Chapter 2: the economic realities of
Scottish independence |
The United Kingdom single market
17. The United Kingdom forms a single market
of over 60 million people. There are no borders, customs checks,
administrative or accounting procedures on the movement of labour,
goods or services. Currency, regulation and most taxation are
uniform. In short, economic activity within the United Kingdom
carries minimal transaction costs. This promotes price transparency
and competition and the efficient use of resources between Scotland,
England, Wales and Northern Ireland.
18. Access to markets was a main driver of the
Act of Union of 1707 which established the unitary Kingdom of
Great Britain. Excluded from England's trade with the colonies,
the Scots had tried in the late 1690s to set up their own entrepot
on the Darien isthmus, investing perhaps a quarter of the country's
liquid capital. After the disastrous failure of the Darien scheme,
the Act of Union brought economic security to Scotland and secured
England's defences. It led to economic integration of England
and Scotland and to greater prosperity in the later eighteenth
century as Glasgow tobacco barons, for example, grew rich on colonial
trade. The industrial revolution of the nineteenth century and
the service-based economy of more recent times have further consolidated
the UK single market.
19. After 300 years of union, Scotland's economy
and that of the rest of the UK remain closely integrated and the
UK market is more truly single than that of the EU. At present,
trade with the rest of the UK is worth over two-thirds of Scotland's
output (see Appendix 5). Rt Hon Alistair Darling MP reminded
us that 94% of Scottish insurance industry products were sold
to the rest of the UK and only 6% in Scotland.
Mr John Cridland, Director-General of the CBI, told us:
"The single market is a key UK asset and
the certainty and level playing field of rules on tax, law and
regulation adds to economic growth
we feel inevitably that
if there were two independent countries in this one island there
would be a fragmentation of the single market."
20. The United Kingdom single market has helped
the Scottish financial services sector to grow. Financial services
make up a similar proportion of the Scottish economy as the UK's.
But the Scottish economy is dwarfed by the balance sheets of Scottish
banks. The total assets of Royal Bank of Scotland (RBS) and Halifax
Bank of Scotland (HBOS) are over 15 times Scottish GDP and were
more than 20 times its GDP in 2008. Both figures are much higher
than for the UK and countries which buckled under the weight of
rescuing their banking sectors such as Iceland and Ireland.
The banking sector's size creates particular problems for an independent
Scotland which will be examined later in this report. Mr Darling
and Rt Hon Danny Alexander MP, Chief Secretary to the Treasury,
separately reminded us that UK government support for RBS had
amounted to a sum equivalent to 211% of Scotland's GDP.
21. The UK's single market brings economic
benefits to Scotland and the rest of the UK. If it fragmented
after Scottish independence, Scotland's smaller economy would
be disproportionately affected.
22. The trade policy of an independent Scotland
would crystallise after a "Yes" vote. If, after negotiation,
it became a member of the European Union, as the Scottish Government
intends, single market regulations would apply which would encourage
trade. Even if it did not, it must be assumed that it would continue
to adhere to the GATT, and the general consensus in favour of
free trade, though an autarkic alternative would of course be
available to a Scottish Government. A combination of the use of
the pound and membership of the EU would clearly make it more
likely that the present close trading relationship endures. Professor David
Bell of Stirling University said: "For the rest of the United
Kingdom, if Scotland stayed with the pound, there would be little
disruption of trade flows."
23. One key objective of an independent Scotland
would be to attract substantial investment from outside Scotland.
This is an area where Scotland has been successful under devolution.
Professor Gerald Holtham, Chairman of the Independent Commission
on Funding and Finance for Wales, thought this was in part because
"Scotland has a high degree of international recognition
in a way that Wales does not".
In his view, Scotland would still be attractive to
foreign investors after independence. Professor John Tomaney
of Newcastle University agreed. He thought that Scottish Enterprise
"gave certain kinds of economic development advantages that
were not available in the north of England". He added: "Many
of the things
terms of Scotland's ability to attract a higher proportion of
foreign direct investment are already there."
24. Many of the same considerations affecting
its trading prospects would also influence an independent Scotland's
continuing scope to attract investment. Success is again likely
to depend on the decisions the Scottish Government takes on some
of the issues raised in this report. Preservation of an effective
UK single market would be desirable; Professor Tomaney pointed
out that Scottish Enterprise had successfully offered investors
in Scotland access to the United Kingdom market. Important also
would be an independent Scotland's relationship with the EU (see
Chapter 5 below).
25. A single market is not simply a matter
of free trade and investment. Its cohesion can also be weakened
by divergences over currencies, regulation and taxation. The severity
of the threat to the UK single market would depend to a large
extent on the decisions of the Governments of an independent Scotland
and of the rest of the UK.
