Are Brexit fears exaggerated?

Economic growth, democracy and economic freedom lead to the political separatism of nations

Scissors cutting UK and Euro flags that are currently joined together

This year, over 1 million people from across the UK marched to central London to demand a second vote on whether the UK should leave the EU. That is a drastic shift from just three years earlier, when over half of all UK voters (17 million people) voted in favour of the United Kingdom leaving the European Union in what became known as the Brexit referendum.

Millions of people have also signed an online petition calling for a Brexit referendum do-over since the original vote.

But what led to Brexit in the first place was public discontent with policy decisions coming out of Brussels. The 2016 vote signalled a desire on the part of UK residents to have more autonomy over their country’s governance and finances.

According to economic theory, had a pro-EU government sufficiently compensated (represented) the policy preferences of the 17 million individuals from the UK who voted to leave the EU, the UK majority may have opted to stay in the EU. Years of EU membership may have created winners and losers, and many Brits are hoping that Brexit could restore the balance.

On one hand, if a political jurisdiction is too large, a smaller jurisdiction can improve the welfare of those whose policy preferences differ greatly from the law of the land. On the other hand, the average cost of government increases, as a jurisdiction gets smaller. The efficient size of nations optimizes this trade-off.

Brexit is far from an isolated event. National borders are forever changing and while some political jurisdictions are created, others are being dissolved. Economists Alberto Alesina and Enrico Spolaore claim that political separatism could be a good thing. In their book ‘The Size of Nations’, they argue that political separatism is the result of more democratisation and more economic integration.

In 2017, the Catalan independence referendum was declared a breach of the Spanish constitution, therefore silencing over 2 million voters (92% of those who voted) who had expressed their desire to see Catalonia become an independent state. In 2014, Scots headed to the polls to decide whether to remain part of the United Kingdom and Northern Ireland or to become an independent sovereign state. The majority rejected Scottish independence with over 2 million voters (55.8% of voters) expressing their satisfaction with the London-based government.

Brexit, Catalonia and Scotland were peaceful and democratic examples of individuals choosing to join or to break away from a central unit of government. Unfortunately, our known history is also full of less democratic examples of new country formation.
It took multiple civil wars for South Sudan to become an independent state in 2011.

Territorial disputes in the Balkan Peninsula eventually led to the formation of the Republic of Kosovo in 2008. The single nation of Serbia and Montenegro, formed after the collapse of Yugoslavia in 1991 also led to two separate independent states in 2006.

Others such as Palau became independent on Oct. 1, 1994, 15 years after it had decided against becoming part of Micronesia due to cultural and linguistic differences. It is clear that the more recent trend towards peaceful, democratic secession movements is far more preferable than the way most borders were redrawn in the past.

Why are the world’s political jurisdictions constantly being redefined?

Country formation and secessions depend on a large and complex mix of factors such as geography, history, ethnicity, ideology, politics and economics. However, Alesina and Spolaore illustrate that a simple story of trade-offs between the benefits of large political jurisdictions and the costs of heterogeneity in a large population can explain the size of nations. In their book, they show that political separatism was caused by widespread democratisation and an increase in global economic integration.

The per capita cost of any non-rival public good decreases with the size of a political jurisdiction. However, since a large population is likely to be less homogenous, policy decisions may be less correlated with the preferences of the average constituent in large political jurisdictions. When policy decisions are not congruent with constituent preferences, these constituents have an incentive to secede.

Geography, linguistic and cultural differences could result in a set of policy outcomes that may benefit a majority but differ greatly from the preferred policy choices of a large number of constituents that are far from the place where most policy decisions are made – the political capital. It is easy to see why geographical, cultural differences and policy preferences may coincide. Individuals similar in ideology and policy preferences have an incentive to form a country together. It is also true that individuals choose to live in regions inhabited by people of similar ethnicity, language, beliefs, ideology, etc.

