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Monday, 4 July 2016

Blindsided by Brexit Bias


The result of the UK’s referendum on the EU caught markets by surprise. They’d soared the previous day in the expectation of a Remain vote and were thrown into turmoil when it turned out a majority of the British were less concerned with economic stability and more with mass immigration.

The polls leading up to the referendum were finely balanced; if they were to be believed then the result was far from certain right up to the end. Yet many people took the market surge at face value – that markets were pricing in known information –  and that a Remain vote was in the bag. But it wasn’t, and the whole thing is behavioural bias writ large. Not that anyone will actually learn the lessons of course.

Wishful Thinking

Brexit bias is a casebook example of what Charlie Munger calls the Lollapalooza Effect, where a number of different psychological issues combine to cause a cascade. Each issue on its own is perhaps manageable, but when combined they’re an unstoppable force for wilful stupidity.

Perhaps the over-riding issue amongst investors was wishful thinking. It’s clear from the demographics of the poll that Remain voters were disproportionately from the London area, were better educated and tended to be younger. Not unsurprisingly these people are the ones that have benefited most from EU membership and, I surmise, are most likely to be among the movers and shakers in UK stockmarkets.

Confirmation Bias

In fact, one of the more noticeable oddities in the lead up to the referendum was the way that Leave voters only seemed to know other Leave voters and Remain voters only other Remain voters. This was an early indication of the split through British society that influenced the overall result. Unfortunately we know all about what happens when people get stuck in closed groups benefiting from mutual support for their ideas – it’s the ideal breeding ground for confirmation bias. If no one is gainsaying your views then you’re even less likely than normal to challenge them yourself.

The split in British society is largely about economics and globalisation. Opening up the EU to ex-Soviet countries and simultaneously allowing freedom of movement has seen significant migration into the UK at the same time as globalisation is impacting traditional working class jobs.  


Less affluent areas of the country have been dealing with significant influxes of EU migrant workers, which have changed communities, impacted local services and driven down wages. This is a generalisation, but the anger in some of these communities has spilled over into the referendum campaign. 

Given that migration has had a disproportionate impact on areas outside of London then it’s understandable that people suffering are inclined to blame something tangible like the EU, rather than something intangible like the industrialisation of developing nations. None of this is to say that London hasn’t been impacted, but adding lots of cheap service oriented staff to the service led economy there has generally made life better. London is richer, more cosmopolitan and always has had a significant migratory population: it’s better able to deal with migration and much less affected by it.

Group Polarization

But we know what happens when you set two groups with different viewpoints at odds with each other. You get group polarization – peoples’ views move from moderate to extreme. As we saw during the campaign there comes a point where rational argument makes no difference to opinions, where debating with opponents simply comes down to exchanging insults.

The polarization in Britain has led to a narrow decision in favour of leaving the EU, but leaves a difficult legacy to deal with. It’s not just the negotiations with EU and the inevitable downturn in the economy in the short term, but the ongoing tensions in society. Whatever happens next won’t please everyone and will probably not please anyone. The recriminations will be long-lasting.

Inter-Group Bias

The lessons, of course, are global. Tapping into the disenchantment of blue collar workers who’ve seen their wages declining in real terms for thirty years by finding some out-group to blame relies on another psychological quirk, inter-group bias, and it’s a powerful one. Whether the phantom menace is the tribe in the next valley, Eastern Bloc EU workers or Mexican migrants the message is the same: here is someone to blame, get rid of them and you solve your problems.

It’s not true, of course, but rationality and emotion are only loosely linked. Some of the reaction from the losing side to the referendum result has shown this quite clearly: it would appear from some of the more hysterical market commentary that the British economy is about to collapse and a return to the Dark Ages (or at least the 1970’s) is inevitable. 

Disaster Myopia

In reality things are more nuanced. I’m no Nostradamus (although to be fair, neither was Nostradamus) but it’s clear that the EU itself is not in the greatest shape. The euro continues to be a bleeding sore, with a banking crisis in Italy and the latest set of Greek debt repayments looming. Retaliating against the UK by sending it into a deep recession isn’t likely.

What is more likely is that UK inward investment will stop until the outcome of the EU negotiations are known – probably 2 years and possibly more away – and we will see a general reversal of EU migration. A deal on access to the EU’s single market – particularly for financial services – will be forthcoming eventually, probably at significant cost and with some almighty fudge around immigration.

Meanwhile the drop in the pound boosts UK exporters while probably reducing demand in the UK and pushing up inflation a bit. None of which is entirely bad, although if it feeds through into a reduction in UK property prices that might trigger a proper recession (the average Brit believes passionately that you can never go wrong investing in property despite regular house price crashes, a severe case of recurring disaster myopia).

What Crisis?

However, look at the situation dispassionately: the UK has surprised markets by voting to leave the EU and take a jump into the unknown, our Prime Minister has resigned and the leader of the main opposition party has seen 80% of his party’s representatives declare against him, the pound has plummeted, the country is split 50/50 along lines of age, education and geography and Scotland is demanding another independence referendum. And to top it all the English soccer team has been dumped out of the European Championships by a country of 300,000 souls led by a dentist.

It this ain’t a crisis I don’t know what is.  And yet, and yet ... life goes on. The streets are not on fire, the protestors are not manning the barricades, everything still functions with its normal haphazard efficiency or lack of it. Our democracy stands.

Frankly, if that’s not something to be proud of – and to invest in – I don’t know what is.

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