15-04-10 toscafund discussion paper - 2015 uk election outcome - update

TOSCAFUND April 2015

Toscafund Discussion Paper

The 2015 UK Election outcome – Update

Authors: Professor Richard Rose and Dr Savvas Savouri

Toscafund Asset Management LLP 90 Long Acre t: +44 (0) 20 7845 6100 e: [email protected] London WC2E 9RA f: +44 (0) 20 7845 6101 w: www.toscafund.com

Toscafund Discussion Paper April 2015 The 2015 UK Election outcome – Update

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Preface

In January Toscafund issued the discussion paper titled “The 2015 UK Election outcome”. In that

piece the accomplished political scientist Professor Richard Rose set out what he expected to unfold

in the wake of the upcoming General Election, to which I added my conclusions on what this might

mean for the UK economy. Fast forward three months and we return with a second, and let me

make clear, final instalment.

Let me cut to the chase. This report involves almost no material change to how Professor Rose sees

the assorted parties represented in Westminster. He expects the Conservative Party to have the

largest contingency of MPs, 20 or so more than Labour, but believes they will fall thirty or so seats

short of outright majority. For their part Professor Rose is convinced the Liberal Democrats will pay a

high political price for their presence in the coalition, not least across Scotland. The result will be the

Scottish Nationalists deciding the political fate of the entire Union. And it is on what the SNP

leadership has been proclaiming as its intentions which this report focuses.

Readers familiar with our January report will remember our conclusion: a minority Conservative

Government could survive were the SNP to refuse to back any Labour approach to vote out David

Cameron. Reasons why we expected the SNP ‘not to vote’ Cameron out were made reasonably

clear. We suggested that the SNP would see a Minority Conservative Government as more amenable

than a Minority Labour Government to the most generous devolution of legislative powers to

Holyrood. We also argued that with their sights more on elections at Holyrood next year than

Westminster this year, they would not want to ‘ally’ themselves with a Labour Party which is after all

their traditional challenger in Scotland. In the period since outlining our conclusion Nicola Sturgeon has lost few opportunities to make clear

the SNP will use its influence in Westminster to oust David Cameron. According to the Labour Party Sturgeon is trying to dupe traditional

Labour voters across Scotland into opting for the SNP as a Labour ‘proxy’. This may well be the case, and only time will tell whether the SNP

allows itself to install a Labour Minority Government with fewer seats in Scotland than itself, and fewer seats in England than the

Conservative Party. We are left, however, having to consider the real possibility that Nicola Sturgeon will indeed actively use SNP power to

vote David Cameron out of Prime Ministerial office and Ed Miliband into it, and what price she will extract for doing so.

According to the thinking of Professor Rose, negotiations to tie Labour and the SNP into a parliamentary knot could last four to six weeks. He

explains why such a knot could easily slip within a year. I leave readers to follow his reasoning in the section which follows and then return

with my view on what a Labour/SNP pact, however long-lived, might mean for Britain’s real economy, its currency and Gilts. Whilst I explain

my thinking later, I will summarise the conclusion now.

I see as inconceivable the pound not weakening significantly against the dollar as a Labour Minority supported by the SNP is ‘priced in’. Why?

Because the Labour Party of 2015 is one which has shifted more ‘leftwards’ from New Labour elected in 1997. Moreover, New Labour

entered Westminster back in 1997 with a clear majority; this time – no longer New - Labour will have to be encumbered by an SNP with

ambitious fiscal policies, not simply for Scotland but by implication for the whole of the UK. The upshot is that Gilt prices would respond by

moving downwards and so too the pound. And the latter would be most noticeable relative to the US dollar. Against the euro the slippage

whilst noticeable could conceivably be contained by the potential that any move down in Gilt pricing provides something of a yield support at

a time of euro-zone QE.

Ultimately what will most significantly influence how sterling and Gilts perform is what the OBR and MPC choose to write and say about the

economic policies presented in any Labour/SNP Pact. Were the OBR to alter its forecasts for the pace of UK debt reduction, this could hardly

fail to have a material financial market impact. Moreover, against the backdrop of sterling weakness and a newly installed Government

following an expansionary fiscal programme, the MPC would itself be expected to have something to say on how appropriate its continued

monetary restraint was. Both the OBR and MPC would also be expected to opine on the implications of the issuance of Kilts and other

regional forms of “sovereign” sterling debt. As for the UK’s real economy I would caution against assuming weakness in sterling and Gilts

implied downward revisions to GDP growth, as I will explain in my conclusion which follows the work of Professor Rose, which comes next.

Dr Savvas Savouri

Professor Richard Rose is the most senior practicing election expert in Britain; he co-authored his first two books on the 1959 British general

election and has since published more than a dozen books on voting and elections in Britain, Europe and worldwide. As director of the Centre

for the Study of Public Policy at the University of Strathclyde, Glasgow he has also published dozens of books on comparative politics and

public policy in Europe, the United States and beyond. For details, see www.cspp.strath.ac.uk.

