Scottish independence: The cost of breaking the union

MoneyWeek cover illustrationCould an independent Scotland become the next Singapore, or would a ‘Yes’ vote be an act of national self-harm? Merryn Somerset Webb investigates.

In the late 1690s, Scotland’s government granted a charter to the Company of Scotland to set sail and attempt to establish a colony on the coast of Panama.

The interesting thing about this adventure is not so much its miserable end (most people died and only one ship returned to Scotland)*, but the way in which Scots of all sorts took part in it.

The Oxford Dictionary of National Biography puts it like this: “While Williamites and Jacobites remained implacably opposed over the monarchy, they came to be united in a belief that the Company of Scotland offered the prospect of national and personal prosperity. The original joint-stock company of 1695 was now the vehicle for the Scottish colony of New Caledonia, supported by a remarkably diverse group of Scots who had set aside their many and varied differences in pursuit of national glory and personal wealth.”

They didn’t get either, of course. The wealth was lost and the union (which allowed participants to recoup their losses via a payment from England to Scotland known as ‘the equivalence’) was found.

But the idea of pulling together in the name of national glory and personal wealth is finding its parallel in the variety of people prepared to vote for Scotland to separate from the rest of the UK (rUK) in the referendum on 18 September.

There are wealthy people voting ‘yes’ because they genuinely believe that post-independence Scotland would find itself in such a tricky financial situation that it would be forced to roll back the welfare state and become the Singapore of Europe – a low-spending but very wealthy small state.

Others – of a libertarian bent – think the removal of one layer of government (Westminster) is in itself a good thing, regardless of the centralising tendencies of its replacement. There are those who think that Scotland is less rich than it could be, because it is held back by being part of the union.

Then there are those who are convinced that the Scottish are different to those living in the rest of the UK – that the Scots have a keener sense of social justice and of the evils of inequality, and so will vote in governments that bring about real change.

They see a future in a more socialist state, where a drive to redistribute wealth somehow creates it, and where ‘fairness’ (definitions of what is fair can, I find, vary) reigns above all.

Among this group are those who are determined that Scotland should “have the government it votes for” and who feel this isn’t possible under the current arrangements. Finally, there are those who just feel a strong sense of nation and want Scotland to be independent regardless of the social or economic arguments.

MoneyWeek’s editor John Stepek (a born Scot) and I (a Scottish resident with a vote) have both made our own positions clear on this over the last few months. We are both firmly pro-union.

We aren’t remotely convinced by the Singapore argument – no one has ever yet really rolled back a welfare state and it seems highly unlikely that Scotland (where not far off 50% of GDP comes from state spending) would be the first. You could turn Singapore into Scotland over a few decades if you put your mind to it. But not Scotland into Singapore.

It is worth noting that so far the Scottish government has shown itself to be rather more into interfering than letting be (look up ‘named persons for children in Scotland’ on Google if you’d like to shock yourself in that respect).

We are utterly unconvinced on the values argument. This has gone oddly unchallenged, but Scotland’s sense of social justice is all but identical to that of the rest of the UK – as John McDermott noted in the FT this week, the Scottish Social Attitudes survey shows that “Scots have broadly similar views towards social security benefits, the unemployed, immigrants and tuition fees”. Any differences, says Professor Lindsay Paterson of Edinburgh University, are far too small to “signal a fundamental gulf of social attitudes”.

Not convinced? Then you might ask why, if Scotland is so mad for progressive policies, it doesn’t use the powers it already has to implement them. Health is devolved. Education is devolved. Holyrood controls business rates, has the right to vary income tax by 3p in the pound (a right it has now so definitively declined to use that HMRC has mothballed the software it created for its use), can raise money for infrastructure projects, and controls around 60% of the country’s expenditure.

Yet neither educational outcomes nor health outcomes have improved since devolution begun, while policies such as no up-front tuition fees at university, free prescriptions and care for the elderly “largely benefit the middle classes”, says McDermott.

