Jul 11, 2016

On Brexit and the governance of globalization

The outcome of the vote on Brexit surprised many people, myself included. Nonetheless, the fact that Brexit gained momentum should not come as a surprise. The reasons why Brexit became relevant do not necessarily have to do with populism and issues with democracy as many observers seem to imply. Populism is always a consequence of something else and the rants about "stupid" voters really miss the point. In this post I take a different perspective and ask: what if voters were actually behaving rationally?

Disclaimer: this post is long, not particularly well structured and has not been revised.

Many different observers have said different things about Brexit. They all highlight some interesting aspects, but I believe they miss the central point.
Here some of the things that have been said.

Paul Johnson of the IFS argues that economists were unable to deliver their message. While I have being saying for years that the profession has communication problems, I am afraid that this not a good explanation of anything.

I agree with Simon Wren-Lewis that "Even if you had put all these things right, I do not think it would have made any difference to the result"; morevover, the economic information was readily available in the period before the vote.

The argument that people were uninformed is quite common. Someone attributes it to the communication side (populism, the media, economists etc.), someone else attributes it to the the fact that Brexit supporters were ignorant or stupid.

As an example consider the figure below reporting the number of EU myths debunked by the European Commission. Note that the existence of such myths is not per se a problem, people have to believe them and they must influence voters, which is hard to prove. Nonetheless, the fact that the EC had to debunk them demonstrates that is was needed. Importantly, all the information to debunk the myths was freely available, but there was maybe a need for an "official" debunking.


It is true that people were uninformed. For instance Google Trends reports the top questions on the EU after the Brexit results: "What does istmean to leave the EU" and "What is the EU" are the top 2. Google Trends tweets "+250% spike in 'what happens if we leave the EU' in the past hour." https://twitter.com/GoogleTrends/status/746137920940056578
Hard to believe, and in fact it bounced for a while in the social media.

The problem is that while the list and the shares are true, the absolute numbers - as always - matter too. And if we look for the actual number we see that less than 1000 people actually searched those entries. Less than 1000 people. Which means no one, a very negligible share of voters in a 60 million people country. As Paolo Attivissimo stresses, it could easily be due to a few classes doing a school research on the EU and Brexit.

This is not to deny that uninformed voters are a problem. I believe many voters were actually uninformed, as it often happens. But I think that the effect of that might have been overestimated.

On the basis of the uninformed uneducated voters, some people even talked about issues for democracy. I even read claims that ignorant or stupid people should not vote.

Giampiero Gallo https://twitter.com/giampierogallo/status/746279279953068032

WSJ http://graphics.wsj.com/brexit-whos-voting-what/?mod=e2fb

WSJ http://graphics.wsj.com/brexit-whos-voting-what/?mod=e2fb

So while on the "intellectual/educated" mainly-remain side Brexit pushed such posh comments. On the opposite side, Brexit vote has “legitimised the prejudice of some people” as the number of hate crimes reported to police soar by 57%. Not quite a win-win situation.

What the above arguments miss is that those people might not be stupid at all. They might be uninformed about what exactly is the EU etc., but this applies only if we assume to know the relevant kind of information.

What if those people are instead (collectively and unknowingly) rational and the relevant information is not the one we have in mind (like "what is the EU" or "what is the effect of deflation")?

For instance, while voters were uninformed, a majority of them knew that the economy would have been no better off if leave had won. Some of them must have voted for leave even though the overall economy would likely suffer. Why?

WSJ http://graphics.wsj.com/brexit-whos-voting-what/?mod=e2fb

And now let me come to my argument.

I argue that the outcome in favor of Brexit perhaps was fortuitous, but the demand for a change was predictable and has to be read together with other recent political events.

To put things in perspective, this post is not just about Brexit, but uses Brexit as the most recent example of a more general issue about the governance of globalization.

The intuition is simple for any economist who took a basic course in international trade. In a basic Heckscher-Ohlin model, intenational trade, while welfare improving on the net, creates winners and losers. This is the most basic fact for any non-trained-in-economics person. The surprising part, the result that needs to be proven in the eye of the layperson is that trade is beneficial overall.

If trade creates winners and losers we should expect winners to favour trade opennes and losers to oppose it. Can such a simplistic intuition from a simplistic model be of any help in undertanding a complex reality? Yes. Much more than many sophisticated reasonings.

This is exactly what we see in the data.

A study by Autor, Dorn & Hanson (2013) about USA estimates that a 1% increase in Chinese import penetration implies a reduction in employment by 1.3% in import competing industries. About 17% of lost manufacturing jobs between 1991-2001 can be attributed to Chinese imports. Workers that lose their job due to globalization often have troubles finding a new job in a reasonable time.

In the last decades we have assisted to an increase in the skill premium: roughly said, being skilled pays more than working in the export sector. A similar evidence applies to many high-income countries, in which we assisted to a clear job polarization - increases in low- and high-wage jobs (Goos et al. 2014).

If instead of traditional sectors employing capital and labor we think in terms of skilled and unskilled workers what we get from an H-O model is that trade benefits skilled workers and hurts unskilled workers in skill abundant countries (developed countries). If we add to this that international outsourcing is a relevant phenomenon we can even get that skilled workers are those who benefit from trade also in less developed countries - however this dinstinction is not important here. What is important is that we have models (and actually pretty basic standard models) that clearly show that skilled workers can gain from trade, while unskilled workers lose.

In a study, Scheve & Slaughter (2001) show that skilled workers are more likely to favor globalization. Moreover, O’Rourke (2016) argues that the pattern is inverted in poor countries. In 2005, France and the Netherlands voted against the European Constitution. In France only 35% of professional was against it, while the share among blue collars was 79%. In the 2008 Irish refendum on the Lisbon Treaty, more than 60% of voters from a rich zone south of Dublin voted in favor, while more than 60% of the working class voted against.

Recently, Keller & Utar (2016) showed that Denmark, despite being a country with relatively high income equality, had a clear job polarization, a strong globalization and a rise in income inequality in the last decades, quite similarly to the US. Not surspisingly, there are people talking about a ‘Dexit’ as the next referendum about exiting from the EU.

The above figures must be read together with the statistics from the Brexit vote. And with the UK referendum on the European Constitution that was indefinitely postponed after the rejection in France and the Netherlands, with opinion polls reporting 57% of voters against it.

Globalization is beneficial on the net and has contributed to decreasing poverty and inequality worldwide. But it has also led to increased inequality within some countries, notably advanced economies. But globalization has the potential to be beneficial to all. Put simply, when there are efficiency gains, everyone can be made better off. The role for the government is to set up the rules of the game so to allow efficiency to be reached and to redistribute the gains as equally as possible.

When redistribution is not effective, you have a problem. Any rational person would not support something that is expected to have a negative impact on him or her. People who voted for leave did not vote against globalization or against the EU in general, they voted against the type of globalization and of EU that does not shares the gains with them.

Brexit and many of the above mentioned things were predictable exactly because those people are rationally responding to incentives.

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