Post-Brexit Scottish Independence: An Economic Disaster?
As the UK Government seeks to reverse a recent High Court ruling on Brexit, the Scottish First Minister Nicola Sturgeon has asked for a second Brexit referendum. But given the fragile state of its finances and uncertainties regarding EU membership, Scottish independence as an alternative would be a leap into the dark for Scotland.
Although the United Kingdom voted to leave European Union (EU), 62% of the Scottish electorate voted to remain in the EU. In light of recent Brexit negotiations, the Scottish independence movement has stressed the importance of a second Scottish referendum. According to the movement, an independent Scotland would prosper by joining the European Union, using the euro, and be better off economically.
However, given its precarious finances, an independent Scotland would not meet the European Union’s eligibility requirements. In order to join the EU, a potential member must have a budget deficit under 3% of GDP. Currently, Scotland runs the highest budget deficit in the European Union, for now. Its deficit of £14.9 billion, or 9.7% of its GDP, is about three times higher than that of the United Kingdom as a whole.
To make matters worse for Scotland, the budgetary deficit is projected to widen further. Its economy is highly dependent on North Sea oil and gas revenues, accounting for up to 20% of its annual revenues. North Sea oil and gas revenues have plunged in recent years: in 2016 alone, they fell by 96 percent. Experts predict that, with falling oil prices, these revenues will decline even further in the coming years.
Additionally, a newly independent Scotland would be charged substantially higher rates for borrowing, which is likely to grow deficits even further. Unless the government is willing to cut taxes and reduce spending dramatically, it is unlikely that Scotland will be able to reduce its deficit to under 3% of GDP and become eligible for EU membership.
In fact, the European Commission (EC) recently ruled out the possibility that an independent Scotland would automatically be EU member and use the euro. According to EC President Barroso, Scotland would be “a third country with respect to the EU” and as such, “the EU treaties would no longer apply on its territory.” This means that joining EU would require a formal application via Article 59, which would take a long time, creating further uncertainty for Scotland’s future.
If Scotland cannot join the European Union and adopt the euro, it raises serious questions about its currency. Given that 85% of all Scottish exports go to the United Kingdom, keeping the pound would minimize exchange rate uncertainty and lower transaction costs for Scottish businesses. As such, it would make sense for Scotland to keep the pound. In fact, many Scottish nationalists are in favor of keeping the pound, arguing that its global reputation will lower borrowing rates. But the Treasury and the Bank of England have both advised the UK Government against a currency union with an independent Scotland, on grounds of lack of fiscal oversight.
Among the other options, Scotland could adopt a new currency using a floating exchange rate, allowing it to set its own monetary policy. But an independent Scottish currency is likely to experience wild exchange rate fluctuations. As such, borrowers are likely to charge much higher rates, severely worsening Scotland’s deficits.
Alternatively, Scotland could peg its currency to pound, but this would make the new currency vulnerable to speculative attacks by currency traders short selling the currency. In the past, Britain itself fell victim to speculative attacks. In 1992, George Soros led a speculative attack on British pound, causing the UK interest rate to hike from 8.8% to 15% and imposing on the UK government a loss of £3.4 billion. The speculative attack ultimately forced the British Government to break its fixed exchange rate on September 16, 1992, now known as Black Wednesday. This incident greatly reduced the economic credibility of the conservative government, which would stay out of power for the next 13 years. Given such historical precedent, it would not be in Scotland’s best interest to peg its currency and risk speculative attacks by traders.
In light of such economic and political uncertainty, it is not surprising that since the last Scottish referendum in 2014, support for Scottish independence has barely bulged from 45%, despite Brexit. The Scottish Independence Party itself is divided over the right course of action in a post-Brexit Britain. While First Minister Sturgeon would like to have a second Scottish referendum soon, her excitement is not shared by many others within her party.
Given Scotland’s precarious finances, uncertainties about its currency and economy, it would be unwise for Scotland to take a leap in the dark. Considering the rise of populist movements throughout Europe, the last thing the nation needs is an extended period of political and financial uncertainties caused by Scottish independence.