Scottish independence: A yes vote would have plunged Scotland into a deep depression

 
Ronald MacDonald
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With today’s price of oil an independent Scotland’s fiscal deficit would be around 10 per cent of GDP (Source: Getty)

The first anniversary of the Scottish referendum on independence seems a useful point at which to take stock of the economic issues that would be facing an independent Scotland if it had voted ‘Yes’ in the referendum. There were two key strands to the Scottish National Party’s economic strategy which indicate that a Yes vote would have resulted in austerity in an independent Scotland the likes of which has been rarely seen in a developed country and which would have plunged the country into a deep depression.

The fist strand related to the price of oil. This price is central to the amount of tax revenues an independent Scotland would garner and specifically the size of its fiscal deficit. At the time of the referendum, the key assumption made by the SNP was that the price of oil would remain in the region of the then $113 per barrel which would have given an independent Scotland a fiscal deficit of around five per cent of GDP.

However, since then the price of oil has fallen precipitously and at today’s price I estimate an independent Scotland’s fiscal deficit would be around 10 per cent of GDP. With some analysts predicting that the oil price will fall further to $20, this would of course increase the deficit further.

Read More: Scotland's business climate is calling for independence

Such deficits are not sustainable and non-credible to financial markets and the deficit would need to be reduced sharply by severe cuts in public spending and /or tax hikes (the latter could be counter productive given the mobility of the Scottish labour force). If the deficit was the only substantive economic issue, financial markets would probably require a reduction from 10 per cent to around the three-four per cent of GDP mark. However financial markets would require an independent Scotland to run a fiscal surplus of around six per cent of GDP.

This is due to the second key strand in the SNP’s economic policy - the proposed retention of sterling post independence. As I and other specialists in currencies and exchange rate regimes pointed out at the time, remaining in a formal sterling zone was the worst possible option for an independent Scotland as it would have had no mechanism to change its competiveness other than through an extremely painful internal adjustment mechanism. Given that a formal sterling zone was ruled out from a political perspective, the SNP’s alternative exchange rate regime – its plan B – was to adopt sterling anyway as the currency of an independent Scotland.

Such a policy has a number of important drawbacks, not least that it does not provide an independent country with a way of accumulating foreign exchange reserves (which is what sterling would have become). At the time of the referendum, I calculated that Scotland would have had a current account deficit of around five per cent of GDP and that would need to be covered by foreign exchange reserves. With fall in the price of oil since the referendum, it is likely that this deficit would now be in the region of eight-10 per cent of GDP.

Read more: Is an independent Scotland becoming inevitable?

Normally a country would gather foreign exchange reserves by running a current account surplus and a key way of achieving this is to run a competitive exchange rate policy, much as China has done. But the adoption of sterling effectively rules this out. Such reserves could only be obtained by the country collectively (i.e. the public and private sectors) saving around eight-10 per cent of GDP per annum, which would require additional extreme austerity.

Clearly the level of austerity facing an independent Scotland would be unprecedented and unsustainable resulting in a classic currency/ financial crisis with the Scottish economy being plunged into a deep depression that in all likelihood would be generational in length.

To put it into context – the current austerity programme pursued by the Conservative government across the UK would be seen as a picnic compared to the retrenchment of the state and the loss of tax base facing an independent Scotland. Since the government of an independent Scotland would in all probability have to monetize its debt this would add an extra layer of pain.

Don't agree with Ronald MacDonald’s argument? Why not read Alex Russell’s claim that Scotland would be better off under independence

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