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24 January 2019

Beyond Brexit: what next for Britain’s model of democratic capitalism?

Brexit is the most significant peacetime rupture since the repeal of the Corn Laws. Is renewal possible? 

By Gavin Kelly

British politics is regularly said to be at a critical juncture. With Brexit, this is for once not hyperbole. It represents the most significant moment of political choice and potential rupture since the Second World War, and in peacetime, possibly since the repeal of the Corn Laws in the 19th century.

For four decades, membership of the European Union (EU) and its predecessors has shaped the evolution of Britain’s model of democratic capitalism. It has anchored the UK’s economic policy framework, governed the UK’s trade, restructured British manufacturing and its supply chains and helped attract foreign direct investment into the country. The City of London has been transformed since the 1970s to serve the EU as well as global markets. European companies now supply many of Britain’s utility needs, from energy to rail and bus transport. EU membership is even built into our hard infrastructure, most obviously through the Channel Tunnel. The supply of migrant labour from the EU, particularly since 2004, has greatly altered the UK’s workforce, transforming a number of sectors like retail, hospitality, care and food processing. Other industries like agriculture and fisheries have been fundamentally reshaped by common EU policies.

The impact of the EU extends far beyond economics, however. British society has a different make-up and look and feel due to EU membership. The population, and the places in which it lives and works, has become more European. Several generations’ horizons, sense of mobility and travel patterns have been greatly broadened. Social and environmental policies, from annual holiday rights to clean beaches, have rested on EU initiatives. The UK’s place in the world and foreign policy has been moulded and moderated by our membership. Our legal system, and the very form of statecraft pursued by the British state, has been transformed. It is no exaggeration to say that the European project has re-made us.

Yet to present this simply as a story of disruption and transformation would be to mislead. There are deep continuities too. There is a UK “pre-history” to EU membership that has also endured, not least in our political economy, much of which is rooted in the Victorian era. The UK is a liberal market economy with a global financial sector, deregulated labour market, shareholder dominated corporate governance, and an education system with a strong bias against vocational skills in favour of generic ones. Entry to the Common Market in 1973 helped cement the structures of this British liberal market economy, rather than fundamentally reforming it along coordinated or social market European lines. The UK did not leave its economic past behind when it joined the European project.

The role of the state in the economy was significantly reduced as well as reformed in the 1980s, and the postwar growth model of an export-orientated national economy with significant domestic manufacturing, energy and food production was progressively dismantled. But the underlying institutions of the UK liberal market economy remained in large part intact throughout these transformations. They evolved in tandem with a political system dominated by two main parties and a liberal welfare regime of mostly flat rate benefits and significant means-testing, rather than the multi-party politics of proportional voting systems, and social insurance or universalist models of welfare found in northern Europe.

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As it entered the new millennium, the UK was an open, financialised economy, deeply integrated into European markets, with a growth model underpinned by consumption and an oversized housing sector. High value service exports and foreign direct investment helped to offset a persistent deficit in manufactured goods. To be sure, this growth model had formidable strengths: competitive advantages in knowledge-based sectors; a buoyant labour market, drawing in highly skilled migrants; and productivity gains driven by leading edge service companies and world class universities and research. But these were matched by chronic failings: weak investment; entrenched inequalities between people, places and generations; a dystopian housing market; and rampant insecurity in segments of the jobs market, among others.

When the UK was battered by the financial crisis in 2008, it exposed economic fault-lines that had been obscured by the long era of benign growth in the 1990s and 2000s. They became even more visible, and acquired greater public consciousness, following the Brexit referendum. Despite the gains made before the crisis, levels of UK productivity remained comparatively low and, remarkably, have now barely improved for a decade. Real wages are still significantly below pre-crisis levels. And longstanding inequalities of income and wealth, between both the regions of the UK and its social classes, show little sign of diminishing. As a nation, the UK continues to rely, in the words of the governor of the Bank of England, on “the kindness of strangers” to pay its way in the world.

