The Costs of Economic Nationalism: Evidence from the Brexit Experiment
37 Pages Posted: 1 Dec 2017 Last revised: 2 Jul 2018
Date Written: November 2017
Economic nationalism is on the rise. What are the costs of cutting back international economic integration and rising policy uncertainty? We use the unexpected outcome of the Brexit vote in June 2016 as a natural macroeconomic experiment to study the costs of economic disintegration and their causes. As a methodological innovation, we propose a novel combination of synthetic control methods to identify the output loss caused by the Brexit vote, conjoined with an expectations-augmented vector autoregression to understand its drivers. Using the synthetic control, we first show that forward looking households and businesses have lowered spending in response to the Brexit vote, causing an output loss of close to 2 percent. Decomposition of the VAR estimates shows that shocks to economic policy uncertainty and growth expectations in the quarter following the Brexit vote explain almost the entire output loss. While higher uncertainty accounts for much of the initial output drop, the economic costs increase over time because of a downward revision of output growth expectations. Overall, both uncertainty and growth expectations account for about one half of the total economic costs of the Brexit vote. Linking quasi-experimental identification to structural time series variance decomposition, our study exposes not only the aggregate costs of the UKs expected economic disintegration from Europe but also specifies the channels through which the Brexit vote affected the macroeconomy.
Keywords: Brexit, European Union, policy uncertainty, synthetic control method
JEL Classification: E65, F13, F42
Suggested Citation: Suggested Citation