26. The Scottish Government at present intends
that sterling should be Scotland's currencythough it used
to favour the use of the Euro, as Professor Gavin McCrone
recalled. Professor Robert
Rowthorn of Cambridge University said: "Sterling is probably
the simplest currency because Scotland trades on such a large
scale with the UK."
Business strongly favours retention of sterling, as Mr Iain
McMillan, Director of CBI Scotland, made clear.
An independent Scotland's use of sterling would raise many questions
about monetary policy and financial regulation in the rest of
the UK as well as in Scotland; these are discussed in Chapter
3. Despite the Scottish Government's target of March 2016, independence
might not occur for some years after a "Yes" vote in
2014 because lengthy negotiations would follow between the Scottish
and the rest of the UK Governments, as witnesses including Professor John
Kay told us. During
this time, it is perfectly conceivable that the relative attractions
to a Scottish Government of the pound and those of the Euro could
shift in the latter's favour. Scotland might even decide to have
a currency of its own, neither Euro nor pound. Use of a currency
other than sterling would raise greater transitional risks. If
the pound was not the currency, a barrier to trade would immediately
arise, a risk foreseen by Mr Keith Cochrane, CEO of Weir
Group. The implications
of an independent Scotland's use of a currency other than sterling
are examined in Appendix 6.
Regulation & Taxation
27. Even with commitment to free trade and a
shared currency, the British single market could be eroded if
an independent Scotland's regulatory regime came to differ from
that of the rest of the UK. There might be (for example) different
regimes for health and safety, or different competition regulation,
or different rules for advertising. There already are divergent
plans for minimum alcohol prices. The prospect of more or different
Scottish regulation is unwelcome to Scottish-based business. Sir Philip
Hampton, Chairman of the Royal Bank of Scotland, said: "The
overriding preference would be for simplicity, because we already
have enormous complexity."
Mr David Nish, CEO of Standard Life, said: "What I benefit
from today is from having a single regulator in a geographical
area." Mr Rupert
Soames, CEO of Aggreko, pointed out in relation to pensions that
"we have a defined benefits scheme. Which side of the border
will that fall on? Who will be the pensions protection agency?"
28. Professor Bell noted that the Scottish
Government had not made use of its power under devolution to vary
the basic rate of income tax up to 3p.
But Professor McCrone thought: "Over time personal taxation
in [an independent] Scotland would be different from England,
just as it is in Ireland."
Mr Darling doubted if cutting corporation tax in Scotland
would be effective: "Suppose Scotland cut its corporation
tax and it worked. How long do you think it would be before the
rest of the UK thought, 'Well, it's working; [we] will cut our
Then you get the ridiculous situation of beggar
your neighbour, and the only people laughing are the multinationals
who pay corporation tax
I have always been sceptical about
whether cutting corporation tax would make a big difference. There
is no way that the other side will not retaliate."
Mr Cochrane expressed concern about the possible effects
on his business of different rates of corporation tax in Scotland
and the rest of the UK.
Ms Katie Schmuecker of IPPR North thought that the fear that business
would drain north in response to low Scottish corporation tax
was overplayed. But
Mr John Swinney MSP, the Scottish Government's Cabinet Secretary
for Finance, Employment and Sustainable Growth, said that the
Scottish Government "still take the view that business taxation
is an area where we can provide the opportunity to make Scotland
an attractive place for investment".
29. One of the arguments for independence is
that an independent state can make decisions on e.g. currency,
regulation and taxes which reflect the preferences of its people.
These decisions need not mean that trade would be greatly diminished.
The nature of a country's regulatory regime is one of the factors
that affect its costs of production and therefore its comparative
advantage in trade. Nevertheless regulatory differences can affect
trade relations. A post-independence Scottish Government and
its counterpart in the rest of the UK should try to preserve,
as far as possible, the single UK market, which brings economic
benefits to both.
30. As things stand, the economic structures
of Scotland and England are very similar.
Scotland's output per head of £20,200
and its fiscal deficit of 11% of GDP
are close to the UK's (see also Appendix 5). But there are already
differences, even under devolution. Public sector spending per
head is 11% higher in Scotland than the UK overall.
Professor Kay said: "The proportion who are employed
in public sector activities is about 2% higher in Scotland than
in the UK."
31. The "challenges to the medium-term fiscal
sustainability of Scotland as a single unit"
foreseen by the Chief Secretary to the Treasury would be heightened
by an independent Scottish Government's dependence on volatile
net tax revenues from North Sea oil and gas.