A new and darker global context also overshadows the withdrawal of the UK from the EU. The protectionist, America-first agenda of Donald Trump reverses 70 years of US commitment to an integrated Europe and has already engendered geo-political division over tariffs, the role of Nato, and the EU’s relationships with Russia and Iran. In tandem with this we’ve witnessed the rise of nationalist and neo-fascist parties, both within the EU and outside it, who share a common hostility to internationalism at a time when the looming crisis of climate breakdown demands urgent global action. Brexit arises at a moment when the postwar institutions of the international community are under huge stress.  

At the level of domestic policymaking, withdrawal from the EU presents a series of discrete challenges, such as how to handle a range of repatriated powers. Each policy area is important. But if our analysis is narrow, focussing on a set of single issues, we risk missing the bigger shifts. Hence, in this book, we address Brexit in the context of the impending challenges of the 2020s and beyond. We situate the question of leaving the EU and what it could mean in the larger sweep of the outlook for democratic welfare capitalism in the UK. The leading contributors to this special volume range widely across politics, economics, social policy and democratic and constitutional reform, while the book as a whole seeks to connect the domestic situation of the UK with its external position, both economic and geo-political.

At the time of writing (January 2019), the politics of Brexit remain radically uncertain. A number of scenarios – Theresa May’s proposed deal, leaving the EU without a deal, a soft Brexit, an agreed extension of the Article 50 process, or a second referendum with the option of remaining in the EU – are all still possible. For the most part, the contributions to this book are predicated on some form of withdrawal from the EU taking place in the years ahead. But beyond that, the scope for analysis and interpretation remains very wide, and the chapters consequently contain diverse perspectives on what has caused the Brexit rupture in British politics, and what its consequences might be.

The political causes of Brexit

To make sense of the vote to leave the EU, we need to unpack both the moment in history in which it occurred, as well as the coalitions who supported it. The timing of the vote was inauspicious from a Remain perspective. Not only did it take place amid the worst decade of pay growth since the Napoleonic wars, the deepest austerity in modern times and in the shadow of the eurozone crisis. It also occurred when broadly eurosceptic baby boomers were at their electoral peak, while the more pro-European “silent generation” of the war years was in steady decline, and their younger more Remain-minded cohorts were yet to reach their full electoral potency. Economically, as well as electorally, it represented a truly reckless moment for a Remain-supporting Prime Minister to seek to settle the European question.

But whatever the timing, the referendum fundamentally pivoted around the creation of an alliance of older, conservative middle class voters and the semi-skilled and unskilled working class – a combination of what David Willetts has called “the insulated and the excluded”. Political discourse about the referendum has been dominated by the plight of so-called “left behind” voters. Yet in reality, older, relatively prosperous voters were just as significant in number, reflecting the UK’s marked inequalities in voter turnout by age. The referendum result, therefore, represented a reckoning with places that have never recovered from the shock of de-industrialisation and Thatcherism, as well as groups who have not been reconciled to the ascendance of ever greater social liberalism and the cosmopolitan remaking of Britain, or the European remaking of the British state.

For those reasons, the outcome of the vote is difficult to explain in terms of the dominant political economic interests in the productive economy. The City of London, the major business organisations and the trade unions all supported Remain, as did the main political parties. The Leave vote disproportionately came from interests outside the labour market – older voters with a foundation of housing and pension wealth, or the state pension and pensioner benefits – and those struggling precariously within it, like the low skilled and self-employed. Its campaign was led by a political and economic elite – even if it was an unconventional one, drawn from beyond the organised pillars of the economy – but it successfully channelled an eruption of politics against the established political economy. It shook to its core the world-view that the big contours of the UK’s economic policy were firmly set and resided outside the reach of democratic contest. And it forced attention – if not public policy – upon an economic trajectory that had so unevenly distributed the gains of growth over the last four decades.  

