On Brexit solipsism

Imagine the following scenario. I give you and a stranger an envelope each, one of which contains twice as much money as the other. I then say you can swap envelopes if you give me £1. Do you do so?

You might think: yes, for the following reason. Let’s say my envelope contains £10. Then the other contains either £5 or £20. So I have a 50-50 chance of losing £5 or making £10. This has an expected value of £2.50. For moderate levels of risk aversion – or for those who gamble (pdf) with the house money! -  it makes sense to pay to swap.

But having swapped, the same logic suggests you should swap again. And again. And again. And each time, I make a pound out of you. I’ve got me a money pump.

In fact, though, there’s a simple way to protect yourself from this mistake. You should put yourself in the shoes of the stranger with the other envelope. He’s reckoning – by the same logic – that he should swap envelopes. But if he wants to swap with you, you should reject the offer, because his gains are your losses.

Putting yourself in the other guy’s shoes can therefore save you from losses that can arise from apparently good thinking.

This is no mere abstract thought experiment. One of the strongest stock market anomalies – in both the US and UK (pdf) – is the tendency for newly-floated shares to do badly in the months after flotation. Investors pay too much for new companies.

One reason why they do so is that they make the same mistake we see in the envelopes problem. They fail to consider the other guy’s position. They don’t ask: “if this business is worth buying why is the owner – who presumably knows more about it than me – so keen to sell?” Asking this would alert investors to the possibility that the company is over-priced and its owners are trying to cash out at the best time.

In both situations, the same mistake is made. David Navon calls it the egocentric framing error – then tendency to consider problems only from our point of view rather than the other guy’s.

To put this another way, it’s the failure to distinguish between parametric and strategic rationality. Parametric rationality asks: how can I maximise utility, given particular parameters? Strategic rationality, however, recognises that the parameters aren’t fixed, and that your choice depends upon the choice of the other fellow.

I say all this because I fear that some people might be making the same mistake about Brexit. Looking at much of the reaction to May’s speech yesterday makes one suspect that the UK is the only actor in this drama. But this, of course, isn’t the case. The UK’s demands and strategy is only half the story. We shouldn’t overlook the EU’s position – such as discontent with the UK’s “cherry-picking” and a desire to ensure that a nation can’t be better off outside the single market than in. In calling May’s position solipsistic, Martin Sandbu is right: she’s looking at it solely from a UK perspective.  

In this respect, the tendency towards the egocentric framing error is exacerbated by our traditional insularity (“Fog in the channel: continent cut off”) and monolingualism. As Simon Kuper says:

Foreign countries are opaque to mostly monolingual Britons and Americans. Foreigners know us much better than we know them. This asymmetry probably helped Russia get its favoured candidate into the White House, and it will handicap Britain in the Brexit negotiations.

Perhaps, though, I’m missing the point. Maybe May wasn’t speaking to Europe yesterday so much as to right-wingers here: she’s trying to placate Ukip. In this, she’s continuing a long tradition of treating UK relations with the EU as a by-product of internal Tory party politics.

Comments

[Luis Enrique]

oh man now I cam going to spend the rest of the day puzzling over the envelope problem, it feels to me like both parties should be able to consider the problem from their own perspectives and both come up with the answer don't swap. This is not a strategic situation, the other's response does not change what's in the envelopes.

my intuition lets me down. again.

[Patrick Kirk]

You answered your own question in the final paragraph. May has made her stance clear to the UK voters. Now we wait for the EU response but so far, she has done a good job. I am a Remain voter but it has to be accepted that setting out her objectives clearly is exactly what was needed from her.

[Brendan Jackson]

Given that not-swapping yields the same results as swapping, but no swapping-fee, why is that not the preferred option?

[MJW]

I was a remain voter, but it's good to see a bit of clarity. By making it clear that we're not staying in the single market we've put an end to the cherry picking argument, what we now what is the best possible free trade deal, which should benefit both the EU and the UK.