Next year, under the painstakingly negotiated Scotland Act 2012, Scotland gets even more power – the right to vary income taxes by 10p in the pound, power over stamp duty, land taxes and landfill taxes and the right to raise money in the markets, to name but a few. That, you might think, would be challenge enough – particularly given that all party leaders have promised further devolution if there is a ‘No’ vote.

Finally, regular readers will know that we don’t buy the idea that Scotland would either be economically better off or even more independent outside the union. Those “flirting with a dreamy socialist idyll”, says The Times, might like to remember that a ‘Yes’ vote could “entail a future with less government money rather than more”.

It might also be far more volatile: no one knows how much oil is left in the North Sea, but everyone knows how hard it is to extract and how unpredictable its price is (the price of Brent crude is currently at a 16-month low, despite the increasingly nasty geopolitical situation).

Undecided voters might also like to note that all the financial assumptions underlying the SNP’s case for independence rest on a currency union. A currency crisis of any kind would make a nonsense of every number.

But this is not about whether Scotland can or can’t go it alone. With the right policies, of course it can. This is about whether doing so will mark an improvement. The only question that matters to us is this: will the economic and social standard of living for most people in Scotland be better post-independence than before? The evidence suggests the most likely answer is ‘no’.

We are of the general view that the point of all political activity is to make as many things as possible better for as many people as possible, so this conclusion is the key plank of our unionism.

Still, try as we might to persuade them that we are better together, we can’t persuade everyone to our way of thinking. The YouGov poll for The Times done in July showed that those in favour of continuing the union had a comfortable 18-point lead.

The most recent one shows that lead down to six points, as undecided voters move to ‘Yes’ “by a ratio of two to one”. That means it is time for the UK government, UK residents and the markets to start taking this whole thing seriously. This week it seemed that process finally began.

An FT headline announced: “Scots vote fears rattle City”. Firms with heavy cross-border exposure saw share price falls (2.4% for RBS on Tuesday) and “investors rushed to buy protection against swings in sterling around the date of the vote”. The pound has also been weak – down from a peak of $1.71 to $1.65 earlier this week.

Is this sudden reaction paranoia? No. The markets are beginning to grasp not only that a ‘Yes’ vote is possible (if an astonishing act of national self-harm), but also that a ‘No’ vote is a problem too.

As a recent report from UBS points out, a ‘No’ vote will still “lead to significant changes for the UK and perhaps Europe”. It means further fiscal devolution, which “may have a bearing on UK debt dynamics”. It will have a bearing on the UK general election – ‘rUK’ will want to see action on the West Lothian question and a fall in the number of Scottish MPs in Westminster with the rise in devolution.

If the margin of victory is narrow enough to suggest another referendum in the near future, the markets must still price in a risk premium to equity and bond markets for the ongoing uncertainty. Add in the horrible divisions and anger already apparent in Scotland and a ‘No’ vote clearly doesn’t mean “business as usual”.

It would, however, be better than a ‘Yes’ vote. Right now, there’s a core assumption among all participants that this will be controllable – negotiations will take longer than 18 months but will be controlled and amicable. This, say the economists at UBS, is “naïve”.

Markets don’t work like that. Instead, there’s a good chance that there will be a scenario more like that seen when the Czech Republic and Slovakia separated in 1993. They too “envisaged a negotiated separation”, but got near-chaos with “markets dictating the pace and terms of key aspects of the separation”.

So, what exactly should UK residents be nervous about? Four main things – we run through them in the box below.

The four key things investors should watch out for

The main result of an unexpected ‘Yes’ vote on the UK would, as one fund manager told the FT, be an “unfathomable” level of uncertainty – not only about the result of the negotiations, but also about their amicability and timing.

Brian Wilson, former Labour trade minister, UK business ambassador and chair of the firm that produces Harris Tweed in the Hebrides, made an excellent point on the matter in Shetland this week.

SNP campaigning assumes everyone will make nice around the table. But common sense actually says “the country state you’ve just walked out on is not going to be falling over itself to accommodate you”.