Other drivers of the referendum vote are perhaps easier to grasp. The young and middle aged, and the better educated, were far more inclined to vote Remain. These are the social groups most comfortable with immigration and the diversity of modern Britain. The geography of the referendum reflected this, pitting most of the major urban centres and university cities against the towns, countryside and coastlines. Majorities in Scotland and Northern Ireland voted Remain, while most of England and Wales opted to Leave. This political geography is new: in 1975, none of the UK’s constituent nations voted No to EEC membership, and England and Wales recorded the largest supporting majorities.

While these headline territorial patterns are striking, consideration needs to be given to differences within regions and how they interact with the effects of age. Look, for instance, at retired voters in a strongly Remain region like London and we see that they backed Leave in similar proportions to the retired of Yorkshire, the north-west or Wales. Equally, if we just consider those in work we see that Remain won in more nations and regions of the UK than Leave. Brexit has certainly fractured the electorate in important ways, but it is a far more complicated picture than London, Scotland and Northern Ireland versus the rest of England and Wales.

The Brexit juncture comes in a new era of UK politics. It marks the first real crisis of politics in the post-devolution era in which the UK has become formed as a multi-national state, not just in terms of its governance, but in its identity too. Formal decisions concerning Brexit reside with the Westminster Parliament, but the consequences ripple across the UK’s nations and their assemblies, parliaments and civil societies. The European question has layered another deep cleavage onto the already fractious territorial politics of the union.

The consequences of Brexit: political economy

Over the last 40 years, Britain has sought consistently to entrench its liberal market model within the EU, pursuing the creation and completion of the single market, while (for the most part) resisting Delorsian ambitions to embed European capitalism in a pan-European social democracy. Its period of membership may have often been grudging, but it has also been consequential. The decision to leave the European project can therefore be expected to alter the future trajectory of the EU. But what might it mean for the future political economy of the UK? Will it essentially be a story of continuity or should we see dislocation? Will it be the same but worse, or is this the start of something very different?

When it comes to the UK’s growth model, it is hard to see where a significant re-orientation will come from. The major devaluations of sterling over recent years (one following the 2008 crisis, the other after the Brexit vote) have not spurred export growth but have reduced real wages. If nothing else, they have exposed the contemporary hollowness of the age-old hope that a weaker currency will prove to be an elixir for British manufacturing. A surge in export-led growth in the years ahead seems highly unlikely: if the UK ends up outside the single market and customs union, there will inevitably be new frictions in trade with Britain’s biggest market, while any new trade deals with other countries will be time consuming, involve sharp trade-offs and are likely to generate only negligible gains in GDP compared to the expected losses arising from diminished access to the EU. Financial services, on which the UK relies heavily for export performance, are likely to shift a significant proportion of business to the EU. Gravity is not so easy to defy.

A new era of wage-driven growth feels unrealistic too. Even now, at a mature stage of the economic cycle and in the face of a tight jobs market, pay rises remain anaemic by postwar standards. Without a turnaround in productivity, wage growth will remain weak, as will household income growth, all of which is a major constraint on the consumption-led UK growth model. Business investment, too, is not well placed to come to the rescue. The UK’s long-running problem of weak investment has, if anything, intensified in the post-crisis era and now Brexit uncertainty represents a major additional drag on business sentiment. Public investment is increasing substantially, but not at a rate sufficient to transform the overall outlook.

The engines of demand in the UK economy have been slow to recover since the financial crisis and have been further weakened by the prospect of Brexit. This will place more strain on macro-economic policy. It is unlikely the UK will return to anything like “normal” monetary policy in the immediate future. Fiscal pressures are set to ease relative to the deep austerity of recent years, but this is only likely to mean that spending keeps up with inflation rather than recovering any of the ground lost after 2010. And history suggests that before too long – even leaving aside any disruptive shocks – we should anticipate another recession or slow-down. A new phase of policy activism may well be needed before the last phase has been wound down.

