Short-Term Impact of Brexit on the United Kingdom's Export of Goods

The short-term impact of Brexit on goods exports is assessed using the Overall Trade Restrictiveness Index of the United Kingdom's major trading partners. The analysis shows that in the short run, leaving the European Union may cause the United Kingdom's exports to the European Union to decrease by 2 percent, and the prospect of a major trade collapse post-Brexit is unlikely. This is because the European Union's Most Favored Nation (MFN) tariffs are higher on products that are less responsive to tariffs, and lower on products that are more responsive to tariffs.


Introduction
On June 23, 2016, UK voters stunned the world by deciding to leave the EU. The news sent the British pound to a 30 year low, stock markets plummeted as much as 8 percent around the world, and David Cameron resigned as the Prime Minister. The vote result went against the advice of many experts. In fact, most economists thought that Brexit was a bad idea (see Baldwin, 2016). Some actually predicted a big short-term drop in trade and income per capita post-Brexit (see Dhingra, Ottaviano, Sampson and Van Reenen, 2016). More than a year has passed, contrary to these experts'advise, the exports of UK to the EU have in fact increased by 2 percent since July 2016. 1 While the full impact of Brexit is yet to show, particularly because the UK has not yet o¢ cially left the EU and thus currently still enjoys the tari¤ free access to the EU market, there are reasons to be optimistic even after the divorce is …nalized. This paper analyzes the short-term fallout of trade in goods from Brexit, through potential changes in the trade policies of its main trading partners. We construct the Overall Trade Restrictiveness Index (OTRI) of the UK's major trading partners. 2 Our analysis shows that in the absence of any trade agreement between the UK and the EU post-Brexit, facing the EU's Most Favored Nation (MFN) tari¤s could cause the UK's export of goods to the EU to drop by 2 percent. The impact is not larger because the higher tari¤s are placed on the less elastic products that the UK exports, while the lower tari¤s are placed on the more elastic products that the UK exports. The negative relationship between the MFN tari¤s and demand elasticity softens the potential collapse in the UK's exports of goods to the EU, in the event the UK and the EU fail to strike any trade agreement post-Brexit. We assume 1 Data source: Eurostat. 2 The OTRI was developed in Kee, Nicita, Olarreaga (2008 and 2009) based on the theoretical foundation of a series of seminal work by Anderson and Neary (1992, 1994, 1996, 2003and 2007 It should be noted that this paper will not talk about services trade, "passporting" and the role of London as a …nancial center post-Brexit, or immigration and the social aspect of Brexit. 3 It also will not speculate about the optimal timing to invoke Article 50 and "soft Brexit". Finally the long-run impact of Brexit could depend on whether the UK can continue to retain and attract foreign direct investment, which surely will shape the UK's exports for years to come, which is beyond the scope of the current paper. Recent …rm survey evidence from Bloom and Mizen (2017) suggests that while most …rms expect a negative impact of Brexit on sales, investment and costs, only larger …rms and those that are more exposed to international markets are likely to think that they might move part of their business abroad.
Thus, there are reasons to be optimistic post-Brexit.
The paper proceeds as follows. Section 2 brie ‡y describes the theoretical framework underpinning OTRI. Section 3 provides a data description for the paper. Section 4 presents the OTRI of the UK's major trading partners, while Section 5 concludes the paper.

Overall Trade Restrictiveness Index
The Overall Trade Restrictiveness Index (OTRI) summarizes the trade policies stance of a country. For a country, c; OTRI takes into account the trade responsiveness of all product n; " n;c , with respect to its trade policy, T n;c ; weighted by its total import, m n;c : OT RI c = P n m n;c " n;c T n;c P n m n;c " n;c : (1) 3 For the impact of Brexit on services trade, please refer to Mulabdic, Osnago and Ruta (2016).

