The heterogeneous effect of uncertainty on firms trade margins destruction and diversion

Uncertainty over future tariff schedules and customs arrangements is a key factor in defying firms’ participation in international markets. This paper investigates firm heterogeneity in the effects of trade policy uncertainty on the margins of trade, exploiting the Brexit process as a quasi-natural experiment and using transaction-level trade data for UK firms. Comparing UK trade flows to the EU and extra-EU countries, and the variations of product-specific tariff threats along firm size, our results show an overall reduction in UK-EU trade flows in respect with extra-EU markets, as uncertainty regarding future trade policies increased during the post-Brexit referendum negotiations. This is the result of two contemporaneous effects: a destruction of trade flows for smaller firms more exposed to uncertainty and potential tariffs, while a consolidation and diversion of trade flows, in particular towards more distant and emerging extra-EU markets, for larger firms. Falsification tests and alternative identification strategies corroborate the robustness of the main findings