A recent report published by the Pew Research Center shows a link between geography and the growing partisan divide in US states. Pew data indicate that Republicans prefer to live in rural areas, while Democrats prefer urban living. Sixty-five percent of Republicans say they would rather live in communities where “houses are larger and farther apart” and “schools, stores and restaurants are several miles away”. In contrast, 61% of Democrats said they would prefer to live in a place where the homes are smaller and more densely packed into neighbourhoods, and stores, schools and restaurants are in walking distance. Those preferences line up with the urban-rural divide that showed up in the results of the 2016 presidential election.

This evidence illustrates how geographical location and policy preferences coincide. There are huge costs associated with distance from where policy decisions take place, and unless these constituents are well represented and compensated by the appropriate redistributive scheme, the likelihood of discontent and secession increases. These costs could certainly explain why nations are bound together by geography.

Democratisation leads to secession

The efficient number of countries increases with the costs of distance (preference heterogeneity and geography) and decreases in the cost of government (taxes). This is because the efficient number of nations optimises the trade-off between average taxes and heterogeneity in policy preferences (i.e., the average distance from each government’s policy choices).

The efficient number of countries is not stable. When everyone faces the same tax burden, whether or not they agree with policy decisions, then not everyone achieves the same level of welfare. It would be unfair for those who benefit least from the public good to be taxed at the same level as those who benefit most. Government benefits some more than others, but there have to be counterbalances – a redistribution scheme – to keep those who do not come out on top in the game satisfied, otherwise they will leave. However, the redistribution scheme that restores efficiency is difficult to implement because the scheme must be linked to individual preferences. This is why allowing individuals to vote on whether or not to secede via a democratic majority-rule referendum can lead to an inefficiently high number of more stable countries.

When a democratic referendum is not an option, more economic integration and free trade across borders makes unhappy residents of a large country better off and reduces the incentive to secede. Free trade also increases the welfare of residents in small countries. As a result, in the absence of democratic referenda, higher economic integration is always welfare improving.

Large nations are large economies. Relative to smaller economies, they have access to more human capital, which improves living standards. More economic integration makes breaking up large nations less costly. The benefits of large nations become less important if trade barriers are removed and small nations can freely trade with each other. For that reason, democratisation coupled with economic integration leads to more political separatism. A higher degree of economic integration can cause both the efficient and the stable number of nations to increase.

If higher economic integration makes countries smaller, welfare could decrease if a country is already “too small”. Relative to the efficient country size that maximises welfare, the average cost of public goods will be too high in the more stable, smaller country. Since more economic integration makes countries smaller, average welfare will decrease if a small country breaks up below the efficient size.

On one hand, the smaller size leads to more congruence between policy choices and voters, and greater economic integration increases income. On the other hand, a smaller country faces a higher average cost of government. When a country becomes “too small”, the cost of government can begin to outweigh the benefits of integration resulting in lower welfare.
Political separatism is linked to higher living standards

History largely agrees with economic theory. As the number of absolute monarchies and authoritarian regimes decreased, the number of nations increased. Democratisation and economic freedom that led to the creation of more (smaller) countries are positively linked to higher living standards.

Empirical evidence from a panel of around 100 countries form 1960 to 1990 suggests that economic freedom improves living standards regardless of country size. However, the relationship between political freedom and economic growth is more complex. Some political freedom is good for growth but too much can harm welfare. There exists a growth maximising level of political freedom and once a moderate amount of democracy has been attained, a further expansion can reduce living standards. In contrast to the weak causal effect of democracy on living standards, there is a strong positive influence of the standard of living on a country’s propensity to experience democracy.

Political freedom, economic freedom and Brexit go hand in hand

Although political and economic freedom could lead to countries that are too small and too inefficient, there is enough evidence to suggest that Brexit falls on the right side of history. Large heterogeneity within the EU block has already led to severe economic pain for some of the member countries.

A globally integrated economy means that fears of a decline in economic activity surrounding the break-up may be exaggerated. Globalisation means that the UK should be just fine without Brussels and the one thing that remains certain: a smaller political jurisdiction will lead to better representation for all.