Brexit and the welfare state

Between 1997 and 2010, New Labour pursued a social investment strategy: fleshing out the UK’s liberal welfare state with new spending on tax credits, childcare, investment in education and skills, and a major expansion of higher education. Poverty fell, inequality levelled off and income mobility rose. These were major social achievements, though for many post-industrial towns and cities, they never amounted to the creation of a viable new economic future. What appeared for a while to be a durable electoral coalition of the working class and middle class socio-cultural professionals underpinned this policy shift, but has since fragmented.

This period of growth in our welfare state was followed by sharp retrenchment after 2010, with deep cuts in support for those of working age and a pronounced reshaping of spending in favour of pensioners. By the time the Brexit referendum took place in 2016, public opinion had already begun to turn against further cuts to social security – a trend that is likely to continue in the years ahead – rendering the politics of “welfare savings” ever more intractable.

The fiscal pressures on the welfare state will only grow. All ageing societies like the UK face significant challenges financing their welfare states, particularly because of rising health, social care and pension costs. This shrinks the space for fiscal generosity and sharpens trade-offs between the welfare preferences of different sections of the electorate. The UK has already aggressively pursued the “orthodox” repertoire of strategies for mitigating long-term fiscal pressures of ageing on the welfare state: migration has grown, the employment rate is at a record high, punitive working-age welfare conditionality has been imposed, and the state pension age has been hiked. On each score the limits have been reached.

Any version of Brexit will serve to intensify these fiscal constraints, not only because of the damage done to tax revenues, but also because of additional pressures on spending. Since the referendum, there have been repeated calls from across the spectrum for increased spending to respond to the popular demand for change, and shore up Britain’s domestic and international frailties: we’ve seen this on issues ranging from industrial and regional policy, to training, housing, farming and defence. There is little sign that Brexit points towards a smaller state.

All told, the Brexit penumbra will make the already difficult politics of moving to a sustainable 21st century welfare settlement far harder. The postwar welfare expansion was funded on the back of major switches in spending priorities, historic broadening of the tax base and a prolonged era of productivity growth. Any post-Brexit welfare adjustment will have to put more of the strain onto higher taxes.

There will, however, be clear limits to the tax rises that a wage-squeezed public will bear. Ultimately, the future of the welfare state – and the social contact that depends on it – will require a rekindling of productivity growth. If our liberal market economy cannot achieve this, then political pressure will grow for the state to pursue far more dirigiste strategies. These will have to encompass the “everyday” or “foundational” economy of private sector and publicly procured low wage service jobs in which millions of British workers are employed, not just the leading edge of high valued export sectors that industrial strategy typically embraces.

Politics after Brexit

The marked age divide in British politics that has emerged in recent decades acted as a midwife to the Brexit vote and was consolidated at the 2017 general election. Age has not ended the importance of social class, nor have voters’ “values” become somehow detached from any relation to their material circumstances or the wider institutions of the economy. But it is certainly true that navigating the demographic schism has become the sine qua non of political management in the UK.

If the Brexit cleavage remains central to British politics in the decades ahead – and Remain vs Leave become entrenched in the long-term political identities of large swathes of the electorate – this will only serve to magnify existing intergenerational tensions. Political parties seeking paths to electoral majorities will need strategies – including public policies for tax and spend, and social cohesion – that can plausibly overcome or at least ameliorate these divisions and command cross-generational support.

Population change will, of course, alter the make-up of the electorate over the long run. But recent experience from the UK, EU and US politics shows that demographic destinies can take a long time to arrive: in the meantime, politics can be contingently and rapidly reshaped as parties re-orient their strategies to meet electoral demands made by “declining” or marginalised social groups.

The playing out of the shift towards increased ethnic diversity will remain a feature of British society and its politics. On the one hand, public opinion since the referendum shows a marked weakening of hostility to immigration. And, more generally, Britain remains a relatively cohesive society compared to some European counterparts. However, levels of inward migration are likely to remain high in the future, albeit rebalanced away from the EU to the rest of the world because of the probable curtailment of free movement. And experience in much of the rest of Europe shows that discontent about migrants (and refugees) can quickly be channelled into support for far-right and nativist parties. Britain’s majoritarian electoral system has insulated but not inoculated it from these strains of politics. One of the biggest questions of post-Brexit politics is whether this remains the case.

