Making the big decision on Brexit

It has to be evaluated in the context of great uncertainty and imperfect information

THE British public are faced with the most momentous decision about their constitutional relations with the European Union, to be taken on Thursday, June 23. The UK joined the European Economic Community (EEC) in 1973, when it was a common market, a customs union of West European countries. It grew from six in 1960 to 15 by the 1990s. It had then become a European Community with many common policies on taxation and regulation. It became a European Union aspiring for an ‘ever closer Union’. It adopted a single currency, the Euro, and removed border controls for internal travel between member countries—the Schengen Treaty. It was also a single market moving towards free movement of labour as well as capital, goods and services. It remains a confederation with a weak centre and a budget which is less than 2% of the EU GDP.

The British have been a semi-detached member of the EU. They merely wanted a common market but not a closer Union. They got an opt-out from the single currency and from the Schengen. But even after 43 years of membership, Europe has always been treated as the ‘other’ by the British public. Both the major political parties of the country have been inter nally divided and changed their minds about Europe. The Conservatives were enthusiastic in the 1960s to join as a boost for growth and modernisation. Labour Party was suspicious of the capitalist plot to oppress workers.

The Conservatives succeeded in getting the country to join in 1973. When Labour came to power in 1974, it promised and held a referendum. This was to keep a divided partytogether.Thereferendum was positive. But the differences within the party remained. So, in 1980, a pro- Europe faction left the Labour Party and became the Social Democratic Party which later merged with theLiberalPartytobecome the Liberal Democratic Party which is pro- Europe.

By the 1980s, prime minister Margaret Thatcher had reformed and restructured the economy. Trade unions feared restrictions on their rights. They were reassured by Jacques Delors, president of the European Commission (the executive branch of the EU), that trade union rights would be protected by the EU as they had to be uniform across Europe. This swung the Labour Party to be pro-EU though its extreme Left continued to be anti.

The Conservative Party, in the meanwhile, was divided over the issue of joining the Exchange Rate Mechanism which bound the currency together in a limited flexibility union. Thatcher also objected to the size of the UK contribution to the EU budget (prorata to the UK GDP) and obtained a rebate. She also did not want closer Union or a federal Europe. Her idea was to extend the EU to include the East European countries which had been liberated after the fall of the Berlin Wall.

Thatcher failed to win against a challenge to her leadership at the first round in 1990. Her supporters blamed the proEU MPs for this. Since then, a Eurowound has festered in the party which finally came to a head when David Cameron won a majority in 2015. To keep the Party together, he promised a ‘In-Out’ referendum, just as Harold Wilson had done in 1975.

This time, however, the debate has been ferocious and conducted across the old media of newspapers and TV and social media. The In campaign has warned about the adverse likely effects of withdrawing from a large trading area and risk tariffs being imposed once the UK exits. They have also emphasised the positive effects of being in the EU, in negotiating the treaty with the US for trade and investment.

Their opponents have harped on the loss of control over national affairs and having to obey the diktats of the unelected European Commission. (It is not directly elected but its members have been appointed by heads of governments of EU.) The biggest issue is of free movement of labour across the EU which is part of the single market. Immigration from the EU has become a big bogey and the loss of control over immigration has become the star issue for the Out campaign.

The interesting point here is that people have to evaluate the costs and benefits of either option in a context of uncertainty as well as imperfect information. There are simulations of likely effects of withdrawal by the UK Treasury of different options when the UK is out. They show various amounts of income lost. But, in economics, where the knowledge of even recent past is uncertain, how much confidence can be put in such numbers, no matter how “sophisticated” the model on which they are based? Similarly, the demographic projections of immigration by the Out campaign merely rely on projecting past trends into the indefinite future.

Thus, the decision is under uncertainty and unreliable infor mation. You could compute the expected maximum loss under each option and choose the one which is the lesser loss—a sort of maxi-min rule. But, it won’t be better than tossing a coin. Thus are great decisions made.

There are simulations of likely effects of withdrawal by the UK Treasury of different options when the UK is out. They show various amounts of income lost

The author is a prominent economist and Labour peer