What do we Learn from Disruptions to Other Longstanding Trade Relationships?
Box 3. What do we Learn from Disruptions to Other Longstanding Trade Relationships?
The cumulative gains from attaining EU membership can be estimated with econometric models, such as gravity models (e.g., HMT 2016, OECD 2016). These models tend to imply larger effects than would
be expected from simply reducing tariffs and non-tariff barriers, which is consistent with the argument that membership is associated with permanent increases in productivity and capital.
However, it is unclea r that we can simply “reverse the sign” from such models to estimate the costs of leaving. For example, changing an existing relationship is likely to entail adjustment costs not captured by such models, which may leave permanent scars (hysteresis). On the other hand, gains from harmonization of product standards already achieved do not disappear immediately, nor do productivity improvements that have been gained from competing in international markets. More generally, econometric models may miss important channels and the full interaction between the various effects on trade, capital and labor flows, and productivity. Such considerations provide a motivation to search for historical episodes that are analogous in key aspects to a Brexit shock.
Finding such episodes is not easy, as there are no fully comparable instances. There have been many instances of “sudden stops” leading to financial crises and recessions, but such episodes do not appear very applicable here, typically being cases in which investor confidence evaporates as a sovereign tries to maintain an overvalued exchange rate, most often with limited foreign exchange reserves. Dissolutions of political unions might appear good analogies, but those episodes have most often been associated with all of the entities experiencing dramatic economic collapse (e.g., the collapse of the Soviet Union in the 1990s) and even civil war (e.g., Yugoslavia). The break-up of Czechoslovakia does provide an example of a peaceful transition. The successor countries were able to rely on legal principles of continuity of existing agreements —however, trade intensity between the Czech and Slovak Republics fell sharply and persistently, despite the endeavors by authorities to maintain trade relations (Fidrmuc and Fidrmuc, 2003).
What would be more relevant would be cases in which a smaller economy experiences a sudden and persistent loss of trade access to a larger economy with which it is closely linked, setting off a period of adjustment to reorient the smaller economy. Two examples provide interesting parallels:
New Zealand, 1973: New Zealand’s preferential access to British markets was closed after the UK
entered the EEC. Productivity collapsed (Kehoe and Ruhl, 2007), down by one third after 20 years; New Zealand subsequently slid from 8th in per capita GDP to 22nd by 2000.
Finland, 1990 : The Finnish economy had been very oriented to trade with the Soviet Union. After
the collapse of the Soviet Union, Finland experienced a severe recession, one of the largest in an advanced economy since the 1930s.
In both cases, the countries experienced substantial and extended declines in per capita incomes (see figures, below). It is striking that this was not driven by declines in exports —in both cases, the economies found ways to export their products (Finland by devaluation of the Maarka, New Zealand by substantial reduction in commodity prices). Rather, domestic demand collapsed. This was associated with substantial declines in output per worker —an increase in the unemployment rate of 12 percentage points in the case of Finland and a decrease in labor productivity of 10 percent in the case of New Zealand.
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