Making exit costly but efficient: the political economy of exit clauses and secession

Secessionism is on the rise (Griffiths 2016; Lake and O’Mahony 2004). Events in Catalonia gather global attention. This article develops a political economic model of secession and the potential role of exit clauses in making exit costly but efficient. Generally speaking, an exit clause specifies the conditions of exit or withdrawal from an agreement. Examples of exit clause conditions are the payment of a penalty or waiting out a notice period. In most types of international treaties, clauses regulating temporary escape or permanent withdrawal are relatively prevalent (Koremenos and Nau 2010; Rosendorff and Milner 2001). As an alternative way of ensuring flexibility, international agreements may be concluded for a limited duration (Koremenos 2005). This is not the case for federations, which some scholars even define on the basis of lacking legal exit options (Harbo 2008).

Indeed, true constitutional exit clauses are rare (Sorens 2012: 116). According to data from the Constitute Project (Elkins et al. 2009, 2014) among 192 constitutions currently in force, only 23 address the secession of territory. Among these, only 6 explicitly recognize some right to secede: Ethiopia, Liechtenstein, Saint Kitts and Nevis, Sudan, United Kingdom, and Uzbekistan.¹ It is generally accepted that the right to secede in Ethiopia does not amount to much in practice due to the autocratic nature of its government (Habtu 2005). Surprisingly, the microstate Liechtenstein allows for secession by each of its communes. The two-island federation of Saint Kitts and Nevis allows Nevis to secede by a two-thirds majority; in 1998, a referendum was organized but only 62% voted in favor (Veenendaal 2015). After the Comprehensive Peace Agreement of 2005, Sudan’s constitution allowed for secession by South Sudan after 6 years. In 2011, South Sudan exercised this option. The United Kingdom allows Northern Ireland to join a united Ireland. Like in Ethiopia, the right to secede of the Uzbek region of Karakalpakstan does not amount to much in practice (Roeder 2007: 67).

Historically, the Constitution of the Soviet Union allowed for secession—at least on paper (Sunstein 1991: 645–647). Another historical example is the 2003 State Union of Serbia and Montenegro, which allowed for secession after a 3 year waiting period; in 2006 Montenegro exercised the option after obtaining more than the requisite 55% in a referendum. Finally, the European Union (EU), which has many characteristics of a federation, has a withdrawal clause (Athanassiou 2009; Huysmans 2019): Article 50 of the Treaty on European Union specifies that any Member State may withdraw two years after notification.

Depending on how a secession takes place, it can be peaceful and swift, or painful and costly (Tir et al. 1998; Young 1994). According to Sorens (2012: 3), “since the 1980s, at least half of all ongoing civil wars in any given year have been secessionist”—see Cederman and Vogt (2017) for an overview of the civil war literature. If there is no exit clause in the federal constitution, exit from a federation requires an ex-post negotiated solution, i.e. consent from the remaining members. If a negotiated exit cannot be reached, embarking on a destructive secession war may be the only alternative for a member wishing to secede (Griffiths and Wasser 2019; Helfer 2005). Consistent with this logic, this article analyzes three modes of exit: exit based on an exit clause, forceful exit, and negotiated exit.

The idea that in some circumstances reneging on a prior agreement may be socially desirable is known as efficient breach (Goetz and Scott 1977). In theory, if exit from a federation is socially desirable those better off outside could offer an acceptable side-payment for exit and make everyone better off—an application of Coase (1960). In this light, Drèze, De Grauwe, and Edwards (1993) discuss a practical rule suggested by Drèze to ex-post reapportion national debt at the time of secession. However, as pointed out by De Grauwe, ex-post renegotiation may be very difficult politically. Hence ex-ante negotiated exit clauses may be necessary to enable efficient breach.

In spite of the potential benefits of exit clauses, the dominant position in the constitutionalist literature is that they should be avoided. This position was pioneered by Sunstein (1991), who sees constitutions as pre-commitment strategies in the presence of multiple equilibria.² Based on formal models, Chen and Ordeshook (1994) and Filippov, Ordeshook, and Shvetsova (2004) conclude that there should be a constitutional ban on exit, in order to coordinate on non-secession equilibria. However, the strength of this conclusion is limited by the underlying assumption that maintaining the federation is always efficient. While the two-period model of Bordignon and Brusco (2001) allows for shocks and the possibility of efficient breach, it introduces the restrictive assumption that countries are ex-ante identical.

