A bit of proper economics

Gravity modelling is Newtonian physics adapted for economic forecasting. Just as the attraction between two heavenly bodies is directly proportional to their masses and inversely proportional to the distance between them, so the volume of trade and the amount of foreign direct investment between two countries depends on how big and how geographically close they are.

Using this approach, the Treasury says there would be a 43% loss of trade with the EU were the UK to revert to WTO rules, and because almost half the UK’s trade is with the EU this would result in a 24% loss in total trade. The assumption is that there has been a 76% increase in UK trade as a result of membership of the EU and that all of these gains would be lost. There would be no gains in trade with non-EU countries to compensate for the loss.

The gravity model is the standard trade model. And I don’t think it’s right. As in an email I’ve just sent:

Small thought about the gravity model of trade.

Historically geographic closeness might have made sense as a measure. At some time that is. But if we cast further back not so much. Say, just to invent an example, trade over the Pennines was at one time much smaller than trade over the Irish Sea. Ship and river transport was much more important than road (there were no roads).

Or coal from Newcastle to London by ship but near nothing from Newcastle to Carlisle.

The gravity model should thus be tweaked to measure economic geography, which methods of transport are in use? Or, how close is somewhere in travel days, not miles? Travel cost perhaps not miles.

At which point much more makes sense. The container network will move 30 tonnes of anything anywhere for under $5,000 these days. Geographic proximity, what that gravity model assumes, is rather less important.

In fact, transport costs between Birmingham and Barcelona, Birmingham and Birmingham AL and Birmingham and Brisbane are not notably different these days.

Gravity as measured by trade costs rather than geography would make much, much, more sense.

36 comments on “A bit of proper economics

  1. Who at the Treasury says this?

    The same Remainiac punks who did Nobsbourne’s sums for him?

    Sack the Senior Civil Service en masse NOW. Sans any compo and with their pensions confiscated.

  2. So the gravity model takes no account of weightless exports, like a software download or a professional opinion? Y’know, the interwebs thingy?

  3. You would also need to factor in time (for anything perishable) and some element of culture/language – much easier to do business with a company whose employees share your languages and cultural references, without needing interpreters

  4. Another thought on the dire Brexit predictions. If EU external tariffs are kn ever age only 3 % then why are worrying customs unions and single markets at all? Shouldn’t we just thank the world’s economist’s for talking our currency down and our exports up?

  5. That Osborne did NOT sack the core of Brown’s Treasury, and put a properly Conservative Treasury in its place, should never be forgiven. Cameron’s money measures are indistinguishable from the stealth model so beloved of the evil Broon.

    And now, after nearly 20 years of that twin evil, all of us are paying 43.6 % of our monies to the state. Totally unsustainable, and the reason for all the striking discontent now flourishing.

  6. Theo,

    “So the gravity model takes no account of weightless exports, like a software download or a professional opinion? Y’know, the interwebs thingy?”

    I was selling my professional opinion worldwide long before the Internet took off. It did make it a lot easier, though.

    Nothings changed much, politicians, especially the lefty variety, only count stuff that breaks your foot when you drop it as being worthwhile exports, and statisticians and economists have always had difficulty valuing service exports so no change there.

    Flatcap Army,

    “You would also need to factor in time (for anything perishable) and some element of culture/language – much easier to do business with a company whose employees share your languages and cultural references, without needing interpreters”

    And our comparative advantage is that most of the world speaks English as a first or 2nd language and despite what the SJWs would have us believe we are all quite tolerant and understanding of different cultures when we do business overseas. Another reason why we can make a better success of Brexit than Remainers give us credit for.

  7. Wrinkly: They have enough trouble with ordinary calculus, how do you think they’d do with tensors?

  8. Wren-Lewis seems particularly obsessed with geographical closeness to the exclusion of all other factors. No wonder his Bremoaniac wailings are so funny to read.

  9. Wait a sec, “almost half the UK’s trade is with the EU this would result in a 24% loss in total trade”??

    It’s only exports to EU that are at issue, and I thought that was only approx 13% of UK economy. Surely imports would not be affected if we chose not to impose tariffs?

  10. There is also the ‘Rotterdam Effect’. A not insignificant portion of UK exports to the EU is simply destined for the Port of Rotterdam for re-export. In 2014 the ONS estimated that adjusting for this would reduce UK exports to the EU by at least 5% of total exports.

  11. There’s a further fillip to the Rotterdam Effect- the EU’s shipping MRV regs come into full effect this year and next, and require declaration of data shipping companies are very wary of releasing. If the UK (outside Europe) waives MRV compliance, a lot of ships will berth in the U.K. And transship cargo to road/rail for onward journeys to the EU.

    MRV is the precursor to carbon taxes on shipping, and if these market-based measures follow promptly, the U.K. Will have a huge competitive advantage against EU ports.

    (Note- the IMO’s DCS doesn’t substantially worry ship owners as the data required is less specific and aggregated over a fleet, and it shouldn’t lead to a Rotterdam effect- style distortion)

  12. I’m not familiar with these models.

    I note over at Forbes someone has followed up to say the coefficient is growing over time.

    But the coefficients can still all be large and significant and still have a large error term.

    That it is, miles might explain a large amount of the variance in traded amounts, but a large amount of variance might yet remain unexplained. (It depends what the other variables are in the model of course)

    This is what gives rise to prediction intervals, which didn’t seem to feature prominently in the Treasury document.