32. An independent Scotland would need quickly
to establish the legal and administrative framework to promote
its interests in the single British and EU markets and more widely.
This would require enhanced skills and capabilities in a range
of areas now the responsibility of the UK Government, including
revenue raising, payment of pensions and benefits, financial regulation,
treaty negotiation, defence policy and overseas representation.
33. Any reduction in intra-British trade and
investment following erosion of the single market would be felt
in the rest of the UK as well as in Scotland. Given the disparity
in size between the Scottish economy and the rest of the UK economy,
the effect on the rest of the UK as a whole would be much smaller
than that on Scotland.
Division of Assets and Liabilities
34. All sorts of bodies and departments would
need to be divided between the two countries including spending
departments, the armed forces and even the NHS. Assets to be divided
include natural resources such as North Sea oil and gas reserves.
Liabilities include the UK's public sector debt and other commitments
35. What principles would apply to the division?
Professor Rowthorn recalled that in the Anglo-Irish Treaty
of 1921 the newly formed Irish Free State "agreed to assume
responsibility for a proportionate part of the United Kingdom's
debt, as it stood on the date of signature".
Dr Karen Henderson of Leicester University told us that in
the 'velvet divorce' of Czechoslovakia into the Czech Republic
and Slovakia in 1993 the general principle was that property should
belong to the republic in which it was located, and that other
assets and debt were divided 2:1 in line with the size of the
two republics' populations.
The ICAEW argued for a simple approach.
36. Our witnesses agreed that shared physical
onshore assets should be apportioned by location, although military
installations (see Chapter 6) might need negotiation. Most also
agreed that financial assets and liabilities should be apportioned
on a per capita basis. As a starting point, the division of
UK physical assets should be on a geographical basis. Financial
assets and liabilities should be divided by share of population.
North Sea oil & gas
37. One of the traditional arguments for Scottish
independence is that an independent Scotland would benefit from
the bulk of the North Sea oil tax revenues instead of having to
share the benefits with the rest of the UK. Professor Rowthorn
estimates they would be about 5-10% of Scottish non-oil GDP.
Professor McCrone said that, on the expected geographical
division, about 90% of revenues would accrue to an independent
Scotland. This assumes
that Orkney and Shetland remained part of an independent Scotland;
if they did not, Scotland's reserves would be reduced by a third,
with concomitant effects on tax revenues.
38. These North Sea oil tax revenues are the
economic bridge over which Scotland would pass to independence.
Our witnesses expect them broadly to make up for loss of the Barnett
formula's effect on the Treasury's block grant to Scotlandwhich
allocates Scotland a share of UK public spendingon independence.
But revenue from the North Sea is not assured. Output, and therefore
tax revenue, is extremely dependent on the price of oil, which
is set in world markets. Quite small reductions in price can make
much of North Sea oil uneconomic to develop because of high costs.
Therefore the benefit to Scotland of keeping North Sea oil will
vary with the price.
39. What is the likely future oil price? Estimates
of future commodity prices are notoriously subject to large margins
of error. It follows that, whatever is the central prediction
as to the price of oil, there exists a substantial downside risk,
probably greater if forecasts that the US is to become a net energy
exporter are accurate. This matters less to a Scotland that is
part of the United Kingdom. If oil revenues fall short, they can
be replaced by taxes that fall on a largish country (or by spending
cuts), so the effect is diluted. In an independent Scotland however
oil revenues might amount to some 5-10% of non-oil GDP
and some 19% of tax revenues.
If oil revenues turned out lower than expected, and they could
be substantially lower, that would hit the economy of an independent
40. Another issue is how long the oil will last.
Forecasters generally expect a long term decline in North Sea
oil output. Professor Rowthorn said: "If you look over
the 25 or 30-year perspective, Scottish oil revenues will decline
almost whatever happens to the price of oil."
So the Scottish economy will have to cope with a decline similarly
in the benefits to the country and its exchequer that North Sea
41. There is also the question of decommissioning
costs. These are substantialProfessor Alex Kemp estimates
them at some £30 billion over 30 years, of which more than
50% would fall on governments in the form of net tax reductions
to the companies.
The SNP has argued that, since the tax revenues from past oil
revenues accrued to the UK as a whole, decommissioning costs too
should fall on the UK as a whole. North Sea oil decommissioning
costs will be very substantial. The oil companies will want to
offset them against future tax due, which would reduce an independent
Scottish Government's revenues. How these matters are resolved
will have an important bearing on the value to Scotland's economy
42. To make best use of North Sea oil at any
level of price or output, an independent Scotland would need to
take over oil industry regulation from the UK Government. Professor Kemp
drew attention to the complexities, which would need to be carefully
managed, especially during a transition, including licensing,
taxation, capital allowances and decommissioning.
