How exactly could a no-deal Brexit be more economically damaging than the Covid slump?

The UK economy plunged by around a quarter during the first half of this year as the pandemic and lockdown crushed activity on a historically unprecedented scale.  

Growth over 2020 as a whole is expected to be around minus 10 per cent, easily the worst performance on modern record.

It’s hard to imagine how anything could be worse than this for the economy. 

But the Bank of England governor, Andrew Bailey, appearing before MPs on the Treasury Select Committee on Monday, suggested that something could be: a no-deal Brexit.  

But how is this possible? There aren’t any forecasters projecting that a no-deal Brexit in the new year will immediately wipe out 25 per cent of the economy. 

So how could this be worse than the Covid crisis? 

The answer is to think about time. “The long-term effects, I think, would be larger than the long-term effects of Covid,” Mr Bailey told the committee. The key words here are “long term”.

The Covid shock has undoubtedly been huge. But most of that damage is expected to be repaired over the coming years. The economy has already recovered around half of the activity lost earlier in the year as businesses and schools have reopened and people have returned to work.

The statistics will probably show a relapse into contraction in the final quarter of the year due to the November lockdown.  

But it won’t be as severe as the first slump because it has been shorter and more firms have remained trading this time around. And when the restrictions are lifted there should be the same sharp uptick in activity as we saw in the summer.

When we’re talking about the economic damage from the Covid crisis we can look at the short-term impact or the long-term impact. The short-term impact has, as mentioned, been vast.  

But the long-term impact will depend on the degree of economic “scarring” inflicted on workers and firms.  

A spike in unemployment and business bankruptcies will diminish the skills of some workers. And lower investment by companies in the crisis due to the pervasive uncertainty this year is likely to reduce our productivity growth relative to otherwise.

The scarring situation is looking worse than many hoped earlier in the year when there was talk of a V-shaped recovery. The virus, as we know, returned, hampering consumer confidence and business investment.  

The Bank of England estimated this month that scarring will leave the economy around 1.75 per cent smaller by 2023 than it otherwise would have been.

But what will be the long-term impact of a no-deal Brexit, one where the government fails to conclude a free trade deal with the rest of the European Union? 

This has been a question many economic modellers have analysed over the past four years. And they have almost all concluded that additional trade barriers between the UK and the bloc with which we do around half of our trade will be negative for the UK’s economic growth prospects.

The government’s own modellers concluded that a no-deal Brexit would create a roughly 7.5 per cent hit to UK GDP relative to staying in the EU over the next 15 or so years.

Some of this damage might have already been inflicted, as a result of lower investment since the referendum and the fall in sterling.  

But if we assume that this damage begins to occur gradually from this year and then compare that to the long-term damage from the Covid shock, it becomes clear that the harm from a no-deal Brexit does indeed gradually eclipse that of the pandemic.

Thomas Sampson, an economist at the independent UK in a Changing Europe think tank and the London School of Economics, points out that even if we discount the long-term damage from Brexit because those losses won’t be felt until further in the future, the present value of Covid losses is still lower than from a no-deal Brexit.

Some might, at this stage, argue that this analysis is incomplete because it doesn’t allow for the fact that Brexit will enable to do new trade deals with other countries such as the US and Australia.

But all the credible analysis, even that produced by the government, suggests such trade deals will not make any appreciable difference to the overall picture because tariffs with these countries are already quite low and it’s not plausible to imagine that we will do vastly higher levels of trade with them.

Yet this analysis is incomplete in another sense. The modelling of Brexit shows that even an EU free trade deal, which the government is solely aiming for, will damage the UK economy relative to remaining in the single market and customs union.

The government’s own model suggests this will do long-term damage worth 4.5 per cent of GDP, which in itself would be bigger than the long-term damage from Covid.

That means the bank’s governor could quite realistically have argued that Brexit, full stop, never mind a no-deal Brexit, will do more long-term damage than the pandemic.