Within the broader literature on secessionism, others have already zoomed in on potential information problems (Anesi 2012; Gradstein 2004; Olofsgård 2004). Hence we focus here on a setting with complete information, but with other theoretical innovations. Compared to Chen and Ordeshook (1994) and Bordignon and Brusco (2001), our contribution to the literature on the design of exit clauses is threefold. First, using a formal model of costly exit clauses, we show that appropriately costly exit clauses do not increase the likelihood of exit given the implicit option of forceful exit. This formalizes an argument made by Weinstock (2001). Second, our model allows for members of the union to be different ex-ante. Finally, reflecting the fact that benefits from the federation may change over time, we also present a continuous time model of exit.

Empirical evidence concerning Montenegro, Saint Kitts and Nevis, and the EU is shown to comport well with the predictions of these theoretical models, warranting further research into exit clauses.

The rest of this paper is organized as follows. First we present the basic two-period model of exit with costly exit clauses. Next we establish conditions for socially efficient exit and show how to achieve it in a decision-theoretical setting, with a continuous time model presented in “Appendix”. The subsequent sections present the game-theoretical setting, discuss the conclusion of the model and present some empirical plausibility probes. The final section concludes.

The following model describes a union between two federated entities or members indexed by \(i\in \{A,B\}\).³ For tractability, we assume that each entity is composed of identical inhabitants, and leave the analysis of within-entity heterogeneity for future work; see Weidmann (2009) and Gubler and Selway (2012) for empirical evidence regarding within-entity heterogeneity. The assumption of within-entity homogeneity means that each federal entity can be modeled as a unitary actor. For each such entity or member \(i\), the net benefits of being in the federation versus outside depend on the rules of the federation and a member’s characteristics.

As pointed out in the introduction, exit clauses may be able to ex-ante enable efficient breach, i.e. dissolving the federation if it is socially efficient to do so. In order to assess this claim, a condition for socially efficient exit first needs to be established. The condition stipulates in which states of the world \(({x}_{A},{x}_{B})\) the union should be dissolved when taking into account the payoffs of both players equally.

We present the derivation of the socially efficient exit state as stemming from a social planner who has as an objective function \({\pi }_{C}\), the combination of the members’ payoffs:where \({\theta }_{C}={\theta }_{A}+{\theta }_{B}, {x}_{C}={x}_{A}+{x}_{B}, {k}_{c}={k}_{A}+{k}_{B}\). Using (3), the probability density function of \({x}_{C}\) depends on \(\rho \) and is

The social planner will dissolve the union peacefully ifSocially efficient exit requires taking into account the states of both members, as well as the total one-off costs of separation \({k}_{C}={k}_{i}+{k}_{j}\). If the combined state \({x}_{A}+{x}_{B}\) drops below the threshold specified in (7), dissolving the union is socially efficient. Consistent with the notion of efficient breach presented in the introduction, socially efficient exit may require hurting one member if this benefits the other member more. Note that since \({f}_{i},{d}_{i}>{k}_{i}\), dissolving the federation forcefully is never socially efficient. If the federation should be dissolved, it is more efficient to do so peacefully.

Substantively, the condition of a low joint state \({x}_{C}\) required for socially efficient exit can be fulfilled if heterogeneity has increased, or if the outside options of both players have improved simultaneously through an increase in free trade or peace. Elements that hurt one member while benefitting another, such as fiscal transfers, do not matter from this perspective. To see this, note that if \(x\) is only determined by fiscal transfers, then \(\rho =-1\) and \({s}_{A}={s}_{B}\) such that per (6) \({x}_{C}\) is 0 with probability 1. In this case, maintaining the union is ex post socially efficient as long as \({\theta }_{C}+{k}_{C}>0\), which is true provided that both members expected to benefit from it initially (\({\theta }_{i}>0).\)

Similarly, from the social planner’s point of view, exit penalties are internal transfers and do not matter. However, as the next section shows, for the individual members exit penalties do matter.

To analyze the consequences of exit clauses, this section solves a decision-theoretical version of the model, in which only one member can exit. It first discusses optimal exit with a fixed penalty \(c\), assuming that any clause is fully binding. In the second subsection the possibility of forceful exit is incorporated. The third subsection shows how state-contingent exit penalties can enable socially efficient exit in the decision-theoretical setting. The fourth subsection discusses the continuous time version presented in the “Appendix”. The next section will show how state-contingent exit penalties can enable socially efficient exit in the game-theoretical setup.