Asked to forecast net tax revenues from oil production in
the Scottish sector of the North Sea, Professor Kemp told
us: "I can make a guesstimate that for the Scottish sector
it could range annually between £5 billion and £10 billion
per year for the next decade."
43. It remains the case that the Scottish
economy would be likely to gain from North Sea Oil revenues. The
scale of that gain is much more uncertain as is how long it will
last. So is its value to the underlying health of the rest of
the Scottish economy, especially given the very real possibility
of volatility in output and revenues. Oil alone will not ensure
that an independent Scotland is a prosperous Scotland.
44. As things stand, payments from the British
exchequer fund much of the Scottish Government's spending. As
with Wales and Northern Ireland, they are made through a block
grant, itself funded by general UK taxation to which Scotland
makes its contribution. Application of the Barnett formula is
however generally recognised as raising the exchequer's block
grant to Scotland. Block grant payments would cease on independence.
All an independent Scotland's revenue would have to be levied
within Scotland. Witnesses thought that oil revenues would broadly
make up the loss of the benefit to Scotland of the Barnett formula's
effect on the block grant. Professor Kay said:
"The best way of defining the status quo
has been to say that in return for a relatively generous public
expenditure settlement, the issue of what the right division of
the oil revenues should be is allowed, if not to go away, at any
rate to rest on the back burner
it is rather a good deal
for Scotland at least in a sense that oil revenues are by their
nature rather unstable, whereas the flow of expenditure to Scotland
that has come from it [Barnett] is relatively secure. While there
is a lot of discussion in Scotland about whether Scotland would
be better off in public expenditure terms or not, it is probably
not a big issue either way."
After a "Yes" vote in the referendum,
the Scottish Government would need to make timely arrangements
to levy its own taxes on independence. Even if an independent
Scotland's oil revenues broadly made up for the loss of the Barnett
formula's effect on the block grant,
they would be a less predictable source of revenue than transfers
from the British Treasury.
45. Aside from oil, Barnett payments and defence
(see Chapter 6) many UK functions and institutions would have
to be divided on Scottish independence, ranging from tax collection
to air traffic control to fisheries protection. Ms Johann Lamont
MSP, leader of the Scottish Labour Party, recalled the UN International
Law Commission's view that movable state property as well as state
debt should pass to the successor states in an equitable proportion.
The Institute of Chartered Accountants in England and Wales (ICAEW)
favoured a simple approach but recognised that in practice allocations
could be highly complex with different rules applying to different
assets and liabilities.
Negotiations on division of assets are likely to be intricate
and lengthy, leading to uncertainty until successor systems and
institutions prove themselves in Scotland and the rest of the
46. According to the Office of Budget Responsibility
(OBR) the UK's Public Sector Net Debt (PSND) was £1,104bn
in the financial year ending in March 2012.
Assuming that this debt is shared between an independent Scotland
and the rest of the UK on the basis of size of population, Scotland
would be allocated 8.4% or £93bn. If North Sea oil is allocated
on a geographical basis (see paragraph 37), the ratio of Scottish
debt to GDP would be around 62%. This measure does not include
what would become Scotland's share of known future UK liabilities,
such as payment of public sector pensions in Scotland. Added
together, an independent Scotland's share of the UK's public sector
debt and its share of the UK's known future liabilities, based
on relative size of population, would be around 123% of GDP.
These figures are set out more fully in paragraphs 86-89 below.
A newly-independent Scotland would have no track record with international
lenders. Sir Nicholas Macpherson, Permanent Secretary of
the UK Treasury, said:
"Even countries that are pursuing incredibly
tight fiscal policies, such as the Netherlands and Finland,
pay a premium on their debt compared to Germany. So even on day
one, if Scotland was pursuing a surplus, there would probably
be some sort of premium."
An independent Scotland would need to service
its own sovereign debt and to manage its spending, borrowing and
taxation in such a way as to win and retain the confidence of
global lenders that its debt burden is manageable.
47. After agreement was reached on how much public
sector debt would be assumed by an independent Scotland, there
would be the important issue of how to transfer this debt to an
independent Scotland. This is not a straight forward matter. It
would take a newly established independent Scotland some time
to establish a successful credit history (see Chapter 4). This
is an important matter for Scotland and the rest of the UK. It
is for the Scottish Government to explain to voters well ahead
of the referendum how it intends to take over its share of the
UK's public sector debt.
48. An independent Scottish Government would
have to manage its own budget. Estimates show that in 2011-12
a separate Scotland with geographical share of North Sea oil revenues
would have had a budget deficit of 5.0% of GDP, comparing well
with a UK deficit of 7.9% of GDP.
