Ahead of the Scottish referendum, Michael Hewson and Colin Cieszynski analyse what it could mean for Scotland’s economic future, and what lessons can be learned from Quebec’s own independence debate. The report covers: • The prospects of an independent Scotland and the ongoing uncertainty of a ‘no’ vote • The similarities between Quebec and Scotland including the impact of natural resources • How Quebec’s independence debate led to an exodus from businesses such as banks • The potential outcomes if Scotland was to become independent, including renegotiating free movement within the EU The economic prospects for an independent Scotland We’ve heard an awful lot of arguments from both sides of the political divide as to the pros and cons of Scottish Independence with both sides claiming that their view is the correct argument, and best for Scotland. On a cost benefit analysis the numbers as the Scottish National Party (SNP) portrays them, look attractive. On a tax revenue per head basis, revenues were £800 higher in Scotland than the rest of the UK but life is rarely that simple in reality. Given the linkages between the Scottish economy and the rest of the UK, untangling linkages like pensions and other financial services will be like unscrambling an omelette, and that’s before you untangle the liabilities of the Royal Bank of Scotland and HBOS. With the ‘yes’ and ‘no’ camps digging in for the long haul one thing above all else needs to be determined in the event the yes vote wins. Whether Scotland uses the pound or not is neither here nor there. If they want to the UK treasury can’t stop them. The key question revolves around how Scotland will finance itself in the absence of a lender of last resort and its own currency. If it creates a new currency, raising money on the bond markets will be more expensive and if it walks away from its part of the UK debt it will still be more expensive. Bond investors don’t take kindly to sovereigns walking away from their obligations, and if the SNP thinks there wouldn’t be repercussions then they are being naïve in the extreme. SNP leader Alec Salmond claims that independence from the rest of the UK need not mean a significant change to how the Scottish Parliament spends its money, and that Scotland would be better off due to the benefits of revenues it gets from North Sea Oil as well as renewable sources of energy, and the removal of nuclear weapons from Scottish soil. While that may be true the lack of a lender of last resort could well prove ruinous for its financial services industry which is one of the biggest contributors to the Scottish and UK economy. Some have said that a bank exodus remains unlikely in the event an independence vote goes through, but history can tell us a different story, irrespective of the outcome of the vote and that could be a problem, given the nationalists aren’t likely to pack up their gear and go away quietly in the event of a “No” vote. Experience has taught us that these partition debates have a habit of rearing their heads at fairly regular intervals, as can be seen from what is going on Spain with Catalonia and more recently in Italy with respect to Venice. How Scotland’s situation is similar to Quebec’s A modern day example of how a regular independence vote can create uncertainty in a region, and an economy, need look no further than Quebec in Canada, which has had two unsuccessful independence votes since 1975, and could well be set to agitate for another. The province held a vote in 1980 and another in 1995. As we speak there are reports of yet another vote as the separatists once again try to push their agenda in the Quebecois Parliament. Up to 1975 Montreal had been the financial and industrial capital of Canada and hosted the Montreal Olympic Games in 1976, which instead of ushering and era of significant growth and prosperity, became the city`s last hurrah on the big stage. While the economy did grow, and still remains an important regional centre for commerce, aerospace, finance and tourism, it soon lost its national financial leadership position to Toronto. The impact of Quebec’s independence debate and Scottish comparatives Many of Canada’s major banks and businesses were domiciled here on the edge of the St. Lawrence Seaway, but the election of the Parti Quebecois in 1976 who pushed for a separatist agenda saw businesses leave the province in droves, and the city of Montreal soon lost its crown as the financial capital of Canada to Toronto as both Royal Bank of Canada and Bank of Montreal moved their corporate HQ’s there in the intervening years. In some respects the situations of Quebec and Scotland do have some similarities, with Quebec province having a surplus of natural resources as well as the largest oil refining centre in Canada. The Port of Montreal is the largest inland port in the world handling 26m tonnes of cargo annually, but currently the province runs a fiscal deficit and needs substantial fiscal transfers from Ottawa to fund its pensions and welfare system. Scotland also has significant natural resources with North Sea oil and also hosts the sixth largest financial centre in Europe in terms of funds under management, while the whisky industry contributes over £4bn to the UK economy. In monetary terms Scotland’s fiscal situation is better than Quebec’s position which shows net provincial debt of C$175bn or 49% of provincial GDP. That’s before you take into account the amount of Canadian national debt it would be liable for, which some estimates have put at 43% of GDP making a total debt to GDP ratio of 92%. Scotland’s fiscal position based on the latest figures shows that Scotland more than pays its way in terms of tax revenues, a fact that Alex Salmond never ceases to promote. Unfortunately none of that changes how much of the UK national debt Scotland would be responsible for in the event of independence, and it is on this number that the whole question of Scottish independence hangs, as well as the fact that Scotland currently runs a fiscal deficit, with a significantly large amount of spending per head going on health and welfare. On the current numbers Scotland ran a fiscal deficit of 8.3% for 2012-13, up from 5% on the previous year, and also higher than the rest of the UK. This means that Scotland spends £12bn more than it receives in tax revenue. If oil revenues continue to decline as they well might then that figure could well get bigger. Much has been made of the question as to whether an independent Scotland would be allowed to use the pound, but that rather misses the point. If Scotland wants to use the pound it can, unfortunately it won’t have any control of monetary policy or lender of last resort if any of its banks run into difficulties in funding themselves. Scotland also wouldn’t have any say at what levels interest rates would be set, which if the economy hits a bump in the road could be a problem, as countries like Italy and Spain are finding out now that they are in the euro. That could be a problem as Montreal found out to its cost as many of its banks and businesses moved out to Toronto as uncertainty over questions of liquidity, lender of last resort and break up risk created uncertainty. Over the decades political uncertainty has had a cumulative effect. As Montreal’s economy stagnated, it found itself falling farther and farther behind the explosive growth of cities like Toronto, Calgary and Vancouver. Although the province has been able to negotiate some increased powers and financial largesse from Ottawa, it has become clear that the people of Quebec have recognized that over the long-term, courting separatism has had a detrimental impact on their economy. Earlier this month, the separatist Parti Québecois was crushed in a provincial election. They had started out with a minority government and were looking for a majority that could pave the way for a third referendum. After introducing a new high-profile separatist candidate, the PQ`s standing in the polls went off a cliff and they were sent back into opposition by their worst election result in over forty years. The PQ`s leader, Pauline Marois was unable to hold onto her own seat, while the federalist Liberal Party won a new majority less than two years after being kicked out over corruption scandals. Early analysis of the results suggests that after decades of flirting with independence not only are the people of Québec no longer interested in separation, they don`t even really want to talk about it any longer lest it scare off business again. Other considerations in Scottish independence debate One other issue that needs to be addressed in the event that Scotland votes for independence is the free movement of labour, which UK citizens currently have in moving throughout the EU. If Scotland votes to leave the UK, it would surely have to renegotiate the free movement of Scottish workers throughout the EU as a vote to leave the UK also means leaving the EU. Scottish independence is undoubtedly an emotive issue and one that needs to be made with a clear head as to the fiscal consequences of where one puts their tick in the box. Currently the rhetoric has been more of the “you smell” and “stop picking on me” kind rather than an informed debate between politicians as to the advantages and disadvantages such a vote could bring. This needs to change into a much more grown-up debate than the one currently being played out in the media. Given the toxicity of the debate between the “nationalists” and the “better together” campaign the worry is that a “No” vote merely defers the debate into the future and creates uncertainty in the same way that Montreal got left behind in the 1970’s. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.