Investments - Markets

Brexit: Politics Gone Awry?

On June 23, in one of the largest voter turnouts in the country’s history, the people of the United Kingdom shocked the world by choosing to leave the European Union (EU), the collection of 28 politically and economically-bound countries that the U.K. had joined in 1973.

Many politicians, economists, and investors are still asking the same question: How did this happen?


The stage that set the backdrop for this vote dates back to the 1960s when Britain first applied to join the European Economic Community (EEC), the body that eventually would become the European Union. After being denied entrance twice by the French, Britain was finally accepted into the EEC in 1973. From the beginning, the United Kingdom has been the “odd country out” of the European Union membership, separated physically from the continent and reluctant to accept the mandates of the Union in a carte blanche fashion.

During her rule, Margaret Thatcher often voiced her opposition to many aspects of the British integration into the EU. The pinnacle of this was in 1979 when Britain elected to drop out of the European Exchange Rate Mechanism, the precursor to the Euro, choosing instead to maintain the pound sterling as the country’s sovereign currency. Years and years of discussion (and bickering) ensued in the pursuit of creating a constitution for the EU. Finally, on December 1, 2009, the Lisbon Treaty became law with the goal of making the EU “more democratic, more transparent and more efficient.”

As leader of the U.K.’s Conservative Party since 2005, David Cameron has been intimately involved in seeing that the U.K.’s interests would be protected in the doctrine, though Tony Blair and his Labour Party had been the official governing party of the U.K. since 2007. The “heavy handedness” of the ruling bodies of the EU (there are seven of them, all with significant German influence) continued to grate on the U.K.’s politicians and population, cumulating in 2009 when the U.K. Independence Party (UKIP), which is anti-EU, came in second in the U.K.’s European parliamentary elections.

Sensing an opportunity for the Conservative Party and himself, David Cameron promised the people of the United Kingdom that if the Conservatives won the general election in the following year (2010), any major decisions about the U.K. – EU relationship would have to be approved by the British people first.

With this rhetoric as a driving force, in May 2010, Cameron became the 54th Prime Minister of the United Kingdom leading a Conservative – Liberal Democratic coalition into power. No sooner than October 2011 and feeling that Britain had not had a say in its own destiny since 1975, 80 Conservative members of Parliament (MPs) began calling for a referendum on the U.K.’s membership in the European Union.

In January 2013, Cameron decided to roll the dice again, this time promising that there would be an “in/out” referendum on the U.K.’s future in the EU if the Conservatives won the 2015 general election. During the next year and a half, Prime Minister Cameron began the process of renegotiating Britain’s relationship with the EU. His public speeches on the subject matter, however, remained curt, most likely in an attempt to mollify his anti-EU opponents from both within and outside his Conservative party. Cameron’s own skepticism of the EU would come back to haunt him.

In May 2015, David Cameron and his Conservative Party won the U.K.’s general election with a majority of MP seats and he reiterated his pledge to hold a referendum on the U.K.’s membership by no later than 2018. After days of talks in Brussels (the EU hub) this year, David Cameron was able to carve out a settlement with the other EU member states on two stipulations regarding the U.K.’s membership going forward. First, the EU’s notion of an “even closer union” would not apply to the U.K. (i.e. “we’re close enough”), and second, the U.K. could impose restrictions on the welfare benefits offered to EU migrants that had settled in the country. In the end, these stipulations were not enough to placate the voting population in the U.K.


There are three routinely cited issues driving Brexit: the economy, immigration, and Britain’s identity.

The Economy: The debate on the economy revolves around the question of whether having access to the EU’s “single market” is worth the multitude of restrictions (e.g., essentially no trading with China) that come with that “privilege” and the associated costs (the U.K. “membership fee” to Brussels of being included in the EU is estimated to be over 12 billion euro per year). Given that the U.K. ships more exports to continental Europe than it imports from the EU, leaving the EU’s free-trade block would put these goods and service exports at risk to higher tariffs and potential trade barriers.

“Brexiters” believe that new deals can be cut with the EU member nations that will be close to current free-trade terms, but with fewer overall restrictions and at a reduced cost, often described as the “Norway model.” At least, that’s what the voters bought.

Immigration: This is the real flash point of the referendum. The U.K. has accepted well over a million immigrants over the last several years, with large numbers entering from places like Poland, Romania, Bulgaria, other former Russian Federation countries, and now with refugees from the Middle East. Some 40% enter the country without jobs. Many British locals feel that these immigrants are taking away their jobs, pushing down wages, and consuming public services without paying their fair share. The “leave” camp wants to limit net migration to tens of thousands, not the current hundreds of thousands. That is a level not seen since the 1990s and, if taken literally, would also entail restricting immigration from outside the EU as well. The U.K.’s disdain towards immigration is illustrated in Exhibit A.


Britain’s Identity: The “leave” campaign feels that Britain lacks sovereignty and the control of its own destiny as a member of the EU. They define community as their family, friends and neighbors. The “remain” camp generally believes in a broader definition of community, expanding it to Europe and even globally. The most fervent of the “remain” camp have labeled their “leave” counterparts as “xenophobes.”


