in financial services, to make up ground lost by the EU’s refusal to grant equivalence.

He has tweaked some taxes: VAT on sanitary products, a symbolic move on tonnage tax, a much criticised move on domestic air passenger duty, and a sensible proposal to reform alcohol duties. But as far as Brexit Budget rabbits go, these are definitely dwarfs.

Meanwhile, and in contradiction of his own official forecasts, which share the scepticism of the economics profession about their value, he continues to promote freeports as a benefit to the UK economy. They may be a political winner, but the OBR thinks their impact is to relocate not reinvigorate economic activity.

Since taking office, Sunak has focused on the pandemic and sought to leave Brexit to the twin command of the Prime Minister and Lord Frost. Brexit would be Brexit, and the economy would have to adjust to whatever they decided Brexit meant.

The OBR has now confirmed that the Brexit chosen by the government will double the long run scarring effect on the UK economy of Covid: GDP will be permanently lowered by four per cent by putting up trade barriers with the EU.

This is pretty much the view the OBR has taken for some time – that reduced inward migration and ‘trade intensity’ (aka trading less) would exact a price in terms of UK economic performance, and thus living standards.

The Chancellor, when given the chance to comment on the OBR view at the Treasury select committee last week, said it was an ‘old number’ which had been taken into account in his Budgets. He did not seek to challenge it.

But it is still just a forecast, and assumes that the Trade and Cooperation Agreement stays in place and the economy begins to adapt to a future of more burdensome trading with the EU and reduced migration flows.

It did not take into account the possibility of a dramatic worsening of the UK’s trading relationship with the EU.

That seems to be on the cards as both sides unsheathe their sabres over the future of the Northern Ireland protocol (with a side helping of French fishing licenses).

The more talk about the possibility of ‘triggering Article 16’, and the more about potential retaliation from the EU – either surgical or nuclear – the less the Trade and Cooperation Agreement looks like a stable basis for trade and future investment.

Business last year was desperate for the stability provided by a deal. It got to a stage where any deal, however thin, would do. There was a vain hope that that skinny deal might be built on in the future. But rather than regard the deal as a hasty fix to be built on, the risks now are that it turns out to be a high point in the post-Brexit relationship.

That means that businesses have to anticipate more aggravation as they seek to supply EU markets from Great Britain.

It means that the prospect of tariffs on trade lurks on.

That makes Great Britain a less attractive destination for foreign investment.

It means that domestic firms may think twice about supplying the EU from a British base.

And it may make the UK a less attractive destination for the talented, highly skilled ‘best and brightest’ the UK is keen to lure here under its global migration scheme – and will make it harder, not easier to fill labour market gaps caused by the ending of free movement.

All that suggests that a future where the Trade and Cooperation Agreement repeatedly hangs by a thread is likely to be a more economically precarious future than one where both sides are clearly committed to making it work. And if it was the latter assumption that underpinned the OBR’s assessment of its economic impact, the more the former is a downside risk.

The Treasury has a big interest in avoiding that downside risk.

The Chancellor’s Budget task was eased tremendously by the OBR assuming that Covid-19 had less long term impact than it first assumed. The difference between three per cent ‘scarring’ and two per cent, along with a lot of fiscal drag, allowed the Chancellor to be much more generous on public spending than anticipated by outsiders.

But that bonus could disappear if trade relations with the EU get worse and if the TCA collapses. In the economic analysis published in November 2018, government analysts thought that ‘no deal’ would knock 2.7 percentage points off GDP compared to an ‘average FTA’. It is that margin that is now back in play with talk of trade wars.

The Chancellor sits on the grandly renamed Global Britain (Strategy) Committee. He needs to use that seat to make sure that that strategy takes into account the consequences for the economy, public finances, living standards and the government’s future reelection prospects.

Tough Brexit talk may win votes. But tough Brexit outcomes could cost jobs and squeeze living standards.

The Treasury cannot afford to continue to spectate from the stands.

By Jill Rutter, Senior Research Fellow at UK in a Changing Europe.

The UK in a changing Europe

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