An examination of EU trade disintegration scenarios

• Date: 01 January 2021
• Author: Oleksandr Shepotylo,Karen Jackson
• DOI: http://doi.org/10.1111/twec.13049
• Published date: 01 January 2021

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wileyonlinelibrary.com/journal/twec World Econ. 2021;44:2–20.

© 2020 John Wiley & Sons Ltd

Received: 2 April 2020

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Revised: 9 September 2020

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Accepted: 25 September 2020

DOI: 10.1111/twec.13049

ORIGINAL ARTICLE

An examination of EU trade disintegration scenarios

KarenJackson1

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OleksandrShepotylo2

1Westminster Business School, University of Westminster, London, UK

2Aston Business School, Aston University, Birmingham, UK

KEYWORDS

Brexit, EU, gravity model, trade policy

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INTRODUCTION

Understanding the costs of Brexit is important not only for the ongoing negotiations of the future

trade arrangements between the EU and UK, but also for EU members to evaluate the consequences

of other countries leaving the EU. There is relatively less known about this process compared to in-

tegration. Historically, there are a few notable examples such as the dissolution of empires and the

Soviet block collapse (Fidrmuc & Fidrmuc,2003; Head et al.,2010; Suesse, 2018). However, the

situation in the EU is somewhat different, where some countries have been able to negotiate opt-

outs that have already created variability in integration across the EU. The recent Brexit negotiations

have highlighted the potential to exacerbate this situation, with the UK seeking a special individual

arrangement to disintegrate it further from the EU (Schimmelfennig,2018). In the context of Brexit,

the literature has tended to focus on the impact for the UK, and where it does consider the impact on

the EU-27, it is typically used to provide a benchmark for the estimated UK welfare losses (Dhingra

etal.,2017; Latorre etal.,2019). The work of Mayer etal.(2019) does take a broader look at the issue

but only considers the impact on EU states and does not model the possibility of the withdrawal of

an additional sub-group of EU-27 countries. The impact of Brexit on the EU-27 member states, and

neighbouring middle-income and high-income countries, is less well researched and is the focus of

our attention in this paper.

Our analysis is illustrative as we model a number of scenarios and examine the gains and losses

across countries for different degrees of the EU disintegration. First, there is the possibility of a hard

Brexit, where the UK exits without a deal. This may occur because the UK negotiators do not put a

credible proposition forward. Alternatively, EU negotiators may refuse to compromise with the UK

or some combination of the two positions. Second, it is also conceivable that EU negotiators soften

their Brexit negotiation stance and concede to UK requests; in doing so, they may create a domino

effect of further exits and potentially the disintegration of the EU (Baldwin,1993). The impact of

differentiated disintegration across the EU, due to Brexit, is something on which the modelling lit-

erature has been relatively silent (for a discussion of the political trilemma facing the EU project see

Sampson (2017)). We construct a range of disintegration scenarios and examine the pattern of export

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JACKSON ANd SHEPOTYLO

and welfare changes in each case. This paper does not aim to predict the actual outcome of the Brexit

negotiations or the subsequent disintegration dynamics across the rest of the EU-27; instead, the aim

is to illustrate the range of impacts in this uncertain trade policy environment.

Therefore, the contribution of the present paper is to explore the impact of nine EU disintegration

scenarios, varying by degree of disintegration and number of countries exiting the EU, on the EU-27

and peripheral non-EU countries. We examine these cases by conducting a general equilibrium struc-

tural trade policy analysis developed by Anderson etal.(2015), where we calculate the price effects

of changes in trade costs and trade block disintegration associated with each scenario. This approach

is based on the general equilibrium global trade flows, where the relative merits of each scenario are

examined from the standpoint of the welfare changes of a representative consumer. In the extreme

benchmark case of a complete break-up of the EU, where all EU member states are left to trade on

WTO-only rules, we assume that EU disintegration would result in only an increase in trade costs,

while keeping the level of technology and factor inputs intact. Therefore, our results indicate a lower

bound in the welfare losses. We compute changes in welfare for the conditional general equilibrium

(CGE) and full general equilibrium (FGE). The former calculates welfare changes keeping output

and expenditure constant, while the latter also accounts for the changes in output and expenditure due

to global price adjustments. We consider three particular questions: To what extent do the costs of

Brexit, and any further disintegration across the EU-27, vary across member and non-member states?;

What is the trade diverting effect on third countries, including EU neighbouring countries?; and Do

the potential costs of EU-27 disintegration (even if partial) explain the opposition to giving in to UK

Brexit demands?

Our estimates suggest that all EU-27 countries will lose out from a disorderly Brexit, but that losses

are not distributed evenly between the EU-27. In the event of the UK alone exiting, the most signifi-

cant losses will be felt by the UK’s close EU-27 neighbours. However, if the UK exits with Portugal,

Italy, Greece and Spain, then it is Portugal which is expected to experience the largest reduction in

welfare. In the most extreme case of a complete disintegration of the EU, the largest negative effects

will be felt by the eastern European countries and Luxembourg, where trade would be diverted to

nearby non-EU members. Germany, France, Italy and Spain would be least negatively impacted by

a complete collapse of the EU. Overall, EU countries have more to lose from the disintegration of

the EU than from a hard Brexit since each member trades more with the rest of the EU than the UK.

Therefore, the remaining member states will have more to lose if Brexit arrangements undermine the

continuation of the EU. These results point to a dominant strategy for the EU to stand firm against UK

demands, assuming that the EU negotiators believe this to be the most likely approach to avoid the

complete disintegration of the EU.

The remainder of this paper is laid out as follows. Section2 discusses the methodology, with

Section3 explaining the data. Section4 describes the scenarios. The results for EU countries and their

closest neighbours are discussed in Section5. Section6 presents the results by regions and income

groups. Section7 concludes.

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MODEL AND METHODOLOGY

This paper uses a structural gravity approach that is consistent with a wide class of trade models.

Based on the estimation of the structural parameters, we compute counterfactual changes in trade

and welfare relative to the baseline scenario. This approach has been used to estimate the effect of

the North America Free Trade Agreement (NAFTA; Anderson etal.,2015), Transatlantic Trade and