Authors: Professor Richard Rose FBA Dr Savvas Savouri

Contact information:

Professor Rose Director, Centre for the Study of Public Policy University of Strathclyde, Glasgow t: 01436 672 164 e: [email protected]

Toscafund Asset Management LLP 90 Long Acre London WC2E 9RA England t: +44 (0) 20 7845 6100 f: +44 (0) 20 7845 6101 e: [email protected] w: www.toscafund.com


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1. What it takes to win the 7th May UK election: coming first in seats.

To win a House of Commons seat does not require an absolute majority of the vote; it is enough to win a plurality, that is, one vote more

than any of half a dozen or so competitors. In 2010 three-fifths of all seats were won with less than half the vote.

The general election result is the sum of results in 650 constituencies. In the past the first-fast-the-post electoral system usually

manufactured an absolute majority of seats in Parliament for the party winning a plurality of the vote. This did not happen at the last

general election. The Conservatives won a plurality of votes and of seats, but not an absolute majority. It had to negotiate a coalition with

the Liberal Democrats to create a government supported by an absolute majority of MPs.

The big certainty about the forthcoming election results is: one party will have a plurality of seats but no party will win an absolute

majority. The weekly average of party support in the polls has been steadily showing that the Conservatives and Labour are virtually tied

with one-third of the vote each (see www.UKpollingreport.co.uk). In this situation a fluctuation of a few percentage points in a party’s

support will be news in the media for 24 hours but statistically insignificant. The British Polling Council advises that any change of up to 3

percentage points in support for a party can be due to the random fluctuations inherent in sampling. If fluctuations occur in opposite

directions, this could give the false appearance of one party being up to 6 percent ahead when there was no underlying change in the

division of the vote.

A second certainty is: the direction of change in each party’s share of the vote is clear. Since 2010 the polls have consistently shown that

Conservative support has fallen and that of the Liberal Democrats has collapsed. Concurrently, Labour support has risen and the United

Kingdom Independence Party (UKIP) has come out of the shadows to attract more than 10 percent of voters. However, any attempt to

convert a national swing in votes into a change in the seats of House of Commons is misleading, because it assumes political competition

is still uniform throughout Britain. This is not the case: a general election is no longer general.

The outcome of the May election will be the sum of competition between different pairs of parties. This is most evident in Scotland. The

rise in support for the Scottish National Party (SNP) does not threaten the Conservatives because they have only one Scottish MP.

However, Labour’s losses to the SNP will sink its hopes of winning a majority and handicap its efforts to win a plurality of British seats. In

England there are more Conservative-held seats in which a Liberal Democrat rather than a Labour candidate came second in 2010. This

means that the Conservatives are better placed than Labour to gain seats from Lib Dems losses. UKIP’s rise has drawn more voters from

Conservative ranks, while the rise of support for the Green Party has taken more defectors from Labour and the Liberal Democrats.

Both of the largest parties will win and lose seats at the forthcoming election. To come first, the Conservatives need to minimize their

net losses by making some gains from the Liberal Democrats. The Labour Party needs to do more than this. To erase the lead that the

Conservatives held at the 2010 election, Labour needs to win up to four dozens seats from the Tories in England to compensate for its

loss of dominance in Scotland.


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2. Third-force parties are now part of the action.

For many decades Conservative and Labour leaders dismissed parties that attempted to challenge their electoral duopoly as irrelevant

because they usually finished third in constituency contests. Even if they gained millions of votes, the handful of seats that these parties

won in the House of Commons was insufficient to affect who governed Britain.

In the forthcoming general election, so-called third parties are a force that cannot be ignored before or after election day. The total vote

for third-force parties will hardly alter from the 35 percent taken in 2010, but how that vote is distributed has changed radically (Figure

2.1). UKIP will treble or quadruple its vote and the Liberal Democrats will see their support drop by almost two-thirds. Both the Greens

and the Scottish National Party will see their vote go up substantially. Even though the share of the vote for the miscellany of parties in

the Other category will fall, the Welsh Plaid Cymru and three or four Ulster parties will together return more than 20 MPs.

Figure 2.1 Changing Share of the Vote for 3rd Force Parties

Note: Average results of last three polls taken: Survation, Panelbase and IPSOS-Mori

The Liberal Democrats will be the big loser of both votes and seats. By becoming a partner in government with the Conservatives, the

Liberal Democrats have lost a large portion of the support that gained them 57 seats in 2010. Currently, polls show the Liberal Democrats

winning 8 percent of the national vote. In arithmetic terms, this is a fall of 15 percentage points. However, there are dozens of seats in

which an also-ran Liberal candidate did not gain 15 percent of the vote at the last election. If Liberal losses are calculated in proportional

terms, then a drop of three-fifths in its share of the national vote would imply a loss of 27 percentage points in a seat won by the party

with 45 percent at the last election.

