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Politics vs economics: which best explains the world we live in?

“Leaving the EU would almost certainly damage our economic prospects”. Those words formed the headline of a joint statement from the National Institute of Economic Research, the Institute for Fiscal Studies and the Centre for Economic Performance at the London School of Economics way back in June 2016.

Still, a few days later the British public voted to leave the EU and, if Boris Johnson’s landslide majority is anything to go by, its opinion remains steadfast. For much of history, politics and economics have been inextricably wed. It’s the reason for the near-constant flurry of eye-catching tax cuts and attractive financial promises: people care about their pockets.

But, occasionally, a political issue arrives to buck the trend. Brexit is a key example: the referendum result brought a flurry of think pieces on post-truth politics when emotions outweighed financial motivation. Concepts such as national identity, political sovereignty and control simply mattered more than money. In other words, politics came first.

On the other hand, politics is whimsical and unpredictable – vulnerable to the effects of populism. Economics, at least, has been accurate in its predictions in recent years. What’s more, even this type of politics is often economically motivated. Following a period of relative centrism, populism took off in Europe and the United States after the 2008 financial crisis, after all, growing its roots from economic hardship.

Economics: systematic and volatile

Economics deals in numbers and graphs rather than words and maps, true, but it’s actually far from infallible. When Genius Failed by Roger Lowenstein serves as a warning against taking economic rules as gospel. It was named one of the all-time best trading books by IG – its cautionary take provides economic insights for traders who want to avoid the common pitfalls.

Overconfidence is a trait economic disasters seem to share. Gordon Brown said there would be no return to boom and bust throughout his tenure as Chancellor of the Exchequer, but later had to backtrack when the Great Recession swept the UK economy. It turned out to be the worst recession since the Second World War.

Similarly, the central members of Long-Term Capital Management – including two Nobel Prize-winning economists – were so confident in their approach that their gambles became too bold. The book charts a story that’s familiar to anyone who remembers the British bail-out of 2008 and its impact on investment banking.

To make money from unpredictable markets, it is necessary to manage risk – and, importantly, to understand that the rules can always change. That’s true for small traders and hedge fund arbitrage tycoons alike.

Unpredictable politics, unpredictable people

Some things can’t be predicted – and just as political polling doesn’t always get it right, sometimes the markets don’t behave as expected. Long-term Capital Management had some of the world’s best mathematical models and minds, but when the East Asian crisis of 1997 and the Russian default of 1998 hit, the markets reacted with fear. A financial meltdown never materialised, but panic among lenders worsened the effects.

Similarly, after the stock market crash of 2008, a wave of panic selling made the crisis far worse than it otherwise could have been, according to some academics. In other words, emotions can influence economics just as they drive politics.

Perhaps political and economic spheres are more closely wed than we realise – but not in the way we traditionally think they are. People are political animals, who are motivated by hope and fear as well as money – and some of those people are driving the stock market.

Whether it’s Nigerian militants threatening to cripple the economy on purpose if their rival President Muhammadu Buhari is re-elected, the British public holding onto its Brexit dream or panicked financiers, sometimes people act against their own financial interests. In this sense, economics is always political. The world we live in is best understood as a result of the interaction and combination of both factors.

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