The behavioural economics of choosing between hard and soft Brexit
Making decisions is not always easy. One reason it is difficult is that trading off two possible choices often means we need to compare apples and oranges. How do you decide whether your time is better spent going to the cinema than doing your laundry? How do you know which job is better — the one within walking distance, with really cool colleagues, or the one 20 miles away which pays 15% more?
Another reason might be that the decision affects several people, with different preferences. Finding a compromise just for yourself is one thing, but making one that is at least satisfactory for several people is quite another one, as anyone who needs to choose a family holiday will know.
When the scale is upped to that of a whole country, we’re talking truly serious toughness. Enter Brexit, with its headline trade-off between economics and politics.
If you are ever searching for an illustration why business and government are different, then the kind of decision-making involving Brexit might just be it. Business decision-making is largely guided by objective, financial criteria. Some people would regard this as rational, but a better term would be reasoned, reflecting the process that explicitly weighs up pros and cons, costs and benefits of a decision. Should a business invest in a particular country? That depends on stuff like the laws, the trading environment, the public policy, and how all this is expected to affect its ability to generate profits. Nissan boss Carlos Ghosn, for example, has said that the firm will put any investment in its Sunderland plant on hold, unless the government provides compensation for the losses it would inevitably face in case the UK leaves the European Single Market.
Investment decisions are sizeable, often involving billions of dollars, yet they are a doddle in comparison with the kind of decisions politicians have to make. These mostly also entail money — few policy measures come free of charge — and indeed the anticipated effect on the country’s economy. But they also involve much fuzzier affairs like ideology, party support and electability. These are the political oranges to the financial and economic apples.
It’s not that we, ordinary individuals, never encounter such tricky dilemmas, where we need to weigh up our economic interest against our convictions. Should we buy fair-trade bananas, and pay 50% more than the equivalent not-so-fair-trade variant? We can decide how much our desire to support banana growers is worth to us, without needing to bear in mind anyone else’s opinion, though. But politicians need to take into account the opinions of many people, which — as in the case of Brexit — are not just diametrically opposed, but mutually incompatible. How so?
The two principal options now lying ahead are colloquially referred to as ‘soft’ and ‘hard’ Brexit. The former favours economic concerns, seeking to retain membership of the single market and/or the customs union (the Economist has a great explainer) to maintain the ease with which the UK can do business with customers across the EU (and vice versa for EU firms). In the latter, more ideological elements like sovereignty and autonomy dominate: full control of the country’s borders, no submission to non-UK jurisdiction, no contribution to supranational bodies. The snag is that the first option comes with all the conditions the second option wants to stop, and the second option implies far worse trading conditions with the EU, which represents nearly half of the UK’s international commerce, thus severely damaging the economy.
The population splits very much into two categories. There are those who are quite relaxed about, or even favour free movement of people, and who above all want to continue operating as before in the single market, happy to pay the price of membership. And there are those who, more than anything else, want to ‘take back control’ as the Vote Leave campaign slogan called out, irrespective of the economic consequences.
Is there a compromise possible midway? Formulas with cool names like “EEA-minus”, “Canada-plus”, or even the “continental partnership” proposed by the European Bruegel think tank, are doing the rounds. Dozens of game theoreticians are probably writing PhD theses about these and other possibilities as you are reading this. But at the moment there seems to be little appetite for compromising on either side of the future negotiating table. The EU — the council, the commission and the parliament — appear to have no intention to relax the indivisibility of the so-called four freedoms which include the vexed freedom of movement for workers. And the rhetoric from the prime minister and her colleagues at the Conservative party conference emphasized in no uncertain terms that control of immigration is a central aspiration.
There are still more than five months to go before the current anticipated deadline for starting the EU exit process, known as ‘triggering Article 50’, and much could happen between now and then, but for the time being we can forget that compromise. But we can look at how the choice between hard and soft Brexit could unfolds, and what that looks like from a (behavioural) economics perspective.
A nice collection of pitfalls
It is the prime minister who holds the ultimate power, if not to actually decide what Brexit actually means (other than just Brexit), then certainly to define the starting position. She could attempt reasoned decision-making, much like a business would do and focus on the economic consequences for the country of either decision. But politicians cannot do just that — there is the party and the electorate to indulge.