In the 57 seats that Liberal Democrats are defending, its MPs are vulnerable to the combined effect of a fall in their constituency vote and

a rise in the vote for the party best placed to unseat them. Among these, 39 are held with a margin of less than 15 percent over the

second-place challenger. The Conservatives are second in 27 seats. Labour in 11, and 1 is in the hands of the SNP. Due to the benefits of

incumbency, Liberal Democrat MPs should lose a smaller proportion of their constituency vote than the party does nationally, but they

have more votes to lose. In proportional terms, a 15 percent loss is a fall of one-third of previous support. This allows for MPs to hold on

to more than one-quarter of their constituency vote thanks to an incumbency effect.

Liberal Democratic defectors will increase the scale of the party’s losses by boosting the vote of other parties. This is most evident in

Scotland, where the SNP is set to take at least 8 seats from the Liberals. In England, surveys show that disaffected Liberals split many

different ways: Two-fifths say they will support Labour, one-quarter the Tories, and around one-sixth each incline toward the Greens or to

UKIP. While the collapse of Liberal Democratic support gives Labour a bigger boost in national opinion polls, it gives the Conservatives a

bigger boost in the House of Commons. Gaining 24 seats from the Lib Dems compared to 8 Labour gains would be enough to give the

Conservatives a notional absolute majority before subtracting its losses in England.

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% Vote share

General Election (2010) General Election (2015 estimate)


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UKIP will make the biggest gain in votes but win few seats. Even though it contested 558 seats in the 2010 general election, UKIP was

ignored because it won only 3.1 percent of the vote. At the May, 2014 European Parliament (EP) election, UKIP came first with 27.5

percent of the popular vote and, thanks to the European Union mandated use of proportional representation, it won the most seats.

However, protest parties always do much better at EP elections than at a general election.

Opinion polls since the middle of the current UK Parliament have consistently shown UKIP having supplanted the Liberal Democrats as

third in popularity At the start of the election campaign, opinion polls show UKIP supported by more than one-eighth of voters. UKIP has

drawn support from across the political spectrum, albeit unevenly. While the largest group had voted Conservative in 2010, they are only

two-fifths of the party’s current supporters, compared to one-sixth drawn from Labour’s ranks. As UKIP’s support has grown, the

proportion of defectors from Labour ranks has been growing. This is consistent with the Nigel Farage strategy of being a populist party

rather than making a narrow appeal to rightwing electors.

The biggest handicap that UKIP faces is the British electoral system. If British MPs were elected by proportional representation, UKIP

would be well placed to win upwards of 100 seats. However, for a third-force party to win seats in Britain’s first-past-the-post system, it

needs to limit its appeal to a restricted minority of British constituencies, as the SNP does. By the conventional measure of marginality,

the distance a challenger stands from the winning candidate, there are only four seats in which the UKIP candidate was within 25

percentage points of the winner at the 2010 general election.

UKIP’s best chances of winning seats are in places where there are special situations. The two obvious examples are Clacton and

Rochester, which it won at by-elections as defecting MPs brought with them defecting Conservative voters. The seat that party leader

Nigel Farage is contesting in Kent is another and Farage is already a Member of the European Parliament from Kent. Constituency polls by

Lord Ashcroft place UKIP ahead in one more Conservative-held seat1. On this basis, UKIP would end up with four MPs in the next House of

Commons. If UKIP picked up a few more of its target seats, at least one would be gained thanks to support from older, uneducated

working-class voters feeling that the Labour Party no longer represented them.

Labour will pay the price of being a British party.

A conventional electoral analysis would define Labour as in a strong defensive position in Scotland. At the last general election Labour

took 42 percent of the Scottish vote and the SNP came second with just under 20 percent. However, the political situation in Scotland is

no longer conventional.

In the September, 2014 Scottish referendum the SNP was the only party that campaigned for independence and 45 percent voted for

independence. Voters who had traditionally voted Labour were the biggest source of additional support for the SNP cause. The Labour,

Liberal Democrat and Conservative parties formed a coalition that resulted in 55 percent of Scots voting no when offered a forced choice

between two alternatives. However, in the general election, these parties will divide the anti-independence vote.

Since the independence referendum, opinion polls have registered a categorical shift in electoral preferences. While the breakthrough of

the SNP is startling when viewed from Westminster, where the party had only 6 MPs in the last Parliament, it is consistent with trends in

Scotland over more than a decade. Since 1999 Labour has never won more than one-third of the list vote in elections for the Scottish

Parliament. In 2007 the SNP formed a minority government. In 2011 the SNP won re-election with an absolute majority of seats and 44

percent of the Scottish vote; Labour came second with 26 percent of the Scottish Parliament vote.

