The Treasury warns of a “do-it-yourself” recession after a Brexit vote

THE government’s strategy for winning the referendum on Britain’s membership of the European Union has long been to focus on the risk that Brexit poses to the economy. A month ago George Osborne, the chancellor, published a long-term Treasury study which came up with a “central case” estimate that leaving the EU would make Britain’s GDP 6% smaller by 2030 than remaining would—a figure that he translated into an annual cost of £4,300 ($6,200) per household. Brexiteers sneered that Treasury forecasts were usually wrong and also pointed to the huge uncertainty in any attempt to look 15 years ahead.

Now Mr Osborne has fired a second shot at his opponents, with a Treasury paper on the short-term impact of Brexit that is, if anything, even gloomier. This new study considers three factors that it calls a transition effect, an uncertainty effect and a financial-conditions effect. Adding the three together, and assuming that Britain strikes a free-trade deal with the rest of the EU, the Treasury analysis concludes with two possible outcomes a year after a Brexit vote, compared with its baseline forecast. The first, a “shock scenario”, would see GDP fall by 3.6%, unemployment increase by 520,000, sterling depreciate by 12% and inflation rise by 2.3 percentage points. The second, a “severe shock scenario”, has GDP falling by 6%, unemployment increasing by 820,000, the pound falling by 15% and inflation rising by 2.7 percentage points.

Both scenarios predict what Mr Osborne is calling a “do-it-yourself” recession. Both also predict a fall in asset prices, including house prices. As the Treasury points out, it is not the first body to forecast a recession after a Brexit vote. The governor of the Bank of England, Mark Carney, has spoken of a “technical recession”. And the managing director of the IMF, Christine Lagarde, has said she shares the view that a vote to leave the EU “could lead to a recession”. Many other international bodies, including the OECD, a rich-country think-tank, and independent forecasters like the National Institute for Economic and Social Research, share the view that Brexit would seriously damage the British economy.

Brexiteers have reacted furiously to Mr Osborne’s latest salvo. Iain Duncan Smith, a former work and pensions secretary, said nobody should believe it. Boris Johnson, a former mayor of London, called the study “more propaganda”. Lord Lawson, a former chancellor, accused Mr Osborne of trying to “scare the pants” off voters. Meanwhile Patrick Minford, a leading member of the Economists for Britain group, said the Treasury was ignoring the potential upside from saving Britain’s EU budget contribution, scrapping EU red tape and unilaterally abolishing all tariff barriers.

Yet most economists, even on the Leave side, accept that a vote for Brexit would create huge uncertainty that would be likely to have a short-term cost. Gerard Lyons, a former economic adviser to Mr Johnson, has coined the idea of a “Nike swoosh”, under which the immediate impact of Brexit is a hit to GDP, but this is then followed by a large uptick when favourable trade deals are done and the benefits of less EU regulation kick in. Other Brexiteers have simply conceded that the economic impact will be negative, but argue that this would be a price worth paying to regain sovereignty and the ability to control immigration.

The Treasury numbers may indeed be wrong, as could its earlier figures for the long-term effects of Brexit. But there is a risk that they could also turn out to be too optimistic. The assumption of a free-trade deal with the EU within two years looks heroic given the normal pace of trade talks and the fact that other EU countries will not want to be kind to a post-Brexit Britain. And a current-account deficit running at a record 7% of GDP makes Britain exceptionally vulnerable to a loss of confidence in international financial markets.

Indeed, another concern over the Treasury’s analysis of the costs of Brexit is not that it is all propaganda or that the numbers may be exaggerated. It is that, if the government believes its own predictions, it was the utmost folly to risk calling a referendum in the first place. The real irony in the Treasury forecasts is that, if Brexit were to hit GDP, employment and sterling as hard as the report suggests, it could inadvertently deliver one of its advocates’ biggest dreams: a big reduction in immigration as the economy tanks.