The 19^th century was the century of the rise of large states.  Countries became bigger, empires were formed.  Continental Europe saw the political reunification of German and of Italy.  France, and particularly Britain, built colonial empires.  The United States expanded across the American continent. 

If nineteenth-century states tended to become bigger, in the 20^th century the opposite happened.  Empires progressively collapsed.  That process began in the weak Turkish and Austrian empires.  The process continued, and ended with the century, when the Russian empire disintegrated.  The British empire went by the wayside.  

The number of members of the United Nations at its formation was around fifty, and has today expanded to around two hundred.  Some of the most successful performers in economic terms over the last century have been small states  – such as Switzerland and the Scandinavian countries, which have moved from being among the poorest states in the world to among the richest. 

These developments were reflected in the fall and rise of Scottish nationalism.  In the 19^th century people talked about North Britain – in the 20^th century Scottish nationalism revived to the point at which in 2007 the pro independence Scottish National Party took charge of the government.  Overwhelmingly re-elected in 2011, the overall parliamentary majority they seemed enabled the Scottish Government to hold a referendum on independence in September 2014.  ??  In the 19^th century there was a widespread belief – not then without foundation –  that the prosperity of a nation depended on the physical resources it commanded: land, minerals, population.

 But that belief turned out to be exaggerated.  By the beginning of the 20^th century there were the beginnings of recognition that the price of state expansion by military means to control territory and resources might exceed the value of the territory and resources themselves.  By the end of the century, an understanding of that was a commonplace of western European and Japanese politics, even if not necessarily universally acknowledged in the United States, or Russia, or perhaps China.

The sources of economic advantage can today be seen in a different light.  In a world of relatively free trade, small countries are able to compete effectively in global markets by specialising in narrow areas of competitive advantage.  The success of these peripheral small countries in western Europe such as Switzerland and Scandinavia.   It is the product of that understanding.  The economic success of Switzerland we see prosperity that is built, not primarily on financial services as some people think – they  are a relatively small part of Swiss GDP –  but on exports of precision engineering and speciality chemicals. The motor of the Danish economy is a group of medical industries clustered round Copenhagen.

 The economies of other successful small European states are similar. A country – Iceland – whose principal product is fish is very poor if it is autarchic:  there is a limit to the amount of fish anyone can eat.  As a principal producer of fish for a European market, a small country can be very rich (though not from _____)

Small states in the modern world are not only viable in economic terms but some are among the most successful in the global economy.  There are few economies of scale – as an economist would put it – in state size today, outside military expenditure; and armed strength is of reduced, perhaps negative, value.  Arguably there were such economies in the 19^th century and certainly that was believed in the 19^th century.  But now being small is entirely consistent with very high levels of national prosperity.  However such prosperity is conditional on being an active and effective player in a global economic order.  Ireland’s romantic nationalist fantasy of economic as well as political independence condemned it to fifty years of disappointing performance until EU membership symbolised and facilitated a new open economic order.

       Independence is certainly a feasible option in economic terms.  Is it a desirable one?  In terms of economic statistics, Scotland looks like the UK as a whole.  Income per head in Scotland is close to the UK average.   Over the last fifty years it has moved over in a range from 90% to 100% of the UK average.  The nadir was reached in the 1960s when that figure dipped briefly below 90%.  The peak was reached in the 1990s when it approached 100% and since then has fallen back slightly.  Scotland is the richest region of the United Kingdom outside London and the south east of England.  The growth rate of Scotland has been slightly lower than that of the UK but – as is obvious from the fact that average income per head has remained in line with that of the UK –  that difference is accounted for more or less entirely by slower population growth in Scotland.  Growth has been around ½ % on average less in Scotland than in the UK.  A significant part of that difference is accounted for by net emigration. 

The industrial structure of Scotland is also similar to that of the UK.   There is a small amount of truth in the claim that Scotland is more dependent on public sector employment than the UK as a whole but the difference is modest. But Scotland looks rather like the UK in another sense – it has an economically and culturally dominant capital city.  But Edinburgh is not the country’s largest city, and that is significant for the Scottish economy and society.  Thus Scotland is not in the same position as Wales or Northern Ireland, both of which would find it very difficult to operate economically without a variety of support mechanisms from the United Kingdom. 

       If Scotland were to vote for independence there would have to be extended and elaborate negotiations about what independence would actually mean in practice. The most important of such negotiations would be those with the remaining United Kingdom and with the European Union. 

       Some pro-independence commentators have taken the position that either Scotland as an independent country could unilaterally determine the tenor of its relationships with SUK and the EU, or that most issues could be “parked” and dealt with after independence by negotiation between sovereign states.  Neither of these positions is tenable.   Scottish independence would require detailed legislative activity by both the Westminster parliament and the European Union. It is unlikely – in fact inconceivable – that such legislation would pass without a substantial degree of consensus on specific issues. Moreover, parking issues creates uncertainty about the resolution and that uncertainty is damaging to business over a possibly sustained period.  The biggest issue on which such uncertainty arises concerns the decision an independent Scotland would make about its currency.