The rejection of independence removes the biggest risk that the Unionist camp stressed in the Referendum campaign, the economic

disruption of leaving the UK. Whereas English voters are asked to consider which party should form the British government, the SNP

offers the electorate an alternative choice: Which party can best represent Scotland? Opinion polls in Scotland show that the SNP is now

the most trusted party to represent Scottish interests in Westminster as well as controlling the devolved Scottish government

www.whatscotlandthinks.org. Currently, 46 percent intend to vote SNP as against 27 percent favouring Labour and one-sixth favouring

the Conservatives. Moreover, it is gaining more support from disaffected Labour voters in the West of Scotland, promising gains in what

once appeared very safe Labour seats. Given the size of the SNP’s lead in the polls, the complexities of Scottish political competition will

make little difference for its gain in seats. The SNP should emerge with 46 seats, taking 32 of the 41 seats that Labour held in the last

Parliament, and at least 8 from Liberal Democrats.

1 www.bbc.co.uk/news/uk-politics-29568123


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Figure 2.2 Impact on Seats of Third-Force Parties

Note: Calculated from constituency analyses

Impact of 3rd force parties benefits Conservatives most. While most Liberal Democratic MPs will disappear from the next House of

Commons, the seats they have held will not; they will be redistributed. The Conservatives will be the big net gainer from the impact of 3rd

force parties by taking about two dozen seats from the Liberal Democrats while losing only a handful of seats to UKIP (Figure 2.2). In the

division of the total UK vote, the Scottish National Party will be in fifth place behind the Greens, which is likely to hold its single seat. But

gaining dozens of seats from Labour and Liberal Democrats will make the SNP the third largest party in the House of Commons. As the

most British party, Labour will be specially hard hit by the rise of the SNP. The combined impact of 3rd force parties will be to widen the

48-seat lead that the Conservatives held over Labour after the 2010 election to a 90-seat lead over Labour–before taking into account

what happens in English marginal seats.

3. England: Labour will gain seats but not enough.

England has 533 of the 650 seats in the House of Commons and the Conservatives won an absolute majority of English seats in the 2010

election. Only 9 of its 306 MPs did not sit for an English constituency. This gave it a lead of 106 over Labour’s English MPs. The popular

vote in England was distinctive too. The Conservatives won 39.5 percent, giving it a lead of 11.4 percent over Labour.

The conventional way to assess the strength of the major parties is through polls that estimate party support in the whole of Britain.

However, the development of separate systems of party competition in England and Scotland means that British opinion polls can give a

misleading picture of party preferences in England, because one-seventh of poll respondents are Scottish or Welsh. The Conservatives

won 19 percent less of the combined Scottish and Welsh vote than they won in England, and Labour’s combined share was 12 percentage

points higher than England. Currently, polls show Conservative support continues to be much higher in England than elsewhere while

Labour’s support in England is no longer significantly different from its poll figure for the British vote. Headline accounts of British polls

underestimate Tory support in England. When polls report the two parties receiving the same share of the British vote, the Conservatives

have a lead of 1.5 percentage points in England. In May the Conservatives will again gain a majority of seats in England.

Because of the impact of third-force parties, in order to have a plurality of seats in Parliament Labour needs to win at least 46 English

constituencies from the Tories. In the 46th most marginal seat the Conservative lead over Labour is 7.5 percent. However, at every general

election the incumbent MPs usually do better than their party does nationally. Lord Ashcroft’s polls find that when asked about how they

will vote in their constituency people are more likely to endorse their local MP’s party than they are to endorse it when asked which party

they favour nationally. Thus, some MPs will hold on to their marginal seats even when there is a national tide going against their party. In

order to compensate for this, Labour must win some seats where Conservative MPs are defending a lead of up to 9 or 10 percent.

The last place in which Labour can look for fresh support is among the ranks of disaffected Conservatives. They are far more likely to

favour UKIP than to make a big jump to back Labour. Moreover, gains from such switchers are likely to be offset by the similarly small

number of Labour voters switching to the Tories. Disaffected Liberal Democrats are numerous, but they split five different ways and less

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than half defect to the two biggest parties. Thus, even though Labour is favoured among this group of defectors, it is unlikely to reduce an

incumbent Conservative’s lead by more than one to one and one-half percent. Similarly, although Labour is favoured among first-time

young voters, youths are less likely to cast a ballot and support will be divided five ways. The net benefit Labour can expect from first-

time voters is likewise limited to about one percent.

