Scottish independence: the costs of borrowing and of transition

Money and Saltire purse Image copyright PA
Image caption Think tank NIESR suggests Scotland could trade its future oil revenue to pay off the UK's debt

A year out from the independence referendum, Donald Rumsfeld comes to mind.

The US Defence Secretary who rained missiles down on Iraq ten years ago is also, more fondly, remembered for observing the future carries known knowns, known unknowns and unknown unknowns.

The independence referendum features lots of known unknowns. In some we know the issues, and can guess at their scale. In some, clever people can do the algebra and provide us with estimates.

This week, a conference at a nice hotel just outside Edinburgh, organised by the Economic and Social Research Council, will take a look at some international lessons for the economics of independence.

There will be some observations about known unknowns which matter rather a lot. Here are two of them: the cost of borrowing, and the cost of transition.

The price of Scotland's debt

So, first: Scotland would face a large debt transfer, and an ongoing deficit that needs financed. What would that cost?

Those backing a 'yes' vote point out that Britain's cost of borrowing isn't looking so rosy since it lost its triple-A credit rating. With the help of Scotland's energy resource, they ask: why wouldn't Scotland be similarly rated?


It's taken a look at the implications of Scotland being in a currency union with the rest of the United Kingdom, as the SNP proposes.



One factor is that Scotland would have no track record of servicing debt. But this analysis puts the rate higher because of less liquidity in the bond market for smaller countries' debt. That is, if it's less easy to find a buyer when you want to sell, there's a higher risk in holding the bonds.


Fiscal tightening


However, its average deficit has been around 2.3% (including its geographic share of oil and gas taxation) over that same period of 2000 to 2012.

The gap between that average deficit of the past and the average surplus in the next decade suggests a 'fiscal tightening' of 5.4%. That is, you either cut spending by 5.4%, or you raise taxes, or you do a bit of both.


With some understatement, it is concluded: "There may be significant political limitations to this possibility."

Oil for debt

And so, it's with that background that NIESR is heading in the same direction as others who have considered Scotland's future currency options, including many in favour of independence who don't take the SNP whip - that of Scotland having its own currency.


But what a new currency also brings is uncertainty about the transition, and that's a hard sell to voters a year from now.

The price of change

So, to the second question: even without changing currency, what might the costs of transition be? This is a big part of the economic debate about independence.

It's highlighted by the pro-union side, emphasising the costs, and refusing to reduce them by negotiating in advance to reduce uncertainties. Nor is it willing to talk much about common interests if the UK splits.

Meanwhile, the cost of transition is played down by the pro-independence side. While it gears up for talks on currency, debt, resources, defence, splitting or sharing many other assets, shared regulation, international obligations and so on, the Scottish government reckons that negotiations will be "smooth and co-operative".

For this week's conference, Robert Young of the University of Western Ontario has applied his expertise in Quebec's efforts to secede from Canada.

He doesn't deal in algebra, but in game theory; assessing how the bluff and threat of the prisoner's dilemma or a game of chicken would deliver different results.

Common cause


But the cost of transition comes before that, and if it works badly, it can outweigh any benefits from those other factors in later years.

By international comparison, Young points out that Scotland starts with the advantage of having secured agreement from London on the validity of its claim to sovereignty. That's a long way from agreeing to whatever Scotland's negotiators want, but at least it's the starting point for being able to jaw-jaw.

And it's pointed out that the negotiation of deals with the former capital can have the benefit of bringing people in the new nation together in common cause.


But that one benefit of transition is set against quite a range of costs. One is the transaction cost: the resources devoted to disentangling two new states and of setting up new institutions.

"No advanced industrial capitalist state has ever undergone such a break-up, but transaction costs could be very large," writes Professor Young.



And third, there are the costs of uncertainty. That takes us back to the additional cost of borrowing outlined by the NIESR, on which Professor Young underlines the difficulty of estimating figures for Quebec.

Some costs, we're told, are fixed, such as setting up new institutions. But many vary, and depend on the behaviour of the two sides following a 'yes' vote.

And that's why this will remain one of the bigger 'known unknowns'.