Britain pays the price for a badly designed Brexit choice

17/8/2016

By Richard Thaler

The more complicated a decision, the less desirable a referendum, writes Richard Thaler

The Brexit vote has created an environment of great uncertainty for Britain, the EU and the global economy. No one can predict with any confidence what will happen for at least the next three years, but economists are in unusual agreement that if Brexit occurs it will be bad for the UK and bad for the EU.

How did we get here? One answer lies in “choice architecture”, the decision-making framework in which choices are made.

Consider the original charter of the EU. An important principle of good choice architecture is to anticipate how things might go wrong and take steps in advance to mitigate the damage. In the formation of the EU, this step did not seem to attract the attention it deserved. What will happen if a country breaks the rules but is financially unable to repay its debts? The ambiguity in this answer has been evident in the drama surrounding Greece and a possible Grexit.

Another question that appears to have been left unanswered originally is what would happen if a country wanted to leave, as the UK might wish to do. The EU resembled the Hotel California described in the Eagles song, where, “You can check out any time you like / But you can never leave”. Eventually this omission was addressed by the creation of the now famous Article 50 of the Lisbon treaty, adopted in 2009, which provides the rules for a country that wishes to secure a divorce from the EU. (It has to be said that few states have provisions for leaving a union to which they belong; the US fought its deadliest war over such an issue.)

Although Article 50 was created to determine what happens in the case of a break-up, it is far from a full prenuptial agreement. Rather than stating the terms under which a country can leave, it only prescribes a process. Once a country triggers Article 50, it has two years to negotiate terms and in the event that no agreement is reached (or extension granted), the country is out — and presumably treated like any other country, using the rules established by the World Trade Organisation.

Making the rules so vague has had unintended consequences. First, it allowed proponents of Brexit to offer voters the apparently unrealistic hope that the UK could negotiate an associate status similar to that of Norway, but with some modifications of the rules on free movement of people. Second, the rule creates a long period of uncertainty for both the UK and other member states. The UK could wait a year or more before triggering Article 50, to be followed by what would almost certainly be nearly two years of negotiations. (International negotiations are like home improvement projects: they never finish early.) A better design would have been to spell out the details of a voluntary break-up in advance so any country would have a reasonably solid basis for evaluating the pros and cons of EU membership. It may not be too late to remedy this situation if the EU can figure out a way to clarify the terms of an exit.

David Cameron, the former UK prime minister, was responsible for another piece of questionable choice architecture when he promised to hold the EU referendum.

When should voters be asked their opinion about policy questions? Governments vary greatly on the extent to which they rely on direct democracy rather than a combination of representative government plus bureaucratic agencies, such as central banks. As an example, Switzerland and the state of California regularly rely on referendums to make decisions, but the US government never does.

When governments have the option to use either method, how should they choose? A good rule of thumb is that the more complicated the decision, the less desirable a referendum. And it is hard to think of a more complex choice than Europe to put to voters.

Furthermore, given the ambiguity of Article 50, voters had no way of knowing what outcomes would come from a vote to Remain or Leave. Theresa May, now prime minister, made this point before the vote: “The reality is that we do not know on what terms we would have access to the single market.”

But the referendum was held, so the question is what to do now. Certainly a majority of just four percentage points in a non-binding referendum should not be considered a mandate to hastily invoke Article 50. The vote was more like a straw poll of voter sentiments about a range of issues than a considered evaluation of the costs and benefits of membership of the single market.

Since voters were given a choice that was impossible to evaluate sensibly, they should be given the opportunity to change their mind if the facts change — either via a vote of parliament or a second referendum. In short, Brexit should not mean (an immediate) Brexit.

The writer is author of ‘Misbehaving: The Making of Behavioural Economics’

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