Brexit: Trade Diversion due to Trade Policy Uncertainty

Abstract

AbstractThe paper quantifies how much of the reduction in Spanish trade flows with the UK after the 2016 Brexit referendum was diverted to other markets. To obtain reliable estimates of trade diversion we regress firm‐level changes in flows with all markets except the UK on changes in flows with the UK. In order to solve the positive correlation of trade flows between different markets we use the Brexit referendum as part of our instrumental variable. We then treat firms as units subjected to differential uncertainty shocks according to their initial patterns of sector and trade specialization. In particular, the referendum date is interacted with potential sectoral tariffs and pre‐referendum firm‐level exposure to the UK. The paper shows a close to full trade diversion for exports, mostly to other European countries, for those firms more exposed to that particular market (above 10%) and a heterogeneous response on the part of Spanish firms with low exposure (below 10%). Trade diversion for imports is weaker but the results are less robust. Given a particular share of exposure to the UK market, trade diversion appears to be more limited for big companies in comparison to small companies.