HOW NATIONAL BORDERS INFLUENCE ECONOMIC OUTCOME

Sharing a nation-state produces a substantially higher degree of economic integration than even a very close trading relationship between independent countries – and the consequences for economic performance can be significant. These are among the findings of research by David Comerford and José V. Rodríguez Mora, to be presented at the Royal Economic Society”s 2014 annual conference.

The researchers measure the apparent impediments to trade associated with borders, and show that national borders impede trade flows much more strongly than do the borders between regions within a country. The scale of the difference between national and regional borders is such that there may be significant welfare or productivity effects from removing borders between countries, or conversely from creating borders within existing nation-states. According to the report:

• Replacing the current Scotland-England border with one similar to the current Ireland-UK border reduces Scottish economic output by 5.5%.

• Membership of the European Union (EU) is associated with only slightly easier trade. But UK exit from the EU is likely to have a cost to the UK greater than its current net contribution to the EU of 0.2% of GDP.

• If the EU were to become a United States of Europe, with internal borders as free as those within a country, this could boost GDP in the EU by around 17%.

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What are the welfare consequences of different degrees of trade integration? This study measures trade frictions across borders by calibrating a structural model to trade flow data, and shows that borders between regions within a country are significantly less frictional to trade than borders between countries.

The difference in measured frictions is sufficient to have important welfare effects if regions were to replace their relatively free borders with borders as frictional as typically measured between countries, or if a group of countries were to replace their relatively frictional borders with borders as free as typically measured between regions.

Across Europe there is political momentum behind secessionist movements and some desire to achieve the creation of smaller states within the EU, such as Scotland, Catalonia and the Basque Country. The EU itself is a project to reduce trade frictions to the equivalent of those within a country, though there is a movement for the UK to leave the EU.

Given this background, it is important to understand the differences in the level of economic integration that is entailed by sharing a country or nation-state, compared with the integration that comes with membership of a supranational organisation like the EU.

The researchers find that sharing a nation-state produces a substantially higher degree of economic integration than even a very close trading relationship between independent countries. This is illustrated in the Figure below, which shows that the border frictions are significantly higher between the independent countries of the OECD and EU, than they are between US states, Canadian provinces or Spanish autonomous communities.

The researchers ask what the consequences are of regions taking on country-level frictions, and countries taking region-level frictions, using counterfactual exercises. For example, they quantify the impact of the Scottish-rUK border becoming as frictional to trade as the measured Irish-UK border.

Ireland is chosen as the counterfactual for an independent Scotland because it is the country with which the UK has the lowest measured trade frictions. Likewise, Portugal is chosen as the counterfactual for the Spanish regions.

The researchers find that increasing these regional frictions to those of a close trading partner country eliminates a substantial fraction of total gains from trade enjoyed by these regions. The Table below shows some of these results.

It shows that replacing the current Scotland-rUK border with one as frictional as the current Ireland-UK border causes welfare (GDP) losses of 5.5%, compared with further losses for an independent Scotland then becoming autarkic of 16.3%. Therefore, the close trading relationship that Scotland has with the rest of the UK represents more than 25% of Scotland”s total welfare gains from trade.

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There does not appear to be a strong difference in measured trade frictions between the EU and matched countries within or outside the EU – for example, Sweden versus Norway, or Austria versus Switzerland. The researchers” best estimate is that membership of the EU is associated with only a very small reduction in trade frictions, but even such a small impact on trade frictions, when applied to such an important trading partner as the rest of the EU, is such that a UK exit from the EU could cost 0.5% of GDP. This is greater than the UK”s net contribution to the EU of 0.2% of GDP.

The small effects on trade frictions from membership or otherwise of the EU as it stands, can be compared to the gains available if the EU were to become a United States of Europe, with internal borders as free as those typically measured within a country (rather than as frictional as those typically measured between countries). Such a large reduction in trade frictions could boost EU welfare by around 17% of GDP.

”Regions are Not Countries: A New Approach to Border Effects” by David Comerford, University of Stirling, and José V. Rodríguez Mora, University of Edinburgh.