Implications of Scottish Independence and exit from the EU

The date on which Scotland will decide its faith in the 307 year old union is approaching fast. Despite that, neither the nationalists nor pro-unionistic British government are making any dramatic moves, keeping their best cards hidden. The recent stipulation of Alexander Salmond, the First Minister of Scotland, that Scotland will keep its pound, mildly stirred the referendum waters, but the leader of the Scottish National Party knows that major battles are yet to come. At the same time, UK is fighting its battle with the European Union, with the Conservatives promising a referendum on British membership in the EU by 2017.

Should the Scottish nationalists get their way, it would present the wider British public with evidence that notwithstanding some of the ostensive shortfalls of the pan-European project, in economic terms, there is no better alternative currently, especially for UK, whose economy is heavily dependent on its banking sector.

The Barnett formula, a mechanism for calculating per capita public spending used by the HM Treasury, clearly suggests that Scotland’s relative public spending is more than England’s, thus more money is flowing into Scotland. Moreover, in the event of a break up, UK would be unburdened from a portion of its debt, which Scotland needs in order to create a sense of creditworthiness.

At the same time, Scotland’s oil production in the North Sea yields the region higher per capita tax revenue than England, thus contributing more taxes per capita. The arguments could go on and it would be difficult to side objectively on whether Scotland is better off the Union or Union is better off Scotland. As many economists have stressed, there are highly volatile and unknown variables, such as cost of oil, division of debt or future productivity gains. Thus, with no smoking gun at hand, taking a stance seems risky and futile.

One thing is certain though.  Shrinking the size (economy, population, area…) of the United Kingdom would significantly diminish its global political power. Therefore, as many observers have concluded, maintaining the Union while to some extent pleasing the Scottish nationalists is at the moment the most feasible option, especially for Westminster. According to the latest polls, so far around 40-42 percent of decided voters support independence.

Despite that, for the sake of the argument, lets imagine that the outcome on September 18th 2014 is going to be in favour of independence. Under such scenarios, two off the biggest banks based currently in Scotland, Lloyds and Royal Bank of Scotland, would under an existing and untested EU directive need to move their legal residence. According to the Council Directive 95/26/EC from 29 June 1995 the head office must me “in the same member state as its registered office.” That, in combination with 90 percent of the banks’ respective customers coming from outside Scotland, would mean that offices would move to London, which among other things also offers better accessibility to international markets. Along with other legal problems, this would  mean incurring extra costs for the banks in an already fragile economic environment.

Standard Life, financial services giant based in Edinburgh, was among the first to warn of the negative effects on its business that could emanate from Scotland opting for independence. Moreover, RBS also warns on page 206 of its report that “the group’s borrowing costs and its access to the debt capital markets and other sources of liquidity depend significantly on its and the UK government’s credit ratings which would be likely to be negatively impacted by political events, such as an affirmative outcome of the referendum for the independence of Scotland.”

Bearing in mind that banking sector contributes to Scottish economy approximately 8 percent and financial services assets make up to 12 times more than Scotland’s annual output, the new regulatory and legal frameworks that would be needed for a practically new nation state could dramatically impact not only Scotland’s GDP but in short to medium term also its ability to borrow on international markets and by implication its public welfare. The negative consequences of Scottish independence on the banking sector and the wider Scottish economy can be vividly imagined.

According to TheCityUK website, the financial sector contributes 10 percent to UK’s GDP, thus more than it does in Scotland. Moreover, in the 2011-12 tax year, the City of London contributed to government’s coffer £63bn, and 15 percent of income tax revenues (£21.4bn) came from just 4 percent of UK workers employed in this sector. Naturally, one cannot compare setting up a new nation to a withdrawal from international agreements (as national sovereignty remains above any institutional arrangement), but in terms of banking sector where access to international money markets represents a key variable, the issue is more than pertinent.

A report by Open Europe, a think tank, argues that Brexit would freeze UK financial services from accessing European markets. Financial firms such as Goldman Sachs enjoy access to EU’s £9.8 trillion single market (Bloomberg estimate). Should UK decide to leave this market, parts of the financial centre would inevitably move to Paris and Frankfurt, officials familiar with the issue said.

This meets with a lot of disaprooval coming from the City. A 2013 survey conducted by TheCityUK found that 84 percent of leaders in the financial industry want UK to stay in the EU. The former chairman of Lloyds Banking Group Plc Win Bischoff said: “London is really the most important financial centre in Europe, and we benefit enormously by being part of Europe” and Brexit “wouldn’t be a cliff event, but over a period of time, market share will go to other centres.”

Oddly enough, City’s priorities collide with David Cameron’s politics. This is somewhat striking as according to Bureau of Investigative Journalism, in 2011 Conservatives received more than half of all political contributions to the 2010 election from donors working in the financial sector. What is more, the Conservatives are arguing for keeping Scotland in, while threatening the EU with exit. Considering the implications on the financial sector, this stance is clearly at least paradoxical and it implies that much larger political strategies must be at play.

Nevertheless, should the Scottish voter decide for independence, it would significantly exacerbate the already fragile argument for leaving the single market.

 

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Categories: Europe

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