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Border economics at heart of questions over Scottish independence

DOES it make economic sense for Scotland to be an independent country? While political, social and historical forces are key drivers of national boundaries, economics does have a lot to say. There are two economic forces at play: the gains from a larger market and a single set of institutions versus the losses from imposing common policies on diverse areas. Lots of the issues being debated in Scotland are manifestations of one or the other of these forces.

One thing we do know is that national borders drive up costs. Analysis of trade patterns between and within countries shows that the mere existence of a line on a map drastically reduces economic linkages. It’s possible to reduce these effects through harmonisation of regulations, but we would see a spike in the cost of moving goods or services across the Tweed if it became a border.

Nor is it just about trade. Firms with access to larger markets can drive down costs through economies of scale, and there is more competition as well as more scope to take advantage of the benefits of clustering of highly productive firms and individuals. Edinburgh attracts great firms and entrepreneurs, but this could be under threat.

Another issue to consider is the potential to spread risk. While the economies of Scotland and the rest of the UK are pretty similar, there are some differences that mean staying together has benefits. When oil prices are high, Scotland can be a net contributor to the public coffers. The opposite can apply when prices are low, or when Russian oligarchs pour money into London property. The net result is that uncertainty can be lower in a larger jurisdiction. Uncertainty also has a history of de-railing referendums.

What about the other force, that of the gains from allowing different areas to pursue different policies? Certainly, there is plenty of evidence that the existence of different institutions in their subnational states creates a hotbed of policy innovation and useful competition. Scots do seem to have a different set of policy preferences to those south of the border, and perhaps they could be better off through a different mix of spending and taxation. Smaller countries next to similar big ones also have a good track record of using policy differences, like lower tax rates, to attract business. Think about the relationship between Ireland and the UK, or Luxembourg and France.

The issue of sterling has taken centre-stage in the debate, especially given the lesson from the eurozone about setting the rules before you jump into a currency bed together. Whether a currency union makes economic sense is driven by the same forces mentioned above. Ultimately, it is a political decision; an independent Scotland would be perfectly within its rights to go it alone and use sterling without seeking anyone else’s permission, as a host of British territories do already.

In economic terms, it would likely be in the best interests of both countries to share a currency after independence, given the economic integration. The benefits would be more significant for Scotland, but they would not be negligible for the UK. However, the costs are also higher for Scotland. Would they be willing to accept the loss of control that sharing a currency with a much larger neighbour would entail? They probably would. But it’s a point of uncertainty that opponents of independence will make much of between now and September.

And so, how would a rational economist vote on 18 September? The answer would have to be no, as the costs of throwing up a border are almost certainly higher than the gains. But it’s not all about economics. Even though the message from business has been that independence would be a bad thing, recent polls have shown a slight rise in support for separation. There’s the all-important factor, the warm and fuzzy feeling of belonging, which will prompt some to vote for independence and some to opt for continued union. Economics can’t help us much on that one. ?

Simon Baptist is chief economist at The Economist Intelligence Unit

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