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Is the UK about to become Canada?

Summary:
Overall, I believe the EU has had a positive effect on Europe. Unfortunately, it has become too interventionist in some areas, especially when imposing regulations that are better left to national or local governments. At the same time, in many other areas it has not gone nearly far enough, especially in terms of creating a free trade zone in services. The UK is likely to leave the EU in the near future and there are indications that it may adopt a relationship that is roughly like the relationship between Canada and the US: What really matters is that Mr Johnson is seeking a goods-only or “Canada minus” deal for the rest of the UK.                              This will involve only minimal coverage of services, they write. “It will also involve significant

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Overall, I believe the EU has had a positive effect on Europe. Unfortunately, it has become too interventionist in some areas, especially when imposing regulations that are better left to national or local governments. At the same time, in many other areas it has not gone nearly far enough, especially in terms of creating a free trade zone in services.

The UK is likely to leave the EU in the near future and there are indications that it may adopt a relationship that is roughly like the relationship between Canada and the US:

What really matters is that Mr Johnson is seeking a goods-only or “Canada minus” deal for the rest of the UK.                             

This will involve only minimal coverage of services, they write. “It will also involve significant non-tariff barriers on trade”, because there will be extra costs for business as the UK operates its own customs regime. 

This means the Johnson deal is far worse for the economy than Theresa May’s. Menon and Portes calculate that, under the May deal, income per capita would have been 1.7 per cent lower than under continued EU membership.

The equivalent figure for the Johnson deal is 2.5 per cent lower while that for a no-deal Brexit is 3.3 per cent.

I believe “Canada minus” refers to Canada’s new free trade agreement with the EU, not Nafta, but what interests me is that a “goods only” relationship is similar to what Canada has with the US.  If this distinction is confusing, consider the difference between shipping goods from Belgium to France, vs. Ontario to Michigan.  Both are free trade zones.  But unlike in the EU, you have to go through customs at the US/Canada border.

Generally, when I see those loss estimates from an opponent of a policy I take them with a grain of salt.  Industry is surprisingly adaptive; for instance, the cost of environmental regulations is often less than first estimated.  Perhaps the same is true of trade disruption. 

So the 2.5% of GDP loss estimate may be too high. On the other hand, consider that Canada’s per capita GDP is more than 20% lower than in the US.  It’s not obvious to me why this is the case.  Consider some hypotheses:

1. Natural resources?  Nope; Canada has more in per capita terms.

2. Ethnic mix?  In America, whites and Asians earn considerably more than blacks, Hispanics, and Native Americans.  Canada has a smaller share of its population in the lower earning ethnic groups.

3.  Lack of free markets?  Canada is 1.2% freer in the Heritage ranking of economic freedom, while the US is 1.4% freer in the Cato ranking. Average the two rankings and they are virtually identical.

4.  Big government?  Canada’s government is a bit bigger as a share of GDP (sources differ on the precise figures) but not dramatically bigger.

You can quibble about my comparisons, but the US/Canada income gap of more than 20% is really large.  Think about how British Columbia is sort of like Washington State.  Or how Toronto is sort of like Chicago.  Or how Alberta is sort of like Texas, or how Saskatchewan is sort of like the Dakotas, or how New Brunswick is sort of like Maine, or how Canada’s north is sort of like Alaska.  If there were no boundary line at the 49th parallel, wouldn’t you expect Canada to be as roughly rich as the US?  Maybe even bit richer, given that the northern US (which Canada most resembles) is a bit richer than the South. Thus I’m not so sure the 2.5% Brexit loss estimate is too high. 

You might wonder why I don’t come up with an even larger estimate, based on the US/Canada income gap.  However, even with all the success of the EU, Europe remains far less integrated than the US economy.  A few weeks back, The Economist had a nice set of stories on the sad decline of the European economy:

A decade ago ten of the world’s 40 largest listed firms by market value were based in the eu; now only two are—in 32nd and 36th place.

This is because Europe doesn’t yet have a single market in services:

European companies selling goods can make use of the single market, reaching scale and so profitability quickly. They have an edge over those that sell services. Partly as a result, Europe is a continent of goods companies. Fully 21 of the eu’s 25 biggest listed firms supply goods, including cars, make-up, alcohol and planes. Two decades ago the same was true in America—where now 17 of the 25 biggest companies provide services such as software, data plans and bank accounts.

This matters: services companies are, on the whole, more productive than those making goods. That usually translates into higher salaries for their employees. Services companies spring up quickly. America’s five biggest companies are tech giants mainly focused on services (and gadgets, in the case of Apple) with an average age of just 30, worth $4.3trn between them, 35 times last year’s profits. Europe’s biggest firms all existed in one form or another a century ago—think of Unilever and Royal Dutch Shell. Combined, they are worth under $1trn, about 23 times last year’s profits.

The UK’s GDP won’t fall by 20% because they start from a position less well integrated into a continental size market than the US.  They are already poorer than Canada.

Will we ever know the effect of Brexit?  Probably not, but in my view the best estimate will be as follows:  Right now, the UK and France are amazingly similar countries in two respects.  The have almost identical populations and almost identical GDP/person in PPP terms (based on IMF or CIA estimates, the World Bank has a small difference).  Both countries have been growing slowly in recent years.  If nothing dramatic happens to public policy in France (which is a politically stable country), it may represent our best way of measuring the effect of Brexit on the UK. 

If the UK’s GDP/person is still roughly even with France in 10 years, then Brexit probably won’t have hurt.  If it’s 2.5% behind, then the Financial Times will likely be correct.  In my view, either outcome is plausible.  If forced to offer an opinion, I’d guess the UK will be 1.5% behind in 10 years, if the rumored Boris Johnson proposal is adopted.  Somebody needs to remind me of this prediction if I’m still alive at age 74!

Is the UK about to become Canada?

Scott Sumner
Scott B. Sumner is Research Fellow at the Independent Institute, the Director of the Program on Monetary Policy at the Mercatus Center at George Mason University and an economist who teaches at Bentley University in Waltham, Massachusetts. His economics blog, The Money Illusion, popularized the idea of nominal GDP targeting, which says that the Fed should target nominal GDP—i.e., real GDP growth plus the rate of inflation—to better "induce the correct level of business investment". In May 2012, Chicago Fed President Charles L. Evans became the first sitting member of the Federal Open Market Committee (FOMC) to endorse the idea.

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