Brittle Bri­tain

Financial Mirror (Cyprus) - - FRONT PAGE -

Which Euro­pean coun­try faces the great­est risk of po­lit­i­cal in­sta­bil­ity and fi­nan­cial tur­moil in the year ahead? With less than a day to go be­fore the Bri­tish gen­eral elec­tion on May 7, the an­swer is both ob­vi­ous and sur­pris­ing. Once a haven of po­lit­i­cal and eco­nomic sta­bil­ity amid the tur­moil of the euro cri­sis, the United King­dom is about to be­come the Euro­pean Union’s most po­lit­i­cally un­pre­dictable mem­ber.

In­deed, con­ti­nu­ity is the one elec­tion out­come that can al­most cer­tainly be ex­cluded. Un­less opin­ion polls are in­ac­cu­rate to a de­gree un­prece­dented in Bri­tish his­tory, the two par­ties com­pris­ing the gov­ern­ment coali­tion, Prime Min­is­ter David Cameron’s Con­ser­va­tives and the Lib­eral Democrats, have al­most no chance of win­ning a com­bined par­lia­men­tary ma­jor­ity.

One pos­si­bil­ity – with a prob­a­bil­ity slightly above 50% ac­cord­ing to the polls – is that Bri­tain, the birth­place of Thatcherism and the EU’s stan­dard-bearer of ne­olib­eral eco­nomics, will soon have a Labour-led gov­ern­ment com­mit­ted to the big­gest taxrais­ing pro­gramme since the 1970s. More­over, be­cause of the pe­cu­liar­i­ties of the Bri­tish elec­toral sys­tem and the rise of Scot­tish and Welsh na­tion­al­ism, a Labour gov­ern­ment’s sur­vival would de­pend on the sup­port of par­ties with even more rad­i­cal eco­nomic agen­das and ded­i­cated to dis­man­tling the UK.

An­other sce­nario – al­most as prob­a­ble as a Labour-led coali­tion – is a weak and un­sta­ble Con­ser­va­tive gov­ern­ment. To judge by the opin­ion polls, Cameron’s best hope is to win more par­lia­men­tary seats than Labour and try to form a mi­nor­ity gov­ern­ment, which could sur­vive as long as the other par­ties failed to unite against it. This might be pos­si­ble, be­cause the Lib­eral Democrats and Scot­tish Na­tion­al­ist Party may see benefits in al­low­ing a weak Con­ser­va­tive gov­ern­ment to re­main in power, at least for a while.

But a mi­nor­ity Con­ser­va­tive gov­ern­ment would cre­ate ad­di­tional un­cer­tain­ties and risks. Cameron would be more vul­ner­a­ble than any leader in post­war Bri­tish his­tory to black­mail by his own party’s dis­si­dents and ex­trem­ists, who see it as their his­toric mission to pull Bri­tain out of the EU. And a mi­nor­ity gov­ern­ment would be un­able to pass any con­tro­ver­sial leg­is­la­tion that the Scot­tish Na­tion­al­ists op­posed.

More­over, Bri­tain’s po­lit­i­cal in­sti­tu­tions might be un­able to cope. The UK’s un­writ­ten con­sti­tu­tion is based en­tirely on tra­di­tion and prece­dent. That ar­range­ment has al­ways pre­sup­posed strong gov­ern­ments with clear man­dates. The con­sti­tu­tion is so poorly adapted to coali­tions and mi­nor­ity gov­ern­ments that some legal schol­ars ques­tion whether the Queen should ad­dress Par­lia­ment on be­half of “her” new gov­ern­ment if there is a risk that it will be top­pled within a few weeks or months.

And yet, although the elec­toral arith­metic makes a sta­ble cen­trist gov­ern­ment – one that could main­tain Bri­tain’s cur­rent poli­cies on taxes, eco­nomic man­age­ment, and Europe – al­most im­pos­si­ble to imag­ine, con­ti­nu­ity is the out­come that most in­ter­na­tional busi­ness lead­ers and politi­cians seem to ex­pect.

