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Brexiteers need to respect gravity models of international trade

Oct 1st 2016 Like 408 Tweet

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AS BRITAIN contemplates its post-Brexit identity, government ministers are racking up

the air miles. Theresa May, the prime minister, thinks Britain “should become the global
leader in free trade.” Officials are discussing trade deals with a range of Asian and Middle
Eastern countries. Daniel Hannan, a prominent Leave campaigner, even suggested in the
Sun newspaper that he wanted Britain to join NAFTA, an intra-American trade
agreement. The Brexiteers have spent less time wooing the EU, to which Britain sends
roughly half its exports. Indeed, given promises made during the campaign to restrict the
free movement of EU labour, reaching a post-Brexit trade deal may prove difficult.

The focus on achieving trade agreements outside Europe may seem a smart move. The

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Down to earth | The Economist 2017-01-05, 1:27 PM

EU’s economy is weak: its demand for British exports has been depressed for years.
Britain’s membership of the customs union prevents it from making trade deals with fast-
growing economies such as India and China, where Savile Row suits and Scotch whisky
find ready markets. Brexiteers say that if Britain quit the EU it could forge new deals
wherever it liked, boosting trade even without a new agreement with the EU.

That may sound reasonable, but mainstream economists In this section

argue that turning away from the EU, far from boosting
Hard bargain
Britain’s trade, would restrict it. The so-called “gravity
The little cartel that could
model”, concocted in the 1960s by Jan Tinbergen, a Dutch
Nobel-prize winner, makes two simple points about the Slip slidin’ away

geography of international trade. First, the bigger the GDP Taking it to 11

of the countries involved in a bilateral trading relationship, Warping the loom
the more they trade with each other. Larger economies have
Tests of character
more demand for goods and services and offer more
Cornering the market
products, supplying a broader range of consumers.
Fat help
Second, the farther away two countries are from each other, Down to earth
the smaller the volume of trade. That is partly related to
Reprints
transport costs: sending a parcel from Britain to France
costs half as much as sending one to India. Cultural and

linguistic differences also come into it. Exporters have a better feel for nearby markets
and can meet suppliers more easily. According to official data only about 2% of Britain’s
exports go to India (population 1.3 billion), much less than is sold to tiny Belgium
(population 11m).

The implications of the “gravity” model for a post-Brexit Britain seem to be clear. The EU
is a trading bloc roughly the size of America and it happens to be on Britain’s doorstep.
That explains why Britain has always traded heavily with the continent. It also suggests
that trade deals with far-flung places may not compensate Britain for restricted access to Follow The Economist
such a market.

However, that is not the end of the story. Brexiteers have studied gravity models and
insist that they have been “long discredited”. Their critique rests on two points. First, says
Patrick Minford of Cardiff University, gravity models are simple “associations” rather than
causal relationships. Indeed it is even possible that the statistical relationship between Latest updates »
GDP and trade volumes suffers from the problem of “endogeneity”. Large trade volumes
may cause large GDP, rather than the other way around. Podcast: The Economist asks: Bernard
Henri Levy
This critique appears misplaced. A paper from Shang-Jin Wei, then of Harvard University, International | 1 hour 1 min ago

looked for a clean variable—one that runs from GDP to trade, but not the other way
round. Mr Wei used data on population (since it is unlikely that lots of trade causes a Finance and economics: The Greenspan
large population). After correcting for the endogeneity problem, the gravity effect still held. legacy
Buttonwood's notebook | 1 hour 47 mins ago
Furthermore, according to Swati Dhingra of the London School of Economics, gravity
models do a good job of predicting actual trading relationships today.
Daily chart: Remittances to Mexico spike
The second Brexiteer criticism of gravity models is that geography may not matter as in anticipation of Donald...
Graphic detail | 3 hours 37 mins ago
much as it once did. As emerging-market economies continue to outgrow the rich world,
their increased pulling power may override distance. It will only be a few years before
Nostalgia and satire: “Ripping Yarns” remembers a
China’s GDP (as measured in dollars) exceeds the EU’s.
Britain that is not...

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Down to earth | The Economist 2017-01-05, 1:27 PM

As those economies grow, British trade with emerging markets will certainly increase. Prospero | Jan 5th, 14:19

However, size alone does not make a faraway country an enormously attractive trading
partner. Britain exports far less to America than it does to the EU. Moreover, for the
foreseeable future, GDP per person in places like India and China will be lower than the Indicators: Retail sales, producer prices,
EU’s, points out John Springford of the Centre for European Reform, a think-tank. It will wages and exchange rates
be many years before these countries’ citizens are rich enough to demand the same sorts Markets and data | Jan 5th, 11:13

of goods and services from Britain as the EU does.

Indicators: Foreign reserves
In one other way, however, geography may matter less than economists assume. The Markets and data | Jan 5th, 11:11
logic of gravity models may be sound when applied to trade in goods, which cost a lot to
move around, but its applicability to trade in intangible services is surely a little more
suspect. After all, a website-designer or a financial adviser in London can deliver her The Economist explains: What do think-
services to a Chinese client costlessly and instantly over the internet. Britain is one of the tanks do?
The Economist explains | Jan 5th, 06:36
world’s most service-intensive economies and is becoming ever more so.
More latest updates »
With a bump
The gravity effect does indeed appear to be smaller for services. But it is still strong,
according to a report on Brexit by the IMF. The reasons for this link are less explored in
the literature, though shared time-zones and languages are likely to be important. A Most commented
paper on Brexit from the National Institute of Economic and Social Research, another
think-tank, also notes that much services trade is a by-product of goods trade. If Britain’s 1
Israel and the
exports and imports of goods declined, Britain’s services exporters would also suffer.
Palestinians
The hopes for peace
In the long term, better communications and cultural homogenisation may mean that and Palestinian
international trade is less and less at the mercy of proximity. But for now, the central statehood fade away

premise of Tinbergen’s model still holds for a post-Brexit Britain. Exploring trade deals 2 Spain and Catalonia: In their search for
with Asia and the Middle East is all well and good. But if Britain really wants to be a global independence, Catalans can resemble Brexiteers
leader in free trade, it needs to work with its closest, biggest neighbour. 3 Medieval memes: The far right’s new fascination
with the Middle Ages
Visit our Free exchange economics blog 4 Congressional ethics: How to lose votes and
irritate people
5 Assassination in an art gallery: An
ambassador’s murder may push Russia and
Turkey together

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The way forward Election fever Taking back Life after Brexit From Big Bang
Voting was just Why a new control Medical and to Brexit
the start of a long election is The High Court pharmaceutical The financial-
process. To unlikely rules that firms ponder their services industry
determine what Parliament must position outside considers its
Brexit means is a vote to trigger the Europe future outside the
job for Parliament Brexit process European Union

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• This article appeared in the Finance and economics section of the print edition

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