Labour will benefit more from the attractiveness of UKIP to disaffected Tories than it will from winning converts from the Conservative

ranks. In opinion polls before the start of the election campaign, this reduced the gap between the Conservatives and Labour by two

percent or more. However, the rocket-like rise of UKIP makes it vulnerable to losing support quickly. Compared to Conservative and

Labour supporters, intending UKIP voters are less likely to identify with their party. The latest British Election Study survey finds that only

34 percent do so. Equally important, 27 percent identify themselves as Conservatives. Since UKIP supporters are less definitely committed

to that party, Conservative MPs in marginal seats are seeking to call back these defectors by stressing positions consistent with UKIP

policy, such as holding a referendum on the European Union, reducing immigration and by warning that a vote for UKIP risks the return of

a Labour prime minister.

Figure 3.1 Predicted Election Outcome May, 2015

Note: Calculated from constituency analyses

Since every British MP is elected in a single-member constituency, where your vote is counted is as important as how you vote. Figure 3.1

combines the 3rd force impact and the outcome of Labour’s attempts to unseat Conservative MPs in England to arrive at how the 650

seats in the United Kingdom Parliament are likely to be distributed. Labour will gain seats but not enough to offset the effect of their

losses to the SNP (cf. Figure 2.2). The Conservatives will lose some seats by comparison with the 306 that they won in 2010, but not

enough to lose their position as the party that has come first. The strength of the third -force parties will differ greatly. The SNP will hold

about as many seats as the half a dozen other parties winning seats. Both the Liberal Democrats and the Ulster Unionists will have more

seats than UKIP but differ in one important respect. The Ulster Unionists will be united in what they want from the British government

whereas the Liberal Democratic MPs that survive will be shell-shocked by their losses.

290272

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CON Labour SNP Lib Dems Other Unionist UKIP Plaid

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4. What it takes to win Downing Street: the bigger coalition of MPs.

When the final result is declared on Friday 8th May, the Conservatives will have the most seats in the House of Commons. However, the

party will be well short of having an absolute majority of 323 seats, a figure that allows for abstentions by Sinn Fein and the Speaker. How

long David Cameron can remain in Downing Street depends on a combination of conventions, laws and political arithmetic.

The convention that the Queen’s Government must be carried on means that the prime minister does not resign until it is clear who is

moving in2. It requires about a fortnight for newly elected MPs to be sworn in and for a Speaker to be elected. Concurrently, both the

Conservative and Labour leaders will discuss terms for securing support from leaders of other parties. This will introduce them to a fact

known to every coalition prime minister in Europe: If you want to get what you want, you must give others some things that they want.

Party leaders will also need to consult frontbench colleagues and with their backbench MPs to make sure that any inter-party agreement

they negotiate is accepted by their nominal followers.

By convention, a British government is assumed to require the support of an absolute majority of MPs. Figure 3.1 indicates that

agreement between three parties would be required to create an absolute majority for or against such a motion. A Conservative coalition

with either the Liberal Democrats or the Ulster Unionists would fall short of an absolute majority. Any outcome in Scotland would

likewise leave a Labour and SNP combination short of the magic number of 323 MPs. Once the actual result is known, a computer can

instantly generate a great variety of three-party absolute majorities. But getting agreement to a three-party coalition is easier done when

facing a VDU than when facing fractious and demanding potential partners.

There is no legal requirement for a government to have the confidence of an absolute majority of MPs. A plurality of MPs is sufficient to

confirm a government and this can be obtained if one or more parties abstains from casting a ballot. Internal disagreement about which

party to support is one reason for a third-force party to abstain. Liberal Democrats were divided about forming a coalition with the

Conservatives in the last Parliament. A major electoral setback in May will intensify these divisions. Abstention would be a compromise

that avoided revealing internal disagreement about the party’s future.

When David Cameron seeks a vote of confidence before the end of May then he will need allies. Ulster Unionists are the most congenial

backers; however, on the division of seats estimated in Figure 3.1, Cameron would only have 300 votes. This would not be enough to

carry the day in the face of the 312 votes that could be marshalled by Labour, the SNP, Plaid Cymru and the Green party. Nor would

adding the support of 4 UKIP MPs confirm Cameron in office. However, if Conservative incumbents in marginal seats could recall

sufficient defectors to UKIP to reduce its losses to Labour to 29 seats, then its 297 MPs, joined by 10 Ulster Unionists, would give it the

support of 307 MPs and reduce its opponents to 305 MPs.

The defeat of a Conservative motion of confidence would not be sufficient to install a new government; a separate vote of confidence is

required to achieve this. The 2011 Fixed-Term Parliaments Act allows 14 days following the defeat of a government for a second vote

about an alternative government. While both Labour and the SNP have ruled out a coalition in which the two parties shared seats in

government, the SNP is committed to discuss terms with Labour. Its agenda goes beyond Labour’s desire to have the SNP support its

budget and votes of confidence. The SNP has set out three major policy demands: replacing spending cuts with more public spending

than the shadow Labour Chancellor currently endorses; devolving greater powers from Westminster to the Scottish Parliament; and

removing nuclear weapons from British submarines based in Scottish waters. Each of these demands is divisive within the Parliamentary

Labour Party. If the Labour Party could meet the SNP’s terms within 14 days of the ousting of the Conservative government, it could be in

Downing Street by mid-June. However, it would be at the mercy of the SNP withdrawing its confidence at a time of its choice3.