The prospective budget deficit of an independent Scotland is harder
to estimate since it is not clear whether Scotland would raise
enough tax revenues to compensate for loss of the block grant.
Moreover, the UK has (still) a strong credit rating based on a
very long record of international borrowing. International markets
might exact higher interest payments from an untried Scotland
much more dependent for income on volatile oil revenues. This
issue is explored further in Chapter 4.
49. Ultimately the prosperity of an independent
Scotland will depend on the productivity of its businesses and
workers. That in turn will largely depend not just on how much
firms invest, but on the skills of their managers and workers,
and entrepreneurship. Such factors are hard to predict let alone
quantify, but they will in the end determine if an independent
Scotland is a success economically.
50. So far as management skills are concerned,
Scottish managers have established some powerful reputationsnot
least in countries other than their home country. The Scottish
financial services industry boom depended on the reputation for
probity and canniness, though this has been somewhat eroded by
the subsequent bust. Scotland has produced not only great managers
but the great professionalslawyers, accountants, actuariesthat
great managers need to succeed.
51. So far as entrepreneurship is concerned,
Scotland's position is less strong. There are of course some Scottish
firms which have grown to be acknowledged successes. But Scotland
needs to do better at incubating new businesses. As Mr Ian
McKay of the Scottish Institute of Directors pointed out: "Scotland
continues to have a very poor record of business start-ups."
Data from the Office of National Statistics show that the share
of innovative businesses and the amount of expenditure on research
and development relative to output in Scotland is lower than the
52. Few of our witnesses believed that independence
would set loose a new spirit of entrepreneurship north of the
border, one enthused by the historic destiny of this small nation
to strive and to succeed. Others, particularly the economists
who gave evidence to us, are less convinced. Professor Kay
"Perhaps the largest issue in the whole
debate, is whether we think that an independent Scotland would
to some degree help release entrepreneurial energy in Scotland,
or whether the policies of a Scottish Government would depress
them. I can see arguments on both sides."
Professor McCrone did not believe independence
would generate a wave of entrepreneurship.
53. There can be no definitive answer to the
question of whether an independent Scotland would be more prosperous,
less prosperous or as prosperous as Scotland is now. Our report
identifies clear threats to Scotland's prosperity under independence;
while the upside is uncertain.
12 Q 571 Back
Q 279 Back
Scottish Parliament Information Centre, Banking inquiry: additional
material supplied in response to Members Enquiries, (Edinburgh:
SPICe, February 2009), p. 6 Back
Q 570 Back
Q 514 Back
Q 22 Back
Q 340 Back
Q 267 Back
Q 143 Back
Q 206 Back
Q 651 Back
Q 85 Back
Q 680 Back
Q 762 Back
Q 613 Back
Q 815 Back
Q 27 Back
Q 156 Back
Q 577 Back
Q 684 Back
Q 271 Back
Q 898 Back
Q 100 Back
Q 244. Output per head measured by Gross Value Added (GVA) per
Q 14 Back
Government Expenditure and Revenue Scotland 2011-12, Table 5.6. Back
Q 101 Back
Q 503 Back
Professor Robert Rowthorn. Article 5 of the Anglo-Irish Treaty
states: "The Irish Free State shall assume liability for
the service of the Public Debt of the United Kingdom as existing
as the date hereof and towards the payment of War Pensions as
existing at that date in such proportion as may be fair and equitable,
having regard to any just claim on the part of Ireland by way
of set-off or counter claim, the amount of such sums being determined
in default of agreement by the arbitration of one or more independent
persons being citizens of the British Empire." Back
Q 487 Back
ICAEW paragraph 12 Back
Q 195 Back
Q 118 Back
Professor Robert Rowthorn's written evidence discusses the
oil and gas reserves of Orkney and Shetland Back
Q 195 Back
Government Expenditure and Revenue Scotland 2011-12, March 2013,
Table 4.6 Back
Q 215 Back
Q 560 Back
Q 550/Q 553/Q 560 Back
Q 553 Back
Q 61 Back
Barnett Formula Select Committee, 1st Report (2008-09): The
Barnett Formula (HL Paper 139) Back
Johann Lamont MSP paragraph 37 Back
ICAEW paragraph 12 Back
Office for Budget Responsibility (March 2013), Economic and
Fiscal Outlook, Table 1.4 Back
Q 512 Back
Government Expenditure and Revenue Scotland 2011-12, Table E.4
Q 648 Back
ONS Regional Economic Indicators 2013 Back
Q 100 Back
Q 169 Back