The Gains from Economic Integration

This paper measures the effect of political integration, such as sharing a national state or economic union, on the degree of trade integration. Consistently with previous work, we find large border effects. However, such estimates may be biased and overestimate the effects of borders because of endogeneity: selection into sharing a political space is correlated with affinities for trade. We propose a method to address this and to estimate a causal effect. We then conduct speculative exercises showing the costs and benefits of the changing levels of integration associated with: the independence of Scotland, Catalonia and the Basque Country from the UK and Spain (but remaining within the European Union); the UK’s exit from the EU; the break-up of the EU itself; and the achievement of frictions between members of the EU similar to those expected between regions of a single country. We find that the border effect between countries is an order of magnitude larger than the border effect associated with the European Union.