If something sounds too good – or indeed too bad – to be true, it probably isn’t. That applies to statistics, even when they come from a source as ostensibly reliable as the former governor of the Bank of England. Unfortunately, though predictably, that wasn’t the reaction to Mark Carney’s recent claim that “in 2016 the British economy was 90 per cent the size of Germany’s. Now it is less than 70 per cent.” Rather, commentators seized on the claim as evidence of the disastrous economic consequences of Brexit, despite the fact it fails the most basic smell test. The idea that we have become more than 20 per cent poorer compared with Germany in six years just doesn’t make sense.
It’s not clear exactly where Carney’s numbers come from. His subsequent Twitter explanation appears to compare nominal growth (without adjusting for inflation) in Germany with real, inflation-adjusted growth in the UK – the sort of spreadsheet error all of us economists make occasionally. But the key point is that his view that the UK has hugely underperformed against Germany (and the EU and US too) is based on comparing the size of economies measured using market exchange rates; that is, translating the size of the UK economy into dollars or euros according to the exchange rate at the time.
In early 2016, the pound was unusually strong; now it is historically very weak. So, if you translate UK GDP into dollars or euros, it looks like the UK’s economy has performed very badly compared with Germany. This is misleading, because exchange rates move around a lot; indeed, over the past month, after the cancellation of the disastrous “mini-Budget”, the pound actually gained almost 10 per cent against the dollar. It’s self-evidently absurd to suggest that sacking Liz Truss has meant that we’ve suddenly become 10 per cent richer compared with the US.
Even leaving aside Mr Carney’s use of selective dates, this is simply the wrong way to compare the size of different economies over time. This is because, while exchange rates matter a lot for goods and services that are traded over borders, that’s not the case for those which aren’t. A barrel of oil or an iPhone is pretty much the same price (taxes aside) in different countries. A haircut, not so much. And when we compare the size of different economies, we are looking at how much we produce (and consume) of both.
That means that a fall in the pound, as after the Brexit referendum, does indeed make us poorer, because it means we can buy less oil and fewer iPhones. But a 10 per cent fall in the pound doesn’t mean we’re 10 per cent poorer overall, or anything close to that, because most of what we produce and consume isn’t traded at all (haircuts), so isn’t directly affected by the exchange rate. One credible estimate, for example, is that the sharp post-Brexit drop in sterling – roughly 10 per cent – cost us a little more than 1 per cent of our incomes.
If we can’t just convert everything to dollars, how do we decide if the UK has indeed underperformed Germany? We need a measure that reflects not just how much a pound buys of tradeable goods and services but of all goods and services in the economy, including those that aren’t traded. That’s what “purchasing power parity” (PPP) does, by comparing the cost of non-tradeable goods across countries, and constructing a measure of relative exchange rates that allows for this. Essentially, this is just a sophisticated version of the Economist’s famous “Big Mac index”, which does what it says on the tin – compares the price of Big Macs across countries to get a sense of what people can actually buy with their currency domestically as well as internationally.
Constructing a PPP index is complicated and involves quite a lot of judgement. But it gives results that are much more consistent with common sense. According to the World Bank – the most reliable source for this data – the UK’s economy is about 70 per cent the size of Germany’s, almost unchanged since 2016, although on a per capita basis we’ve fallen behind by perhaps 2 per cent. Indeed, as the chart below shows, the UK’s underperformance arguably owes rather more to austerity and George Osborne than to Brexit and David Cameron.
Mr Carney’s claim that Brexit has led to a 20 or 25 per cent relative shrinkage in the UK economy is nonsense. That doesn’t mean Brexit hasn’t had a measurable, and significant, impact. Nor that it won’t continue to be a drag on growth. My recent summary of the evidence shows that, exactly as economists predicted, introducing new trade barriers with our largest trading partner means we’re trading less. UK exports to the EU have now belatedly recovered to slightly above their pre-Covid level. But world trade has been booming; overall, the UK has done worse than almost all other advanced economies. A large part of this shortfall is likely due to Brexit. Despite the increasingly shrill voices of some ideologically committed Brexiteers, no serious economist disputes this.
It would be very surprising if this reduction in trade hadn’t reduced growth, and indeed John Springford, of the Centre for European Reform, estimates that if you look at the UK’s performance compared to a basket of “similar” countries, our growth shortfall is about 5 per cent. The Office for Budget Responsibility (OBR) has forecast that the long-term impact of Brexit will be to reduce GDP by about 4 per cent; of this, it estimates that 1.5 per cent has happened already. My own judgement is closer to that of the OBR’s – the damage so far is probably between 1 and 3 per cent, with more to come over time. There’s plenty of room for debate about the precise numbers. But overall, the evidence is clear. Brexit has damaged the UK economy, but it has not been a catastrophe; a slow puncture, not a car crash.