The economics of Scottish independence: introduction.

Armstrong, Angus ; Ebell, Monique

On September 18th 2014 the people of Scotland will choose whether to remain part of the United Kingdom or to become an independent country. If Scotland becomes an independent country this would bring to a close one of the longest serving and most successful economic and political unions in the modern era. The process of Scottish devolution began in 1997, with the creation of the Scottish Parliament and Executive, and has been followed by more devolution of powers up to the Scotland Act 2012. Independence would be a fundamental and historic change. On the one hand it offers an opportunity for the Scottish government to choose its own economic, social and political framework. On the other, Scotland would no longer automatically be an integral part of risk-sharing arrangements within the UK, including monetary arrangements, welfare and pension provisions and defence.

The outcome of the referendum could also have important consequences for the rest of the UK and indeed the world. The political balance of power in the rest of the UK would change decisively with the loss of the 59 Scottish MPs in Westminster, a majority of which have been Labour in recent decades. (1) This could lead to a rightward shift in the UK political balance, with consequences for all areas of policy. Even setting that political shift aside, the mere mechanics of Scottish independence will have an important impact on the UK. The UK will be left with a significantly higher public debt to GDP ratio, with gross debt to GDP possibly exceeding 100 per cent. Both the UK and Scotland might feel the impact of higher transactions costs on trade, as regulations gradually diverge. The political influence of the rest of the UK in Europe and other international forums is also likely to change.

The consequences of the referendum may have ramifications well beyond these isles. The Scottish government has made clear that an independent Scotland would no longer house the UK's nuclear weapons. Finding a new base would have significant costs which may lead to a reappraisal of the current policy with implications for other members of the North Atlantic Treaty Organisation. For all the fluidity of international borders and a near tripling of the number of independent states in the past sixty years, there are few examples of cordial separations which have not followed the end of colonialism or communism. If an important region within the European Union can secede from a sovereign state with ongoing membership to the international community, this would set an interesting precedent for other regions such as Catalunya, the Basque Country or Flanders. The settlement between the UK and an independent Scotland would be particularly important in terms of setting a precedent for the separation of highly indebted countries.

Given the long lasting and far reaching consequences of the referendum, the Scottish and UK governments recognise the importance of making impartial information and analysis on key issues available to voters. Both governments support the particular role of the Economic and Social Research Council (ESRC) in funding independent research on Scottish independence and in assisting in planning for whichever outcome prevails. Three of the six articles in this Review are co-authored by ESRC Senior Scottish Fellows (Angus Armstrong, David Bell and Michael Keating) and four articles are co-authored by members of the ESRC's Scottish Centre on Constitutional Change (Angus Armstrong, David Bell, Katerina Lisenkova and Michael Keating). We are grateful for this support and the opportunity to contribute to the debate on Scottish independence.

The first paper, 'Scotland's economic performance and the fiscal implications of moving to independence', by John McLaren and Jo Armstrong of Glasgow University's Centre for Public Policy for Regions, provides an overview of the economic position of Scotland as it approaches the referendum, and examines how its fiscal position might evolve over the coming years and decades. One important focus is on different measures of aggregate income, Gross Domestic Product versus Gross National Income, and their implications for assessing living standards and the tax base available to an independent Scotland. Another important distinction is real versus cash terms measures of aggregate income, which are especially important due to volatility in the oil price. The authors go on to assess the impact of competing forecasts on future oil production and revenues for an independent Scotland's medium- and long-term fiscal position.

Next, Angus Armstrong and Monique Ebell of the National Institute of Economic and Social Research contribute an article entitled, 'Scotland: currency options and public debt', in which they examine the implications of the level of public debt that Scotland might expect to inherit at independence for its optimal currency choice. Armstrong and Ebell argue that, at high levels of government debt, a monetary union with the UK would restrict Scotland's capacity to adjust. Only being able to use fiscal policy would limit its degrees of policy freedom to manoeuvre in adverse economic circumstances. An independent Scotland would always retain the sovereignty to change its currency and fiscal arrangements in the future. This makes agreeing and implementing fiscal constraints which bind in all circumstances difficult to achieve. It may also mean that investors question the commitment of the government to remain within the union when a significant economic shock hits.

The next three papers are all concerned with the long-run aspects of Scottish independence, in particular with the affordability of pensions and the impact of demographics. David Bell, David Comerford and David Eiser lead off with their piece on 'Funding pensions in Scotland: would independence matter?', which considers the costs to providing state and public sector pensions in an independent Scotland. They note that the lower cost of financing pensions in Scotland due to lower further life expectancy makes providing pensions in Scotland less expensive per retiree, but that higher dependency ratios (2) work against this when pension affordability is assessed in terms of the cost per working adult. They also examine the distributional implications in the case that government debt carries higher interest rates for an independent Scotland. Pensioners would benefit from the higher interest rates, but at the expense of higher taxes for younger cohorts of taxpayers due to higher costs of debt service.

Katerina Lisenkova of the National Institute of Economic and Social Research and Marcel Merette of the University of Ottawa examine the affordability of pensions in their article entitled, 'Can an ageing Scotland afford independence?'. They address this question using a dynamic multi-regional overlapping generations model spanning Scotland, the rest of the UK and the rest of the world, which differentiates two cases: under independence, Scotland would finance its pensions alone, while as part of the UK pensions would be funded jointly. Lisenkova and Merette find that Scotland would be slightly worse off under independence, but that this difference is small compared to the effects of ageing on both economies.

Next, Rowena Crawford and Gemma Tetlow, both of the Institute for Fiscal Studies, present their work on 'Fiscal challenges and opportunities for an independent Scotland'. They first examine how public spending and revenues differ between Scotland and the UK average, before presenting a detailed national transfer accounts analysis of how Scotland's fiscal position might evolve in the next 50 years if current policies were maintained. Crawford and Tetlow project that if Scotland targets a debt to GDP ratio of 60 per cent by 2062-3, it would have a fiscal gap of between 1.5 and 5.9 per cent of GDP, compared to a fiscal gap of 0.4 per cent for the UK. They conclude that Scotland would either need to rein in its current spending levels, or increase taxes, in order to fund this gap.

Finally, Michael Keating and Malcolm Harvey of the University of Aberdeen conclude this special issue with their work on 'The political economy of small states: and the lessons for Scotland'. This provides some fundamental analysis on the different political models that an independent Scotland might choose. It distinguishes between the market competition state, similar to Ireland or the Baltics, and the social investment state model favoured by the Nordic countries, as well as discussing corporatist models. This work begins to map out the alternative social and economic models which would be available to an independent Scotland. Keating and Harvey conclude by examining which of these models fits most closely to Scotland.

NOTES

(1) Of the 59 Scottish MPs in the UK Parliament, 41 are members of the Scottish Labour Party against a single Conservative, while II are Liberal Democrats, and 6 belong to the Scottish National Party. This would imply a loss of about 15 per cent of Labour's 257 MPs in the current parliament, while the Liberal Democrats would lose 19 per cent of their 57 sitting MPs.

(2) The dependency ratio is the ratio between pensioners and the working population.