That’s particularly so, given that talks will begin just as the UK gears up for its own election: all parties will have to explain what compromises they will and won’t make with the Scots, and there are unlikely to be many prizes for those who back big concessions. Worse, no negotiations can realistically take place before May 2015. Why? Because the SNP can’t be sure that the government they are negotiating with pre- and post-May will be the same, so they can’t be sure any deals made will survive.

So there will be a very nasty period in which talks are pointless and we will know nothing about debt, currencies, defence, or anything else. The results of that are unlikely to be happy ones. Here are four (from a long list) that UK investors should watch.

1. The first thing to really worry about is capital flight. Deutsche Bank put out a widely ignored report in May in which it noted that money is likely to “flow unchecked” out of Scotland while Edinburgh frantically fights to make a currency deal with a mostly uninterested rUK.

A new Scottish currency, or the prospect of one, would also “trigger capital flight by worried savers ahead of any decisions being made”. UBS agrees this is a whopper of a risk. During the Czechoslovak separation, the idea was that a currency union would stay in place for six months while the new central banks sorted themselves out. That didn’t happen.

“Companies and citizens were not prepared to await the outcome” and bank deposits drained from the weaker partner (Slovakia). The “façade” of economic negotiation collapsed and the currency union lasted six weeks.

Will the same happen to us in the six weeks after a ‘Yes’ vote? It is entirely possible. Savers are by definition people with a low tolerance for risk: if there is even a chance of anything less than a full monetary union, they will pull money out of Scotland.

This would make life very tricky for the Bank of England (which would have to act as a lender of last resort and manage a falling Scottish money supply alongside a rising rUK money supply), but would also further weaken Scotland’s negotiating position.

2. The gilt markets. If rUK refuses to enter into a currency union with Scotland (which I think its voters will insist on), the SNP says it will repudiate its share of UK debt. That would push up the UK debt-to-GDP ratio by more than nine percentage points.

However, UK GDP would also rise as Scotland’s financial sector moved south, so the total rise in debt would be more like four percentage points.

That’s not really a problem for the UK, given the scale of its debt already, and it is almost certainly better than taking on the costs of a monetary union. However, while we wait for this conclusion to emerge (which it surely will – not least because Scotland will realise that currency union isn’t independence), there is likely to be some risk to the UK’s credit rating and some upset in the gilt market: what foreigner would want to buy in as the squabbles kick off? The risk premium has to rise and prices to fall.

3. The pound. Given the unfathomables and the risks inherent in them, we can expect sterling to weaken as well. How much? Consider a very fast fall of 2%-4% to be a “bare minimum”, says Bill O’Neill of UBS. We do.

4. The UK equity market. All this volatility has to have an effect on business confidence. Scottish firms don’t make up much of the UK index (just over 3% of the total, according to economists Paul Marsh and Scott Evans), but there are 100 listed Scottish firms.

You can expect the prices of shares in them to fall pretty sharply as they come to terms with the odds of a new and weak currency (Barclays suggest that a new Scottish currency will instantly fall 15% or more against sterling); uncertainty over EU membership; rising domestic interest rates (there are few scenarios under which Scottish rates will not rise); and a rise in the frictional costs of trade.

You should also expect prices to fall across the market as a whole to reflect the general rise in political and business risk.

So what do you do? If you need foreign currency in the next few months, buy it now. Avoid shares in firms with significant exposure to Scotland – from wind-farm operator Infinis Energy to FirstGroup and Standard Life, as well as some of the big defence contractors, such as BAE Systems. Keep out of the gilts market in the short term. And consider moving your deposits out of Scottish banks before the rush.

More sophisticated investors could follow James Mackintosh’s advice in the FT: buy protection against default by RBS, using credit default swaps (CDS). It’s “cheap to do” and “ultimately London would have to stand behind RBS and it would probably shift its HQ south”. But in the chaos of a ‘Yes’ vote, it is “easy to see how” investors would push the CDS price up in the short term. Get it right and you could turn a nice profit.

