For England! On its economic outlook in the face of changing trading costs

Abstract

This paper examines the relationship between trade costs and trade for the United Kingdom, in order to inquire about its economic outlook after its 31 January 2020 withdrawal from the European Union. By using a recently developed implicit trade cost measure and temporally disaggregated data from OECD’s 2020 edition of the Structural Analysis database into a quarterly frequency, we deploy an autoregressive distributed lag model for import and export estimations with three other countries: France, The Netherlands and Italy. From a Keynesian perspective, output is determined by aggregate demand so that changes in any of the component demand functions should translate onto the real economy. Two such component demand functions of aggregate demand are export and import. The relationships between trade costs, export and import are therefore are therefore theoretically significant in determining the future output of the UK. We apply a Mundell-Fleming framework where a decrease in net export in the medium-term perspective causes a contraction of the real economy. We investigate the relationship between trade costs, export and import by establishing an empirical model with the implicit trade cost measure. Within the temporal perspective of 1989-2017, we find empirical support for several cointegrated relationships between the trade cost measure, export and import, which all suggest negative relationships between trade costs and trade.