Blog 27th April 2016
The referendum to be held on June 23rd casts a dark cloud of uncertainty over the UK and its financial markets. This blog will look at the background to the vote and the issues involved. I will make a guess at the outcome of the referendum, and also at what might happen in its aftermath should the Leave campaign win.
Inevitably, this will be rather a long blog, so I will begin with a summary, before looking at the individual issues in a series of appendices. On some issues, such as trade, the Remain campaign appears to me to have by far the best of the argument, while on the encroachment of unelected bureaucracies into our national life, discussed under Sovereignty, the Leave Campaign appears to have a very strong case. Below each section, I have given score, which always adds up to 10, indicating which of the sides has the strongest argument. 8-2 indicates that Remain has a much stronger case in my opinion, while 5-5 would indicate equally good arguments on either side.
The referendum is an emotive subject, so I will try to give a balanced view of the arguments on both sides.
Synopsis – Why was the referendum called? – What are we voting for? – Who will win? – What will happen if the UK votes to leave? – How are the Wise Funds positioned for Brexit?
Appendices – What reforms did David Cameron ask for and what did he get? – The costs of EU membership – Sovereignty – Trade – Immigration – Security
Why was the referendum called?
The Conservative party has been split on the question of Europe for at least the last quarter of a century. The right wing of the party resents the growth of the EU’s interference in UK affairs, together with the costs of membership. During the last parliament, the Prime Minister, David Cameron, decided to resolve the matter by offering to renegotiate the terms of our EU membership. Having secured favourable terms which everyone could agree to, he would then put the matter to a referendum, and would himself campaign strongly in favour of staying in. In doing so, he hoped to restore public confidence in EU membership, reunite his party, and weaken support for UKIP in the 2015 general election.
What are we voting for?
Voters will be asked whether the UK should remain part of the European Union (the EU) or whether to leave.
Who will win?
No one can anticipate the result of a vote which is expected to be very close, but here are a few thoughts.
Recent polls have forecast the result as being too close to call. However, there has been a difference between the online polls, which are indicating a very close result, and the telephone polls, which show a lead for Remain of around 8%. The difference appears due to the fact that the telephone polls ask for ‘Yes’ or ‘No, without offering a ‘Don’t Know’ option. Most of the ‘Don’t Knows’ would vote ‘Yes’ if pushed. The bookies quote a 30% chance of Brexit, and a 70% probability for Remain.
An article in the Financial Times in March argued that Remain would win comfortably. It pointed out that in referendums, the status quo usually wins. In this case, the alternative option involves major changes which are impossible to predict (though I will attempt to do so below under ‘What happens after Brexit?), and when the time comes, it expected the voting public to pull back from the brink of the unknown. Up till March, the Government, which had said that it would only campaign for Remain if its demands were met, was unable to start making its case. Furthermore, the establishment is wholly in favour of staying in the EU, including the business, academic and scientific communities, all the main political parties, the Governor of the Bank of England, David Miliband, Barack Obama, and a group of eight former US Treasury secretaries.
Polls suggest that there is a correlation between voting intentions and levels of education. People who left school at 16 are more likely to vote Leave, while graduates are more likely to vote remain. Older people are more likely to vote Leave, while the young are overwhelmingly pro-Remain. Young people are less likely to turn up to vote, and their failure to do so might be a factor in favour of Leave.
The Remain side appears more united. Its representative ‘Britain Better in Europe’ secured the campaign funding unopposed, while the Leave side is more divided, with at least three main factions (Vote Leave, Leave.EU and Grassroots Out).
Overall, the state of the polls and the parties, together with the uncertainties consequent on a Leave vote, suggest that Remain is more likely to win, though possibly by a very narrow margin.
What is at stake?
For the Leave Campaign, the benefits of an exit from the EU are freedom for the UK to manage its own affairs, an end to our onerous contributions to the EU budget, and the ability to control immigration.
Remain campaigners would say that immigration makes a positive contribution to our national life, that the budget contribution is a relatively small sum (0.5% of the UK’s GDP), and that while the EU’s many stupid and onerous rules are a burden, other benefits of EU membership more than outweigh them.
