What would happen to Scotland's economy after independence?

By Douglas Fraser
BBC Scotland Business and Economy Editor

image captionThe big question is whether the Scottish people would be better off or not outside the UK

Timing... the question... legality. Let's cut to the chase about Scottish independence. What would it mean for the economy?

The answer matters, of course. One recent poll suggested that support for or against is decisively swayed if people think they would be better or worse off by £500 per year.

But which would it be? Better or worse off? No-one's tried this before, either breaking up a political and currency union after three centuries, or splitting a member of the European Union.

We can at least consider some of the questions of independence for the economy of Scotland - and for the rest of the UK.

Historically, Scotland's growth has been lower than the rest of the UK.

From the mid-2000s, it averaged about the UK level, helped by growth in the finance sector.

That doesn't only mean the discredited boom for Royal Bank of Scotland and Halifax Bank of Scotland.

Through the downturn, Scotland's growth has been close to the average position of the UK.

The Scottish economy contracted slightly less, and the recession itself was a bit shorter, and while it appears to be suffering a weaker recovery, it's at least as significant how closely it tracks the UK position.

Convergence with the UK is also a feature of the employment levels and of unemployment.

It's ironic, at a time when Scotland is debating a break from Westminster rule, that it's probably never looked so similar to the UK average.

Smaller nations

Part of the nationalist case for independence is that the Scottish economy has been held back by policy made to suit the south-east of England, and the City of London's financial sector in particular.

Before the credit crunch, First Minister Alex Salmond put the argument at the heart of his campaigning that small nations were more agile and grew faster, citing the "arc of prosperity" around Scotland; Ireland, Iceland and Norway.

For reasons visible from Cork to Keflavik, he's not saying that now, except about oil-rich Norway.

The case can still be made that small Scandinavian nations can enjoy sustained, strong economic growth and prosperity, alongside generous state provision.

But how similar is Scotland to its Nordic neighbours, and how high would taxes have to rise?

The transition to a Scandic-style economy is not a simple process.

Could Scotland afford to go it alone?

The answer is simple - of course it can.

But at what cost to its public finances?

In other words, what might have to change?

Almost every aspect of this debate is contested.

The Treasury's figures are cited as showing higher spending per head, though it's reckoned that gap has been narrowing. BBC Economics Editor Stephanie Flanders took a look at that earlier.

The debate often portrays Scotland as requiring a "subsidy".

But as Stephanie Flanders pointed out, the Treasury's regular requirement of funding from the bond markets is no different, and it's that familiar feature of Britain's public finances - a deficit.

The most recent figures, using Treasury and Scottish government data, show the deficit on Scottish spending over expenditure is a smaller share of gross domestic product than that of the UK as a whole.

According to Glasgow University economists projecting Treasury figures, it's on course to stay that way until 2015-16.

That requires a large share of oil and gas revenue.

Without oil and gas, the Scottish deficit looks very large.

But an independent Scotland could expect to have more than 80% of the UK's oil and gas revenue, subject to negotiation with the Treasury.

With that, the public spending deficit looks more manageable.

But it's often a deficit, nonetheless.

The volatile price of oil means volatile income. The trend is clearly for the volume of oil and gas production to fall, though that is partly offset by higher average prices, higher tax rates, and so buoyant revenues.

So Scotland's public finances could break even some years, but there's little sign of large oil revenue surpluses to pay off debt and build up a national trust fund.

That's what the Norwegians have successfully done with their offshore oil revenue.

Debt and liabilities

Scotland would be expected to take on a share of the UK's national debt. Just how big a share is one of many negotiations that could be expected between administrations in Edinburgh and London.

Alex Salmond said this week it should be based on either share of UK GDP or share of population.

These proportions are not far apart, so with the way public sector net borrowing looks now, the Scottish portion of it would be around £80bn, and continuing to head north.

Scotland would have to service that debt by issuing bonds.

It would have its own credit rating, and with no credit history and political leaders who want to turn on the spending taps to get out of recession, the bond markets may not be impressed.

And what about its bank exposure?

Opponents of independence ask what might have happened if Scotland had faced the meltdown in 2008 of Royal Bank of Scotland and Halifax Bank of Scotland all on its own.

Pumping in more than £70bn in capital and hundreds of billions in guarantees looks impossible for a small country.

Other small countries faced bank crises and they're handling them in different ways.

But it doesn't seem that Ireland or Iceland have been destroyed by the scale of their financial implosion.

It's reasonable to assume that an independent Scotland would have sought to work alongside the rest of the UK to resolve the bank crisis.

It would clearly have been in Whitehall's interests to co-operate, as both economies would have suffered badly from those banks being allowed to go bust.

