Across the channel, commentators are predicting that a likely outcome of Brexit is that, after withdrawing, the UK will lower corporate taxes and deregulate its economy to attract relocations from the Continent and elsewhere. After all, even out of the EU, the UK would still have the advantages of proximity to the largest economic free trade area on the planet and perhaps, depending on the outcome of the negotiations, of still being associated with it one way or the other. George Osborne appears to have plans consisent with those predictions, having declared his intention to lower the corporate tax rate to 15 percent, which would be the lowest among large economies.

The mere possibility that the UK engages in fiscal and regulatory competition is a powerful argument for the remaining EU member states to insist on either of two uncompromising outcomes following any triggering of Article 50: (a) the “Norwegian” one, ie membership of the EEA, which requires acceptance of the four EU freedoms and all EU rules without a say on their contents, or (b) no agreement at all. Outcome (a) would rule out regulatory competition on all matters that are or will be harmonized. And, with the UK out, the EU can be predicted to move in the direction of more harmonization than has been the case so far. Outcome (b) will mean no free access to the EU market for UK firms, which will greatly discourage relocations.

Yet, the fears that the UK will successfully engage in a regulatory or tax race-to-the-bottom are largely misplaced: in the present conditions, it is highly unlikely that the UK can attract any significant number of foreign businesses.[1] Relocating is costly. If a UK location is no longer cost-effective down the road, for instance because the relevant policies have changed, a second relocation will be needed, adding to the cost of the prior one. Hence, businesses will bear the costs of moving to the UK only if they can be persuaded that the new attractive tax and legal environment is there to stay. The problem is that the UK is not currently in a position to credibly commit to a stable environment. Here is why.

Jurisdictions attracting foreign business with favourable tax or legal treatment (think of Luxembourg or Delaware) tend to have relatively small economies, where the revenues for the state from the economic activity generated by the favourable tax or regulatory regime are a significant portion of the total. That makes the state’s commitment credible, because the harm to public finances from reneging on the promise to maintain the favourable status quo will be huge and, as a consequence, the political system can be expected not to meddle with the existing arrangements.

A large economy like the UK’s is thus at a disadvantage from this point of view. Yet, countervailing factors may still allow a large country to attract a disproportionate amount of economic or financial activity within its borders. After all, the City of London has attracted financial activities from all over the world for decades despite the large size of UK’s economy. That is not to say that the UK won the competition in financial services via regulatory or tax dumping. It means, rather, that the UK was eventually able to credibly commit to preserving the quality of its regulatory and tax environment over the long run.

How did it do it? There are, of course, many explanations. But arguably, in the past decades the appeal of the City as a financial centre owed much to the high quality, stability, and trustworthiness of UK’s institutions. A long tradition of parliamentary democracy, free and inquisitive media, the rule of law, independent courts, stable governments, a strong legal profession and, relatively speaking, a predictable electorate that could be expected not to be willing to renounce the advantages of hosting a highly profitable financial centre all played an essential part in the City’s success.

The context is now different. First came the diffused, and no matter how justified, anger against bankers following the financial crisis. While UK policymakers were arguably no harsher than others in reshaping financial regulation, there can be currently no presumption that a pro-business and/or pro-financial institutions agenda will go down well with the electorate. Then, and relatedly, the EU referendum has given a severe blow to the UK’s political institutions’ credibility. To an external observer, the very decision to ask such a complicated (and open-ended) question to the electorate via a simple majority vote looks reckless. The quality of the campaign debate and coverage was surprisingly dismal, while the low instincts and fleeting emotions of the enraged majority in favour of Leave entail a degree of unpredictability in British politics that was hitherto unacknowledged.[2] Finally, the cluelessness of politicians about what to do after the unexpected outcome, and more generally the messy state of post-referendum national politics, have added a final touch of amateurism to an already grim picture.

In short, the post-referendum uncertainty relates not only to the future of UK/EU relationships, but also to the stability and trustworthiness of British political institutions. That uncertainty may not be enough to erode the competitive advantages for firms that are already established in the UK (for them, relocating elsewhere will be a certain cost to be compared to the uncertain ones of remaining here), but it makes any attempt to attract new businesses or to rebrand the UK as a tax or regulatory haven at the border of the EU highly unlikely to succeed.

It is far too early, of course, to write off the UK as a stable democracy with trustworthy political institutions (a point the Economist has already made). Yet, it will take a lot of political goodwill, a committed leadership and a less temperamental electorate, not to mention a streamlined constitutional framework, before foreign businesses will find a UK commitment to a friendly tax and regulatory environment credible in the long run and decide to move here.

To conclude, the other 27 countries will find it convenient to parade the prospect of a UK tax or regulatory haven as a bugbear during the Article 50 negotiations. But the truth is that, even if the UK wanted to go down that road, it would hardly have any chance to succeed after the self-inflicted wound of the EU referendum.

Luca Enriques is the Allen & Overy Professor of Corporate Law at the University of Oxford.


[1] Depending on the magnitude of the dumping, however, it may succeed in retaining existing businesses, which is not at issue here.

[2] It is of no relief that voters are behaving no more rationally elsewhere in Europe. The point here is whether one could trust the electorate to behave more rationally in the UK than elsewhere.