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The Brexit Vote As Harbinger Of A Populist Age, Or Not

On Tuesday, markets all over the world experienced a sharp “risk-on” rally. This rally started in European hours after a weak Asian day. One possible driving force was a British opinion poll showing a big drop in support for Brexit. Indeed, sterling jumped 1.2% against a strong dollar and 1.4% against the euro to its strongest level since early February. Why might a British poll have triggered a global risk-on move? Because the biggest threat to the world economy is no longer slumping industry in China, failing banks in Italy, unpredictable monetary policies or seesawing oil prices. All these familiar economic problems now pale into insignificance compared with the political risks of Brexit, a Trump presidency and resurgent nationalism in Germany.

Investors usually downplay political risks. After boldly declaring that their companies can succeed in any political environment, they often add, sotto voce, that politicians rarely carry out rash promises made in election campaigns. Unfortunately, in today’s conditions, this is wishful thinking. The political insurgents will doubtless change their minds about many issues, but the promises to which they will have to commit themselves unequivocally in order to win elections will be exactly the ones that are most economically destructive: a Brexit victory will certainly pull Britain out of Europe; a Trump presidency will certainly initiate a tariff war with China and an economic attack on Mexico; any involvement in Germany’s government by the xenophobic Alternative for Germany party will certainly mean expelling Greece from the euro, probably followed by Spain and Italy.

Because Brexit, Trump or AfD will need to make their nationalist commitments unequivocal to have any chance of electoral success, the consequences of a victory for any one of these populist movements would far outweigh the impact of the 2008 financial crisis—just as the upsurge of nationalism and protectionism in the 1930s proved more destructive than the immediate financial effects of the 1929 stock market crash.

Germans and Americans can only be disappointed

In Britain, the likelihood of a deep economic slump if the nation chooses Brexit has at least been widely recognized and debated. So Britons will have no-one to blame but themselves if they consciously vote for what George Osborne aptly calls “a DIY recession.” By contrast, Americans and Germans who vote for Trump or the AfD will expect to boost their living standards. When they discover that a trade war or break-up of the euro has the opposite effect, as it surely will, the blame will fall on foreigners and nationalism could turn into belligerent xenophobia or worse. But what are the chances of such disasters? Financial markets, political analysts and computerized voting models have consistently put low odds on the insurgents winning—in late May, Brexit was at 22% and Trump at 26%—despite the fact that opinion polls until recently showed Brexit and Remain running almost even and now show Trump-Clinton close to a dead heat. But the low odds attached by experts to both Trump and Brexit are less reassuring than they seem.

One problem is whether to believe the polls or the bettors and experts. Another is that even a low-odds event has a high probability of happening if there are several independent attempts. Suppose, for example, we accept the view of the betting markets that the odds of Brexit and President Trump are each around 25% and we also give similar odds to an AfD electoral breakthrough big enough to destabilize Angela Merkel. Then a simple calculation shows the probability of at least one of these events happening is 58%. In other words, a politically-induced disaster for the world economy seems significantly more likely than not in the year ahead.

Luckily, this calculation is only statistically valid if political events in Britain, America and Germany are completely independent events, like three draws from separate packs of cards. If, on the other hand, the populist revolts in all these countries are to some degree manifestations of the same phenomena, a vote against Brexit on June 23 could substantially reduce the odds of populist victories in the US, Germany and other advanced democracies. This is not because Americans or Germans would be directly influenced by what happens in Britain, but because populist voters in all these countries come from broadly similar demographics and are responding to broadly similar pressures.

The anti-establishment revolts are all driven by stagnant living standards, widening income inequality and disillusionment with conventional politicians who have failed to respond adequately to a once-in-a-lifetime economic crisis. The revolts are occurring in strongly democratic societies with longstanding political traditions of two-party dominance and a clear electoral bias towards the status quo. And the polls in Britain, America and Germany are all distrusted for similar reasons: the breakdown of previous political allegiances means that the methods used by all pollsters to calibrate their samples can give wildly inaccurate results.

Similar economic backdrop

Economic conditions in Britain, the US and Germany are also quite similar. All are, more or less, back to full employment, with jobless rates of about 5%, but as many of the new jobs created pay low wages, income inequality has become a big issue. House prices, consumer confidence and household finances have recovered above pre-recession levels, but feelings of economic insecurity are still widespread. Immigrants have recently displaced bankers as the scapegoats for all economic and social ills. Perhaps most importantly, populist voters in all these societies face similar warnings not to risk economic disaster by overthrowing the status quo—the campaign of admonitions from establishment figures that Brexiteers describe as “Project Fear”.