Just as demography will remain a defining divide in post-Brexit politics, so too will territorial politics. One of the paradoxes of recent years is that the post-1998 institutions – the Good Friday Agreement and 1998 Scotland Act – have at a deep level shaped our constitution. Yet, surface level political debate (if not the substantive nature of the deal finally reached with the EU) has often proceeded as if we still inhabited some bygone era of unitary-state, Westminster-centric politics. This contradiction and its consequences – not just in terms of its impact on nationalist sentiment in Scotland and Northern Ireland, but also on the future trajectories of pro-union parties within each of our nations, in particular Scottish Conservatives and the Scottish Labour party – will be one of Brexit’s legacies. It is also possible – though difficult to predict – that the politics of Englishness, and the place of England in the union, will remerge as an important vector of politics in the UK once the intense focus on Brexit and the institutional form it takes diminishes.

All of this will reverberate through our party system for decades to come. To date, much of the focus of political debate has been on whether there might be a formal realignment in our party system – either through a new centrist party or the emergence of an insurgent English nationalist alternative to Ukip that folds in a swath of Conservative Leave supporters, as well as some traditional Labour voters. 

Whether or not this party realignment comes to pass is moot: the hurdles to it are high in a majoritarian electoral system. Either way, the aftershocks of Brexit will continue to cause flux within and between the existing parties, not least because devolution and the proportional voting systems of the devolved parliaments and assemblies create space for political insurgency that can profoundly influence the major UK parties. Political identities have been shaken up, if not completely broken, by the Brexit convulsion. It will be years before they settle down and when they finally do, it will affect not just who voters trust and the issues they gravitate to, but the political coalitions they might join.

After the Brexit storm

The Leave vote was not simply an exercise in imperial nostalgia, as some have claimed. But, as we have shown, there are deep continuities between Britain’s present and its past that will shape its future. The dominant role of the City in the UK economy and the liberal framework of its political economy have endured over decades, as has the nature of its welfare state. Even the newly emergent forces that are restructuring the institutions of the union and the relationships between its nations have deeper historical roots.

But a political moment as large as Brexit will, without doubt, bring change too – some of it directly related to leaving the EU, but much of it rooted in other long-standing failings – whether on regional inequality, housing, or economic insecurity – that now have greater political potency. Add to this the newer societal challenges that any government has to face up to in the decades ahead: switching to low-carbon production and transportation systems, meeting the escalating care costs arising from ageing, and supporting the workforce to transition to longer working lives. And then consider the pent-up problems caused by the austerity decade that will trouble our public realm in the years ahead: councils and school-chains going bust, hospitals needing bailing out, demands for the Universal Credit roll out to be halted, and so on.

In addition to these burdens on state capacity will be the return of EU responsibilities to the UK amid a period of uncertainty. Whether it is forging a new trade policy in a protectionist age, a competition policy fit for the challenge of big tech, or a migration framework suited to a greying society, the British state will be learning to read a new map in a fast shifting landscape.

The confluence of these pre-existing pressures with the new and urgent imperatives of Brexit will put strains on the state that have not been experienced since at least the mid-1970s. It is hard not to see government becoming more involved in key aspects of our national economic life – certainly as a result of necessity, and possibly ideology too.

Will, however, this greater involvement give rise to any fundamental shift in our political economy? In part, the answer will, of course, come down to political choice. No variety of democratic capitalism is immutable. For the first time in recent memory, the momentum in both main political parties simultaneously lies with those favouring radical economic rupture: whether through leaving the EU without a deal if necessary and pivoting towards a low tax, deregulated “Singapore of the West” model; or restoring public ownership and state-financed and directed growth. The politics of the moment would suggest the British model is set for profound upheaval.