Beyond that, there isn’t much you can do. As one fund manager put it: “even if you were to know the results of the referendum, it would be difficult to make money out of it because it is hard to predict what would happen”. Frightening, isn’t it? One more reason to vote ‘No’.

* If you’re interested in this ‘Darien Scheme’, Douglas Watt’s The Price of Scotland is still the go-to book on the matter.

• This article was published in the 5 September edition of MoneyWeek magazine. Sign up here for a free four-week trial.

  • Sceptical

    Excellent article Merryn – you make some very good points. I wonder why Darling hasn’t been more vocal about some of them?!

    Like many others I was born and brought up in Scotland but am disenfranchised by Salmond as a result of living in England for the last 50 years. Salmond has previously stated that we of the Scottish diaspora in England will be regarded as Scottish citizens in the event of a Yes vote. He can stuff that idea – I’m not interested if the collective stupidity of those resident north of the border results in a Yes vote good luck to you all: you will need it!

  • NigelB

    Best reading I’ve done on the subject so far. Standard Life’s nice big special dividend payable early 2015 is designed to keep us English shareholders hanging on in there through the turmoil then?

  • So Ellen14, whatever the cost it’s worth it is your message

    I lived in Singapore for over 3 years and have visited Scotland a lot.

    Can’t see the Scots competing food wise, no one in Singapore would eat a deep fried mars bar!

  • John George

    Excellent article, however you seem to glance over the fact Scotland cannot walk away from its share of the national debt.

    1. Under international law a country cannot unilaterally declare independence. For a new independent state to be recognised by other states, the independence needs to be ratified by the original umbrella state. Such ratification only comes if there is a settlement agreement.

    2. The UK has an arsenal of tools at its disposal to force Scotland to take its share of the national debt. For instance, it could turn off the Barnett formula immediately if Scotland does not want to enter into fair negotiations. It would leave Scotland massively out of pocket before it is even independent. It could veto Scotland’s EU entry.

    3. No international partner would like a precedent of a part of a highly developed country becoming independent ridding itself of all public debt. Why? (a) Because of their government bond market. Once such a precedent is said, Flanders could walk way from Belgium without taking any of the Belgian public debt. rBelgium would be left with a Public debt / GDP ratio of over 200%. If a precedent were set, it would also be priced in for other countries facing separatist movements. (b) China, India, France, Italy, Spain, Romania, i.e. all countries dealing with domestic separatist movements would simply not want to see such precedent as it would be a massive boost for their domestic separatist movements. In fact all these countries have a vested interest in an iScotland failing. (c) other countries such as the US would not want a precedent that could be a source of instability. It would be too easy if regions could just walk away from failed or unsuccessful states without taking their share of the debt.

    4. If Scotland did not take any of the public debt, it would also not be entitled to any of the public assets. The Crown Estate which owns the seabed is just one example. Infrastructure assets are another example.

  • Borachon

    You could be right. Or, similar to your bullishness on Gold at all costs, and the daily emails I get from you telling me the sky is about to fall in on the UK and World economies, and I should sell all my assets, buy a big mattress, stuff my cash pile inside, and sleep through the crisis with my money safely under my derriere -you could be hopelessly wrong.

    If Scotland was such a basket case, Cameron et al would be delighted to get shot of us. You have to wonder at his desperation to keep us. He even came here! Sorry, but I’ll risk it. I expect a couple of years of uncertainty, but when the fog clears, every truly independent assessment of Scotland’s wealth suggests we’ll be just fine.

    • Ed Bowsher

      Hi Borachon,

      You say that ‘every truly independent assessment of Scotland’s wealth suggests we’ll get by just fine.”

      This simply isn’t true.

      Just one example, the US academic and writer, Paul Krugman, says independence would be an economic mistake. Now Krugman is a controversial figure. He may be wrong on this issue.

      But how can you say that he isn’t ‘truly independent?’ He’s a US citizen who lives in the US and isn’t employed by either the Scottish or UK government.