Yes there are those within the EU that will be annoyed. The UK is a major net contributor and leaving puts a hole in finances. The EU administration and bureaucracy has only ever known its gravy train to get more lucrative and has successfully fought off even modest attempts at reform, the UK leaving undermines that record. The EU loses a seat on the UB security council. Net beneficiaries of EU funding won't want to take a hit to their subsidies, especially if end of free movement means they can no longer export some of their unemployment as low skilled labour to the UK (the combination of English as global lingua-franca and UK's alleged monolingual tendency means this is an asymmetrical relationship).

On the other hand those who are looking towards a Euro superstate will see the path easing without the UK. It is perhaps a sign that the UK is accepting a post-imperial future that it is definitively backing away from a project that is attempting to create a modern liberal European Empire.

[Gary Taylor]

Let's try out your logic:
- We know from Laura K that EU leaders' reactions to the TM speech 'ranged from sad to nauseous'. That suggests that the EU feels they will lose from a clean Brexit.
- So we should look at this from the perspective and think 'if they are so sad to see the end of this deal, then why do they think they are getting such a good deal until now? And doesn't that suggest we are currently on the losing end of this deal? And if so wont be be better off ending this deal?

I'm sure that not where you intended your logic to end up so I must have misunderstood.

[Mark]

I think your application of game theory to demonstrate that there's a need to consider Brexit negotiations from the other countries' perspective is valid. However, I don't believe you've taken it through to its logical conclusion - and that doing so will yield a more positive conclusion about May's stance.

EU officials may well be keen to punish the UK to deter other countries from leaving. The reason is clear: the pot of money available to pay them, and the range of career opportunities from which they may benefit, diminish if the Union contracts.

Publicly, elected politicians from member countries may endorse this approach. But with most of them facing populist movements within their home nations and aware of rising anti-EU sentiment, none can afford to be pilloried for setting a precedent of anything other than a dignified and economically attractive exit path for the first nation to take that option, in case their own might follow.

[oliver watson]

Sorry - this is a misleading account of the envelope 'problem'. Basically all it shows is that you can't just say a binary choice is 50-50 because you have no information on it. I use this as an illustration for the necessity of Bayesian reasoning for students who are starting to learn statistics. Depending on your prior as to the distribution of the money you may or may not swap...

(technically 'the flat prior on positive reals is improper')

[Dave Timoney]

@MJW,

Exiting the single market does not put an end to cherry-picking. That remains very much alive in respect of the customs union. We must either cherry-pick to preserve advantageous elements or we must start with a blank slate. The former would likely be by sector, so some UK industries will lose out, while the latter would require a comprehensive trade deal that we'd have little chance of negotiating inside 2 years. The EU27 are expecting cherry-picking.

The UK has long been a net contributor to the EU, but it has usually paid less in absolute terms than Germany, France and Italy. As a percentage of gross national income (GNI), the UK is actually one of the lowest net contributors, thanks to the famous rebate. Similarly, on a per capita basis, we have traditionally paid in less than the likes of The Netherlands, Belgium, Sweden and Denmark.

It's academic now, but the idea that the EU is financially dependent on the UK is simply wrong. If it could absorb new net beneficiaries in Eastern Europe, it can accommodate the loss of the UK. EU contributions are the ticket price for access to the single market etc and the wider economic benefits this brings. The redistribution between contributors and beneficiaries is incidental and marginal overall (about 1% of EU-wide GNI).

The UK's seat on the UN Security Council has never been representative of the EU because the UK's policy has been to position itself as equidistant between the US and Europe. It is the French who have traditionally sought to informally represent the EU on the UNSC (though even they are prey to chauvinism on occasion). The EU loses nothing here.

The majority of free movement occurs on the continent, not across the Channel, for pretty obvious reasons of geography. If Poland was seeking to "export its unemployment" it would do so to Germany, not the UK. The end of free movement to Britain is only going to be an issue if we deny visas to skilled workers and students (and the objections will come mainly from domestic business) or if we mass-expel existing residents (unlikely). This is going to be close to a non-event for the EU27.