If political pressures in Britain, America and Germany are all related, then June 23 becomes even more globally significant. What Britain decides that day will provide the first really credible evidence about the true magnitude of the anti-establishment protests. And it will reveal whether a gulf really exists, as assumed by political pundits and financial markets, between what disillusioned voters tell pollsters and how they actually vote.

If the Brexit camp loses, the low odds accorded by bettors and experts to the populist movements will gain credibility, while the higher probabilities suggested by opinion polls will become less believable. In fact, statistical theory allows us to quantify how expectations for the US election should shift after a Brexit defeat.

Suppose for simplicity that we start by giving equal weight to opinion polls, which in mid-May suggested that Trump and Brexit were almost equal with their opponents, and to the views of experts, who have consistently given Trump and Brexit only a 25% chance. Now suppose that the Brexit camp loses on June 23. A statistical formula called Bayes theorem then tells us to change the initially equal weighting between expert views and polling data and instead give a two-to-one preference for the expert views. We can get different numerical answers by starting with different assumptions, but the broad message is clear: if Britain rejects Brexit, this will strongly confirm that voters tend to opt for the status quo when they reach the ballot box, however much anger and disgust they express to pollsters.

A vote against Brexit on June 23 will sharply reduce the probability of success for anti-establishment campaigns in the US, Germany and other advanced democracies. If, on the other hand, Britain does choose Brexit, the world should brace itself for two even scarier prospects: President Trump and Deutschland uber Alles.

9 Comments

  • >Anonymous

    Anonymous

    25/05/16

    Anatole,

    "xenophobic AfD party?"

    How do you come to that conclusion? AfD has never had a problem with the people of other European countries, West or East, North or South, and Islam is not a race.

    Brexit will be rejected because its proponents have failed to provide a detailed roadmap for an exit. There is actually little to fear because the British pretty well invented global trade and the commercial jurisprudence that still underpins it, but British voters will lose their bottle because no one has reassured them, only concentrating on the negatives, real enough, of why the EU is so loathed by so many apart from the oligarchical elites who profit from it.

       

       

    Reply
    • >akaletsky

      akaletsky

      26/05/16

      I disagree. The AfD have had a big "problem" with Greece and other "Club Med" countries and German fantasies about being sucked into a "Transfer Union". The euro crisis is what got AfD going, even before Merkel's immigration debacle. 

      And Xenophobia is not necessarily racist. Xenophobia is defined as "fear or hatred of foreigners", not necessarily of other races. 

      Reply
      • >Anonymous

        Anonymous

        26/05/16

        Thereby proving my point. It's not foreigners that AfD is worried about. It's the EU's large number of basket-case economies that got them worried.

        Reply
  • >Anonymous

    Anonymous

    25/05/16

    What is it with 'Europhiles' that whenever something is threatening or even questioning their dream of a Unified European Utopia, they stop using rational arguments and start with scaremongering?  Ultimately ending with the 'traditional' Godwin reference.

    Maybe it's exactly this attitude of the the 'well off elite' that is driving voters to the extremes (left and right).  I just don't see why a British exit from the EU or an electoral victory of AfD would basically mean the end of the world.

    Reply
    • >akaletsky

      akaletsky

      26/05/16

      I didn't say that a Brexit victory or AfD victory would mean the "end of the world" - only a slump in the British economy worse than 2008 and possibly a breakup of the euro which would generate an even bigger slump. 

      The world didn't end in 2008, but a lot of people lost a lot of money and jobs.  

      Reply
      • >Anonymous

        Anonymous

        26/05/16

        Plenty of economies thrive outside of the EU (and quite a few in it are doing terribly). Why should the UK be any different?

        Reply
  • >Anonymous

    Anonymous

    26/05/16

    Hi Anatole,

    Thanks for your as usual inspriring post.

    But isn't the division between polls and experts somewhat artificial? In which camp do you place the bookmakers, who seem to agree why the so-called "experts"?

    francois

    Reply
    • >akaletsky

      akaletsky

      26/05/16

      Hi Francois
      It's good to head fro you. The bookmakers are quintessentially "experts". In fact, I define "expert opinion" as equivalent to the betting odds (or spread-betting prices, which amount to roughly the same thing). 
      I tried to explain this in the piece, but maybe I should have been clearer. 
      Reply
  • >Anonymous

    Anonymous

    27/05/16

    No faith my coz
    Wish not a man from England
    Gods peace !

    16% undecided, U of K is a buy on a leave vote. Who is not going to pick up the phone to the 5th biggest economy.

    Reply