Why Scottish independence would be costlier than the nationalists believe

 
Peter Dixon
Even oil revenues may not stabilise an independent Scotland's finances

ON 18 September, the Scottish electorate will vote on whether to secede from the UK. Although supporters of the Union may be reassured by polls suggesting that break-up will not happen, this should not be taken for granted. And both sides have not properly analysed the economic consequences if the Scots do vote to leave the UK. The pro-independence camp has woefully failed to account for the costs of secession, while the anti-lobby is overdoing the gloom.

First, the good news. According to our calculations, a stand-alone Scotland would rank just outside the top 50 largest global economies, with income per head in the top 25, ahead of Italy. The rest of the UK would remain its biggest trading partner: the total value of non-oil exports from Scotland to the rest of the UK totalled 40 per cent of Scottish GDP in 2012. But Scotland currently benefits from economies of scale derived from being part of a bigger union, and would have to devote considerable funds to replicating existing infrastructure. The Scottish government is vastly underestimating the cost of divorce in this regard.

Second, revenues derived from energy taxation are vital to Scotland’s future, although there is uncertainty as to how much still lies underground. Nonetheless, Scotland will need all the revenue it can get: public spending per head of population is 10 per cent higher than the UK average. Even assigning the bulk of energy revenues to Scotland, the public deficit relative to GDP is higher than in the UK, and it is far from clear whether the Scottish government will be able to meet all its long-term fiscal commitments without raising taxes.

Third, an independent Scotland would be required to meet its share of the UK debt burden. None of the options for devising a split are very appealing, but one possibility is a debt asset swap in which Scotland uses future energy tax revenues to pay off debt. This, however, would represent yet another claim on already-stretched energy resources.

But it is likely that an independent Scotland would be able to quickly establish fiscal arrangements. Monetary policy is a much more delicate matter. Westminster has ruled out a currency union allowing Scotland to formally retain the pound. And while it could do so informally, it would have to generate surpluses in its public finances and on the current account to maintain sterling parity in the longer run. In order to benefit from maximum fiscal and monetary policy flexibility, Scotland could consider issuing its own currency. But it would also have to work out how to deal with a large banking sector, whose assets are 13 times larger than GDP – higher than Iceland or Ireland in 2007 – although bigger banks may relocate to London, to benefit from lender of last resort facilities offered by the Bank of England.

Of course, the rest of the UK would be affected by Scotland’s departure. It would have a diminished presence on the global stage and there would be an impact on domestic political dynamics. This is one reason why the debate over divorce proceedings, amicable so far, could become less so in the event of a Yes vote. But it’s difficult not to conclude that the pro-independence camp has downplayed the costs of a break-up, with their opponents guilty of overstating them. In truth, it is likely that an independent Scotland will fare better than the Westminster government expects, but considerably worse than the nationalists believe.

Peter Dixon is UK economist at Commerzbank.