January 16, 2012

Of course Scotland can stand on its own two feet. And here's how


Scotland's voters will be asked to make a political decision in its referendum on independence, but it will be a decision coloured inevitably by economics – or at least economic perceptions, for the long-term economic impact of independence is far from clear. But such is the nature of politics that economic arguments will be used by both sides to support their case.

To caricature, there will be those on one side who argue that Scotland would be too small to "go it alone" and that there would be a flight of capital to the south, while others will say that the flexibility for Scotland to make appropriate policy decisions will bring greater prosperity than the union can provide.

So what do we know about the economic impact of break-ups of country unions? The answer seems to be that the policies that a country adopts post-separation are much more important than the act of separation itself. The experience of the Czech Republic separating from Slovakia in 1993, and that of Ireland leaving the UK in 1922, throws up contrasting evidence. Both parts of the former Czechoslovakia have prospered. The Czech Republic has been cited as the first Soviet satellite to achieve full developed country status; Slovakia has managed from a rather lower base to be one of the region's fastest growing countries, thanks in part to developing a big car assembly industry.

Ireland's path has been more difficult, partly because from the 1920s onwards it deliberately cut its economy off from Britain's by bringing in import and other economic controls, and partly as a principally agrarian economy, it started from a long way back. But after the 1987 economic reforms that triggered the "Celtic Tiger" years, it has largely managed to catch up, notwithstanding present troubles. (Disclosure: I am part-Scottish, part-English and was brought up mostly in Ireland.)

Apply this experience to Scotland and what lessons emerge? Well, the first is that it is important to have an amicable separation rather than a hostile one. Trade ties will continue irrespective of political union and even of currency union. Britain remains Ireland's largest export market even now, while Ireland is Britain's fifth largest. So Scotland's economy would remain closely integrated with England's unless it was in some way pulled apart by political feuding.

A second point is about scale. Scotland has 5.2 million people, against 62.3 million for the UK as a whole. So there is a huge disparity of size. But in an open trading environment, countries of about five million people can function very well. Ireland has 4.6 million, Slovakia 5.5 million, Denmark 5.5 million, Norway 4.7 million, Finland 5.3 million, and so on.

Leading on from this, the third point is that there would, despite this disparity in size, have to be a deal crystallising the separation. On paper, this does not look too difficult. GDP per head is very similar, with Scotland within a percentage point or so of the UK average. While Scotland is poorer than London and the South East, it is richer than the whole of the north of England and much richer than Wales. So there would be no question of Scotland needing some form of continuing subsidy from a richer England, though the apportioning of assets and liabilities would be a difficult negotiation.

The reason for that is two-fold. You could split national debt in proportion to GDP but there would have to be an agreement as to the apportioning of the revenues of North Sea oil. And there would have to be some adjustment for the fact that public spending per head in Scotland is higher than that in the UK as a whole.

Each country believes it subsidises the other, and clever people can cite a ream of arguments supporting their side of the case. For example, there is the argument that Scotland should not be responsible for the debts of Royal Bank of Scotland; or that because the development costs of North Sea oil were funded under the UK, some of the revenues should continue to accrue to the UK as a whole and not just to Scotland.

There are other things that would have to be settled. These would include the future of defence installations and whether or not to maintain a currency union with the UK, as Ireland did until 1979. In the longer term, Scotland might choose to join the euro – if the euro still existed. But provided there was goodwill on both sides, it should be possible to strike a deal. The much bigger issue – the issue that would determine Scotland's economic future – would be the policies the country adopted after the split. Put at its simplest, would an independent Scotland be more or less supportive of economic growth?

It is quite impossible to predict the direction any country will take at any particular time. The Irish turnabout of policies from 1987 onwards was not foreshadowed at the election that year. There seems to be a presumption in some quarters that an independent Scottish government would lean towards a high spending and high taxation economy. That is possible and it would certainly scare the business community were it to head in that direction. But it is not at all sure that this would be the case.

For example, the Scottish government commissioned a report on public spending, led by Crawford Beveridge, that called for a complete rethink of public services in Scotland. It was published 18 months ago and was more radical and more forward looking than anything Westminster has considered. Thus it argued that there would be a continuing squeeze on spending right through to the mid-2020s. The message was that a Scottish government, whatever its precise constitutional status, would have to learn to do more with less.

If we cannot know what direction Scotland will take, we can at least be sure on one thing. The two economies would remain closely integrated. Scotland would have to compete with the rest of Britain, with Ireland and to some extent with the rest of the EU for investment funds, and for human capital. Ireland has been extremely successful at attracting inward investment, and England has been extremely successful at attracting talented human beings. So Scotland would have to remain competitive on both counts; there would, for example, be a strong case for Scotland following the Irish model and creating a particularly attractive corporate tax regime. That would affect policy south of the border, too.

That leads to the most intriguing question of all: how much could an independent Scotland affect – indeed, improve – economic management in England? Might more competition within these islands lift overall performance? That would be a prize worth chasing.


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