The vote on Scottish independence is less than a month away and there’s a lot at stake. ‘Yes’ voters are hailing it as a once-in-a-lifetime opportunity to establish a proud, progressive and independent Scotland, free from the financial and political shackles of Westminster. Those voting to stay in the union, on the other hand, argue that an independent Scotland will be a poorer Scotland, both economically and culturally. The undecided, who make up around 11-12% of those registered to vote (according to a survey by The Scotsman) are providing answers to questions surrounding changes to Scotland’s economy and currency that are proving too vague. It’s a truism that, when it comes to elections, most people vote with their wallets. So which side is right? How would independence affect interest rates and the overall Scottish economy?
Economic pundits from both sides of the border point to several factors that make it hard to determine Scotland’s economic future with any certainty. One is North Sea oil and gas reserves, which will almost certainly form a major part of the Scottish economy for decades to come. However, it’s very difficult to predict how quickly reserves will deplete, how extractive technology will improve and how all this will affect the price of energy in future.
Other economic matters - out of the hands of Scottish voters but intimately linked to their fortunes – would be determined as much by Westminster as Stormont. These include how much of the UK’s national debt Scotland would take on, and the interest rate it would pay on this and other debts. Westminster would also have a major say in what Scotland’s share of UK assets would be, including hydrocarbon reserves and gold held by the Bank of England. Scotland’s currency and monetary arrangements would also be determined only after lengthy negotiation.
While such uncertainties will give voters on both sides cause for concern, most economists believe that an independent Scotland is unlikely to sink into financial ruin any time soon. In all likelihood, Scotland may be slightly poorer in the years following independence but not significantly so. One factor for this mild economic decline – according to the Institute for Fiscal Studies – is that the gap between what Scotland spends and what it receives in taxes will be bigger than in the UK overall. This gap is likely to be between 1.3-3%, depending on how much North Sea oil taxes contribute to Scottish coffers.
Scotland’s future currency and the interest rate it would pay on borrowing are also significant factors. Whether an independent Scotland kept the pound, adopted the euro or created a brand new currency, it would likely pay a slightly higher rate of interest on any debts than Westminster. This is because the Scottish economy would be relatively small, without a central bank for printing money and with no track record as a borrower.
Supporters of maintaining the union argue that the UK’s combined economic might – together with the strength and credibility of the Bank of England – keeps interest rates lower on mortgage payments and business loans. Scottish Labour leader Johann Lamont this month warned that the average homeowner north of the border could face £1,600 a year more in mortgage repayments under First Minister Alex Salmond’s plans for independence.
However, while a Scottish government would likely pay a slightly higher rate of interest on its debts, most believe that any increase is unlikely to be destabilising. For example, Pimco - the world’s biggest investor in government bonds - estimates that Scotland would pay 0.5-1% more than at present, shrinking its economy by a similar amount. This would make a difference but not as big as the doomsayers are forecasting.
One widespread prediction is that a new Scottish Government would issue gilts with higher interest rates to reflect a slightly higher level of risk. The NIESR, for example, predicts that 10-year bond yields would be 0.75-1.65% higher than UK bonds. Without political union, the spread would be even higher. The prospect of higher returns could attract some investors but they would need to weigh up the additional risks, such as putting their savings into a weaker currency. Those approaching retirement might also look to Scotland for a better annuity income but they would need to consider any losses incurred when converting their pension back into sterling.
While unionists point to the risks of Scotland going it alone, those in the independent camp claim that Scotland will be harmed by staying put. For example, the Scottish government is currently struggling with the effects of house price appreciation, in part because its currency is tied to UK interest rates. With a high growth rate and low interest rates, inflationary differentials are increasing between Scotland and the UK. With broad money supply growing rapidly, many worry about the effect on Scotland’s financial institutions.
An independent Scotland, it is argued, would avoid such inflationary pressures by being able to regulate financial institutions and markets to better suit its own interests. ‘Yes’ voters also promise that an independent Scottish regulator would take stronger action on issues of concern to Scottish voters, including caps on interest for short-term and pay-day loans. However, Scotland would still need to coordinate with relevant UK bodies, especially with regard to cross-border markets.
Perhaps the deciding factor for voters will be less about macroeconomics and more about local pride. Would independence spur Scotland’s entrepreneurs and small businesses to rise to the challenge of a new economic reality? Would more wealth be created by those determined to see a newly independent nation rise in prosperity? Would a smaller and more nimble business sector be able to maneuver more effectively in response to international financial markets, while coordinating efforts with greater focus at home?
Even if Scottish voters opt for independence on September 18th, the answer to these questions may not be known for years to come. However, should Scotland choose to remain in the UK, the ‘what ifs’ will sound immediately.