15 November 2017

The paradoxical case for preparing for no deal

By Tom Doughty

The debate over what the UK’s future relationship with the EU should be has dominated British politics for more than a year.

That debate will soon benefit from a lot more detail. Last week, the Government was forced to announce that it will publish Brexit impact reports pertaining to 58 economic sectors across the country, following a House of Commons motion introduced by Labour.

The government’s resistance to publishing these reports was based on the claim that doing so would harm their Brexit negotiating position. They were right. And a simple piece of game theory demonstrates why.

The negotiations between the UK and the EU can be simplified into a game of chicken. The game describes a generic bargaining position in which two players each have two possible strategies: they can either play “tough” or “weak”. If both players play weak, both sides win. If one player plays weak, and the other opts for tough, the latter wins. And if both players play tough, they both lose.

The UK’s bargaining position, and therefore the possibility of leaving the EU with a favourable deal, hinges almost entirely on whether it can make credible threats to leave without a deal. The UK must prove that if it were to be offered a bad deal, it would not harm itself by walking away, and that the EU would be better off playing weak.

Of course, this analysis turns an incredibly complex set of negotiations into one very simple payoff matrix. Along the way, we are making some sizeable assumptions. In reality, each side needs to balance several different aims, and may not be as uncompromising as implied in this game. But it is nonetheless a useful way of understanding the UK’s dilemma.

So far, the EU has played tough. It would be reasonable to suggest the EU entered these negotiations from a position of relative strength. The EU’s insistence that the UK has just two weeks left to find a solution on the divorce bill is a clear indication of this.

Given the EU’s tough strategy, the UK is left with two options. Depending on which yields the higher payoff, the UK can play weak – accepting any deal – or play tough.

Whether the UK would be better off with ‘No Deal’ or ‘Any Deal’ is a key question in the negotiations. However, for this game we must assume that at least to begin with, if the EU were to play tough, the UK would be better off playing weak. In other words, we assume for now that at least in the short term, taking any deal would be better for the UK than leaving with no deal.

The government’s reluctance to publish the assessments seems to suggest that this assumption is true. However, we don’t know what the assessments contain and David Davis has himself suggested they aren’t what Labour MPs expect.

Either way, disclosing information relevant to the negotiations would reduce the credibility of the UK’s threats and would undermine any tough UK strategy. Poker players don’t show opponents their hands.

As the EU’s bargaining position strengthens, they will be less convinced to play weak and more convinced to play a tough strategy that is damaging to the UK. The UK’s payoff from playing weak would fall as the EU’s negotiation demands increase.

At a certain point, the payoff to the UK under any deal – by playing weak and meeting the EU’s demands – would become equal to, or even less than, the payoff under no deal. The UK would be indifferent between the two or even better off leaving without a deal in place. A bizarre inverted self-fulfilling prophecy arises in which the publication of impact assessments, or desperate demands for a Brexit deal actually reduce the likelihood of a deal happening.

It is curious that these calls often come from those who are most keen to see us leave with a deal. Remainers who are worried about Hard Brexit are shooting themselves in the foot.

Yanis Varoufakis, the game theory expert and former Greek finance minister, learnt the hard way what happens when you negotiate with threats that aren’t credible. He tried a tough strategy in taking on the EU during the Greek economic crisis. Varoufakis warned that if the Greek economy was to collapse, the Eurozone would come crashing down with it. A deal was struck where the Greeks would be bailed out by several loans, on the condition that the Greek government implement a severe programme of austerity.

The bailouts ring-fenced the crisis, and as soon as an austerity-induced recession hit Greece, Varoufakis’ bargaining position deteriorated. Greece was told it would be allowed to hang if it did not meet its creditors’ repayment requirements. His tough position was not credible, and he was forced to play weak.

Fortunately, the UK is in a stronger negotiating position than Greece. While Greece’s strategy changed from tough to weak, the opposite is likely to be the case for the UK.

What the UK government probably hopes, and could yet be the case, is that the EU will abandon its tough strategy at the last moment. There is plenty of evidence to suggest that it is in the EU’s interests to ensure a deal on at least free trade and security. For example, one in seven German cars are sold in the UK. This seems to be the view of Sir Christopher Meyer, who recently suggested that the UK should pause the negotiations to regain the upper hand. Even so, a worsening negotiating position makes the UK more likely to blink first.

Strangely, if the UK wants to achieve a favourable deal with the EU, its best hope may now be to act as if it doesn’t want one at all, and to divert resources towards giving a No Deal outcome a positive payoff. Conversely, the more we insist we must achieve a deal with the EU, the more likely it is that we won’t. Perhaps the solution to these complex negotiations is just a little more optimism.

Tom Doughty is a CPS Economic Research Intern. He studied Economics with French at the University of Nottingham, and has previously worked for an international market research company in Paris.