Thursday, 55% of Scots voted to remain in the 307-year-old union with England, Wales and Northern Ireland, resolving a big source of UK political uncertainty. But political jitters still linger, largely owing to party leaders’ eleventh-hour pledge to extend Scotland’s autonomy if voters chose the union—and Prime Minister David Cameron’s post-game pledge to devolve more power to all the constituent countries. Negotiations on what this entails are about to start, and Cameron’s goal is to have legislation written by January and passed before May’s election, driving fears over the fallout of a potentially radical, quick shift in how the UK is governed. Political drivers like this are important for stocks, but what matters most is whether changes impact economic competitiveness and corporations’ ability to grow and profit. While no one knows yet what exactly a more federalized UK would look like, the likelihood changes would undermine the country’s many economic strengths or the current expansion seem slim.
Devolution, launched under Tony Blair’s government in 1998, stems from Wales’, Northern Ireland’s and Scotland’s long-running concerns about English MPs’ influence over local policy. Historically, the UK’s government was heavily centralized, with Westminster setting policy for the entire union. But 533 of the House of Commons’ 650 seats are English, compared with 40 for Wales, 18 for Northern Ireland and 59 for Scotland—all of whose economies are structurally different from England’s. So each country was granted its own national legislature with powers to set policy in certain areas. All three countries control their own health care, education, environment and agriculture and tourism. Scotland and Northern Ireland have their own judiciary. Scotland also has power to set its own tax rates under the Scotland Act 2012—where it can vary its income tax rate by up to three percentage points (and by 2016, up to 10 percentage points). Scotland can also issue debt in its own name, as of February, but has yet to do so.
However, none of the constituent countries can control social spending—one of the principal drivers of Scotland’s independence campaign. Many Scottish politicians and voters prefer more spending, but they didn’t believe the UK Parliament would ever loosen the purse strings due to a perceived ideological split between England and Scotland. To fight this perception and keep the union together, the three main party leaders—the Conservative Party’s David Cameron, Labour’s Ed Miliband and the Liberal Democrats’ Nick Clegg—promised Scots more fiscal autonomy if they stayed put, publishing a letter on the front page of Scotland’s Daily Record that loosely promised what pundits call “devo max”[i] and what former PM Gordon Brown called “home rule.” With Cameron’s implied backing.
But what any of this really means isn’t clear. The open letter implied the Barnett Formula—the occasionally criticized model that determines each country’s share of total UK revenue proportionate based on population—will continue. After the vote, Cameron said Scotland would get more say on taxes, welfare and other spending, but the three parties have long differed on the specifics. In proposals published earlier this year, Labour pledged to give Scotland power to vary basic income tax by up to 15 percentage points, but not to monkey with the highest tax band. The Conservatives would grant Scotland total control over income tax rates, but they’d also have to fund 40% of spending on their own. The Lib Dems would give Scotland control over income, capital gains and inheritance taxes OR replace the union with a “declaration of federalism,” moving the UK more toward US-style governance. But all three fall short of what the Scottish National Party considers devo max—total control over taxes and welfare spending.
So negotiations will likely be heated—especially because Cameron headed off the inevitable objections from Wales, Northern Ireland and the English members of his Conservative Party by promising to broaden powers for all—including, for the first time, England. English voters have long felt disenfranchised by devolution, which skipped them. The UK government’s traditional explanation is that with 82% of Parliament representing England, there was no need for a separate English legislature. But English voters always rebutted with what is known as the West Lothian question—why can Scottish MPs vote on England-only laws but English MPs can’t vote on Scotland-only laws?
Cameron didn’t promise England its own parliament, but he did propose England-specific issues be limited to English MPs, essentially pledging to decentralize the UK government—something observers characterize as either a “massive constitutional change” or a “constitutional crisis.” The West Lothian question has been the third rail of UK politics for nearly 20 years, and now Cameron is pledging to answer it in mere months, which most see as pledging to do the undoable. And ram it through a hung Parliament. Which will involve all manner of horse trading with Labour and the Lib Dems. And his own party, if their poll numbers start slipping. And with massive change come the fears of economic impact. How much will the change cost? How will it impact lawmaking in the future? Will it add unnecessary red tape? With Cameron pledging to act quickly, will businesses have enough time to adapt? Will more autonomous constituent countries make themselves more competitive or less?
All these issues are worth considering, but it is premature to jump to dim conclusions. For one, it is an open question just how much nationwide devolution Labour and the Lib Dems support, and—again—this is a hung Parliament. Cameron has his pledges, but legislation can’t pass without at least the Lib Dems’ support, and it seems fairly likely he would seek as broad a consensus as possible, lest Labour crucify him for steamrolling massive change through Parliament against much of the population’s will. He does, after all, have an election to fight soon. Even if we do end up with a significantly decentralized UK, there is no reason it would have to be any less competitive than the status quo. For one, more autonomy in Scotland, Wales and Northern Ireland shouldn’t have much bearing on London’s standing as a global financial center. Nor would it impact trade policy or financial regulations, which would remain under Westminster’s purview. The BoE would continue setting monetary policy. In other words, the driving forces of the UK’s strength—not to mention the current expansion—would remain intact. Perhaps some of the constituent countries would exercise their newfound powers in a way that would undermine their competitiveness relative to their peers, but within the UK this is probably zero sum. If companies don’t like it, they can just vote with their feet and relocate within the union, just as several Scottish banks and businesses threatened throughout the campaign. It wasn’t an economic risk for the UK then and likely isn’t now.
Of course, these are politicians, and politicians are quite capable of doing things that do more economic harm than good. This process deserves close scrutiny as it develops, and we’re eagerly awaiting the first proposals, which are due in October. Perhaps some unintended consequences will be evident (but perhaps not). But this is very much a take-it-as-it-comes issue, and not inherently a negative one. And, in the meantime, the UK’s strong underlying fundamentals should continue propelling its economy—and stocks—higher.
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