    Moreover, just because an equation is moderately good at explaining currently existing patterns of trade, doesn’t mean it is useful for explaining the patterns of trade after a structural break. We don’t have any precedents for Brexit, and saying that it will just be the same as if we never joined is probably bogus.

  13. @Ironman “If EU external tariffs are kn ever age only 3 % then why are worrying customs unions and single markets at all?”

    Because that’s the average (think its closer to 4%) tariff on goods we export to the EU (aircraft parts, pharma, chemicals). The external tariff on goods they export to us (food, cars, household products) are much higher.

    Back on the gravity model, can the Treasury please explain how Brexit changes the size of the UK & EU economies or why it increases the geographical distance between the UK and the EU?

  14. “Just as the attraction between two heavenly bodies is directly proportional to their masses and inversely proportional to the distance between them”

    No. It’s inversely proportional to the square of the distance between them.

  15. It’s so cute when economists do this sort of thing, like a toddler getting into Mummy’s lipstick and tottering round in her shoes pretending to be a grownup. “Gravity modelling”. Oh my sides.

  16. The Treasury is a tad behind the times.

    Newtonian gravity model relates to non-relativistic speeds and low gravitational fields, and was the ‘consensus’ for some time until along came Einstein with his theory of relativity.

    This expanded the range of physical conditions over which the Newtonian theory applied. Special relativity extended the range to include high speeds: general relativity extended it to include high gravitational fields.

    The Treasury then is using an incomplete model – as you imply – which leaves out the notion that distance is ‘relative’ (if you will) to speed/cost of transportation, volume that can be transported and of course Internet.

    Adding ‘relativity’, a mile becomes a few yards… relatively speaking.

    Is this the same Treasury that predicted falling skies post Brexit?

  17. Hmm.

    Physics is a science. Yes
    Economics is a science. No
    An anology is science. No
    If we steal some science from physics and use an analogy to graft it on to some economics, we have scientific economics. No

  18. Meanwhile the Euro is causing big problems in Germany.

    It’s pretty clear that the EU will be in flux for years. Was that factored in?

  19. almost half the UK’s trade is with the EU

    Are they perhaps using “UK’s trade” to mean “UK’s exports”? Because there’s just no way that’s true if you understand “UK’s trade” to include British people buying British stuff in Britain — which of course it does.

  20. Has anyone read to the end of the Grauniad article? I can understand if you all quit after one paragraph because the Grauniad habitually makes you want to throw up, but it amazingly has some sensible comments later such as “Using different but still relatively pessimistic assumptions, the Cambridge study says the loss peaks at 3% of GDP early in the 2020s. The loss of GDP per head is smaller – never much more than 1% – and soon recovers.”
    “The Treasury says” is just bad grammar – the author is quoting the April report that was part of “Project Fear”

  21. @ S2
    “UK’s trade” is habitually (albeit non-pendantically) used to mean “international trade by the UK with foreign countries (other than the Channel Islands and Isle of Man), both imports and exports.
    “Trade within the UK” is treated separately.
    So, of course you are right, but most of us are so acclimatised to the phrase that we don’t notice.

  22. 77,

    I would argue that, in the context at hand, using the phrase in that way is extremely misleading. I’m sure there are plenty of voters out there who read that leaving the EU could put half of the UK’s trade at risk and were very reasonably extremely worried.

  23. “I’m sure there are plenty of voters out there who read that leaving the EU could put half of the UK’s trade at risk and were very reasonably extremely worried.”

    The useage john77 describes has been traditional in BBC broadcasts for at least the last 50 years, so I don’t think many will have been worried.

  24. I can see the logic that distance is a significant factor for our continental cousins. One might expect (other things being equal, which they rarely are) that Germany would have more trade with France than Spain and more with Poland than Ukraine, because it costs more to shift physical stuff the extra kms.

    But for the UK, physical exports go mostly by sea. And once a container is loaded onto a ship at Felixstowe, it doesn’t cost that much more to send it to New York or Shanghai than it does to Rotterdam – at least, the differential is significantly less than for land transport.

  25. @Alan Douglas, January 9, 2017 at 9:51 am
    “That Osborne did NOT sack the core of Brown’s Treasury, and put a properly Conservative Treasury in its place, should never be forgiven. Cameron’s money measures are indistinguishable from the stealth model so beloved of the evil Broon.

    And now, after nearly 20 years of that twin evil, all of us are paying 43.6 % of our monies to the state. Totally unsustainable, and the reason for all the striking discontent now flourishing.”

    +1

    Cameron/Osborne were indistinguishable from Blair/Brown and equally in love with socialism.

    Key statement from Osborne in 2010 – I do not intend to be remembered as a tax cutting chancellor.

    BluLab traitors who conned the electorate

  26. For some reason, my comments are no longer allowed. At the height of the referendum, the Treasury issued a chart showing that UK exports to non EU were higher than to EU. And the trend was diverging. So let us continue to suck up EU imports as long as they are priced right. The international trade models are as good as the GCMs used by climate idiots.

  27. Amazingly, of the 27 Euro nations, there are not many targets for UK exports. Who would have guessed? Obviously not Luis Enrique, Paul Krugman, Simon Wren-Baxter, etc. The clue could be that there are Eastern European emerging market funds, who invest in maybe half of the 27

  28. Gravity modelling is how transport modelling traditionally worked.

    Its nonsense because it doesn’t allow for dynamice changes – i.e. behavioural change due to other things change.

    I can see why its probably flawed for trade modelling too.

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