       When Ireland became independent in 1921, the issue was parked.     After independent home rule people in Ireland carried on using English pounds in exactly the same way that they had been doing before.  These English pounds were issued by the Bank of England through Irish banks.  Only in 1927 did Ireland start to have its own bank notes and for a long period after that the Irish currency board backed these Irish notes 100% by Bank of England notes.  An Irish note was only an Irish badge attached to an English currency.  It wasn’t until 1942 that Ireland established its own central bank and only in 1979 was the fixed link between the Irish pound and the British pound finally broken.

       The financial world is now very different, as illustrated by the most significant parallel in Europe in living memory; the breakup of Czechoslovakia.  The intention there was to park the currency issue; but  this proved impossible.  Three weeks after the two separate countries came into being at the beginning of 1993 there was a decision to have separation between the Czech crown and the Slovak crown.   That decision was kept secret for three weeks for preparations.   But six weeks after the two countries became independent there were Czech crowns and Slovak crowns and the Slovak crown immediately went to a discount.

       There are three basic currency options for an independent Scotland:  to join the euro, to form a monetary union with RUK and continue to use Bank of England pounds, to have a separate Scottish currency.

       If Scotland were to apply for membership of the European Union, it would have to accept that the euro is the official currency of the European Union.  However, initially, Scotland would not even qualify for membership of the eurozone because its debt and deficit levels would violate the Maastricht criteria. There is thus no immediate issue.  The position of a Scottish currency would be one of many issues to be negotiated between Scotland and the European Union.  Recent accession countries to the European Union have broadly been told they have to take the Treaty as it is and it can be expected that much the same would be said to Scotland.  There would, however, be discussion of areas where the United Kingdom has negotiated opt outs or special arrangements. 

       It would not be sensible for the European Union to insist on Scottish accession to the Schengen agreement on a common passport zone, since Scotland’s only land border is with a state outside it.  Nor need the EU require Scotland to abandon its zero VAT rate on food, clothes etc.   There is, however, no chance at all that Scotland would inherit any share of the UK’s budget rebate.   The currency question would probably be settled by vague aspiration on the part of Scotland to join the euro at some time in a future so indefinite as to be irrelevant to any current decisions.

       The euro option can be excluded.  It would be sensible, as Scottish ministers have currently proposed, for Scotland to attempt to form a monetary union with England after independence.  But it would not be easy to achieve that outcome.  The debate would be conditioned by recent eurozone experience. Conventional wisdom today – not necessarily well founded – is that monetary union is only feasible if there is a very high degree of fiscal coordination leading in the direction of fiscal union, if there is a banking union, and if there is also widespread coordination of other policies.  It is certain that if negotiations took place between Scotland and the UK over the formation of monetary union, that the position would be adopted by the Bank of England and the Treasury at Westminster would take. 

       Would the outcome of such a negotiation be consistent with aspirations for an economically independent Scotland?  The fundamental asymmetry between a country that represents 8½% of monetary union and one that makes up 91½% of a monetary union is a fundamental difficulty.  The rest of the UK would seek extensive fiscal oversight over the management of the Scottish economy and would be unwilling to concede analogous oversight from Scotland over the fiscal and other policies of the UK.  At the very least the Scottish government would have to prepare for the possibility that these negotiations would not succeed.  The principal alternative for an independent Scotland would then be the adoption of a separate currency.

       Now if that option is on the table –  and it has to be to talk seriously about independence for Scotland – then the fact that it is on the table becomes relevant not just from the day of independence but the day at which independence  itself becomes a serious option.   If there were to be a vote in Scotland for independence – indeed if it were believed to be likely that the vote in Scotland would go in favour of independence – sophisticated individuals and businesses would start positioning themselves to ensure that they benefited from, or at least did not lose out, from the establishment of a separate currency.  

       They would start to ask, as Czechs and Slovaks started to ask, “what might happen to my bank account,, my life insurance policy, my mortgage. Is my account  likely in future to be a mortgage in Scottish pounds or in English pounds?”  The consequential uncertainty and instability are obvious.   It is difficult to decide what the outcome of monetary negotiations would be and yet vital that  everyone knows the answer.

