A method developed more than a decade ago to assess the cost of political violence in the Basque country has become a key tool for economists trying to figure out the cost of Brexit.
The U.K. voted to leave the European Union in 2016 and is due to formally withdraw from the bloc in March next year. Attempting to estimate the effect of the referendum result runs into a problem familiar to anyone curious about the economic consequences of a particular event: No one can be sure how the economy would have performed had the vote gone the other way.
One approach might be to extrapolate the pre-referendum trend to paint a picture of how the economy might have behaved had voters chosen to keep the U.K. in the EU. Another might be to take the average growth rate of the world’s other advanced economies and compare it with the U.K.’s. Both approaches have drawbacks. The first misses out more recent developments in the global economy that might be important, while the second isn’t a precise match for the U.K. economy and its idiosyncrasies.
In the early 2000s, similar concerns led Alberto Abadie, a professor at the Massachusetts Institute of Technology, to develop a technique he dubbed the synthetic-control method. He wanted to calculate the terrible price of decades of terrorism on his home region of Spain but couldn’t figure out how to do so while controlling for other economic factors, such as the recession Spain suffered during the late 1970s and early 1980s.
“We had to come up with a different way to approach the problem,” Prof. Abadie said in a recent interview. So they hit upon a novel idea: Why not create an economic model of a virtual Basque country that had known nothing but peace?
In a 2003 paper, Prof. Abadie, then at Harvard, and Javier Gardeazabal of the University of the Basque Country in Bilbao, Spain, built this alternate world by melding together bits and pieces of the economies of other Spanish regions. This “counterfactual” Basque country displayed similar characteristics to the real thing, such as population density and weight of industrial production in output. But it hadn’t been plagued by the violence that resulted in 800 deaths before separatists unilaterally called a truce in 1998.
This experiment and related analysis led them to conclude that separatist violence held back growth per person by as much as 10% between the start of the conflict and a 1990 ceasefire.
The method developed by Prof. Abadie and colleagues has since been used to estimate the economic effect of California’s pioneering tobacco ban, German reunification, the legalization of prostitution and the right to bear arms. “We realized this could be applied to many other situations,” he said.
Now researchers in Europe are using it to construct a virtual Britain where 2016’s Brexit vote didn’t happen to determine whether that decision has already had a cost. Those who have used it include economists led by Benjamin Born of the Frankfurt School of Finance and Management, investment bank UBS AG, the University of Sussex’s Trade Policy Observatory and the Centre for European Reform, a London-based think tank devoted to European policy.
There are small differences in the various studies, but they all use Prof. Abadie’s method as the basis for constructing a “doppelganger” U.K. from other similar advanced economies, such as the U.S., Canada, France and the Netherlands. They reach similar conclusions, suggesting the British economy at the start of 2018 was around 2% smaller than it would have been had the 2016 referendum gone the other way, a reflection of factors such as weaker investment and consumer spending.
Prof. Abadie said he’s aware his technique has been applied to Brexit but hasn’t followed the studies in question closely. He said researchers need to take care in selecting the countries used to construct the doppelganger to ensure an appropriate match. And he added the bigger question remains how Brexit will affect the U.K. over the long term. Britain won’t leave the EU until March 2019 and the shape of its future ties to the bloc are still under negotiation.
“We are only in the middle of this process,” he said.
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from Real Time Economics https://ift.tt/2OtcOfy
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