It would appear that to some extent the argument is between society’s ‘haves’ and ‘have-nots’. It is probably the ‘haves’ who are more glad of the local Polish plumber, and it is not their jobs that are at risk. And it takes a degree of financial sophistication to realise that in the context of our national accounts, £8.5bn isn’t a lot of money. The ‘haves’ may be more reassured by the array of public figures who have spoken in favour of Remain, while the pronouncements of members of the elite merely fuel the anger of those who society has marginalised.
What will happen after Brexit?
The other question ‘What will happen if we stay in?’ is easier to answer – nothing.
Someone asked me the other day ‘If we weren’t in the EU, would we vote to go in now?’ The question misses an important point – we are in, and extricating ourselves could be hugely costly, and take ten years or longer. We have never done this before, and since we have been members of the EU, we have had no experience of negotiating trade terms on our own behalf.
The procedure when a country leaves the EU is contained in the 2009 Lisbon Treaty. Following a decision to leave, the UK has two years to renegotiate its agreement with the EU, though the time can be extended by mutual agreement. Under the treaty, it is for the EU to decide on the terms of the new agreement, and it seems unlikely that they would be generous, as the EU does want to make it appear easy for others to follow.
The UK will not be in a position to start negotiating with any other countries until terms with the EU have been finalised.
On exit from the EU, the UK would regain sovereignty over agriculture, fisheries, justice, home affairs, regional funding and trade.
Our access to the single market has brought investment to the UK, so in the event of a BREXIT, it is likely that some investment would be withdrawn, which could cause the economy to weaken. In the short term, the pound and the stock market would probably fall. The weaker pound would be make imports more expensive, causing inflation to rise. Thus the Bank of England could be faced with a dilemma, whether to lower interest rates to help the economy, or to raise rates to support the pound.
After losing the vote, Messrs Cameron and Osborne might resign, causing a leadership election and possibly a general election. Far from unifying the party, a lost vote could cause the divisions in the Conservative party to widen further. Scotland, which wishes to remain in the EU, would demand another independence referendum, which it would probably win. Meanwhile, Northern Ireland would be outside the EU, while southern Ireland remained in.
Assuming a weaker pound, one might expect that the larger FTSE-100 companies, which earn in aggregate 79% of their revenues overseas, could strengthen, while the more domestically-focussed smaller ones might suffer. Retailers might be affected by the higher cost of imports. A weaker pound could make foreign travel more expensive, so overseas-focussed travel and leisure companies might perform less well, while UK-focussed ones fared better.
BREXIT could result in lower demand for offices in London.
Following a BREXIT, the two million UK citizens who live in the EU might lose their entitlement to benefits there.
How Are the Wise funds positioned for BREXIT?
While it is useful to consider what the effects of a Leave vote might be, we are not tactical investors and do not believe that there is anything to be gained be positioning the portfolios for this or that result. On balance, we believe that Remain is more likely to win. If Leave wins, the effects may not be as predicted above, and even if they are, much of the adjustment may have taken place already, for example in the pound’s 10% drop against the Euro over the last year. Our analysis of companies won’t change. BREXIT won’t turn good companies into bad ones, or vice versa.
However, it seems likely that, as the referendum date approaches, share prices may become more volatile. In anticipation of the bargains that may appear, we have raised the cash in the funds, which until very recently have been fully invested, to around 4-5%. We have taken this precautionary step in the knowledge that it may turn out to be the wrong thing to do.
What Mr. Cameron demanded and what he got
Critics of the negotiations dismissed Mr. Cameron’s deal as irrelevant. Some of his demands were negotiated away, some of the reforms would have happened anyway, and important issues such as the UK’s contribution to the EU budget and the unelected bureaucracies were untouched. However, the reforms give the UK significant guarantees, including a commitment that the UK will not be required to contribute to future financial bail-outs, and in the event that such bail-outs happen, and are paid for out of common funds, the UK will receive compensation.
Mr Cameron’s made four demands
- An opt-out from the principle of ‘ever-closer union’. Result – achieved. The final text states that ‘references to ever-closer union do not apply to the UK’. However, the repatriation of the UK’s social and employment law did not happen. The UK is still subject to EU laws such as the Working-Time Directive (see below under Sovereignty).
