Scottish independence: Is it affordable?

"As with Brexit, too, some economic arguments against leaving are exaggerated"
April 7, 2017
Economics was pretty much invented in Scotland, and over the years, the economics profession has had more than its share of Scots. However, as the Brexit referendum shows, most people don’t vote on the basis of economics in contests involving national pride. Just as with Brexit, it is hard to make an economic case for separation: Scotland’s links with the rest of the UK are even more substantial than the UK’s links with the rest of the European Union. Ironically, even though Brexit now looks set to precipitate a fresh Scottish referendum, some of the strongest reasons for voting to remain in the EU (as a majority of Scots did) also apply in the case against Scottish independence.

But as with Brexit, too, some economic arguments against leaving are exaggerated. The share of Scotland’s trade with England might shrink, but probably not by much. Some two-thirds of Scottish exports currently go to the rest of the UK, compared with less than a fifth to the rest of the EU. Even if there were border controls at Gretna Green, England would remain the largest trade partner—just as it did for Ireland, after independence a near-century ago. How can we be so sure? Standards in Scotland for goods and services are already virtually identical to those south of the border, and standards matter as much as tariffs for trade. Moreover, Canada sells three-quarters of its exports to the United States without being the 51st state.

What about a Scottish currency? Scotland could, like Ireland in the 1920s, create its own currency and peg it to sterling. But independent Ireland had to get by without a fully functioning central bank for a couple of decades, and Scotland would not want to wait. It would just be too frustrating to accept all of London’s decisions on montetary policy. And even if Scotland joined the euro, this nation with a rocky banking history would need a lender of last resort: the collapse of the City of Glasgow Bank in the 19th century led to the creation of limited liability, and it was again Scottish banks that were at the heart of Britain’s financial crisis in 2007-08. Managing a separate currency would impose extra costs on Scottish taxpayers, but with the benefit of giving Scotland some freedom to develop its own policies. How much freedom would be determined in part by whether Scotland became a member of the EU, and the euro in particular.

The budget deficit would be the biggest economic issue confronting the new state. As the Institute for Fiscal Studies points out, public spending in Scotland is more than £1,000 per head higher than in the rest of the UK, even though tax revenue per head is similar. The gap partly reflects Scottish policy priorities, including free prescriptions, university tuition and social care. The deficit also reflects the halving of the oil price since the last referendum, which has slashed tax receipts of both oil and associated activity. It would help if the price recovered, and Scots recently cheered when oil was found off Shetland. But oil revenues fluctuate widely, so the best way to use them is—as the Norwegians have shown—not to underwrite intractable deficits, but to build up a national cushion against bad times.

How rapidly an independent Scotland closed its huge spending gap would also depend on the deals done with London and Brussels. London would want an independent Scotland to take on some share of UK national debt, in which case debt interest would swell the gap. Brussels might demand that Scotland meet the Maastricht criteria, which would accelerate the need for cuts. But London may have bigger worries than forcing debts on to the Scots as they left, and Brussels may be keen to show that Scotland can flourish by returning swiftly to the EU.

Further ahead, two questions arise. First, the removal of the insurance policy that the UK provides: a small open economy will be more prone to global headwinds. Secondly, the kind of economy that Scotland wants. It has strong financial services, upmarket tourism, and in St Andrews and Edinburgh some grand universities. It could boost revenues—and fund all those free social goodies—by cutting top tax rates, and wooing back a prosperous diaspora. But would it? When England cut higher-rate tax bills this year, the SNP declined to follow suit.

Leaving the Union may not make Scots much poorer. But it won’t make them richer than they would otherwise have been.