Which European nation faces the greatest risk of political instability and financial turmoil in the year ahead?
With less than a week 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, Britain 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 tax-raising 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 that are even more radical economic agendas and that are dedicated to dismantling the UK.
Another scenario — almost as probable as a Labour-led coalition — is a weak and unstable Tory government. To judge by the 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 Tory government to remain in power, at least for a while.
However, 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 even 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’s 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 US, 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 saw the fastest economic growth among the major OECD countries in 2014 and has an unemployment rate of only half the EU average. However, these favourable indicators obscure a source of enormous risk: One of the world’s largest external deficits, financed last year by foreign-capital inflows totalling £104bn (€143bn).
The current-account gap, at 5.5% of GDP, is the highest among the major OECD countries and is at a level long associated — 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 a 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.