What Game Theory Says About May’s Brexit Choices

(Bloomberg Opinion) -- Almost immediately after she safeguarded her position as leader of the Conservative Party on Dec. 12, Prime Minister Theresa May headed to Brussels to try to gain concessions from the European Union before a second vote in Parliament on a Brexit deal. Her tireless efforts are commendable. But if success eludes her in the next few weeks, her negotiating stance will be increasingly costly to maintain — economically, politically and socially — strengthening the case for a determined, though risky, pivot.

Game theory provides important insights into May's current negotiating approach and why a solution has remained challenging.

Unable to unite her party on Brexit, the prime minister has looked to the European Commission to come up with an acceptable compromise that would provide a catalyst for a cooperative outcome. But European officials aren't convinced she can impose her will at home and have become increasingly hesitant to make concessions that would, in effect, mean negotiating against themselves. And threats of either a unilateral break or extreme consequences if there is no agreement do little to focus minds on either side in this increasingly polarized and uncooperative environment.

It is hard to see how this could be resolved anytime soon, because the solution involves an elusive balance between a hard Brexit and the type of association status that other countries have negotiated with the EU. Specifically, London will continue to resist a soft withdrawal option that would maintain preferential market access but that would take away any say for the U.K. in the rules and procedures of the EU. Brussels will resist an outcome that allows Britain to have its cake and eat it too for fear of establishing an undesirable precedent. Yet the search for some middle way remains the focus of most of the discussion. Without a bold policy shift by one or both sides, the inclination will be to prolong a standoff that is evolving into a war of attrition — not just between the EU and the U.K., but also within British politics and society.

 This “no-war, no-peace” situation buys time in the short run, but it carries significant costs and risks:

• It undermines Europe's ability to address long-standing structural weaknesses that eat away at the prospects for higher and more inclusive growth, both for national economies and for the regional economic architecture.

• It diverts policy makers' attention and energy away from the design and implementation of new measures needed to enhance productivity and growth at a time of major changes in the global economy and in the impact of technological innovations.

• It creates an environment that enables divisive forces to flourish amid heightened sensitivity to identity, culture and migration issues.

May will have to make a bold political call to move forward. She can go for a hard Brexit, accepting the inevitable short-term disruptions in exchange for the longer-term promise of operating in a less constrained and constraining environment. Alternatively, she could revisit the June 23, 2016 Brexit referendum through a three-step process: First, agree with Brussels that this effort would be pursued under the more general umbrella of a reforming EU over time. Second, hold a second referendum that would be preceded by comprehensive and transparent debates on the cost and benefits of the two choices. Third, and only if the remain camp wins, have the political will and courage to see through a process that will inevitably be controversial and strongly opposed by some segments of society.

Many feel that the prime minister has already gone too far down the road to compromise to be able to opt for either a hard Brexit or a new referendum to remain in the EU. But if she wishes to ensure her legacy and better secure the economic future of her country, she may have no choice but to pivot to one of those two options. I know which one I would pick.

To contact the editor responsible for this story: Max Berley at mberley@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide.”

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