      • Borachon

        Hi Ed,

        Of course you’re correct. I can’t possibly assert “every”. I should have said “almost every” and followed that with “I have seen”. Often, my arrogance gets the better of me.

        Krugman may be correct, but then he was absolutely convinced the Euro faced imminent, unavoidable Armageddon, and as far as I’m aware, it’s still alive, and still backed by the ECB.

        On grounds of impartiality however, you probably know better than me that he and Gordon Brown are good friends. He makes Brown absolutely blameless for the big depression. That would be the same Gordon Brown who came out of political limbo to fight for the Union, round about the time Krugman was dropping his bombshell…

        Probably coincidence, like today, when the big retailers threatened to raise prices in an independent Scotland, just hours after Cameron phoned them all personally.



  • Stuart Clark

    As a Scotsman living in Fife , I must concede that Salmond and his team have played a blinder.

    He has managed to “Govern ” by managing a block grant , , implying that Scotland did not have roads , Schools or Hospitals prior to 2007 .

    And now implanted some “fervour ” in the minds of Scots , which remind sme of Orwell and “Animal Farm ” .

    “two legs good , four legs bad ” , seems to be the only justification for anything , Scotland “pure white ” , “poor” , victims , underdogs ,

    “Westminster ” reposnsible for everything from the Jimmy Saville scandal , to the Bank collapse

    ( A Bank collapse precipitated by a LAB govt , that the Scots voted for )

    These “YES ” converts (it must be compared to soem religous zealotry ) they really do beleive we are approacjing some promised land .

    Among which are many of my friends these last 15 years

    Any attempt to discuss with them , is met by the same ,deluded denial ,

    This will go the wire , and a sa gambling man , i would not bid £500 on Yes or NO

  • NeutronWarp9

    As an Englishman living in a country where English-ness & British-ness has been institutionally despised for decades, I am irritated that 5.3 million people should seek to dictate terms to the majority. (I suppose it is how some in the EU see the UK).
    Because I don’t really care about Scotland – mildly indifferent, at best – let the Scots fall prey to the primitive, simplistic tactics of the SNP.
    Or are the Scots simply showing us that inclusiveness is a myth and that perceived self-interest is the order of the day?

  • Clive

    Despite the Yes campaign saying the NHS will be in better shape under them rather than the UK government, IFS show that’s the opposite of what’s been happening, with Scotland spending LESS on the NHS, says

    2. Between 2009-10 and 2015-16 spending on the NHS in England will, on currently announced plans, have risen by about 4% in real terms despite an overall fall of 13% in English departmental spending.

    3. Over the same period the vagaries of the Barnett formula mean that Scotland will have had to cut overall public service spending by less – by about 8% rather than 13%. But the Scottish government has chosen to protect the NHS in Scotland slightly less than it has been protected in England. Spending on the NHS in Scotland has fallen by 1%.

    4. Analysis we published last year shows this is not a new pattern. Between 2002–03 and 2009–10 – years of plenty for public services rather than cuts – real-terms health spending per person grew by 29% in Scotland compared with a 43% increase across the UK as a whole

  • Pinkers Post

    Alex Salmond is right: The No camp is, indeed, orchestrating a campaign of business “scaremongering”. However, he is wrong to assume that Scots will ignore the warnings and that “Scotland will vote Yes next Thursday.” Wishful thinking. 

    Big business has argued convincingly that uncertainty surrounds a number of vital issues including currency, regulation, tax, pensions, EU membership and support for Scottish exports around the world. And uncertainty is bad for business. Very bad, indeed.

    The outcome looks assured: It will be a No. And neither will it be a Quebec-like razor-thin margin but a surprisingly decisive No. Scotland will remain an integral part of the United Kingdom and armageddon has been averted. Further to this:

  • Michael Robertson

    It might be as well to bear in mind in the dying days of this debate…

    That it is likely that there are more Pandas in Edinburgh Zoo than credible economic models proposed by Alex Salmond in iorder to run the finances of Scotland should it ever achieve independence!

    Vote early, vote often and vote NO!

