Could there be some method behind Brexit Madness?

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In spite of this week’s political chaos, the mood in financial markets still seems reasonably relaxed that a ‘hard Brexit’ can be avoided. Do the markets know something that escapes politicians and the media or are we now facing into major event risk and troubling market as well as economic conditions in coming months?

One admittedly contentious possibility might be that markets believe there could be some method hidden deep beneath the madness. On this view, really damaging outcomes will be avoided because UK politicians are engaged in a clever if confusing strategy to maximise the concessions they might win from what is clearly a very weak bargaining position. Seen through a ‘Game theory’ lens, the various twists and turns could be elements in a complicated plan entailing a sequence of interactions with other ‘players’ designed to win the best possible deal for the UK.

The starting assumption in standard Game theory is that all ‘players’ act rationally. However, in current circumstances, rational behaviour for UK policymakers could be to act unpredictably and seemingly irrationally in their negotiations to create uncertainty that may make others more cooperative in their dealings with them. To do this properly, Mrs May would avoid giving clear signals of her strategy or even any indication that a coherent approach was being followed. On that interpretation, the UK is playing really well!

Importantly, the Brexit ‘payoff’ that the UK and the EU are trying to maximise must be measured in political as well as economic terms. If Brexit was viewed exclusively in economic terms, the UK should not have voted to leave and would now be entirely at the mercy of EU negotiators. In this context, a recent poll found 43% of Britons favoured leaving at end-March compared to 38% that wanted a delay. Strong political drivers mean there is now some tolerance for the likely significant economic costs of a no deal Brexit within the UK. Such ‘rational irrationality’ may make negotiating the endgame a little easier for Mrs May.

For Theresa May’s government, dealing with the EU has probably been far less complicated than winning domestic support. Game theory might suggest it would have made sense for Mrs May to sustain some element of domestic tension through the past couple of years to win concessions from the EU (as domestic differences would limit how much she might reasonably be expected to concede). However, a persistent problem has been to ensure these domestic differences didn’t become so wide that they completely undermined the credibility of the UK government with its EU counterparts.

To play this domestic game successfully, Mrs May would have needed to run the clock down towards the Brexit deadline while keeping outcomes at both ends of the spectrum (no deal and remain) firmly open as possibilities. As the original deadline approached, she has increasingly threatened domestic factions to believe that if they didn’t compromise, their least preferred outcome might materialise. 

This process has been painful particularly for Mrs May but that should have been expected. A frequently cited example of Game theory, ‘the prisoner’s dilemma’, suggests circumstances in which a group might adopt an obstinate position even if other positions held out some possibility of better results to lessen the likelihood of their least preferred outcomes. Mrs May now seems to be desperately trying to draw various factions within the UK parliament away from such non-cooperative games towards a compromise centred on ‘her’ deal.

The new two stage deadline of April or May is a clever device that should increase risk aversion among at least some of the factions within the UK parliament. The outcome of a prospective third vote next week should be much closer than previous debacles but is still uncertain. The possibility, if Theresa May loses, of a lengthy extension that might allow both a general election and a second referendum as well as pose the more immediate problem of holding EU elections is a marvellous mechanism for sharpening the mind. For the main parties, the threat of a voter backlash as well as the risk of even more public and damaging internal divisions might encourage reluctant support for the current withdrawal agreement or something quite similar.

It is far from clear that there is any method in the madness surrounding Brexit. However, financial markets remain reasonably confident that a withdrawal agreement will be reached and wide reaching economic and political fallout from the UK crashing out of the EU can be avoided. This may simply reflect the view that common sense will prevail once all other approaches have been exhausted. Alternatively, it could be that some see in recent chaos a heavily concealed pattern consistent with the strategic interactions of Game theory. If that is the case, even more complicated manoeuvres lie immediately ahead and it could become even more complex thereafter as attention turns to the UK’s future relationship with the EU.