By Jennifer Ryan
Imagine a country with the population of Colorado, the land mass of the Czech Republic, a finance industry that’s 10 times as big as the economy, and exports fueled by oil, alcohol and tourism.
That’s how Scotland will start out as an independent entity if separatists in the nation of 5.3 million people win their campaign to break away from the U.K. later this week.
Haggling over how to split assets, share debts and ensure banking stability could change all that. At the same time, companies including Royal Bank of Scotland Group Plc have said they’ll relocate their headquarters, potentially shrinking the corporate landscape.
With polls showing the vote in two days too close to call, economists, companies and politicians are taking seriously the prospect of a breakup of the 307-year-old union. Beyond that, there is disagreement over how the economy of the world’s newest nation will perform, with some forecasting extended fiscal austerity and higher prices and others saying a planned cut to company tax rates will help attract new industries.
“In the short term, living standards would take a hit and there’d be huge economic fallout from the uncertainty,” said Rob Wood, an economist at Berenberg Bank in London and a former Bank of England official. “In the long term there are plenty of countries in the world that are Scotland’s size that are wealthy and prosperous, but that depends on how good their elected officials are.”
Scotland’s economy is about 130 billion pounds ($211 billion), or 150 billion pounds based on a geographic share of North Sea activities. Based on the former figure, that’s about the same size as Qatar, and on the latter, Greece.
Among the key challenges for First Minister Alex Salmond will be financing the state. Striking out on its own, it will have to woo lenders without the benefit of centuries of a commitment to never defaulting on its debt, something the U.K. currently enjoys.
While officials on both sides of the border will argue over ownership of North Sea oil and gas, one thing Scotland can count on will be whiskey, with an annual export value of about 4.3 billion pounds. It also has tourism, with visitors spending about 4.6 billion pounds in the country last year.
In the first quarter of this year, the economy grew 1 percent. Services were the biggest contributor, led by business services and finance. Government, health and education are the largest part of the economy, followed by finance, insurance and real estate.
The final shape of an independent economy would depend on Salmond’s planned 18 months of negotiations to hammer out the logistics of separation, and a key issue will be the value of future revenue from the North Sea. The Institute for Fiscal Studies said that makes up almost 19 percent of total Scottish revenues, against 2 percent for the whole of the U.K.
Oil production has dropped about 40 percent in four years and income is volatile, with prices swinging 17 percent this year alone. That raises questions about the stability of a key source of income for the Scottish government.
“An independent Scotland can have more bespoke policies,” said Victoria Clarke, an economist at Investec Securities Ltd. in London. “But you have to weigh that up against what it might lose through the period of uncertainty and the costs of being a smaller nation with a less clear path of policy.”
Those custom policies include the ability to set corporate-tax rates to court companies and investment. Salmond has said he will strengthen the economy by giving companies “a competitive edge in taxation.”
Throughout the campaign in the buildup to the Sept. 18 referendum, the issue of the currency has proved among the most divisive. Salmond says Scotland can continue to use the pound, and the leaders of the three main political parties in Westminster say it can’t.
The ultimate outcome could affect the prices Scots pay in shops. If they choose a new currency and it devalues relative to the pound, that would raise the price of imported goods. The creation of a new border and set of transactions will also amount to a tax on businesses, according to Adam Posen, president of the Peterson Institute in Washington and a former BOE policy maker.
Among retailers warning of increases are John Lewis Partnership Inc., owner of Waitrose food shops, and clothing retailer Next Plc. Mobile phone provider O2 said bills could rise.
Against that, Andrew Harrison, chief executive of Whitbread Plc, the owner the Premier Inn hotel chain, said he doesn’t see any impact on the company regardless of the referendum result.
Offsetting any price increases may be the end of the air-passenger duty, something the Scottish National Party has promised to scrap. Officials would also have leeway to cut the price of a pint by lowering alcohol duty.
“It matters greatly whether they link to the pound,” said Brian Hilliard, an economist at Societe General in London. “The preferred outcome is a float, because that would give more flexibility on monetary and fiscal policy.”
Constraining a new government’s ability to act is the need to establish a credible track record.
An independent Scotland faces a fiscal gap of 1.9 percent under the IFS’s most optimistic scenario. This would require 8 percentage points of increases to the basic rate of income tax or 7 percentage points to the standard sales tax rate; alternatively, the Scottish government could reduce spending by 6 percent, or cut public services by 8 percent if spending on benefits didn’t fall.
Scotland could use North Sea oil and gas revenue to manage fluctuations in revenue and buffer public-sector finances in the short term, according to a panel advising the independence campaign that includes Nobel-prize winning economist Joseph Stiglitz. In the longer term the new nation would have a wealth fund similar to that of Norway.
“Independence may have its costs, although these have yet to be demonstrated convincingly; but it will also have its benefits,” Stiglitz said in an op-ed column published in the Glasgow-based Sunday Herald newspaper, which backs the “yes” campaign.
According to Posen, a smaller economy will be more vulnerable to global forces.
“Generally, there are some small economies that make it ok,” he said. “Once you leave a union where you are already integrated with a bigger economy, you’re in more trouble. You’re automatically subject to more ebbs and flows in the world economy.”
To contact the reporter on this story: Jennifer Ryan in London at [email protected]
To contact the editors responsible for this story: Emma Charlton at [email protected] Fergal O’Brien