UK Poorer?

The commentary after the EU Referendum has moved into a consensus from economists claiming that “Brexit” will make the UK poorer. So we hear it from Paul Krugman:

Yes, Brexit will make Britain poorer

Krugman’s thoughts are also echoed by Simon-Wren Lewis. First SWL claims that:

Calculating the size of this effect is an exercise in trade economics not macroeconomics

I don’t understand this. Calculation is both an exercise in trade economics and macroeconomics. So in stock-flow consistent models of the open economy, you see such a thing. It’s both macroeconomics and trade. Trade is automatically incorporated in a macroeconomic model.

This is not just a minor point in semantics. In stock-flow-consistent models, one cannot avoid some parts and talk of the rest. One is forced to incorporate trade, not just in goods and services but also financial assets. Something which models which SWL uses isn’t sophisticated enough to handle.

Moving on, SWL claims that the UK’s exit from the EU makes the UK poorer. He says:

This decline in trade leads to a loss in productivity which makes UK citizens poorer over the medium term. It also means that the real value of sterling has to fall to make up for the fall in net exports. Other things being equal, this fall in sterling will happen immediately, as indeed it already has. This will make people poorer immediately, because imported goods cost more. But here the macroeconomics gets complicated. The hit to trade from leaving the single market will evolve gradually, but the fall in sterling is immediate. (The reason is something economists call UIP.) That means that trading firms might get a short term competitiveness boost, even though this will evaporate in the medium term. This may or may not be enough to compensate for the short term impact of rising prices on consumption spending.

Unfortunately that is not all that happens in the short term. Uncertainty about future arrangements will hold back investment, and it may also add to the depreciation in sterling. For this and other reasons the short term impact on aggregate demand is likely to be negative, although measuring its size is difficult. We then need to think about whether the MPC will raise or cut interest rates. The National Institute’s analysis is very readable on all this.

[underlying: mine]

So the claim that it will make the UK poorer. In effect, SWL’s model is telling him that real GDP will fall as well as real wealth as well fall in real household expenditure. There are several ways in which it happens. Productivity falls. Fall in productivity leads to a less than rapid increase in production. Consumer prices rising means lower real expenditure and so on.

Now, in Kaldorian story the causalities in the real story of actual economic dynamics are almost reverse than the ones presented above. Faced will less free trade, the UK government is less constrained to expand domestic demand and output. It can protect its manufacturing industry. Rising production leads to rising productivity, reverse of what is implied by SWL’s model. True, imported goods will be costlier, but it also reduces import penetration which allows domestic demand to be expanded and hence output and hence real national income and household income so that consumers are more than compensated for imports being made more expensive.

Of course, all this depends on whether the UK government reduces austerity and expands domestic demand. But some effects can be seen, although uncertain. This is because the foreign trade multiplier is improving and the fiscal policy multiplier improves, even if the fiscal stance is not changed. Higher wages if immigration is controlled also provides a boost to demand.

At any rate, the important point in this post is that the remain campaign’s economics is a model which is completely erroneous about causalities and how economies work.

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