What does a Brexit mean for politics?

Executive Summary

  • Britain's decision to leave the E.U. is now irreversible. The result of yesterday's 23 June referendum revealed a fault-line in national politics which the major parties must now address.
  • Tax revenues will fall as a result of the vote, necessitating a reallocation of the tax burden that is likely to produce a backlash against those politicians who initially stand to gain from the result.
  • It is likely that the immediate threat of Scottish or Northern Irish secession is overstated, given the economic outlook and public mood respectively. Anglo-Spanish tensions over Gibraltar will escalate.

The way forward

In the Allan & Associates risk scoring system, the United Kingdom has for months been set at ‘Minor’ with a Political Risk subscore of ‘Medium’. This was specifically to reflect the unresolved questions of the U.K.’s membership of the European Union and secondly, the continued appeal of Scottish independence from the U.K.

With Britain having yesterday voted by a narrow but clear four-point margin to invoke Article 50 of the E.U.’s 2009 Lisbon Treaty and leave the regional union, sober analysis is in short supply. There is no realistic possibility of the decision being overturned. The ballot attracted the highest turnout since 1992, and the margin of victory was more than one million voters. It will be accepted as a legitimate and representative result, notwithstanding the objections of those who voted ‘Remain’.

David Cameron, the Conservative prime minister who inserted the referendum into his party’s 2015 election manifesto, apparently on the assumption that he would have coalition partners to prevent him fulfilling this pledge, has announced his intention to resign. He will continue as interim prime minister until October 2016. His finance minister and close political partner George Osborne is certain to follow suit.

Scotland, Northern Ireland & Gibraltar

Scotland’s nationalist first minister, Nicola Sturgeon, immediately said that the result mandates a second independence referendum for Scotland, noting that 62 per cent of Scots voted to remain in the E.U. against 38 per cent who voted to leave. She says that the Scottish government will begin to prepare legislation for such a vote.

Sturgeon’s threat should be treated with some scepticism, in the one-year outlook. Scotland’s economy is heavily exposed to the global price of crude oil due its North Sea fields and reserves. The oil price has halved since the last independence vote less than two years ago – an exercise that was agreed at the time to be ‘once in a generation’ – and fell sharply after the latest referendum result. With the public sector employing 20% of Scotland’s workforce, the oil price means the economic case for independence would be more difficult to make than in 2014.

Moreover, a separate Scotland must accede to the Eurozone currency area were it to apply to the E.U., a prospect which most Scots would oppose given the current difficulties of aligning the euro’s monetary reality with democratic consent. The strictures necessary for this currency union would cast doubt over the extent to which Scotland was in fact independent. For this reason, it is unlikely that any new vote on independence will be held within the next two years.

A majority in Northern Ireland, long plagued by sectarian violence between Protestants and Catholics, also voted to remain in the E.U. Following in Nicola Sturgeon’s footsteps, Northern Ireland deputy first minister Martin McGuinness, a former member of the terrorist Irish Republican Army (IRA), has questioned the central U.K. government’s mandate and has called for a referendum on the future of the province. Northern Ireland’s peace process has been financially supported by the E.U., partly explaining the ‘Remain’ camp’s victory there. McGuinness’s party, Sinn Fein, is the most pro-European party in Northern Irish politics and seeks unification with Ireland. The largest party in Northern Ireland, the Protestant Democratic Unionist Party, supported ‘Leave’ adding a sectarian strand to the issue.

A referendum on Northern Ireland’s status within the U.K. is only a low risk in the medium term. There is little appetite for a return to the violence of ‘the Troubles’ that defined the provinces from 1968 to 1998. The global attitude to non-armed state militancy changed out of all recognition after the New York attacks of 11 September 2001, and the IRA is now primarily an organised crime group. However, a flare-up of sectarian violence in Norther Ireland is possible as the U.K. attempts to negotiate the terms of what will now be an external E.U. border between the Republic of Ireland and the U.K. In the five-year outlook, as E.U. funding for Northern Ireland dries up, Sinn Fein’s calls for devolution will garner support and destabilise this region of the U.K.

Spain’s acting foreign minister José Manuel Garcia-Margallo has announced that his country is to seek ‘co-sovereignty’ of Gibraltar, a strategic peninsula on Spain’s southern tip that has been controlled by the U.K. since 1713. The E.U. was the key impediment to the dispute over Gibraltar becoming a source of serious friction between London and Madrid, as the bloc forced Spain to allow the flow of goods and people into the territory. Britain’s exit from the E.U. suggests this dispute will become much more fractious (Spain could resort to embargoing Gibraltar) although again, much is contingent on the negotiated state of relations between the U.K. and E.U. from 2018, when the U.K. will formally exit if it begins the process at once.

Tax choices

Within the British government, the Foreign & Commonwealth Office must now assume an importance and stature that it has not enjoyed for 40 years, with a shift in mindset reflecting that at least some of the U.K.’s negotiations with Brussels will henceforth be zero-sum. Britain’s best cards in securing its future relations with the E.U. would appear to be:

  • Its large trade deficit in goods with the E.U., with it buying more from the continent than it sells
  • Its sizeable economy (the world’s fifth largest)
  • A large number of affluent British nationals living in Spain and France, contributing to their local economies
  • At least two million E.U. nationals who rely on the British economy for employment, amid high rates of joblessness within the Eurozone
  • Its large net contribution to the E.U. budget, some proportion of which could be maintained in exchange for E.U. concessions
  • The E.U. in turn is likely to focus on the City of London’s status as Europe’s leading financial centre, particularly its status as the major hub for trading of the euro – a currency Britain never joined. Much of the current U.K. government’s efforts in its recent E.U. negotiations have been to defend the City, but it is highly unlikely that it will succeed in this regard in the post-Brexit environment.

There is a clear prospect of U.K.-based businesses re-locating their headquarters to within the E.U., potentially to low-tax jurisdictions such as Ireland and Luxembourg. Today, the BBC reported that U.S. investment bank Morgan Stanley had already begun to move 2,000 of its London staff to Dublin or Frankfurt, Germany, to avail itself of the ‘passporting’ system that allows it to offer E.U.-wide financial services. The bank publicly denied this report. Others, including HSBC, have reiterated their commitment to their U.K. staff and base of operations. Financial institutions have a strong business incentive to restore confidence at this juncture, including in their London operations, in the face of dramatic market volatility caused by the referendum result.

The U.K. government, under any leadership, will seek to create incentives and disincentives to discourage such movements…