Trade and foreign direct investment‐related impacts of Brexit

María C Latorre,Zoryana Olekseyuk,Hidemichi Yonezawa

doi:10.1111/twec.12859

Abstract

AbstractWe offer a general‐equilibrium analysis of Brexit incorporating the state‐of‐the‐art differences in productivity and firms' selection within manufacturing sectors à la Melitz (Econometrica, 2003, 71, 1695) and multinationals in services. Our results suggest that trade, output and average productivity diminish across most sectors in the UK and the Rest of the European Union (REU), as well as GDP, welfare, wages and capital remuneration. However, the UK loses more due to the missing preferential access to the huge EU market. Significant welfare losses along the extensive margin occur in the UK due to the lost imported varieties produced by highly productive European firms. These cannot be compensated by the new varieties of less productive domestic firms that enter the British market due to increased protectionism and reduced import competition. In addition, the emergence of barriers against multinationals, which is often ignored in previous studies, explains approximately one third of the negative effect in both the UK and REU. Furthermore, we show that the Brexit impact is about only half if we do not include both foreign direct investment barriers and Melitz structure. Thus, previous studies without these important model features would underestimate the Brexit impact significantly.

Highlights

The potential impact of Brexit has attracted much attention since the referendum in 2016
We address the following questions in this paper: Which side (UK or EU) will be more harmed? Will the UK or EU be able to recover much of its lost trade after Brexit in other regions of the world? Who wins in that trade with third nations? What is the role of UK and European multinationals as well as multinationals in UK and EU?
Our results suggest that the UK experiences much more sizeable losses in its welfare, foreign trade, production, average industry productivity, wages and capital remuneration than the REST OF THE EUROPEAN UNION (REU) does

Summary

| INTRODUCTION

The potential impact of Brexit has attracted much attention since the referendum in 2016. We use a numerical simulation model with 21 sectors, 11 regions and 4 factors of production, which incorporates a Melitz (2003) structure in manufactures and foreign multinationals operating under imperfect competition in services. This combination has not been previously attained in a multiregional framework, to the best of our knowledge. 10 We model a Melitz structure in manufacturing sectors with the share of intraindustry trade over 60% of total trade following Olekseyuk and Balistreri (2018) This is the case for food, textiles, chemicals, metals, motor vehicles, other transport, electronics, other machinery, other manufactures and construction; that is, all manufacturing sectors except for wood and paper as well as other primary products. It is important to note, that after the initial assessment of barriers made by Ecorys (2009), Egger, Francois, Manchin, and Nelson (2015) have updated the estimations including even larger barriers to trade than the ones applied here, which tends to magnify the impact of the shock analysed

| RESULTS

| CONCLUSIONS

Findings

C33 Repair and installation of machinery and equipment