To the brink, but no further

The SNP’s victory in the 5th May elections, which delivered an overall majority of 69 out of the 129 seats, means that the party can now fulfil its commitment to push for a referendum on independence. But independence, if achieved, would bring complications—both political and economic.

The reality is that Scotland would gain little by full independence. In the modern world, economic sovereignty for small nations is inescapably limited, and political sovereignty is largely symbolic. There is very little possible autonomy for Scotland which is not potentially available to it as part of the United Kingdom.

Scotland is the most prosperous region of the UK outside southeast England. GDP per head has been between 90 and 100 per cent of the UK average. It is considerably richer than Wales or Northern Ireland. However, there are wide disparities within the Scottish economy. Edinburgh, the capital, and Aberdeen, the nation’s oil metropolis, are flourishing, but there remain pockets of severe deprivation in and around Glasgow and Dundee. Such imbalances make the Scottish economy similar, in many respects, to that of the UK overall.

Yet the Scottish government spends between 15 and 20 per cent more per head of population than the comparable English figure. It is not clear what Scotland gets for this, beyond correspondingly higher public sector employment. Health outcomes in Scotland are not better than in England and Scottish education has a historic reputation not matched by current performance.

An independent Scotland would clearly be economically viable. But whether Scotland, the remainder of the UK—or both—would be better off after separation is much less certain. In the short run, that would depend on transfers and subsidies to the Scottish government from the rest of the UK. In the long run, the issue is whether independence would promote economic dynamism in Scotland—or lead it to sink into the partisan petty corruption that for so long characterised Scottish politics. The details of the deal it struck to separate from the UK would, to a large extent, determine which path it took.

If you consider the course that an independent Scotland could take, the gain in sovereignty would be limited by the realities of globalisation. For a start, it would certainly seek EU membership, although meeting the requirements of accession would be a formality. Customs union—a consequence of joining the EU—then raises the issue of monetary union. The new state could join the eurozone (although that is no longer as attractive an option as it once was) or link its currency to the English pound. Such a link could be formal, whereby the Bank of England would retain monetary authority, perhaps with Scottish representation on the Monetary Policy Committee. If a more informal arrangement were desired, the Scottish pound could exchange one-for-one for the English pound. Ireland, which like Scotland has England as its principal trading partner, maintained this policy for 50 years after independence before choosing the euro.

Alternatively, the new state could issue its own currency, giving Scotland an independent monetary policy. But small countries operating within a larger free trade area find that exchange and interest rates are necessarily closely linked to those of their trade partners. Autonomy would be more apparent than real. A separate currency would also certainly be to the disadvantage of Scottish business.

Nor would Scotland enjoy great fiscal independence. Monetary union demands the co-ordination of fiscal policies, as Europe now understands. The sharing of existing UK government debt with Scotland would be a difficult issue for negotiation, as would the politically sensitive issue of accumulated public sector pension rights. An independent Scotland could not realistically expect to begin life with a debt-to-GDP ratio much below the large figure in prospect for the UK. So although an independent Scotland would have freedom to access global capital markets, its initial borrowing capacity would be modest.

At present, Scotland’s public spending is funded through a block grant from Westminster, calculated by the Barnett formula. This gives Scotland annual increases for health, education, and other functions devolved to the Scottish government, based on UK-wide spending plans.

Gordon Brown’s spending glut meant that, in the early years of devolution, the Holyrood parliament had more money than it could sensibly spend. Between 1999 and 2006 public spending in Scotland rose by more than 50 per cent in real terms. Most policy differences between Scotland and England today are populist measures which this largesse made possible, such as free university tuition, residential care for the elderly, the abolition of bridge tolls and reduced prescription charges.

Could an independent Scotland sustain its public spending through its own tax revenues? Like all European countries, it would rely on revenue from income tax, social security contributions and VAT. At the moment, Scotland controls none of these. The 1998 Scotland Act conferred power to vary the rate of income tax, but this so-called “tartan tax” was difficult to use and will be replaced in the 2011 Act. An independent Scottish government might consider raising the basic rate of income tax. But labour mobility within the UK presents an obstacle to any increase in higher rates of tax. People would just move south.

One of the most controversial questions is whether an independent Scotland could lay claim to the revenue from offshore oil. It would no doubt try, but the issue is not straightforward, nor is it clear that Scotland would be better off with oil, not subsidies.

When North Sea oil output came on stream in the 1970s, the slogan “It’s our oil” helped turn the SNP into a major political force. Standard principles of territorial allocation would give much of the North Sea and its tax revenues to Scotland. Yet the historic privileges of the monarch mean that offshore energy is largely a UK resource, and so the arcane issue of the nature of the Crown Estate has moved to the centre of Scottish political debate.

Although output is past its peak, oil production is still very profitable, and yields substantial tax revenues. Offshore wind is no substitute, even though Scotland is wet and windy; it is inherently unprofitable, and viable only through cross-subsidy from electricity consumers, mainly English ones. The generous subsidies negotiated with Westminster have partially defused the issue of revenue allocation. But the rise in oil prices keeps the question open. And the unwinding of these arrangements would be one of the most difficult hurdles in any negotiations with the rest of the UK.

On both politics and economics, the advocates for full independence have tended to overstate their case. But on one point, the SNP leader was wrong-footed where he need not have been. Salmond—a former Royal Bank of Scotland economist himself—had his arguments for independence punctured in 2008 by the failure of Scotland’s two largest businesses, RBS and HBOS, and by their subsequent rescue by the UK. That appeared to shatter his claim that Scotland’s businesses were strong enough to support a prosperous, independent nation. His critics argued that an independent Scotland could never have rescued the banks.

The liabilities of the two banks were 30 times Scotland’s GDP—far larger than the equivalent figure even for Iceland. It’s clear that a Scottish government could not have mounted a credible support operation. But that calculation also makes clear that it is preposterous to suggest the liabilities of a bank are liabilities of the population of the country where the head office of that bank is located. Nations should determine the size of banks, not banks the size of nations.

The right response from Salmond would have been to say that an independent Scottish government should have seized the groups’ commercial banking operations within Scotland, and left the rest to be supported by international efforts. If that international rescue failed to reach a deal, then the non-Scottish operations of the banks should have been put into administration. There are strong arguments that this would have been the right response for the UK, too, given the costs of the rescue.

As it happens, there is virtually no chance that a referendum would support independence. Opinion polls (see below) have shown recent support for this option at no more than 30 per cent. A referendum campaign, unless grievously mismanaged by the UK government and other political parties, is more likely to erode support for independence than to increase it, as the risks and complications of separation emerge.

The SNP is more popular than its defining policy. Salmond, an accomplished politician, has recognised this and has already chosen to interpret the election result as a mandate to make demands of Westminster on the three issues of borrowing capacity, corporation tax, and the Crown Estate. The next step is likely to involve adding a compromise option to the ballot paper: greater fiscal autonomy, short of independence.

That is the likely outcome; faced with three options, many people choose the middle one. It is also the desirable one. Scotland can get many of the advantages claimed for independence if it negotiates for more autonomy, while still staying part of the Union.