- Immigration Cameron wanted to prevent ‘benefit tourism’, by imposing a ‘handbrake’ to prevent EU immigrants from claiming benefits in the UK for four years after their arrival, from sending child benefit home to their countries of origin, and from having access to council houses. Result-unsuccessful. The four-year handbrake has been agreed, but is tapered, and the regime is due to last for seven years only. The other two proposals were rejected. However, this failure should be seen in context. Overall, immigrants are net contributors to the Treasury. Jobless immigrants can’t receive jobseekers’ allowance during their first three months’ residence, and can be sent home if still jobless after six months.
- Safeguarding the interests of countries within the EU but outside the Euro zone. Steps to further financial union not to be imposed on non-Euro countries, and the UK not to be involved in bail-outs. Result-success. The UK is to be exempted from bail-outs and will be reimbursed if central EU funds are used for bail-outs.
- Competitiveness Cameron asked for excessive regulation to be reduced, and for the Single Market to be extended. Result-a commitment to reduce red tape. The communique says ‘where feasible, burden reductions in key sectors, with commitments by EU institutions and member states’. We should probably not hold our breath. When bureaucrats commit to cutting bureaucracy the result can often be…more bureaucracy.
The costs of the EU
Within the EU, most countries receive more in subsidies than they pay as members. The UK is one of ten member states that pay more than they receive. Only Germany and France pay more than we do. The important figure to look at is the net figure, that is, what we pay in less what we receive in regional subsidies, etc. In 2013 this figure was around £ 8.6bn, and in 2014, £ 5.7bn. Over time the UK’s contribution has increased faster than inflation – in 1993, it was £2.1bn. Our contributions have tended to rise as the EU has admitted less wealthy countries in the south of Europe, who tend to be net beneficiaries.
However, EU membership is only around 1.0% of overall UK government spending. The benefits of membership in terms of trade and inward investment are almost certainly higher.
Almost half the UK’s exports go to the EU, so if Britain leaves the EU, we will still need to trade with them, probably through joining the European Economic Area (the EEA). As members of the EEA, we will still continue to pay the EU, through contributions to the budget and possibly through trade tariffs as well. Norway is a non-EU EEA member, and the Norwegian contribution to the EU per capita is only 10% lower than the UK’s. It seems likely that the direct cost benefit of leaving the EU is largely illusory.
Score: Remain 8 Leave 2
UK citizens look across to Brussels and see a bloated, unelected bureaucracy, making stupid, unworkable laws which impose huge and unnecessary costs on our country.
One obvious nonsense is the regular movement of the European parliament from Brussels to Strasburg and back, at a cost of roughly £200m a year.
Another nonsense, the Common Fisheries policy, aimed to prevent over-fishing by imposing quotas on fishermen, who were forbidden to land more than a prescribed weight of fish per trip. In complying with the quotas, fishermen in EU waters had to throw around a million tons of edible fish back into the water each year, mostly dead or dying (enough to supply the UK’s fish-and-chip shops with fish for ten years). Bureaucrats in Brussels set the quotas each year, routinely ignoring expert advice. The policy was hugely wasteful, and failed in its primary aim to prevent depletion of fish stocks, but remained in force for thirty years, and only came to an end in 2013, thanks to a high-profile campaign by celebrity chef Hugh Fearnley-Whittingstall, who collected 870,000 signatures in support of a petition against the policy.
The UK is subject to employment laws made in the EU, many of which seem excessively worker-friendly, and tend to infuriate UK bosses. Examples include the Simap judgement in 2000, which ruled that time on call is equivalent to time spent at work, the Jaeger judgement (2003), stating that time spent asleep at work counts as fully-paid time, and the Stringer ruling of 2009, where if a worker is off sick for a whole year, they can defer their holiday and take it the following year.
If we stay in the EU we will continue to be subject to EU employment legislation under the Working-Time Directive.
It is to be hoped that over time, the EU bureaucracy can be reformed and simplified, which it badly needs. However, it appears in no hurry to reform itself.
Score: Remain 2 Leave 8
Leave campaigners argue that the UK, which has the world’s fifth largest economy, and the largest in the current EU apart from Germany, is so important for the EU that it will be in no one’s interest to delay a settlement, and favourable terms will be granted quickly. This seems optimistic. The EU does not want to encourage its members to leave, and it is possible that an example will be made of the UK ‘pour encourager les autres’ as the French general remarked as he watched the execution of one of his soldiers. Our best hope is for a quick entry into the EEA. However, once there, we will be subject to all the EU’s rules (including probably the free movement of people) without having any influence over how those rules evolve.