Yet if there is a lesson from 20th century history, it is that some core features of our political economy are hard to shift: they have survived multiple changes of government, world wars, contrasting philosophies of economic management and profound shifts in the structure of the global economy. Anyone assuming that the political tumult of Brexit will inevitably give rise to some fundamental re-ordering of our capitalist model – whether for good or ill – may well be waiting in vain.  

What is certainly true, however, is that the constellation of pressures facing the UK means that a key feature of the post-Brexit era will be learning to navigate vulnerability. In the macro-economy the UK will live with levels of public debt that are far higher than the recent norm for decades to come, at the same time as interest rates seem likely to sit close to the floor. Reduced policy space means more risk of exposure to shocks.

A sense of heightened economic exposure will also be the norm for the British worker, and not just because of their weak bargaining position and the continued decline of unions. Workers are likely to remain exposed to the risk of further exchange rate devaluation – which, as recent years have shown, feeds through directly into lower real wages. The risk that mobile employers decide to uproot production and leave the UK, or downgrade their operations here, is also likely to be heightened for years to come.

At the constitutional level too, precariousness will prevail. No one can know how Brexit will play out on the forces pushing for Scottish independence – though it is not unreasonable to think that the shock of a hard Brexit might set back the independence cause in the short to medium term, while strengthening it beyond that. Either way, the issue will remain at the fore, as will the status of Northern Ireland and, most probably, the governance of England within the union. Far fewer of these issues are settled than seemed the case just a few years ago.

The governing challenge is not just the technical task of successfully negotiating these risks. If there are reasons to hope that the resilience and flexibility of the UK’s economy will help it to adjust to life outside the EU, albeit with weaker rates of growth and less dynamism than in the past, the same may not be true of our politics. The political challenge of forging a coalition of electoral support that could undergird any sustainable governing programme in the decade ahead is a profound one. As various contributions to this volume show, post-Brexit politics is likely to remain deeply divided along a number of connected fault-lines: generational, geographical and identity cleavages that cut across the support bases of the two main parties. Crafting a political agenda that spans these divides sufficiently to allow tough governing choices to be made would require remarkable leadership by the standards of any age, let alone one in which the main parties are so visibly struggling to rise to the level of events.

Whatever the chain of events in the months and years ahead – a soft or hard Brexit, or remaining in the EU through a second referendum – there will be a legacy of rancour and bitterness that will be hard to contain within the existing party system, and which may even challenge the basic norms of conduct of democratic politics. And even if the UK does leave the EU, the European question will endure as a major vector of British politics, for as Switzerland and others have found, any country that is a close neighbour to a large and powerful bloc like the EU is likely to be in permanent negotiation with it. All the more so if, as seems highly likely, the UK remains a regulatory rule-taker in one form or another. Politics, more than economics, may be the UK’s undoing.

We should, however, exercise caution about the gloom. In the heat of a crisis, it is always tempting to foresee an age of continued tumult. That case is easily made in Brexit Britain. But there are also countervailing forces, too. The consequences of breaking trading ties with the EU are so dire that one way or another the UK will seek to navigate its way towards a relatively close relationship with it. The strengths that have given the British model momentum will hardly fade overnight, even if they now face great strain. Our high value services, world leading university sector, and job-rich labour market, all provide grounds for optimism. The British state has shown itself capable of strategic purpose and organisational ingenuity in the last century. And – however unfashionable it may be to point this out in the current moment – there remains a residual resilience in the democratic politics of the UK.

Declinism is often overwrought and overstated in British public life – that, too, is a part of our tradition. But history suggests powerful new directions can be forged in public policy even in times of adversity. They have many times before, and no doubt will again.

This is an extract from the forthcoming book Britain Beyond Brexit, published by Wiley. It first appeared in The Political Quarterly. 

Nick Pearce is a Professor of Public Policy and Director of the Institute for Policy Research, University of Bath. Gavin Kelly is Chief Executive of the Resolution Trust.

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