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Scottish Independence: Brexit and the Changing Economic Backdrop

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Had the Nationalists won the Scottish indepence debate the country would be declaring independence around about now. Economically, what has changed and how will it influence the debate going forward?

  • In the event of a Brexit, Scottish nationalists would probably be justified in calling for a new referendum. 
  • "Independent Scotland could become a large monetary liability for the rUK" - Capital Economics
  • Scotland's budget deficit in the tax year ending March 2016 will be equivalent to nearly 10 percent of economic output say the IFS

One of the interesting by-products of the UK referendum on membership of the EU is how it could offer Scotland a second chance at its own referendum on independence.

If the UK left the EU Scotland could claim she had grounds to for a 'second chance' at independence, because the UK leaving the EU would constitute a “material change in circumstances”, which according to the referendum agreement allows the Scots another vote. 

Nicola Sturgeon, the first minister of Scotland, has said she will invoke "the Scottish people’s right" to another referendum in the eventuality that the UK voted to leave the EU, as it would be "fundamentally undemocratic to drag the Scottish people out of the EU against their will".

Nevertheless, according to her plan, two further conditions would also have to be met for her to demand another referendum.

The first would be that the majority of Scots would need to want to stay within the EU, and the second would be that the majority of Scots would want to leave the UK.

Apart from the above there is one final critical condition for Scotland to demand a referendum, which is agreement from the British Government.

Clearly if there was extraordinary demand - for example if a high percentage of the Scottish population wished to meld with the EU, or a majority wished to break away, this would probably be sufficient.

However its worth pointing out that sufficient pressure would be required to facilitate reconsideration of a referendum on independence.

The most recent polls show that the majority of Scots do actually wish to stay in the EU (55%), however, the same is not true of the second condition as only 45-49% want independence from the UK.

The Pound or the Euro?

In the run up to the last Scottish referendum Scots showed a marked preference for continuing with the pound rather than adopting the euro.

Assuming the same is true of a future referendum then continuing with the pound would require the cooperation of the Bank of England (BOE).

However, it is unlikely the BOE would agree to such an arrangement without some oversight over Scotland’s fiscal policy which would to a greater extent render redundant the whole purpose of being independent in the first place.

In a paper written on the subject of Scotland leaving the UK, Capital Economics assess the feasibility and the economic pros and cons of a Scotxit both for Scotland and the rest of the UK (abbrev rUK).

According to Capital Economics an arrangement would also make the BOE lender of last resort and guarantor for Scotland’s financial sector, essentially burdening the UK with Scotland’s financial liabilities: 

“In addition, Scotland could become a large monetary liability for the rUK. Big financial sector shocks in Scotland would inevitably have negative effects on activity in the rUK, thanks to the close economic and financial links between the two areas. So even if Scotland only informally adopted sterling as its currency, the Bank of England would probably still have to act as a de facto lender of last resort to Scottish financial institutions,” says Vicky Redwood at Capital Economics.

North Sea Oil no Longer the Nationalist's 'Magic Bullet'

Oil matters for the Scottish independence debate; when prices are high Scots are the richest per capita in the UK.

Government spending per person in Scotland is notably higher than it is in the rest of the UK ensuring an independent Scotland would need a strong income stream to maintain expenditure and oil has long been the magic bullet required to justify this spending.

The recent fall in oil prices has blown a massive hole in the Scottish budget with the deficit racing higher to almost £15 billion pounds in the last financial year.

The Institute for Fiscal Studies has said Scotland's budget deficit in the tax year ending March 2016 will be equivalent to nearly 10 percent of economic output - more than double that in the full United Kingdom - due to lower oil prices, tax breaks for oil producers and higher public spending.

The outlook on the oil front is not good.

“Oil prices might rebound. But even if they do, the sector is in decline. North Sea oil production fell at an annual rate of 7.8% between 2000 and 2015, and the Department for Energy projects that it will fall at an average annual rate of 5% over the next 15 years, reaching half its current level by 2028,” says Redwood.

The decline in North Sea oil means that Scotland now consumes more than it pays back to the exchequer through tax receipts:

“Although Scotland consumes a disproportionate share of public spending, for most of the last few years, this has been offset by the fact that its large North Sea sector means that it also generates a relatively large share of tax receipts.

“But Scottish Government figures released earlier this month showed that this picture has changed – even before the full impact of the fall in oil prices has taken effect.

"Scotland generated lower tax revenues per head than in the rest of the UK in 2014/15 for the first time in 35 years.”

Capital Economics also point out that if it left the UK Scotland would have to bear the high costs of decommissioning the increasing number of redundant oil rigs, and expense which is expected to eclipse the revenue brought from the still-active rigs:

“What’s more, at the same time, taxpayer support to cover decommissioning costs will be rising. While the direct cost of decommissioning oil and gas platforms that have come to the end of their life will be funded by the companies operating in the North Sea, these costs are tax deductible against the profits of the companies concerned.

"Decommissioning costs over the next few decades are estimated to total at least £40bn. In fact, the OBR now estimates that tax relief costs will exceed the tax-take from the oil sector.”

Would it benefit Scotland to remain in the EU?

One of the major benefits of Scotland remaining in the EU if the UK left would be that it might attract businesses from the UK to relocate north of the border in order to continue to reap the benefits of being inside the EU.

A further benefit might be that it could attract foreign businesses to base themselves in Scotland if they were seeking access to the UK market as well as the EU market.

This might help Edinburgh in particularly as it is already an established financial centre and if there is a Brexit it is financial institutions in London which have the most to lose as they might then lose their ‘EU passport’ – a special EU benefit which allows financial institutions based in the EU to do business across member’s borders without the need for any extra licences or agreements.

If the UK could not negotiate a new ‘passport’ for its financial services following a Brexit they might be tempted to move to base themselves in an EU country - Scotland in the EU could be a potential target location for such companies.

Capital Economics, however, also point out that Scotland would probably not gain many EU benefits or subsidies and it would have to pay its full share of membership unlike the UK with negotiated a rebate.

There might also be a problem with the actual mechanics of joining assuming the UK would have left by the time Scotland wanted to join.

During the Scottish independence campaign the wrangling over Article 48 and 49 of the Lisbon treaty reached epic proportions.

The intricacies of the argument are well covered here. The takeway though is that the process for Scotland joining the EU will be a long one, by which time Dublin will most likely have netted any business up for grabs. 

Scotland Stronger In or Out?

Scottish independence would almost be an economic positive for the rest of the UK as Scotland now consumes more than it gives back in tax receipts, thus it is a net burden on the rest of the UK.

Independence would also relieve the UK of the problem of North Sea Oil which is a dying industry, and may cost billions to decommission.

The UK might, however, lose unimpeded access to a large market for its goods (3.7% of trade exports from England go north).

Scotland would find it difficult to cope economically on its own, particularly now North Sea Oil is not making as much revenue as before.

Even if oil prices rebound North Sea Oil’s days are numbered.

Moving to a new currency or the euro would hurt Scotland financially, and would increase the cost of borrowing.

The economic argument makes it difficult to expect the majority of Scottish people to wish to gain independence – given the last time round the economic arguments were more balanced, and this time there is a definite financial advantage to remaining in the UK.