Should Britain Exit the EU (Brexit?)

The PBS News Hour featured a segment tonight (above and here) asking whether "...the economic cost of Brexit is too great?" Brexit stands for BRitain EXiting the European Union. The United Kingdom European Union Membership Referendum will be held on June 23, 2016 to decide the issue.

In the video above, the News Hour presented an interesting debate held at the Oxford Union where heavy weight politicians made the case for and against Brexit. The arguments are interesting and well stated but seemed to be based on the idea that "since no one can know what will really happen," the issue must be resolved by debate. In the end, most of the students attending voted to stay in the EU.

The reason "no one can know the outcome" is that Brexit involves a counterfactual. No country has ever exited the EU and there is no historical experience that can be applied to decide what might happen if Britain did. As readers who follow Fact, Fiction and Forecast know, historical data can be applied to the question if you have models of both the British and the EU economies and if those models can be simulated under different conditions. The challenge is to choose those "different conditions" in a convincing manner.

Without going into a great deal of detail, two state models are available: UK20 and EU20. For the late 20th and early 21st century, the EU20 model is primarily being driven by the world system (outputs for the WL20 model) while the UK20 model is primarily being drive by outputs from the EU20 model. One might easily jump to the conclusion that since the UK20 model was primarily driven by the EU20 model, the logic of staying in the EU is obvious. However, the real counterfactual question is what will happen in the future.

To pose this question, I simulated the UK20 model being driven by the EU20 model and then simulated a version of the UK model with no inputs (the Go-it-Alone scenario). If the EU has been holding back the UK, this comparison would demonstrate the drag being placed on the UK by EU membership. Go-it-Alone is not the only possible strategy for the UK (I'll talk about that below) but these two models are actually the best models for the UK economic system when compared against a number of other competitors.

The graphic above is the attractor path simulation of UK GDP using the state of the EU20 model as input. The red dashed line is the attractor path. The green and red dashed lines are the 98% bootstrap prediction intervals. With a high degree of confidence, the model predicts that the British economy will peak sometime in the 2030s.

The next graphic above is a free simulation of the UK20 model starting in 1960 with no inputs (the Go-it-Alone scenario). In the alternate future, the EU economic system is predicted to peak in 2020 and decline rapidly after that. There is some probability that the economy might peak somewhat later in 2035 (the dashed green line), but there is a higher probability of significant decline after 2020. Also notice that the confidence intervals are wider meaning that this is a less precise prediction.

GDP isn't the only criterion measure we might look at (What about labor force issues? If you are interested, let me know). And, there are many other strategies Britain might choose after leaving the EU and Go-it-Alone is only one. Britain could choose to aline itself either with the US or with the entire World System, bypassing the EU. I have also estimated these alternative models and they are inferior to the ones presented above meaning that the prediction intervals would be even wider.

We will all have to wait for the referendum results on June 23, 2016 and then have to wait again for 2020, 2030, 2040 and 2050 to see what the future may hold. Myself and many of the "heavy weight politicians" who argued the case at the Oxford Union will no longer be alive to see the future that unfolds but many of the students will. Their intuitions, expressed in their votes, seems to favor staying in the EU (as does the counterfactual simulation, the fiction and the forecasts presented above).

EXTRA CREDIT

Assume that Britain stays in the EU.  There are people who now favor Brexit who will argue, at the first signs of slowing in the UK economy, that the reason is having chosen to stay in the EU. What will you say to them?

Was the EU Economy Wrecked by Austerity?

Yesterday, Paul Krugman wrote an interesting OP-ED piece in the NY Times (here) arguing essentially that the EU economy has been "...wrecked in the name of responsibility." Evidently, the EU economy is not recovering as fast as the US economy and economists are starting to ask why. For many years now, Paul Krugman has been arguing that Austerity policies designed to balance budgets during an economic downturn (such as the 2007-2008 Financial Crisis) are wrong-headed and irresponsible (the same argument John Maynard Keynes made during the Great Depression of the 1930s). The US followed the Keynesian prescriptions with the 2009 American Recovery and Investment Act and the EU followed the path of Austerity. The poor performance of the EU economy seems to vindicate Krugman's position.

The idea of imposing Austerity policies during an economic crisis has never made any sense to me especially when governments have long lists of underfunded infrastructure projects, people are out of work and interest rates are almost zero (a great time to invest). Krugman notes that the US economy does have a better set of automatic stabilizers (Social Security, Medicare and Food Stamps) than does the EU. Finally, the EU currency union without a political union has also never made sense to me and has seemed to tie the hands of particularly the peripheral countries in the EU. 

At the same time, using economic policy to return the  economy to its potential level of output also does not make sense to me. Does anyone really expect to return to a level of output that existed at the peak of an economic bubble? The graphic above plots real GDP for the EU countries (the black line). The dotted red line is the BAU (Business-As-Usual) attractor path for EU GDP. A comparison of the attractor path with actual GDP shows that the EU had been in a growth bubble since before 2000, well before the 2007-2008 Financial Crisis. In the late 1990's or in 2007, did economists really think that the bubble growth path (solid red lines with arrows at the end) could be continued into the future? I'm going to guess that some economists and financial analysts did expect the EU economy to continue on the red take off into sustained growth paths. The BAU attractor model, on the other hand, shows that the EU economy is right about where it should be after the bubble. To say the economic policy failed to return the EU economy to prosperity is wrong. 

What economic analysis is missing right now is models that would generate attractor paths. To say that the EU is performing poorly is to beg the question "Compared to what?". It's just not enough to argue casually that the EU should be growing as quickly as the US.  The EU and the US are separate economies with different internal dynamics and different attractor paths.