Scotland the Brave

In her role as Head of State, the Queen is expected to remain politically neutral so while she may express her concerns about the outcome of the Scottish Referendum on the 18th September, she can do little more than she did this week: hope that the Scots will “think carefully about the future” when they make their choice. Whatever happens on Thursday, the uncertainty around the next steps will make markets nervous about investing in the UK (or what remains of it) with the consequences that we have already started to see in terms of capital movements, the value of Sterling and the FTSE. Ordinary Scottish voters will not just have to think carefully, they will also have to be brave: this decision is irreversible.

At first glance, the exit of Scotland from the United Kingdom would harm the rest of the UK far more than it would Scotland. Removing oil exports from the UK’s trade balance would add roughly £1.6bn by the end of 2016 to an already burgeoning energy trade deficit. The trade deficit (net X) is already a drag on the UK’s GDP growth and adding to it would hamper what is still a fragile recovery.

According to UK government calculations, some 80% of Scotland’s GDP is dependent on free trade with the rest of the UK. This includes oil, of course, but equally financial services and whisky – two of Scotland’s other leading export sectors. In other words, a large proportion of Scotland’s economic performance relies on the performance of England, Wales and Northern Ireland. For the “Yes” campaign this is the essence of the reason why independence is a good thing: freedom from the rest of the UK gives the Scots control over their economic destiny.

But there is something slightly misleading in this line of argument; the UK is arguably the world’s oldest and most successful currency union and Free Trade Area. The Bank of England is, already, the lender of last resort ready to support Scottish banks and the Scottish deficit with UK taxpayers’ money while Scotland currently has substantial fiscal and political autonomy.

If Scotland votes to leave the UK, then on Friday 19th September policy makers in Scotland and the rest of the UK have to work out the terms under which Scotland can join a currency union as an independent nation. Effectively, it would face the same challenges as the Eurozone: how to integrate a deficit nation into a structure where a transfer union (i.e. cross-border tax transfers) would be necessary to correct the internal imbalances between members. A transfer union would legitimately be frowned upon by UK taxpayers if Scotland had its own tax-raising powers. But it would ensure that the lender of last resort (i.e. the Bank of England) does not have to loosen fiscal policy through greater Quantitative Easing in order to underwrite the Scottish deficit. This deficit currently stands at around £12bn and will grow if, under Scottish independence, the new administration undertakes to deliver on its expansionary promises.

Finally, the United Kingdom is also the world’s longest standing and most successful customs union. Scotland, England, Wales and Northern Ireland take the free movement of goods and services across borders for granted. This creates all the advantages of a customs union: economies of scale, access to larger markets and lower costs and prices. Some large companies have already warned of the dangers of higher costs, even without the costs of tariffs should no agreement on a common currency be reached. The consequences of ending a currency union may well be the end of the customs union too. How much of Scottish GDP might be affected by that? Quite apart from the political and economic issues that such a situation would create, is the fact that if the Scots vote “Yes”, they are voting for more independence, not less. Yet the paradox of exiting a currency union and then re-joining it is that they may well end up with more dependence and less freedom over fiscal policy than they currently have.

These are technical issues that have given the “No” campaign a reputation for being dull and un-engaging. It is, after all, hard to get really passionate about free trade areas and transfer unions. Yet these are the issues that will determine the long-term economic outcomes, not just for the Scottish people but for the whole of the UK and potentially for Europe as well. “Think carefully” hardly sounds like a wake-up call, but it really is!


Scotland the Brave  |  Author  |  Rebecca Harding  |  CEO