Above we analyzed the case where only one member had an exit option. In this section, we analyze exit in a game-theoretical setting. If players are indifferent between two strategies, we assume that they choose S (stay) over C (clause) over F (forceful exit). Recall that Table 1 presents the normal form of the game, and that for \(i\in \{A,B\}\): \({f}_{i},{d}_{i}>{k}_{i}>0\). For each potential realization of \(x=({x}_{A},{x}_{B})\) and for each combination of exit penalties \(({c}_{A},{c}_{B})\), the strategic nature of this game may be different. Hence giving an exhaustive overview of the potential equilibria is not desirable.

We now show that by introducing state-contingent exit penalties, socially efficient exit can be obtained in the game-theoretical setting as well. Social efficiency requires that the federation is dissolved peacefully if (7) holds, and maintained otherwise. This means that if (7) holds, the equilibrium should be (S, C) (C, S) or (C, C), and otherwise it should be (S, S). However, as discussed previously, given the possibility of forceful exit only a second best solution may be achievable, in which equilibria with C may occur if otherwise equilibria with F would result.

Irrespective of \(({x}_{A},{x}_{B})\) and \(({c}_{A},{c}_{B})\), if \(i\) engages in a forceful exit, \(j\) is always better off by staying than by also engaging in a forceful exit. This means (F, F) is always excluded as a Nash equilibrium. Consider making member \(i\)’s exit penalty conditional on \(j\)’s state as in (10): \({c}_{i}^{*}=Min\{{\theta }_{j}+{x}_{j}+{k}_{j},{f}_{i}-{k}_{i}\}\). Giving this value to \({c}_{i}\) for both \(i\in \{A,B\}\) means that \({c}_{i}+{k}_{i}\le {f}_{i}\), so that F is weakly dominated by C, and only (S, S) (S, C) (C, S) and (C, C) remain as potential equilibria. Suppose \(j\) stays, then \(i\)’s best response is to call the exit clause if \(-Min\left\{{\theta }_{j}+{x}_{j}+{k}_{j},{f}_{i}-{k}_{i}\right\}-{k}_{i}\ge {\theta }_{i}+{x}_{i}\) and to stay otherwise. Suppose \(j\) calls the clause, then \(i\)’s best response is to stay if \({c}_{A}>0\) and to call the clause otherwise.

Suppose that the costs of a forceful exit are prohibitive even in the low state, i.e. \({f}_{i}>{s}_{i}-{\theta }_{i}\), so that the first best is achievable. In this case \({c}_{A}^{*}={\theta }_{B}+{x}_{B}+{k}_{B}\) so that A’s best response if B stays is to call the clause if \(-{\theta }_{B}-{x}_{B}-{k}_{B}-{k}_{A}\ge {\theta }_{A}+{x}_{A}\), and to stay otherwise. Notice that this condition is equivalent to condition (7) for socially efficient dissolution. If \(A\) stays, the same condition results for \(B\), who faces \({c}_{B}^{*}={\theta }_{A}+{x}_{A}+{k}_{A}\). Hence if the condition is not fulfilled, and exit is not socially efficient, the only equilibrium is (S, S).

Now observe the following. If (7) holds, \({c}_{A}^{*}+{c}_{B}^{*}={\theta }_{C}+{x}_{C}+{k}_{C}\le 0\). This means that \({c}_{A}\) and \({c}_{B}\) cannot both be positive. If both are negative, then (C, C) is the only equilibrium. If \({c}_{A}\) is positive and \({c}_{B}\) negative the equilibrium is (S, C), and if \({c}_{B}\) is positive and \({c}_{A}\) negative the equilibrium is (C, S). To conclude, if the costs of F are prohibitive, then with state-contingent exit penalties as in (10) socially efficient exit is guaranteed. If exit is not socially efficient, the only equilibrium is (S, S). If it is socially efficient, the equilibrium will be either (C, C) (S, C) or (C, S), so that the federation will be dissolved peacefully.

If the costs of a forceful exit are not prohibitive, i.e. \({f}_{i}\le {s}_{i}-{\theta }_{i}\), then the setting of \({c}_{i}^{*}=Min\left\{{\theta }_{j}+{x}_{j}+{k}_{j},{f}_{i}-{k}_{i}\right\}\) ensures that F is a weakly dominated strategy, so that (C, C) (S, C) or (C, S) will result instead of (S, F) and (F, S). Again, while it is not the first best solution to dissolve the federation in those cases, at least no additional value is destroyed in a forceful exit.