Once all the new arrangements are in place, the UK’s freedom to negotiate its own terms may or may not turn out to be an advantage. It will be many years before the outcome is clear.
Score: Remain 9 Leave 1
Leave campaigners assume that a BREXIT will give us control over immigration. This may turn out not to be the case.
People move from war-torn countries to more peaceful ones, and from poorer countries to richer ones. The number of both refugees and economic migrants has grown worldwide in the last decade, and immigration has become an acute issue across the continent of Europe.
The UK is a small island, and is home to around 1% of the world’s population. Parts of the UK are among the most densely populated areas on earth. Extra people mean increased pressure on all facilities – houses, schools, roads, health services, and much else.
Immigration means different things to different people. To many, it means hordes of foreign-speaking people coming to the UK, taking our council housing, and signing on for benefits which we have worked for and they haven’t. Others feel that immigration is a positive benefit. The vacuum cleaner entrepreneur James Dyson threatened in 2014 to move his company offshore because it was made so hard for overseas students to remain in the UK on graduation, and for him to recruit the staff he needed. ‘The reason these engineers go home is because we do everything we can to make them unwelcome’ he told the Financial Times.
Voters’ concerns over immigration have brought the issue to the top of the political agenda, and many believe that the referendum is about immigration above anything else. Over the last fifteen years, governments have promised to control immigration at low levels, and all – Labour have failed spectacularly. The latest available figures, from 2014, show net immigration of 318,000, with 641,000 arrivals and 323,000 departures. These figures greatly exceed Mr. Cameron’s target in the ‘low tens of thousands’. At this rate of growth, immigration increases the UK’s population by 1% every two years. However, accusations of ‘benefits tourism’ appear unfounded. Among immigrants, a 2011 survey found that the number of ‘economically inactive’ people was 30%, compared to a figure of 43% for the UK population as a whole.
However, the argument is not just about economics. As Nigel Farage put it
‘If you said to me ‘Would you want to see over the next ten years a further five million people come into Britain and if that happened we would all be slightly richer?’ I would say ‘Actually, do you know what? I would rather we weren’t slightly richer and I would rather we had communities that felt more united and I would rather have a situation where young unemployed British people had a realistic chance of getting a job.’
An independent UK could impose tight controls on immigration, as Australia does, admitting only family members, students and those with skills that were in short supply here. The question is whether in current circumstances the EU, which under the Lisbon treaty is in a position to make the rules of its new trade agreement with the UK, would insist on the free movement of people as a condition. As the EU receives 45% of the UK’s exports, worth £200bn a year, we would be in no position to refuse. The basis of the EU, embodied in the 1993 Maastricht Treaty, is the ‘four freedoms’ – the free movement of goods, services, money and people. It seems unlikely that the EU would allow us to pick and choose which freedoms to accept.
Score: Remain 5 Leave 5
The UK spends more on security than any other country in the EU. If we left, the EU would probably have to increase its defence spending, and to a lesser extent, the UK would probably have to do the same. The UK has a close military collaboration with France, which could continue.
Score: Remain 6 Leave 4
Ideally, the UK would remain within a genuinely reformed EU, with opt-outs from its thrust towards ‘ever-great union’, and with immigration confined to essential workers and their families, while this country digests the several million new citizens it has acquired over the last decade.
That isn’t going to happen, so our choice is between a known situation of which the drawbacks are all too obvious, and, as an alternative, a leap in the dark which might turn out well a number of years hence. If we leave the EU, we can apply to re-join it at a later time, but without all the special terms which we currently enjoy. Although it is a simple yes-no choice, the number of considerations and of possible outcomes is infinite. And whichever way we go, we will never know how the other course of action would have turned. On balance, though, I will vote Remain.
Numerous articles in the Economist, the Financial Times, and other newspapers. A book ‘Europe – In or Out? By David Charter. A briefing note from Lazards on BREXIT was particularly helpful on the possible effects of BREXIT on the financial markets.
April 27th 2016
Please note – this blog contains the personal opinions of Tony Yarrow, and is not in any way intended as financial or investment advice