Europe and trade

The shape of the Scottish economy depends heavily on its future trading relationship.

The country starts within the European Union, and the continent would remain a major trading partner.

There's no precedent for a European member state splitting and creating two new members.

Or would it be one new member and a continuing one?

Would Scotland stay within the EU, and if so, what conditions would other members impose?

There's a lively debate about how that would work.

In short, nobody knows.

Some argue Scotland would retain the UK's opt-out from being required to join the euro currency. Others say it's an automatic requirement for new applicants.

The SNP proposes sticking with sterling until Scots choose, by referendum, to join the euro.

And for obvious reasons in the eurozone, Mr Salmon not rushing into that just yet.

His problem, in explaining this policy, is that remaining with sterling leaves the Treasury and Bank of England in London to set Scotland's monetary policy, while having no influence over it.

Some have questioned whether the Treasury would allow Scotland to use the pound.

What they fail to explain is how the Treasury could stop it.

Border and exchange controls all around England, Wales and Northern Ireland?

That might explain why no-one is threatening it.

However, joining the euro gives an independent government at Holyrood only limited influence in Frankfurt, where decisions are made for a much larger currency zone.

In or out of the EU, it seems unlikely Scotland would lose its access to markets.

Its most important foreign market, by far, would be the rest of the UK.

How well that relationship works politically depends on how the negotiations go.

But within the EU, neither side would be allowed to put blocks on trade.

There would, however, be costs for business. Separate taxation regimes would require separate accounting for those companies operating on both sides of the Cheviots.

And one of the immediate concerns, at least for some businesses, is the cost of political risk while Scotland's constitutional future remains unclear.

Critics of the Scottish government warn that will put off investment, if indeed it's not doing so already. But that argument lacks evidence.

Those sceptical about independence are keeping their heads down, at least until it becomes a more realistic prospect.

And Scottish ministers respond to this warning from UK ministers with a list of diverse, prestige investments in recent months by major international companies.

Which sectors

Unless there are dramatic changes in taxation and currency, some parts of the Scottish economy might see little difference, such as retail, manufacturing, tourism, or the oil and gas sector.

Many companies already operate across many borders, and it would make little difference to deal with another, new country.

But there would surely be a bigger impact for firms in those sectors that look to regulators to shape their markets, such as the finance sector, energy suppliers and rail.

Scotland's corporate sector happens to be very big in those areas.

Finance would continue to be significant, not only because RBS and Lloyds are major players in the Scottish market and as employers, but because there are many other financial companies located in Scotland, to take advantage of the country's financial skills.

It would be open to an independent Scotland and the rest of the UK to agree on sharing regulatory regimes, if only to retain the attractiveness of cross-border trading, and to provide a subsidy mechanism for Scotland's potential in renewable energy.

And what would an independent Scotland do for a historically poor business birth rate?

Bold claims are made for the dynamic effect of unleashing national self-confidence, but they'll never be proven unless it's tried.

Another pillar of the Scottish economy is its education, with universities drivers of innovation and dealers of a strong suit in high level skills.

As with so much of this debate, the future of that sector under independence depends on the decisions made by future Scottish governments. Even if tuition remains free to students, what would be the implications for quality and standards over the long run?

And what about the disproportionately large share of UK research council grants that are won by Scottish academics?

There's another funding gap.

Known unknowns

So the conclusion is, perhaps disappointingly: We don't know how the economy might fare in an independent Scotland.

It depends on the decisions of future governments at Holyrood, particularly as they balance the tension between lower-tax, low regulation, business-friendly policies and, on the other hand, for a strong social contract with state provision universal.

If political rhetoric and voting patterns are any guide, Scots prefer the latter.

A high priority would surely be avoidance of too much dislocation.

This is not a proposed break from the UK on a radical prospectus. The horses are not to be frightened.

It also depends on decisions made by businesses; whether they continue to value skill levels in Scotland as a place to invest, whether indigenous companies find the vision and finance to grow, and what can be done about a long-running problem with branch-line offices answering to distant headquarters.

And what about the rest of the UK?

One thing it can assume is that it'll have far less oil and gas revenue.

That hurts public finances, and the sense of energy security, but it would be odd if an independent Scotland withheld its North Sea riches from English markets.

At a guess, English-based companies would probably have to treat Scotland in the same way they treat Ireland - as a smaller economy but one worth selling into, and providing the rest of the UK economy with migrant, skilled labour.

Ireland, after all, does more trade with the UK than all the Brics (Brazil, Russia, India And China) combined.

And if Scotland keeps sterling, that trade would be simpler still.

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