Brexit - Balancing Trade and Mobility

Control over borders and access to the common market are key issues in the Brexit negotiations. We explore a sequential model, where the UK can commit to mobility, and the EU may constrain trade to dissuade future secession, or to punish the UK. The model highlights the importance of whether the EU views trade and labor mobility as substitutes, in line with standard trade theory, or as complements, as suggested by EU statements about inseparable freedoms. In the former case, the UK can attain its preferred mobility with impunity. Mobility and trade restrictions are higher in the latter case. While the EU’s bargaining position hinges on a willingness to constrain trade, the EU does not benefit from strengthen this, say by fueling resentment about Brexit. The sequence of moves is clearly important. Our model implies that the UK moving first is optimal for both parties. This sequence is also in line with the phased approach guiding the negotiations. With uncertainty about preferences, the EU benefits from claiming to have complements preferences, irrespective of its true preferences. Uncertainty harms the UK. Nevertheless, it is worse off moving second, despite the EU’s preferences then being revealed. Also, if the EU has substitute preferences it could gain from committing to complement preference behavior. Finally, we discuss the scope for efficient bargaining taking the inefficient equilibrium points as points of departure. We note that contributions to the EU budget could potentially substitute for trade restrictions, thereby contributing to a more efficient outcome.