June 30, 2016 10:30 am JST
Commentary

Paul Donovan -- No referendum is an island

The British decision to end the country's EU membership may seem an isolated event. Something for the U.K. to worry about, certainly. Something for the EU to muse over. But not, necessarily, something that Asia should be concerned about. This attitude is a mistake, in my view. The U.K. referendum matters because it signals trends that will shape the world economy. These trends are important for Asia and Asian investors.

Leaving aside the details of EU membership, the referendum result marks a victory for "anti-politics." This is the politics of being against something rather than for something. Anti-politics suggests, "If only we get rid of this one thing, all our troubles will be over." In the case of the U.K. referendum, the anti-politics focused on immigration. Anti-politics is very common in the wake of economic weakness.

Similar forces are visible in the U.S. and in Europe. Anti-politics may also become important in Asia, given the current economic slowdown there. Asia has also been a target of anti-politics in the past (think of U.S. trade policies in the 1990s). The lack of tolerance inherent in anti-politics is damaging to trend growth, in Asia and globally.

The second global feature of the U.K. referendum is polarized politics. Before the vote it was very common to hear people say, "I don't know anyone who is voting Remain." Or, "I don't know anyone who is voting Leave." These statements were very likely true. Although the final result was close, 52% to 48%, regional votes were dramatically divided. Most areas of the country voted with around 60% in favor of one outcome or the other.

Polarized politics may be a result of modern media. With more people getting information through social networks and other online sources, it is more likely they are hearing only one side of the argument -- the side their social networks reflect. This becomes a self-reinforcing news flow and creates polarized politics.

For investors, polarized politics is a deeply negative development. It increases the risk of extreme alternatives being offered. The margin of victory for one side or the other may be narrow, as with the U.K. referendum, but the differences between the two polar views are divergent. If the markets price in the wrong outcome, then the cost to investors will be high (because the difference between the economic consequences of what is priced and what happens is so huge). The U.S. presidential election is another example of this.

Finally, the future path of global trade is challenged by the U.K. exiting the EU. Successive U.K. governments have been strong supporters of free trade. That support was amplified by the U.K.'s membership in the EU. The U.K.'s support for the creation of the World Trade Organization was instrumental in bringing about EU support for the WTO -- and with the EU supporting the WTO, the prospect of free trade became a lot more realistic. With the U.K. outside the EU, the emphasis of the EU could change. Free trade is already under threat in the U.S., and it is unlikely that the EU will champion free trade in the absence of the U.K.

What happened in the referendum should not be seen merely as causing change in the world economy; it was what economists call a "signalling effect."

Paul Donovan is a global economist at UBS Investment Bank. More can be read at www.ubs.com/pauldonovan.

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