Britain is dropping into the second division and has to find a new role

Mike O'Sullivan & David Skilling

The Times

The first year of the Brexit process has not been a good one. The best that can be said is that we now know that it is too late to properly execute a 'hard Brexit' and at the same time the process is too far advanced for 'second thoughts'.  A soft Brexit, made in Brussels rather than London, is the most likely outcome. At what is effectively 'half-time', there are many lessons to be drawn for Britain. Viewed from outside the UK, a couple stand out.

The first is that the world beyond Britain is changing.  As Britain retreats from Europe, the EU has begun to emerge as a more coherent strategic bloc - to the extent that Boris Johnson and Jacob Rees Mogg can complain about becoming a 'vassal state'.  From free trade agreements with Japan and Canada, to leadership on global climate change negotiations, to its increasingly deliberate stance with respect to China, the EU is realising its potential as a big power.  This, of course, is partly motivated by the withdrawal - at least for the moment - of the US from its global leadership role.

Comparatively, Britain is dropping into the second division, a geopolitical reality that has been publicly underlined by the likes of Sir John Sawyers.  There is a very large expectations gap here. With 'Our Darkest Hour' in the cinemas many British politicians talk as if we are back in the 1940's (or even hark back to Empire) rather than heading to the 2020's. Once the shape of the Brexit deal is known in March 2019, this expectations gap will bear heavily on UK politics and may become the basis for a new divide in British politics between those whose vision of Britain is sentimental and those, arguably younger MP's who have a sense for a modern role Britain can play in a multipolar world.

In this respect the crafting of what Global Britain looks like will be the next great political challenge. It will take time for Britain to carve out a new, distinct role.  As a starting point in trying to decipher what that role might look like Britain could do a lot worse than to examine what smaller, developed states are doing. This is not an argument that Britain shrink its contribution to world affairs to that of Belgium, but rather that it learn from the 'secret sauce' that makes the likes of New Zealand, Singapore and Switzerland the most successful socio-economic models. Their example is also germane because for a long time they have had to position themselves with respect to larger countries.

From a geopolitical point of view, an analysis of small states might help British politicians to travel forward in time. The global economy and geopolitical relationships are changing rapidly.  It is an increasingly complex and challenging world, and the discussions around post-Brexit arrangements need to take this reality seriously.  We think that small, developed economies - from the Nordics, the Netherlands and Switzerland, to Ireland, Singapore and New Zealand - offer useful insights for the UK in terms of how best to engage with this changing world.

These economies are deeply exposed to global economic and political dynamics and have been a record of responding effectively. Indeed, small economies are highly successful on a range of measures.  Small countries routinely top global rankings of economic performance, competitiveness, innovation, quality of life, wellbeing, and human development.

These economies clearly differ in many ways - geography, history, economic structure. And there is no single policy approach that works; the Nordic model is at least as instructive for the UK as low-tax Singapore. But taken as a group, there are several shared features that we believe are relevant.

First, small economies are highly open and externally-oriented.  This international engagement has been a key element of their economic success.  But as importantly, they have deliberately managed the risks associated with this exposure to global economic and political developments.  They have well-developed social insurance, flexible labour markets, active labour-market policies, and have preserved the fiscal space to pursue countercyclical stimulus policies.

Small countries also invest heavily in the future: high rates of investment, of R&D spending, and of human capital.  From Israel to Switzerland and Finland, these investments are at the core of their positions of competitive advantage.

And there is a small country 'secret sauce' made up of a focus on intangible factors such as the rule of law, strong institutions, and high levels of trust.  And, perhaps because small economies are so deeply exposed to the external environment, they spend a lot of time thinking about their place in their world and how best to be positioned.  Small countries like Singapore have a well-deserved reputation for long-term strategic thinking.

It is not surprising that small economies are frequently in the vanguard of global policy innovation.  New Zealand led on central bank independence from the 1980s; the Nordics have developed a unique blend of labour market flexibility and social insurance; Israel has become the Start-Up Nation; and from Norway to Singapore, small economies have developed leading sovereign wealth funds.

Britain has much to learn from this international small country experience as it thinks about its new post-Brexit situation.  As with other small economies, the UK will increasingly be a price-taker in the global economy.  A much more deliberate policy response will be required to position itself for success.

Of course, Britain remains a meaningful economy, the fifth largest in the world on a USD basis, and is a G20 member.  But the Brexit experience serves as a reminder that there are real limits to the influence of the UK.  In the future, Britain will not be a driver of global events but will need to adapt to them. In this respect, it has much to learn from other small economies in terms of how they manage risks and capture opportunities.

Michael O'Sullivan is Chief Investment Officer in the International Wealth Management Division at Credit Suisse, David Skilling is Director of Landfall Strategy, a Singapore-based economic advisory firm.