Brexit: what Europe does next

The actions of the UK are probably less important than the reaction of Europe. What the EU does next will matter.

OK, that happened. Brexit is one of the most stunning surprises in recent memory, certainly up there with the collapse of the Soviet Union or the success of Adam Sandler for sheer shock value.

There has been plenty of analysis and speculation about what this might mean and where it could end. Smarter people have more to say so I wont add to commentary about the outcome itself. Two aspects of last week’s events, however, are of interest.

Firstly, this result challenges the impregnable belief in the power of prediction markets. Financial markets had been sanguine about the outcome because betting markets suggested it would be an easy win for the remain camp.

There are plenty of occasions when betting markets perform better than polls and other forms of prophecy but that success is built on the idea that insiders with superior information generate superior insights.

For an event like Brexit, where there is no inside information, the power of prediction markets is limited. The failure of the bookies to get anywhere close to the result should remind us that uncertainty cannot be reined in by the wisdom of crowds. Despite the ubiquity of internet bookmakers, the future remains uncertain.

The second point is that Brexit itself is less important than the reaction of the European Union. On that account, there are reasons to fret.

The EU must juggle two competing interests, one short term and one long term.

The UK is a major trading partner and there will be pressure to accommodate a comfortable exit that maintains many of the benefits of integration while eliminating the costs. That would serve everyone’s commercial interests and is largely viewed as the rational, likely response.

The EU, however, cannot make Brexit too comfortable or it risks encouraging marginal members to follow the UK's lead. In dealing with Britain, it must be punitive and ruthless to demonstrate the high costs of secession.

Most are expecting a fairly benign negotiation where the UK maintains preferential access to the European market and where capital and goods flow freely. A far more punitive regime is likely, one that seeks to exclude and punish Britain. Anything less would effectively end the European Union.

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