Referendum:Decision under Uncertainty

By S. P. Chakravarty-May 29, 2016, 12:00 pm 

(Emeritus Professor of Economics,The University, Bangor, Wales, UK)

The referendum on British exit from the European Union is a symptom of the rise of the politics of identity over the politics of prosperity. Both sides in this debate have made forecasts of the economic outcome. Forecasting organisations, barring a couple of dissenters, have expressed fears of a sharp decline in the economy, at least in the short run, if the Brexit camp wins. The Brexit camp counters these gloomy forecasts arguing that the economy would adjust to a new pattern of trade in no time and enter into a new era of prosperity by leaving the EU. In any event, these arguments about economic forecasts are simply a distraction for those that wish to leave. The Brexit camp places greater store on sovereignty -- taking control over the legal definition of human rights, dispensing with much of the regulations governing commerce and industry, and setting rules for immigration. Once the vote is cast to leave, there is no point of return. The decision criterion of minimising the maximum potential disruption to the economy is the only rational choice given the impossibility of computing the probabilities of predicted consequences of the outcome of the vote. This criterion favours a vote to remain a member.

We know what it is to live with membership, and we have some idea about the likely success of agitating for change to make institution within the UK and also in the EU more responsive to the voter. Institutions of governance are always under the scanner in a democracy. Within the UK, composition and selection rules of the upper chamber and devolution of power between regions is not a settled matter. Likewise, the question of democratic legitimacy of distribution of powers amongst various institutions within the EU is being debated, and not just in the UK. In a pluralistic democracy, not all citizens wish to subscribe to the same agenda for change, and even an encompassing view which might emerge would remain under scrutiny. A referendum is not the best way to proceed.

A difference between parliamentary elections in a system of representative government and voting in referenda is that the voter imposes on herself and the rest of society a greater burden of any unintended and unwelcome consequence of the outcome. This is especially so when the status quo is severely jolted in pursuit of ideas which cannot be measured in terms of their impact on our living standard.

In electing representatives to govern, the voter has the luxury of voting for government on a policy platform, but judging the government on consequences of that policy. Casting a vote for candidates expounding, for example, a tough stance on immigration does not constrain the voter from criticising a government thus elected if food prices rise in consequence or if the availability of medical care is compromised due to lack of qualified staff.

Mrs Thatcher secured a parliamentary majority in 1979 on a policy platform comprising, inter alia, a vow dramatically to reduce the share of government expenditure in the GDP. The ratio had climbed to 45 per cent. Notwithstanding this harsh rhetoric, government expenditure and its share in the GDP continued to increase in the initial years driven by unforeseen fiscal pressure of a sudden and sharp rise in unemployment. The ratio finally came down, but only to 40 per cent of the GDP, when she left office a decade later.

This is not to say that representative governance entails cavalier disregard of promises made at election but to suggest that the promises need to be interpreted in context. The context is the need for elected representatives to engage with complex technical issues and tedious details of policy coherence once in government to avoid chaos.

Those that have voted for a government which commands a parliamentary majority by expounding policies which appeal to the voters’ gut feelings have the option of defeating the government in the next election if the outcomes of following these policies turn out to be unappealing. This paradox is understood by representatives and they moderate in application promises made at election.

Governance by referenda, where policies are prescribed by the electorate, is a different matter altogether. Unforeseen consequences can be more disruptive in a referendum than in representative democracy. That is why stable democracies choose representative forms of government, and governance by referenda is shunned.

A textbook example of the disruptive nature of referendum politics is the story, reported in the New York Times on the 5th of March 1995, of the three strike sentencing referendum in California. A woman was brutally murdered by a repeat offender recently released on parole after a period in jail. In the background of emotive press reports, a referendum was held on whether to mandate a harsh prison term of 25 years to life, without any possibility of parole before 20 years, for all repeat offenders. Professionals engaged in the maintenance of law and order advised against voting for a law imposing such an inflexible mandate on the judiciary. The advice was ignored by a majority of the electorate. Soon after the referendum was passed, a young pizza thief, he was in the habit of going into restaurants eating a slice of pizza and then escaping without paying, was sentenced to a term of 25 years to life with no hope of parole before 20 years. Even those that had voted for the referendum mandating this harsh punishment were aghast. The law was eventually repealed but not before causing disruption to the criminal justice system.

The ensuing referendum on continuing British membership of the European Union is an exercise in making decisions under uncertainty. Whilst the referendum ballot provides a binary choice, whether to remain in or to exit from the EU, the voter is not faced with a binary decision. There are multi-dimensional effects of the decision. The protagonists have forecast vastly different consequences for British trade and prosperity and also for world peace. They seldom emphasise that the probabilities of potential outcomes of the vote for economics can only be assigned subjectively. In our view, even the assignment of subjective probabilities requires knowledge of the unknowable, and the best course of action is to minimise the potential for maximum harm. That is to stick to what we know and shun the temptation to take an irreversible plunge into the unknown that is also unknowable.

Britain is a trading nation where international trade counts for slightly less than a third of its GDP. Roughly half of that, 45 per cent to be precise, is trade with the EU. The EU aspires to a single market which entails companies being able to compete for government contracts across frontiers within the EU without discrimination.

Those in favour of withdrawing from EU membership discount the prospect of any adverse effect on British trade. Their argument is four-fold. Firstly, they assert that access to European markets could be swiftly negotiated without necessarily having to comply with the rules for free movement of labour within the EU and without having to follow EU directives specifying, for example, labour rights at work and environmental conditions in production. A second line of argument is that it does not matter if negotiations stall. Any adverse consequences of disruption to trade with the EU could be ameliorated through improving trade relations with countries outside the Europe. This assumption is oblivious of the fact that the leaders of some of the largest economies outside the Europe with whom the Brexit camp aspires to increase trade have advised against British departure from the EU. A third line of argument derives from the belief that hitherto untapped energies would be unleashed in the British economy freed from EU regulations. A fourth line of argument from Brexit, put forward by some in the left, is a modified version of the above. It is the EU bureaucracy which holds back the ability of a British government to determine for itself policies on selective subsidy to make the economy flourish. Some in the Brexit camp would be prepared to accept a reduction in prosperity to get back sovereignty, but leaders campaigning for leaving the EU, on the whole, do not accept the premise of a trade off between sovereignty and prosperity.

(To be continued tomorrow)