Brexit – Britain is paying the price for a badly designed choice

by Richard Thaler

Financial Times
August 17, 2016

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.)

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N. Christodoulakis, "An Economic Analysis of Conflicts With an Application to the Greek Civil War 1946-1949"

Springer, 2016

This book provides a quantitative framework for the analysis of conflict dynamics and for estimating the economic costs associated with civil wars. The author develops modified Lotka-Volterra equations to model conflict dynamics, to yield realistic representations of battle processes, and to allow us to assess prolonged conflict traps. The economic costs of civil wars are evaluated with the help of two alternative methods: Firstly, the author employs a production function to determine how the destruction of human and physical capital stocks undermines economic growth in the medium term. Secondly, he develops a synthetic control approach, where the cost is obtained as the divergence of actual economic activity from a hypothetical path in the absence of civil war. The difference between the two approaches gives an indication of the adverse externalities impinging upon the economy in the form of institutional destruction. By using detailed time-series regarding battle casualties, local socio-economic indicators, and capital stock destruction during the Greek Civil War (1946-1949), a full-scale application of the above framework is presented and discussed.