English is an advantage for skilled jobs, not low-paid ones like picking beets, and because it is the corporate lingua franca skilled Brits can find work in Berlin (or San Francisco) as easily as French people who speak English can find work in London. There may be an asymmetry of supply (lots of monolingual Brits), but this is offset by a reverse asymmetry of demand (lots of global jobs that require English).

[Gary Taylor]

@Arse to Elbow. I do not challenge your stats, but simply remind you that unfortunately the EU does not spend GNI per capita ratios. It spends Euros. Of which we are the 2nd largest net contributor, contributing more actual spendable Euros that 26 others combined (i.e. excluding DE).

[Gary Taylor]

@Arse to Elbow. Source: http://news.bbc.co.uk/1/hi/world/europe/8036097.stm#start

[MJW]

@ arse to elbow

Cherry picking started out as the idea that we can effectively keep the single market whilst dropping freedom of movement. May has ditched that. So now cherry picking is being "redefined" as basically negotiating the best possible trade deal that is not the single market, which is pretty much the default operation for any trade negotiations anywhere else in the world when a country is negotiating as an individual actor (i.e. not a trade block). Calling normalized trade negotiations cherry picking is just the cheap talk that all parties are currently engaged in.

The EU isn't financially dependent on the UK, but as a major net contributor it makes a notable difference to a project that has never known 'austerity' and a bureaucracy for whom the gravy train has only ever got richer. There will be real economic and psychological shocks to the EU administration that has hitherto balked at even modest reform.

The potential end of mass migration to the UK is of real concern to Eastern European governments. I don't have a link but the last stats I saw showed that the UK has been in absolute terms the number one destination for Polish immigrants since accession. If hundreds of thousands of low skilled Eastern Europeans who currently live or plan to live in the UK shift to Germany post-Brexit that won't please Germans who are already jittery about Merkels immigration policy.

[Boursin]

"Publicly, elected politicians from member countries may endorse this approach. But with most of them facing populist movements within their home nations and aware of rising anti-EU sentiment, none can afford to be pilloried for setting a precedent of anything other than a dignified and economically attractive exit path for the first nation to take that option, in case their own might follow."

This is exactly the kind of entirely false belief caused by the lack of foreign language skills that Chris mentioned towards the end of his post. If there is a truly widespread consensus view about anything among the political class on the continent, it's that the exit path for Britain must be as UNattractive and UNdignified as possible - to function as a deterrent, because their own might OTHERWISE follow.

For instance, if you follow the editorial page of any newspaper particularly favoured by the non-populist segment of the political class in almost any of the EU27, this view is held completely openly and in so many words; only not in English.

[Dave Timoney]

@Gary Taylor,

The BBC analysis you have used is from 2007, which was not only a single year a decade ago but an atypical year in terms of contributions. To avoid (ahem) cherry-picking, you need to look at the trend over time. Here is a Danish analysis for the 2006 to 2014 period. You can clearly see the anomaly of 2007:
http://english.eu.dk/en/faq/faq/net_contribution

This next analysis (see page 2) shows the trend between the 4 largest contributors graphically:
http://ukandeu.ac.uk/wp-content/uploads/2016/01/Who-pays-for-the-EU-and-how-much-does-it-cost-the-UK-Disentangling-fact-from-fiction-in-the-EU-Budget-Professor-Iain-Begg.pdf

In other words, my original statement above - that the UK has "usually paid less in absolute terms than Germany, France and Italy" - is correct. Of course, there are many ways in which the numbers can be represented (hence the analyses vary), to suit all arguments, but the key political truth is that the UK has always had a "good deal".

This is actually a cause for some resentment among the EU27, which you can see in the way that the European Parliament presents the numbers, making explicit that the UK rebate is calculated per country, not in aggregate - i.e. France, Italy et al pay for the UK to be a member; the rebate isn't a back-hander from Brussels. I'm not sure that many Brexiteers understand the psychology of this (see the title of this post) and how it will impact negotiations.

See: http://www.europarl.europa.eu/news/en/news-room/20141202IFG82334/eu-budget-explained-expenditure-and-contribution-by-member-state