In default of either major party securing a vote of confidence within a month to six weeks after the election, the next step is clear. The

2011 Fixed-Term Parliament Act requires holding another general election in July.

Professor Richard Rose

2 If, contrary to the analysis of this paper, the Labour Party secured more seats than the Conservatives, then it would be conventional for a

prime minister with fewer MPs to resign forthwith 3 A Labour government that came first in seats in May would also be vulnerable to defeat as and when the SNP and the Conservative

Opposition agreed on the terms of a vote of no confidence.


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Dr Savvas Savouri – Discussion – Economic reflections from Professor Rose’s conclusion

With the UK economy into its fifth year of continuous growth, why are the incumbent coalition partners not enjoying "political

dividends"? Well, whilst the Conservatives will remain the largest party in Westminster economic their full dividend will be cut by a surge

in electoral support for UKIP, whose strength is based largely an anti-immigration ticket. For their part, the Liberal Democrats will pay a

parliamentary price with their traditional left of centre supporters, particularly the young and especially students, for backing

Conservative austerity and higher tuition fees. David Cameron also faces something of an irony in 2015 for a manifesto failure from 2010.

Irony because whilst the failure to contain annual net immigration below 100,000 has fed the UKIP insurgency - and threatens to draw at

least 1.5 million traditional English Tory voters - it has also contributed in no small way to providing the economy with the momentum in

growth and tame inflation which are now the loudest Tory electoral battle cries. What then of the General Election?

Far from cowed by losing the Independence Referendum or indeed the subsequent fall in energy prices, the SNP is triumphantly heading

to being the third largest group in Westminster. And as such it will do in 2015 what the Liberal Democrats did in 2010, decide which of the

two major parties forms a minority Government. The SNP will no doubt have it pointed at them that they hold the balance of power over

England without a solitary English parliamentary seat. One can only imagine their reply being that Scotland had for long been governed

from Westminster by a Tory Party with little or no parliamentary representation there.

Let us assume then that in the weeks after the election a Labour-SNP axis ousts David Cameron and bestows its 'confidence' on Ed

Miliband. In this case we will be told that a referendum in 2017 on Britain continuing within the EU is “no longer on the cards”. Be warned

however, it will simply be delayed, as I will explain later. What we will get with a Labour/SNP agreement is some form of “Mansion Tax”, a

much faster pace of devolution as well as a very different approach to public spending and debt reduction. And for those planning on

travelling to Dubai, Florida or anywhere linked to the US dollar, my recommendation if you expect a Labour/SNP Parliamentary Pact, is

buy the local currency ahead of the election.

So how long could a Labour/SNP ‘Pact’ continue? Well, to my mind I do not see it lasting anything like a full five years, very possibly less

than twelve months. Why? Because occupying common ground in Westminster risks compromising both the SNP and Scottish Labour

campaigns for Holyrood on May 5, 2016. After all the bigger the devolution concessions a minority Labour Government makes the more it

strengthens the SNP's hand in Holyrood, and weakens Labour in the Scottish and Westminster parliaments. Indeed, there is a real risk

that were the Parliamentary Labour Party to do a deal with the SNP, a large section of the Scottish Labour Party could splinter and contest

next year’s Holyrood elections separately. For its part were the SNP to appear kindred spirits with Labour in Westminster, Labour

defectors to the SNP might return, particularly if they were returning to a Nationalist Scottish Labour Party. In short, whilst its surge in

Westminster seats will come to define the 2015 UK General Election, the SNP leadership will be aware that its intervention there does not

assure it an absolute majority in next year's election to the Scottish Parliament in Edinburgh, and could indeed undermine its chances. So

were we to see the knotting of a Labour/SNP pact, I anticipate it might slip within a year; all the sooner were the Conservative Party to be

embroiled in a leadership contest.

Chart 1: Holyrood – number of seats Chart 2: Holyrood – share of vote

Note: Scottish Parliament

If Britons were indeed to return to the polls before 2020 I expect many traditional Conservatives who will endorse UKIP on May 7th –

possibly up to 1.5 million, mostly across England - to return to the Tory cause. They would realise that their defection contributed to the

Conservatives being frozen out of Government. If I am correct we could witness the Conservative Party improve on its May 2015 showing,

with or without a new leader. This, of course, brings back into play a referendum on continuity within the EU.

