Wednesday, 10 September 2014

The economics of disintegration and why the Scottish should vote no

The world and Scotland fear what may happen if next week the Scottish people votes for Independence. Economic theory has a solid knowledge about economic integration and there are a few empirical studies measuring its costs and benefits (including my own here). Independence is the reversal of integration, so we may apply most of the theory to disintegration.

Apart from the immediate impact caused by changing existing relations and institutions, which may be enormous if independence is not a peaceful process, the long term advantages of separation must be proved in terms on how it will impact on the four basic freedoms – free movement of labour, capital, goods and services. To these one may add the pros and cons of financial transfers through a centralized budget and the use of a common currency.

Let me speculate on each one of them. For this I shall assume, optimistically, that the process will be peaceful and Scotland will remain in the European Union, which itself will not disintegrate if the independence movement extends to countries like Spain, Belgium, etc.

In terms of labour market Scotland is now fully integrated with the UK and workers move freely between Scotland and the rest of the UK. So nothing can be won by independence, but losses are foreseeable in terms of job opportunities.

Likewise, in relation to the free movement of goods and services, as long as Scotland remains within the EU, these will remain relatively free. Again, nothing can be gained through separation but the risk of non-tariff barriers will rise.

When it comes to the free movement of capital the answer is not straightforward, because it depends on what the separatists would decide in terms of their future currency. They promise to retain the British Pound but this may prove untenable. Using a foreign currency only works until the rulers of that currency (in this case the Bank of England) pursue a monetary policy that is good for the local economy, but this is uncertain. What is sure is that there will be a significant change in Scotland’s current account because of the North Sea revenues.

Indeed, the case for independence rests on little else than retaining such revenues in Scotland. However, there is no certainty on how long those reserves will last. And, more importantly, they would only reduce the current government deficit from 14 to 8%, or probably much less if one accounts for loss of revenue in the financial sector and increased sovereignty costs, let alone the local politicians’ eagerness for more spending.

This bet on becoming an oil-producing country is a very dangerous mirage. Not only because of the likely effects of the so-called “Dutch disease”, but also due to the rise of populism and anarchy in the fight for such revenues (Venezuela comes to mind when one thinks about it).

Traditionally, the Scottish are viewed as tight-fisted and prudent people. Let’s trust that these characteristics will lead them to prefer the certain to the uncertain and to avoid embarking on an independence adventure with so many risks for them and the rest of Europe.

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