Trade policy includes both tari¤s and the ad valorem equivalent (AVE) of non-tari¤ measures
(NTM). 4 The OTRI was …rst developed in Kee, Nicita and Olarreaga (hereafter, KNO, 2008KNO, , 2009), based on Feenstra's (1995) partial equilibrium simpli…cation of the theoretical framework of Anderson and Neary (1992, 1994, 1996, 2003and 2007. 5 5 Anderson and Neary's work focuses on general equilibrium feedback of tari¤s, Feenstra's simpli…cation focuses on partial equilibrium and ignores the substitution or income e¤ects of import demands when the tari¤ changes. partner country, p; is the weighted average of its bilateral trade policy, T n;c;p on all imported products, n; with their weights re ‡ect the size of their imports, m n;c;p ; as well as their respective bilateral import demand elasticity, " n;c;p : OT RI c;p = P n m n;c;p " n;c;p T n;c;p P n m n;c;p " n;c;p : For the relevant bilateral import demand elasticity, " n;c;p ; we will utilize the most recent estimates facing UK exports in these markets from Kee  4OT RI c;p = P n m n;c;p " n;c;p 4T n;c;p P n m n;c;p " n;c;p ; where bilateral imports will be kept at the current, pre-Brexit level to isolate the trade policy impacts on trade ‡ows. The total impact of trade due to potential trade policy changes will be 4m c;p = m c;p " c;p 4OT RI c;p ; with m c;p and " c;p measure the aggregate imports and import weighted trade elasticity of country c with respect to imports from partner p: We will use data on 2016 to calculate trade impact according to Eq (3) :

Data
Data used in this study come from UN-Comtrade for HS 6 digit-level import and export data, and UNCTAD TRAINS for tari¤ and NTM data. Most of the NTM data were collected around 2015/2016, so that determines the year coverage of the sample used in the analysis.    Table 3 presents the potential trade impact of Brexit in the short run, according to Eq (3). Here we assume that no new trade agreements will be signed between the UK and its partners, so the UK's exports will face MFN treatment in all markets. For the US and China, nothing will change in terms of tari¤s and NTMs, so the potential trade impact is zero. For the EU, moving from no tari¤ to MFN tari¤ will lead to the OTRI to increase to 0.93 percent, which may cause trade to decrease by almost 2 percent, which is equivalent to a loss of USD$3.14 billion. The short-term disruption in trade due to trade policy is likely to be small: the OTRI of the main partners are low, even after factoring in possible compliance costs of NTMs facing the UK exporters in these markets. 6 The bottom line is that, without any new trade deals, UK exports to the EU may drop by less than 2 percent, while UK exports to the US and China may not be a¤ected by Brexit in the short term, before any relocation adjustment of FDI.
It may be surprising that the short-run trade impact of Brexit is not larger. This is because OTRI can be decomposed into the sum of the import-weighted tari¤ (and AVEs) and the covariance between tari¤ (and AVEs) and import demand elasticity. 7 For the EU, the covariance between tari¤ and trade elasticity is negative, meaning higher tari¤s are placed 6 It should be noted that NTMs consist of many di¤erent areas, including standards conformity and assessment, certi…cation requirements and more. Currently UK …rms exporting to the EU satisfy all their NTMs requirements. We assume that there are no further compliance costs associated with the existing NTMs should the UK leave the EU. 7 Please see Kee (2007), which shows that OTRI equals import weighted average tari¤ and the import weighted covariance between tari¤ and trade elasticity. on less elastic products (such as Transport Equipment, Plastics, Foods and Apparels), while lower tari¤s are on the more elastic products (such as Pulp and Paper, Scienti…c Instruments, Precious Stones). This negative relationship between tari¤ and trade elasticity causes the EU's OTRI to be lower than its import-weighted average tari¤, which leads to a smaller trade impact in the short run.

Concluding Remarks
This note constructed the overall trade restrictiveness facing the UK's goods exports in its major markets. Based on new estimates on trade elasticity and the ad valorem equivalent of NTMs, we show that the overall short-run trade impact on the UK's goods trade due to Brexit is less than 2 percent. This result assumes that the UK will not have any preferential access to the EU market and all its products will enter the EU, the US and China on the Most Favored Nations (MFN) basis. This result also assumes that in the short-run, …rms and investments are not free to move across borders. The long-run consequences of Brexit most likely depend on whether the UK can continue to attract and retain its foreign direct investment.