Tariffs, domestic import substitution and trade diversion in input-output production networks: an exercise on Brexit

In this paper we employ the World Input–Output Database to develop a multi-sector inter-country model that allows us to identify the channels through which the trade effects of Brexit would propagate. The inclusion of global value chains and indirect Brexit effects in the model leads to estimates that diverge with the results of the main literature. Indeed, we found that Brexit could be risky and costly not only for the UK but also for many EU countries. Furthermore, we develop a second model and present the first empirical analysis on the consequences of domestic import substitution and trade diversion policies in Input–Output schemes. We found that allowing sectors and countries to partly substitute foreign products, leads to significantly lower losses for both macro-regions: the UK and EU27 would lose, at worst, the 0.28 and 0.5 percent of value-added, respectively.