Question

In 2016 UK residents voted in favor of Brexit, a proposal to leave the European Union and thereby cancel the UK’s free trade arrangement with the EU. Pro-Brexit analysts have argued that, if the UK now signs a free trade agreement (FTA) with the United States, this U.S.-UK FTA would offset any UK trade losses due to Brexit.

Basing your answer on the simplest gravity model of international trade, do you think the pro-Brexit analysts are correct? The economies of the European Union and the United States were approximately the same size, at $18.8 trillion and $19.4 trillion, respectively, in 2017.

What are some other factors you might want to add to your gravity model in order to strengthen your analysis?

Answer 1

The Gravity model of trade was proposed by Jan Tinbergen in 1962. Gravity model applies the Theory of Gravitation in understanding international trade. According to Newton's theory, two objects are attracted to each other in proportion to their size and distance. The same applies to two economies while involving in trade. Size of the economy is determined in terms of its GDP and distance or proximity is proxied by the physical distance between two countries. Hence trade between the two countries are in proportion to their GDP and physical distance.

According to the pro-Brexit analysist, the UK and US could have a better trade deal and UK can compensate for the loss of Bexit. According to Gravity model, this is not possible since the size of UK economy is very small and distance between UK and US is more compared to distance between UK and EU. Since the size of EU and US economies are similar, US would prefer to have a trade deal with EU as it is more beneficial to them. Further distance between US and UK are more and this will reduce trade between US and UK. UK will benefit more within EU since the distance between UK and other EU countries are less.

Other variables to be included in the Gravity model are

1. Common language dummy- Since UK and US have a common language, this will help them in trade more with each other.

2. The cultural linkage between US and UK- Since America has strong cultural ties with Europe, this would help trade.

3. GDP per capita

4.Distance between UK and US