The Role of Gravity Models in Estimating the Economic Impact of Brexit

The predictions of the Treasury, OECD and IMF for the long-term impact of Brexit remain influential. They provide an important context for the Brexit negotiations and underpin the belief of Scottish and Irish nationalists that Brexit strengthens their case for independence or Irish unity. Because these predictions have received limited scrutiny they are examined in detail in this paper. The bases of the predictions are similar for each of the three organisations. In each case estimates are made of the impact of Brexit on trade and on foreign direct investment. This is followed by an estimate of the knock-on effect on productivity. The OECD and IMF also include an assessment of the impact of lower migration. The aggregate impact of these factors is then fed into a macro-economic model to obtain a forecast for GDP. Much of the final impact depends on the estimate for trade which, in each case, is assessed using a ‘gravity model’. Because gravity models are inaccessible to the general public, they are explained here in comprehensible terms. In addition the Treasury’s gravity model results are replicated and examined in detail. Our conclusion is that different versions of the model give a range of results and that most versions give a smaller trade impact than that reported by the Treasury, OECD or IMF. In particular, equations which estimate the average impact of EU membership on exports of goods tend to over-predict UK exports to the EU. This implies that the average impact of EU membership applies less to the UK than to the other EU member states. The further implication is that these official predictions of the impact of Brexit are overly pessimistic.