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07 September 2014

Scotland independence: the case for Yes

Thursday the 18th Scotland is going to vote what may well be the most important political decision in several centuries for itself and the UK. The reasons that prompted this process are many: the perception of a slow derision of Scottish identity and culture, the crystallisation of the UK's democracy (where non elected individuals still retain important powers), natural resources, budget sharing, NATO, just to name a few.

I am not Scottish, nor do I live in Scotland, thus I can not possibly fathom everything driving the vote. But one exercise I can make: assess the economic risks associated with the decision. And by doing so the complexity of this question becomes apparent, as so how uncertain is the outcome.

First off, independence would immediately force Scotland to a different monetary system. Broadly, two options exist: either create a new Scottish currency or use a foreign currency. The first option would be extremely risky, Scotland has 4 million habitants and a GDP under 200 G€, it would be easy prey for speculative hawks. The collapse of Iceland's banking system in 2008 is a vivid reminder of the fate small currencies have in a global economy. The alternative would then be a foreign currency, which could be achieved, for instance, by pegging a future Scottish Pound to a big currency.

Independence advocates often point towards the Sterling as an hypothesis, but this is again a risky strategy. Scotland would no longer have a say in the UK's monetary policy, thus facing costly counter-cycle decisions; the relatively small dimension of the UK at the global scale renders such scenario a clear possibility. Moreover, Scotland would expose itself to retaliative actions from the UK, with ill intended policy makers in London punishing Scotland for its dare.

Although less risky than the option for a Scottish currency, using a foreign currency equates to the effective abdication of monetary policy. In this light, joining the club of satellite currencies to the EMU (through the Exchange Rate Mechanism) would be far more logic, as the Euro is expected to be managed regarding the economic environment of the whole continent. In any event, neither of these options would leave Scotland at a better place that where it is today, at least in the short term.

Secondly, by voting for independence Scotland would automatically find itself outside the EU. As part of the UK, Scotland is outside the Schengen area and the EMU, thus this aspect may not seem that dramatic. However, Scotland would automatically leave the Common Market (and possibly the World Trade Organisation). Speculation has been rife on Scotland's status beyond the EU in case independence wins, but make no mistake, no legal framework exists for such case, which to happen will be a first. There are no clauses or exceptions to recur to: out of the EU it will be.

And re-entering will not be straightforward. There are member states granted to bar access of a splinter region/state to the EU, obviously Belgium and Spain, but they will not be alone. And also because Scotland will be obliged to join the EMU, which may not only be an unpopular decision, it would force Scottish leaders to an about face on the currency matter. Full access to the EU should be written off in the short term, only after lengthy years of negotiation could such reality materialise. In the meantime, the best Scotland can aspire to is a status similar to that of Switzerland, but even that is not granted (again, Belgium and Spain at least will demand a lot of convincing).

At this stage is should be clear to which decision I lean to, if a non Scotsman can be forgiven for meddling in this debate. Indeed, in the beginning, No would have been my advice to the few (but good) Scots I call friends; but presently, I am not at all that certain of the right decision. The reason: the past two years the UK itself seems to have geared into escape velocity out of the EU.

Things started going astray with the decision to not integrate the European Stability Mechanism. An outsider to the EMU, the UK cast itself out of any economic and monetary policy structures emerging in the EU (e.g. the so called Banking Union). These days, when the moment comes for important decisions in Brussels, Strasbourg or Frankfurt, UK representatives are kindly asked to leave the room.

These past two years the negotiation stance of the UK at the Council has become ever more egocentric, often leading to bare isolation. The failed attempt to bar the nomination of Jean-Claude Junker for Commission President is a recent example of this drive. At the same time the UK has engaged itself in Foreign Policy tactics that seem aimed at destabilising Europe; the coup d'état in Ukraine is possibly the best example. And internally the so called "euro-scepticism" seems to gain traction among all political parties; under different shades, they all seem somehow uncomfortable with the integration trek to which the EMU members are fated.

The UK will in turn held a referendum on its EU membership in 2017; by then it could be just a mere formalism confirming a deepening trend. Thus Scotland may be facing the exact same risks described above by staying within the UK, just somewhat later.

And suddenly independence becomes a far more palatable choice. It can provide Scotland the room to develop its own policy towards the EU, safeguarding its interests in (the likely) case the UK decides to raise anchor and sail into the Atlantic. With the UK leaving, it will be far easier to convince member states such as Spain and Belgium of a special case. In essence, the Yes vote is the long thinking play, hurt in the short term to ease things later on.

I have been into forecasting long enough to know that all forecasts are wrong, but here I leave mine for this referendum. The No vote will win by "the smallest of margins", providing an half-victory to independence advocates, an half-defeat to the UK government and full blown defeat to UK political parties in general. Soon after 2017 a new referendum will be held and the Yes shall win by a comfortable margin.