She has to weigh up the value of the trade apples not only against that of the sovereignty orange, but also against the pear of the possible reaction of the hardline Brexiteers and their electoral supporters: surely she wants to avoid the kind of internal revolt in her own party that has been dogging the Labour party for months. And of course she will bring into the mix her own political future. That may not be easy. But a reasonable rule of thumb that people use to handle similar tricky comparisons is to ask the question: “is it worth it?” Measure or estimate the quantifiable side of the balance and question whether that is outweighed by the unquantifiable side. Is the hard to measure benefit of the newly regained autonomy over borders, law and budget worth the cost to the economy, which can relatively easily be estimated?
The trouble is that there are plenty of cognitive biases and fallacies awaiting her in this attempt to choose. Here are a few:
- Optimism bias — sometimes referred to as overconfidence, Daniel Kahneman’s favourite. Here is a prime example produced by one of the prime minister’s more vocal parliamentary colleagues. Some believe that the EU countries will happily continue to offer the UK the current favourable trade terms without any of the conditions attached, because they need the UK more than the UK needs them. Some (mostly the same people) believe that new free trade agreements that will more than compensate any loss of trade with the EU can easily be established with third countries located elsewhere in the world. Some (still mostly the same people) believe that only tariffs matter in trade, and ignore the significance of regulatory, non-tariff obstacles. Overestimating the upsides and underestimating the downsides of the hard Brexit option may well undermine the robustness of the decision.
- What you see is all there is — a blindness for the true complexity of an issue. Mrs May’s earlier mantra, “Brexit means Brexit”, a brilliant device to appease hardliners, without committing to anything of substance, was correct because it was a tautology containing no substance. But In her conference speech, she insisted that “there is no such thing as a choice between ‘soft Brexit’ and ‘hard Brexit’”, and this is sadly delusional. There is a huge difference, and ignoring this may well undermine the robustness of the decision.
- Planning fallacy — a close cousin of the optimism bias. Aside from embellishing the outcome of a decision, she may well underestimate the amount of effort and time needed to deliver it. The task, not just of disentangling the UK from the EU, but also of establishing free trade agreements with other countries (and potentially with the EU) is colossal, and the available resources are very limited. Once the UK is out of the EU (most people believe that will happen within two years of triggering Article 50), it will in all likelihood take many years before new FTAs are ratified. Discussions on CETA, the Canadian-EU process often held up as an example, started in 2009 and the agreement ‘may come into force provisionally in 2017’. Misjudging the journey to the end goal may well undermine the robustness of the decision.
- Sunk cost fallacy — also known as escalation of commitment — is what happens when a decision is determined by past investment, rather than by what the future will bring. In this case more than just effort and resources are at play: the more you engage and identify with a particular course of action and the more you invest your reputation in a plan, the more you will try to avoid losing face by backtracking and double down on your original position. Being influenced by real and metaphorical sunk cost may well undermine the robustness of the decision.
- Groupthink has the potential to lead to a decision that nobody really wants, simply because everyone thinks it’s the preferred solution of the others, and nobody wants to go against the group. The Abilene paradox is a classic illustration of what can happen if that is the case, and it is clear that it may… yes, undermine the robustness of the decision.
- Arguably ignorance is neither a cognitive bias nor a fallacy, but the prime minister’s Brexit team is showing some worrying signs of it. The foreign secretary was, until recently at least, of the conviction that talk of an “automatic trade-off between access to the single market and free movement [is] complete baloney”. The secretary for international trade has revealed his unfamiliarity with, yes, international trade. And the actual Brexit minister appeared also rather inexperienced in EU trade facts, as well as in the size of the world. Ignorance of facts and consequences is not a good predictor of robust decisions.
So, with a pragmatic way forward, based on reasoned weighing up of the consequences of the options all but impossible, and to add to the difficulty an extensive collection of cognitive pitfalls ahead, the prime minister may find herself pushed towards the faithful guidance of the last resort: dogma.
Following dogma is of course the easiest way to make a hard choice: it is doing what is right without having to make any trade-offs, irrespective of the consequences. Even if that means either economic suicide or political suicide.
Originally published at koenfucius.wordpress.com on October 10, 2016.