0

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Let us return to the days and weeks which follow May 7th. I see the Liberal Democrats in such a reduced state they are in a position to

side neither with Labour nor the Conservatives, focused instead on searching for a new leader and strategy. I also see a UKIP

representation within Westminster as little more than a taxicab of Tory defectors, this despite getting between 10% to 15% of the overall

votes, or three million supporters. For the record, had the referendum in 2011 on Alterative Voting ended the first past the post system,

UKIP would be heading for close on 100 seats, something which high profile supporters of AV, such as Eddie Izzard, would hardly find

funny.

Is it conceivable David Cameron can survive in No.10? If the Liberal Democrats unexpectedly come up with several dozen seats held by

MP's who favour maintaining a coalition with the Conservatives, there would be enough MP's to support Cameron as prime minister.

Alternatively, if the SNP leadership is frustrated in its negotiations with Labour the Conservative Party could offer it satisfaction by

handing over effective full fiscal independence and debt raising powers to Holyrood, because it values Scotland’s involvement in

Westminster far less than Labour. Moreover, the SNP could see the in/out referendum on the European Union that the Conservatives

have promised as an ideal platform to demand a second Independence Referendum. Why? Because there is little likelihood that a

majority of Scots would vote to leave the EU, but a real possibility a majority of English voters express a desire to do so. Were such a

national division to occur, one would need to give credence to the idea of a second Scottish Independence Referendum, even though the

2014 vote was supposed to be a ‘once in a lifetime’ event.

Let me present my thoughts of the broader macro-economics.

As well as triggering weakness in sterling a Labour/SNP pact would most likely unsettle the Gilt market. In both cases concerns would

stem from precisely how promised spending plans might be funded, the mechanism by which significant economic devolution to

Edinburgh is managed, and what the Bank of England and OBR have to say about events, not least to sterling weakness, which

incidentally will cheapen UK assets for overseas buyers. The SNP surge in Westminster also opens up the likelihood that alongside Gilts,

investors will have a second 'sovereign' sterling option, "Kilts", bonds issued by the Scottish Government, a development which would act

to further weaken the Gilt market. I expect weakness in sterling (charts 3 and 4) and Gilts (chart 6) to extend further if tensions in a

Labour/SNP pact reached breaking point and lead to an early second General Election.

As for mainland Europe I am in no doubt economic fortunes across it will worsen and as they do drag nation after nation into political

travails which make events across Britain appear calm by comparison.

Chart 3: Euro’s per pound with contingent forecasts Chart 4: US dollars per pound with contingent forecasts

Source: Bloomberg, Toscafund Note: Blue indicates forecasts in event of Conservative continuity and red in the wake of a Labour/SNP pact

Let me spend a moment considering how the UK equity market might react to a potentially protracted period of negotiations followed by

the formation of a minority Labour Government, installed with the support of the SNP. The downward move I anticipate for sterling will

no doubt find favour with firms relying on exports and overseas earnings. For its part a more expansive fiscal stance would lift sentiment

towards those sectors and specific firms with a gearing towards the UK public sector. Of course, were the base rate and Gilt yields to rise

earlier and greater than were the political status quo to continue, this would have an impact on sectors deemed to be interest rate

sentiment. This would be more a sentiment drag on say homebuilders than on their earnings, which one imagines face a protracted

period of increasing new homes sales and rising prices, underwritten by demographics. Many of these themes will play out across the

FTSE250, the FTSE100 continuing to be influenced by investor sentiment towards miners and other resource linked companies. I will end

on the issue of UK banking and argue that here to the underlining factor will be UK economic growth and in particular the strength in

residential and commercial property markets, both of which I remain convinced have impressive outlooks regardless of political change.

0.0

0.5

1.0

1.5

2.0

2.5

2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 0.0

0.5

1.0

1.5

2.0

2.5

2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

13%

-10%

-5%

-16%


10

Indeed, if one policy thread is common to a Minority Labour or Minority Conservative Government it is the devolution of powers and the

introduction of regional taxation, centred for the most part on property, and a good thing for it widely across the UK.

It is instructive to reflect on net immigration and the ‘failure’ to contain its annual figure below 100,000, something which UKIP are

creating considerable electoral capital of, to which I will make three points. Firstly, this arbitrary target has not only divided the Coalition,

it has dissenters within the Conservative Party, most notably the potential future leader and two-term London Mayor, Boris Johnson.

Secondly, if full-time students - who for the most part far from draw on our benefit system but provide considerable economic benefits -

are removed from official immigration figures, then the target has largely been hit since 2010. Finally, London's economic fortunes have

for the most part been lifted impressively by arrivals from overseas of workers, students, tourists and investors.

Whatever the outcome from May 7th, financial markets will keenly listen to what the Bank of England - particularly the Monetary Policy

Committee - and Office for Budgetary Responsibility, have to say on how events unfold.

