On the Disentanglement of an Economic Union

ABSTRACT We study how the unilateral withdrawal of a region from an economic union affects the spatial distribution of economic activity and social welfare. We explore a three‐region economic geography model under the assumption that this withdrawal can be expressed as a higher transportation cost between the leaving party and the remaining union members. We find that it is not stable for industry to become concentrated only between the remaining union regions and that asymmetric equilibria—in which the withdrawn region has the lowest share of industry—arise. We show that the share of industry in the withdrawn region increases as the differential in transportation costs and the global immobility of workers decrease. Finally, we also conclude that the economy as a whole attains its maximum social welfare when most of the industry is not in the withdrawn region.