Going into the vote on June 23, the “remain” camp held a slight lead over the “leave” camp in the polls, and a commanding lead by those who were actually placing wagers on the outcome (Exhibit B).

It appeared that Cameron’s late inning support of the EU (remember, he had been a skeptic demanding significant reform for over a year leading up to the vote) would be enough to ensure a victory for the “remain” camp. A similar story came from the country’s Labour Party, headed by Jeremy Corbyn. The Labour Party had historically provided a strong base of support for the European Union. The “remain” camp, as a group, felt the EU would foster the creation of jobs across the continent, but Corbyn’s feeble support of “remain” had put that at risk.

Underlying these outward appearances was a deep-seated skepticism towards the European Union by both parties: the Conservative Party believing for decades that the EU was a move towards socialism, and the Labour Party seeing the EU as a veiled threat of overt capitalism. Of the record-setting 46.5 million people that registered to cast their vote over the referendum, 33.5 million actually showed up to vote, a 72% turnout rate representing just 36% of the U.K.’s population. The “leave” camp won by a 51.9% majority over the “remain” votes at 48.1%. The underlying breakdown by age, education and social status is intriguing (Exhibit C).

Taken collectively, the results show that the “leave” win was supported by voters who were older, less educated and of a lower social status than the “remain” camp—the British version of the so-called “inequality gap.”

In essence, the voters in the U.K. have called the bluff of David Cameron, Jeremy Corbyn, and the governing councils of the European Union, who must have thought all along that the U.K. would never pull out of the “club.” Britain’s exit from the EU was backed by just 25% of the MP’s of the Conservative Party and less than 10% of the Labour politicians. Both parties obviously had little idea of the direction, will, and determination of their constituents regarding the issues.


The referendum itself is a non-binding agreement and with the sense that there is a certain amount of voters’ remorse prevalent in the U.K., a belief exists that the U.K. will not proceed with exiting the EU or that a second referendum will be called to override the first. Neither are likely to occur. It is also unlikely that either Scotland or Northern Ireland (U.K. countries which voted to “remain”) will have the parliamentary clout to block the proceedings.

For the U.K. to proceed with Brexit, the U.K. parliament must invoke what is called Article 50 of the Lisbon Treaty, which sets the ground rules and timetable for the U.K. secession from the EU. That motion must be initiated by the Prime Minister (PM), who will be Cameron’s successor. In the wake of the Brexit vote, Cameron announced his resignation by October, as he feels he should not be the one to lead the country through the EU exit as he does not support the move.

Interestingly, Boris Johnson, the former Mayor of London, and the “leave” campaign’s biggest cheerleader, is not a contender to be the next PM. Johnson’s candidacy was submarined by Justice Secretary Michael Gove (Johnson’s former campaign manager) with a series of assaults on Johnson’s commitment and ability to lead the U.K., the party, and movement forward – in essence a political assassination. After a series of ballot runoffs among the Conservative Party’s 330 members of Parliament and one of the two finalists dropping out, Energy Minister Andrea Leadsom (leave), Home Secretary Theresa May (remain) assumed the role of Prime Minister to succeed Cameron.

A letter from the PM to the European Commission stating that the U.K. wishes to invoke Article 50 then sets the process in motion, with a completion of the legal dismantling expected to take upwards of two years. German Chancellor Angela Merkel has rejected any notion of informal negotiations taking place before the official application to leave has been received, and has stated that there will be no “cherry picking” involved in the process. French President Francois Hollande is adamant that any country seeking access to the single market must “respect four liberties: the circulation of goods, of capital, of services, and of people.” Cameron has fully acknowledged that it will be impossible to have any/all of the benefits of EU membership without subsequent costs.


No one can be certain of the economic and investment implications of the move, though diminished economic activity for the U.K. and Europe is expected. A survey of 21 economic forecasting groups conducted by consulting firm FocusEconomics found that GDP in the United Kingdom is expected to drop to 1.4% in 2016 from a pre-Brexit growth level of 1.9%, and to 0.3% in 2017 from the prior expectation of 2.1%. Most forecasts for Europe are geared for a 0.5% drop in economic activity for 2016 and 2017, from previous annual estimates of 1.5% to 2.0% growth in each year. At a minimum, the heightened geopolitical risk that comes with this move will manifest itself with an increase in the price volatility of stocks, bonds and currencies. We certainly experienced this around the Brexit vote (Exhibit D).

It will be interesting to see how hard a line is drawn by the European Commission in dealing with the U.K., as they seek to dissuade any other members from a similar move. A corollary to Brexit may be found with Greece, as last summer Greek voters wound up voting against “Grexit” and in favor of austerity terms imposed on them by the EU that were more stringent than what they had originally been offered. This was the byproduct of the “game theory” negotiating antics of Prime Minister Alexis Tsipris and Finance Minister Yanis Varoufakis, which backfired miserably. Greece is still paying the price.

Published on July 11, 2016

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