Chart 5: UK base rate with contingent forecasts Chart 6: UK 10 year Gilt yields with contingent forecasts

Source: BoE, Toscafund Note: Blue indicates forecasts in event of Conservative continuity and red in the wake of a Labour/SNP pact

There may be readers surprised that whilst suggesting that a Minority Labour Government would trigger a marked move in monetary

metrics, notably sterling and interest rates, I am suggesting little in the way of a material change in the performance of the real UK

economy. I am convinced that whilst the precise - sector by sector - nature of UK economic growth will be impacted by political change

the general speed of GDP and employment growth is unlikely to be much influenced. My reasoning is that from our automotive

engineering and higher education across to our business service sectors, the positive perception of Britain across the emergent world will

not greatly alter. And whilst any weakness in sterling in the wake of political uncertainty would very likely lead to a rise in Gilt yields and

even an earlier and swifter move in base rates (chart 5), a more competitive currency would bring with it its own mitigation for a shift up

in the UK’s term structure (chart 7 and 8). As for how Britain will be perceived from the vantage point of Continental Europe I hardly

imagine it will compare unfavourably with worsening political, social and economic developments there.

Chart 7: UK workforce with contingent forecasts Chart 8: UK’s real GDP growth with contingent forecasts

Source: BoE, Toscafund

So what of London in all this? Whether the UK is in the EU or not and whether Scotland is part of the UK or not, and whether we do see

the introduction of a Mansion Tax and end of non-domicile tax status, I am confident London’s economy is proof against whatever change

is thrown at it. Indeed, in the event the pound did indeed weaken c15% against the dollar in the wake of a Labour Government being

0

1

2

3

4

5

6

2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

%

0

1

2

3

4

5

6

2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

%

-0.25%pts

-1.75%pts

26

28

30

32

34

36

38

1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

Mil

lio

ns

-6

-4

-2

0

2

4

6

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020

% c

han

ge, y

r-o

n-y

r


11

installed and with it a Mansion Tax introduced, the latter might be part be cushioned by sterling weakness relative to the dollar for

investors desirous of owning London-based assets spending using dollars or dollar linked currencies. The reality is that from the

perspective of Beijing or indeed any capital across the emerging world London is increasingly being seen as a City State, a sort of Hong

Kong or Singapore, but larger. And if there are those who do chose to evacuate London and Britain generally in the event of a change in

Government, they will find themselves caught in a busy revolving door; numbers entering greater than those departing. The reality is that

London, indeed Britain more broadly, will continue to draw both human and financial capital regardless of who occupies No.10 –

individual or party – because quite frankly it remains unrivalled as a secondary hub for businesses across the emerging world.

Finally, do not imagine that as economic powers are decentralised to the Scottish Parliament and Welsh Assembly, London’s legislators

will not demand comparability. For as powers are devolved in all directions from Westminster, the shortest distance they will travel is

eastwards along the Thames to City Hall and the London Assembly. I have no doubt that the fiscal devolution genie released by the SNP

will result in differentiated taxes widely across Britain, with for instance different VAT rates on positional goods and services, from hotel

rooms to cinema tickets and restaurant meals. Even local income tax looms and should be viewed favourably.

I wish to close my contribution to this report by drawing upon the closing passage from a Toscafund Discussion Paper released in April

2010 (“Scottish fiscal independence by 2015?”):

“Even if an independent Scotland fails to become a reality, one thing is certain - each passing year will see it gain greater

economic autonomy. Wales, for its part, is set to follow a similar path. In fact, London - bigger in terms of population and GDP

than Scotland and Wales combined - will also move towards greater economic self governance. The UK could, in short, see a

shift towards decentralisation of economic policy not recorded in generations. If it is possible to summarise how things have

developed over recent decades, this would be our attempt. The 1960s and 1970s saw a peak in post war local Government

power, manifesting itself in adventurous municipal building projects which sometimes ended in insolvent City councils. Much of

this local power was prized away by the Conservative Government of Margaret Thatcher. In the late in 1990s the Labour

Government of Tony Blair then offered Londoners, Scots and the Welsh the chance to vote on having their own legislative

chambers and large scale self governing infrastructures. Enough votes were in favour for work to begin in earnest on

establishing these frameworks. However, for a number of reasons many of the new powers vested were never exercised. With a

new Government in Westminster, this restraint looks certain to end. More specifically, we expect a move towards the issuance

of municipal bonds and the levying of local property, income and spending based taxes for London, Scotland and Wales. For its

part, central Government will not object but rather impose conditions, not least that in tandem with greater local revenue

raising powers it can reduce what is provided in the way of Treasury funding.”


12

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15-04-10 toscafund discussion paper - 2015 uk election outcome - update

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