  • Richard Waltereit

    Ironically, the “sterlingization” model of using the pound without a currency union is inspired by Panama, just as the disastrous 1690s adventure. That should be point of reflection for people intending to vote Yes.

  • Marko

    I can’t understand those voting no. I am a high earner so will likely be taxed a lot more in an independent but fairer scotland.

    We are a peaceful country, we don’t want nuclear weapons or to go to war, we don’t want more food banks while westminster is fighting brussels to pay massive bwanker bonuses, we don’t want to be governed by england because we want to govern ourselves.

    Vote YES for a brighter future!

  • JDEvolutionist

    Good article. Primarily because I believe it gets a little closer to the realities of what independence could mean, a little closer to the truth with respect to the probable outcomes. It’s a great shame that it does not have a wider audience.

  • Merryn

    The capital flight out of the UK appears to be well underway: £27bn in net outflows in August and it is bound to have got rather worse in the last few weeks.

    • uncommercial

      Where is the evidence that this has anything to do with Scotland or even matters a great deal? There is no sign of any major asset class declining significantly in value, which strongly suggests that the movement is bank deposits. More likely it’s hot money moving around in response to events such as exchange rate movements or sanctions against Russia. All the “no” arguments seem to have a similar character – they latch onto anything that can be cast as bad news and claim, however tenuously, that it is a result of Scottish independence. The only substantial down trend is in the exchange rate against the dollar (against the euro, sterling is drifting) which is more likely to be to do with dollar strength than with Scotland. And it is utterly misleading to claim that UK citizens are poorer by the amount of the change against the dollar.

  • dave21kj

    Good article. I highlighted months ago in these articles that the NO campaign needed to say something positive, rather than shouting about Armageddon. It has not happened.
    The UK is a mini Europe. 4 countries held by a single currency. London is Germany and Scotland, N Ireland, Wales and N England are akin to Greece, Ireland etc..
    What popular opinion says is not working for Europe is also not working in UK. Same problems, leading to similar outcomes- cancerous growths like Scottish Nationalism (SNP) and English Nationalism (UKIP). The NO campaign was an opportunity to address this structurally for all of UK. (federated structures); But the barnacles on the side of the good ship UK are the same type as the ones in the EU and in Washington. The absence of recognising this fact is leading to fascism.
    The biggest risk to Scotland is that the first country to test the water will be crushed economically. I am a NO, but having zero enthusiasm for UK set up. Salmond called me a “deferred yes”, I hope not. It might not matter!

  • ricard0a

    “London is Germany and Scotland, N Ireland, Wales and N England are akin to Greece, Ireland etc..”

    BINGO !!

    Couldn’t have put it better myself. And therein lies to crux of the matter. highlite that, point out that inconvenient truth, and you point out the ONLY realistic claim to go it alone (i.e. with the means to do it) and that would be for London to declare itself a city state of some sort. It’s got the lot (a port, two airports, a rail link to the continent, infrastructure, and oodles of cash). Perhaps it could call itself LONGDONG or something.

    Anyhoo no matter what the outcome, this is the closest thing this Country (?), sorry this island will get to a revolution (of sorts). There may well be a grudging sort of admiration for Salmond/SNP in the economically repressed areas of England’s East coast (from Sunderland to Essex). If so expect a surge in UKIP support. That support may well even catch on elsewhere.

    The revolution is being televised, and Salmond and Farage are the winners already. The Scots may well be too (probably if they vote NO). The English certainly won’t be, either way (as usual).

  • Merryn, what do you think the impact of a yes vote would have on the valuations of investments in open ended funds where the asset manager is listed in Scotland, and also for investment trusts listed in Scotland? Could there be a de-rating and capita

    Merryn, what do you think the impact of a yes vote would have on the valuations of open ended funds where the asset manager is based in Scotland, or of Investment Trusts listed in Scotland? Could they suffer a de-rating and/or capital flight, even if said funds/trusts do not necessarily have a greater than average holding of scottish assets in their portfolios?