The preceding analysis assumed that exit clauses can be made contingent on players’ states \(\left({x}_{A},{x}_{B}\right)\). It concluded that doing this appropriately results in second-best equilibria given the possibility of forceful exit. If \(j\)’s state is not directly observable by \(i\), state-contingent exit penalties may not be feasible (Fearon 1995). However, even with states unobservable by others exit clauses can still be welfare enhancing. In particular, setting \({c}_{i}={f}_{i}-{k}_{i}\) makes F a weakly dominated strategy, hence avoiding socially inefficient forceful exit. These findings run counter to the dominant point of view in the constitutionalist literature that exit clauses should be avoided in federations.

We identified three potential modes of exit: ex-post negotiation, forceful exit, and exit based on an ex-ante agreed exit clause. If both members of a union are benefitting from it (are in a good state), neither will consider exit. Hence in states of the world \(({x}_{i},{x}_{j})\) where both \({x}_{i}\) and \({x}_{j}\) are high the union continues.

The formal model solved above assumed that a negotiated exit is precluded. However, in the absence of obstacles to negotiating exit, if it is socially efficient those better off outside could offer an acceptable side-payment for exit and make everyone better off. Hence without obstacles to negotiation socially efficient exit would occur irrespective of a potential exit clause.

The formal model also did not incorporate the possibility of an anti-secession war. Intuitively, if \(i\) triggers an exit clause, an anti-secession war may be attractive to \(j\) if the lost benefits from the federation weigh up to the cost of such a war. However, the reputational cost of reneging on a constitutional exit right will likely be prohibitive, especially to democracies.

Combining the conclusions of our formal model with the discussion of negotiated exit and anti-secession wars, we conclude the following. If \(i\in \{A,B\}\) is in a bad state (low \({x}_{i}\)), its decision whether to exit depends on the exit costs of its cheapest mode of exit. If there is an exit clause, the associated costs consist of the penalty \({c}_{i}\) and the one-off costs \({k}_{i}\). If there are no barriers to ex-post negotiation exit occurs when it is socially efficient. If a negotiated exit is not possible because dissolving the union would not be efficient (i.e. \(j\) is benefitting more from the union than \(i\) is losing), or because of barriers to negotiation, then \(i\) considers unilateral exit (clause-based or forceful). The costs of forceful exit are \({f}_{i}\). Since \(i\) picks the cheapest option, the exit costs are equal to \(Min\{{c}_{i}+{k}_{i},{f}_{i}\}\). The higher \(i\)’s exit costs, the lower the state \({x}_{i}\) can drop until exit becomes optimal for \(i\). If \(j\) has low reputational costs, it may start an anti-secession war if \(i\) triggers an exit clause.

We have argued theoretically that exit clauses with state-contingent penalties can enable efficient breach from a federation. Since there are no real-world federal constitutions that ex-ante allow exit upon payment of a penalty, this claim cannot be evaluated empirically. However, below we discuss two relevant cases that may serve as plausibility probes: Montenegro and Saint Kitts and Nevis.

The case of Montenegro clearly supports the claim that constitutional exit clauses may enable peaceful secession. In 2006 Montenegro used the exit clause that was entered in the constitution of the State Union of Serbia and Montenegro in 2003. Serbia accepted the independence peacefully. The fact that the exit clause was called just shortly after the stipulated 3-year waiting period suggests that exit clauses really can play a binding role in enabling peaceful secession. This conclusion seems even stronger in the broader context of the Yugoslav breakup. There was no exit clause available to Slovenia, Croatia, Bosnia-Herzegovina, Macedonia or Kosovo, and so they all seceded forcefully—resulting in violence in Slovenia, Croatia, Bosnia-Herzegovina and Kosovo.⁵

While Nevis has had a right to secede from the two-island federation of Saint Kitts and Nevis since its creation in 1983, the federation is still intact. In 1998, a referendum was organized but the requisite two-thirds majority was not obtained. This shows that including conditions in the exit clause (be it in the form of an exit penalty or a supermajority) can allow exit without automatically making it liable to happen. In fact, the federation may precisely still be together because of the exit clause. With only three of the eleven seats in the federal parliament, Nevis is often not represented at all in the ruling federal coalitions (Veenendaal 2015). The fact that Nevis may secede gives an incentive to Kittitian politicians to take its welfare into account as well. This points to a second role for exit clauses, to be investigated in future work: they may function as safeguards protecting minorities against excessive centralization and unfavorable policy changes.