The clear­est ev­i­dence of this can be seen in fi­nan­cial mar­kets. Although the pound has de­clined by about 10% from its peak of $1.70 last Septem­ber, ster­ling weak­ness has sim­ply re­flected the dollar’s strength. In the same pe­riod, ster­ling has risen al­most 10% against the euro, while Bri­tish share prices have hit all-time highs and gov­ern­ment bonds have gen­er­ated bet­ter re­turns in Bri­tain than in the United States, Ger­many, or Ja­pan.

What ac­counts for this ap­par­ent in­dif­fer­ence – also ev­i­dent among Euro­pean politi­cians – to the loom­ing po­lit­i­cal risks in Bri­tain?

Many in­ter­na­tional ob­servers be­lieve that pol­i­tics sim­ply no longer mat­ters much in Bri­tain, be­cause the econ­omy is fun­da­men­tally sound and grow­ing at a fairly healthy pace. But this is a dan­ger­ously com­pla­cent ar­gu­ment.

Yes, Bri­tain recorded the fastest eco­nomic growth among the ma­jor OECD coun­tries in 2014 and has an un­em­ploy­ment rate of only half the EU av­er­age. But th­ese favourable in­di­ca­tors ob­scure a source of enor­mous risk: one of the world’s largest ex­ter­nal deficits, fi­nanced last year by for­eign-cap­i­tal in­flows to­tal­ing $160 bln. The cur­rentac­count gap, at 5.5% of GDP, is by far the high­est among the ma­jor OECD coun­tries and is at a level long as­so­ci­ated – both in the UK and else­where – with the on­set of fi­nan­cial crises.

As long as Bri­tain was a haven of po­lit­i­cal sta­bil­ity and tax poli­cies favourable to for­eign in­vestors, it had no prob­lem at­tract­ing cap­i­tal in­flows. But the im­pend­ing shifts in Bri­tain’s pol­i­tics and its EU re­la­tions are bound to draw at­ten­tion to the econ­omy’s ex­treme de­pen­dence on for­eign fi­nance.

A Labour gov­ern­ment, wield­ing tax pro­pos­als specif­i­cally de­signed to hit pri­vate for­eign in­vestors, would cer­tainly dis­cour­age in­flows. But in­ter­na­tional in­vestors might be equally put off by a weak Con­ser­va­tive gov­ern­ment dom­i­nated by the party’s Euro­phobe wing. In ei­ther case, GDP growth is likely to slow as busi­ness con­fi­dence, con­sump­tion, and house prices suf­fer – ei­ther from new taxes un­der Labour or from un­cer­tain­ties about EU membership un­der the Con­ser­va­tives.

An­other rea­son why in­ter­na­tional ob­servers may be ig­nor­ing such ob­vi­ous risks is that they have been pre­oc­cu­pied with more dra­matic events in Greece and Ukraine. Politi­cians, fi­nan­cial an­a­lysts, and po­lit­i­cal com­men­ta­tors have limited time and at­ten­tion. They tend to fo­cus on what­ever seems to be the big­gest and most ur­gent story, and Bri­tish pol­i­tics has not been it.

Then again, many ap­par­ently so­phis­ti­cated an­a­lysts may sim­ply be in a state of psy­cho­log­i­cal de­nial. Sur­veys of busi­ness and fi­nan­cial opin­ion in Bri­tain show clear ma­jori­ties in th­ese groups ex­pect­ing a sud­den swing to­ward the Con­ser­va­tives in the closing days of the elec­tion cam­paign, re­sult­ing in a sta­ble coali­tion gov­ern­ment and con­ti­nu­ity in eco­nomic and po­lit­i­cal con­di­tions.

Such a last-minute shift in vot­ing in­ten­tions is pos­si­ble, but the time for it is run­ning out. In fact, Bri­tish public opin­ion has re­mained un­can­nily sta­ble, not only dur­ing the of­fi­cial elec­tion cam­paign, but through­out the past 12 months. There are sim­ply no ra­tio­nal grounds for ex­pect­ing ei­ther the Con­ser­va­tives or Labour to achieve the de­ci­sive victory needed to form a sta­ble gov­ern­ment.

The up­com­ing elec­tion will there­fore mark the be­gin­ning, not the end, of a pe­riod of un­cer­tainty for Bri­tish pol­i­tics, eco­nomics, and fi­nance. No amount of lin­ger­ing faith in sta­bil­ity will change that.

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