The economics of Scottish Independence

On September 18, Scots will go to the polls to vote on the question “Should Scotland be an independent country?” A “yes” vote would end the political union between England and Scotland that was enacted in 1707.

The main economic reasons for independence, according to the “Yes Scotland” campaign, is that an independent Scotland would have more affordable daycare, free university tuition, more generous retirement and health benefits, less burdensome regulation, and a more sensible tax system.

As a citizen of a former British colony, it is tempting to compare the situation in Scotland with those of British colonies and protectorates that gained their independence, such as the United States, India/Pakistan, and a variety of smaller countries in Africa, Asia, and the Americas, although such a comparison is unwarranted.

Historically, independence movements have been motivated by absence of representation in the institutions of government, discrimination against the local population, and economic grievances. These arguments do not hold in the Scottish case.

• Scotland is an integral part of the United Kingdom. It is represented in the British Parliament in Westminster, where it holds 9% of the seats—fair representation, considering that Scotland’s population is a bit less than 8.5% of total UK population.
• Scotland does have a considerable measure of self-government. A Scottish Parliament, created in 1998, has authority over issues such as health, education, justice, rural affairs, housing and the environment, and some limited authority over tax rates. Foreign and defense policy remain within the purview of the British government.
• Scots do not seem to have been systematically discriminated against. At least eight prime ministers since 1900, including recent ex-PMs Tony Blair and Gordon Brown, were either born in Scotland or had significant Scottish connections.
• Scotland is about as prosperous as the rest of the UK, with output per capita greater than those of Wales, Northern Ireland, and England outside of London (see figure).

Because the referendum asks only whether Scotland should become independent and contains no further details on how the break-up with the UK would be managed, it is important to consider some key economic issues that will need to be tackled should Scotland declare its independence.

Since Scotland already has a parliament that makes many spending and taxing decisions, we know something about Scottish fiscal policy. According to the World Bank figures, excluding oil (a resource that is expected to decline in importance in coming decades), Scotland’s budget deficit as a share of gross domestic product already exceeds those of fiscally troubled neighbors Greece, Spain, Ireland, Portugal, and Italy. Given the “Yes” campaign’s promise to make Scotland’s welfare system even more generous, the fiscal sustainability of an independent Scotland’s is unclear.

As in any divorce, the parties would need to divide their assets and liabilities.

The largest component of UK liabilities are represented by the British national debt, recently calculated at around £1.4 trillion ($2.4 trillion), or about 90 percent of UK GDP. What share of this would an independent Scotland “acquire” in the break-up?

Assets would also have to be divided. One of the greatest assets—North Sea oil—may be more straightforward to divide given that the legislation establishing the Scottish Parliament also established a maritime boundary between England and Scotland, although this may be subject to negotiation. But what about infrastructure in England funded by Scottish taxes and Scottish infrastructure paid for with English taxes?

An even more contentious item is the currency that would be used by an independent Scotland. The pro-independence camp insists that an independent Scotland would remain in a monetary union with the rest of the UK and continue to use the British pound. And, in fact, there is no reason why an independent Scotland could not declare the UK pound legal tender. Or the euro. Or the US dollar, for that matter.

The problem is that the “owner” of the pound, the Bank of England, would be under no obligation to undertake monetary policy actions to benefit Scotland. If a sluggish Scottish economy is in need of loose monetary policy while the rest of the UK is more concerned about inflation, the Bank of England would no doubt carry out policy aimed at the best interests of the UK—not Scotland.

If a Scottish financial institution was on the point of failure, would the Bank of England feel duty-bound to lend pounds? As lender of last resort in England, the Bank has an obligation to supervise—and assist, via the extension of credit—troubled English financial institutions. It seems unlikely that an independent Scotland would allow its financial institutions to be supervised and regulated by a foreign power—nor would that power be morally or legally required to extend the UK financial safety net to Scotland.

At the time of this writing (the second half of August), the smart money (and they do bet on these things in Britain) is on Scotland saying no to independence, although poll results released on August 18 found a surge in pro-independence sentiment. Whatever the polls indicate, no one is taking any chances. Several Scottish-based financial companies are establishing themselves as corporations in England so that, in the case of independence they will not be at a foreigner’s disadvantage vis-à-vis their English clients. Given the economic uncertainty generated by the vote, the sooner September 18 comes, the better for both Scotland and the UK.

Headline image credit: Scottish Parliament building, by Jamieli. Public domain via Wikimedia Commons.