While we claim that constitutional exit clauses may be beneficial both on theoretical and empirical grounds, we do not claim that an exit clause is always a necessary condition for peaceful secession. In some cases, secession may be negotiated peacefully even in the absence of a clause. Examples that come to mind are the “velvet divorce” of Czechoslovakia in 1993, and the independence of Norway from Sweden in 1905. However, given the high frequency of civil wars over independence, it is clear that there are many barriers to ex-post negotiation. This is why we think that ex-ante negotiated exit clauses may improve outcomes. Given the possibility of stipulating fines or other conditions, they need not make secession more likely than under the implicit option of forceful exit.

The case of the EU illustrates the importance of including an exit penalty in the clause to obtain efficient exit. Most observers would agree that the UK leaving the EU is not efficient. A naïve conclusion would be that exit clauses increase the likelihood of (inefficient) exit. However, Article 50 does not provide for a penalty.⁶ An example of a penalty that could have been included explicitly—and that perhaps could have dissuaded the British public from voting to leave—would be the payment of a certain number of additional years of budget contribution without corresponding membership benefits, or the reimbursement of the EU’s administrative costs related to Brexit.

We presented a political economic analysis of secession and exit clauses in federations. In our model, a member’s benefits from a federation are determined by its type and its state. Because of changes in the state of the world, a member’s ex-post benefits may be higher or lower than expected. If a member’s ex-post benefits are negative, i.e. it is in a sufficiently low state, it may wish to exit if the exit costs are not prohibitive.

Exit costs depend on the mode of exit. If a federation has an exit clause, exit can occur on the basis of such a clause. Exit clauses can contain several conditions, among which we focused on exit penalties. If there is no exit clause, or the exit cost is high, exit may occur forcefully. The costs of such forceful exit consist of tangible costs (such as military expenses) and reputational costs (which depend on the international recognition of the exit). A third mode of exit is through ex-post negotiation, although this can be expected to be difficult because of barriers to renegotiation.

If there is an exit clause with a low penalty, and exit occurs while other members are benefitting a lot from the union, they may try to prevent exit forcefully through an anti-secession war. However, such attempted prevention of legal exit carries heavy reputational costs, especially for democracies.

When a member exits, the benefits for the other members of that member being in the union are also lost. From a social welfare perspective, exit should occur if and only if it generates value taking all members’ benefits into account: this is the principle of efficient breach. Based on a game-theoretical model, we showed that appropriate state-contingent exit penalties can ex-ante enable efficient breach. If exit penalties cannot be made state-contingent, fixed exit penalties can still increase social welfare by avoiding forceful exit. These findings run counter to the dominant point of view in the constitutionalist literature that exit clauses should be avoided in federations.

Our theoretical models are obviously simplified, and in no way definitive. However, we do hope that in light of the severity of the problem of secessionism and civil wars, our research at least prompts further investigation of the potential of ex-ante negotiated exit clauses.

An obvious question in light of our results is why exit clauses are not more prevalent in real-world federations. We tentatively advance two reasons. First, politicians negotiating federations may wish to tie their successors’ hands. In our model, we assumed that each federal entity could be represented as a unitary actor. In practice, each federal entity may be composed of a heterogeneous population. If that is the case, politicians whose electorate expect to benefit more from the federation may want to prevent exit in the future by not having an exit clause. Second, federations may not be rationally designed. This may be especially true for long-established federal countries. But even for modern federations there may be a norm against exit clauses because they are perceived as going against the spirit of collaboration. After all, who likes to talk about divorce on their wedding day (Weiler 1985)?

We leave for future research the negotiation of exit clauses. Given their distributional implications, the bargaining process will be important and socially efficient exit clauses are not guaranteed. However, to the extent that members are negotiating behind a veil of ignorance, their ex-ante preferences over exit clauses will be closer to the social optimum and ex-ante negotiations over a clause will be easier than ex-post negotiations over exit directly. In spite of potential information problems and strategic bargaining for concessions once exit clauses are in place (Anesi 2012; Olofsgård 2004), if ex-ante agreed exit clauses can reduce the incidence of secessionist violence they could do the world a great service. On the other hand, as the discussion of Brexit shows, if exit clauses are included, clear exit penalties or conditions are required to deter inefficient secession.

A second area for future research is to make members’ states endogenous. In the model presented here, the payoff-relevant state of the world is exogenous. In practice members may be able to change how the state of the world affects their payoffs by renegotiating the terms of the union. For instance, if at some point the prevailing transfers make the federation undesirable to a member, this member will likely try to renegotiate the laws affecting transfers before considering exit.