The Impact of Brexit on Foreign Investment and Production
February 2017 | Federal Reserve Bank of Minneapolis Staff Report 542
In this paper, we estimate the impact of increasing costs on foreign producers following a withdrawal of the United Kingdom from the European Union (popularly known as Brexit). Our predictions are based on simulations of a multicountry neoclassical growth model that includes multinational ﬁrms investing in research and development (R&D), brands, and organizational capital that are used nonrivalrously by their subsidiaries at home and abroad. For the main simulation, we assume that U.K. investments in the European Union face the same restrictions as Norway’s and that E.U. investments in the United Kingdom are treated reciprocally. We ﬁnd a significant fall in foreign investment and production by U.K. ﬁrms, and a small but positive welfare gain for U.K. citizens. Following the Brexit, the United Kingdom increases international lending, which ﬁnances the production of others, both domestically and abroad. In the European Union, declines in investment and production are modest, but the welfare of non-U.K. citizens is lower. If, during the transition, the United Kingdom reduces current restrictions on other major foreign investors, such as the United States and Japan, domestic production and investment in the United Kingdom fall by less, and the welfare of U.K. citizens rises by more.