The Real Effects of Brexit on Labor Demand: Evidence from Firm-level Data

Using the most comprehensive longitudinal survey on small and medium-sized businesses (SMEs) in the United Kingdom to date, we study the extent to which the implementation of Brexit in 2020 impacts their labor demand in a difference-in-difference framework. Our identification strategy hinges on using firms’ distance to the Irish border as a novel instrument to isolate the effects of Brexit at the firm level. Specifically, after Brexit in effect, while firms located in Great Britain are subjected to higher costs of doing business with the European Union, their Northern Irish counterparts are not, following the provisions arising from the Northern Ireland Protocol. Leveraging the distance to the border as a plausibly exogenous proxy for Brexit exposure among firms that did not change their location before and after the 2016 referendum, we find that the 2020 implementation of Brexit caused exposed firms to cut their workforce by up to 13.59% on average. The exposed firms are also more likely to have lower growth expectations and more likely to increase their research and development (R&D) expenditure in response. These results highlight the expectation channel and support the hypothesis that firms prioritize innovations in response to Brexit.