       The perhaps inevitable, if  second best, option for an independent Scotland would be an independent currency:  an outcome which entails costs although these costs should not be exaggerated.  If there were an independent Scottish pound it would be sensible for Scotland to peg it to the English pound, as the Irish did for so long.  A more relevant current example  is the Danish krone which has been pegged against the euro since the establishment of the eurozone.  Danish businesses maintain accounts in krone and in euros and the peg provides Denmark with much of the stability which a formal currency union would offer.    That said, it must be acknowledged that Danish politicians and business people would mostly like the country to join the eurozone. It does not happen because the voters won’t agree.  A currency peg, formal or informal is a realistic option for Scotland and such a move may in fact be a necessary outcome of moving towards independence.

       Allocation of debt between the two countries would naturally be based on population or (onshore GDP share – there is little difference between the two.   rUK (as successor state) would continue to be liable for the totality of outstanding would continue to be liable for the totality of outstanding debt but Scotland would presumably be responsible for servicing a pro rata share and would roll over that share into Scottish debt as the historic stock matured.  Scotland could expect to pay a modest premium for the unfamiliarity and relative illiquidity of a new small country’s debt, although this might initially be offset by some enthusiastic patriotism (both in Scotland in the diaspora).  Scotland’s borrowing capacity would be limited by a debt to GDP ratio not very different from the unfavourable debt to GDP ratio for the UK as a whole.

              The current fiscal position is that Scotland receives a block grant from the UK government for the bulk of its expenditure.   Health and education are the main expenditure items among devolved functions.  The allocation to Scotland in that block grant is around 10 – 12% higher per head of population than the corresponding figure for the UK as a whole.   In other words, there is a cross subsidy from the UK to Scotland.  But –  perhaps not coincidentally – that cross subsidy equates roughly on average to the gain to Scotland from an allocation of oil revenues by reference to the general principles of territorial rights in the North Sea in international law.  Scotland would have a budgetary position that was more volatile and more uncertain but on balance neither substantially more favourable nor substantially less favourable than the status quo.  The additional per capita public expenditure in Scotland mainly goes on higher staffing levels in health and education services.  Class sizes in schools in Scotland are significantly lower than in the UK.  That favourable pupil teacher ratio is not reflected in higher levels of educational attainment in schools in Scotland.  While educational attainment levels in standardised tests have been improving slightly in England since the beginning of the century, this has not been true in Scotland over the same period. 

       Scotland also spends more per head on health, employing more doctors and nurses and other ancillary workers per head of population than in England.  However morbidity, or mortality figures in Scotland are markedly worse than that of the UK as a whole and Scotland is the worst health performer among major countries in western Europe.  That adverse outcome is partly but not wholly accounted for by particularly poor outcomes in Glasgow and the west of Scotland. 

       Scotland spends a lot in its public sector and it is not very clear what Scotland gets as a result. As a result of the spending splurge which took place in the United Kingdom from 1999 – 2006.  Over these seven years, public expenditure in Scotland increased by almost 50%. Scotland was given more money through the block grant than it could sensibly spend in the early years of devolution.

       But these discussions as to whether Scottish voters would, in the short term, be net gainers or losers from the replacement of a subsidy from the UK by a _____ from the oil industry are hardly a serious basis for a decision as to whether Scotland should become an independent country.  The central economic issue is:  What would independence mean for the performance of business in Scotland?  The long run success or failure of the Scottish economy depends on the answer to this question.  The economic performance of a small state like Scotland depends on the country’s ability to develop competitive advantages in relatively narrow areas of specialism which are then exploited on a global scale.  The issue then becomes ‘what competitive advantages does Scotland have, or might Scotland have, that would enable Scottish businesses to compete as effectively as Swiss businesses, or Danish businesses, or Swedish businesses, or Finnish businesses: first within the European Union and then in a worldwide market?’ 

       Scotland enjoys a traditional strength in financial services, product of a long Scottish involvement in imperial trade and finance.  The record of Scottish financial services over the last decade has certainly been distinguished, but not in a good way.  Having established a reputation for prudence and conservatism over a century or two, Scotland’s banks managed to dissipate that particular reputation in a short-lived phase of folly.  Even if Scotland no longer has the position in international banking to which it once aspired, Scotland nevertheless retains quite a strong position in insurance, and in asset management.  In these industries, a reputation for conservatism and competence remains largely intact.    

       Edinburgh is Britain’s second financial centre and Scotland has an obvious source of competitive advantage in tourism.  But tourism levels in Scotland relative to other European countries are lower than Scotland’s potential as a tourist destination might appear to offer.  And it is hard to identify Scottish firms that will compete effectively and globally in that sector.  They once existed:  they have mostly be absorbed into global corporations. 

       Here we come up against one of the most serious problems of Scottish business –  the drain of Scottish business and Scottish headquarters out of Scotland over 20, 30 , 40 years.  Is this due to Scotland’s membership of the United Kingdom? Or would much have happened anyway in a world in which London is a major financial and business centre, and in which merger and acquisition activity across borders has become progressively easier?  But certainly Scotland has not been able to adopt policies of retaining corporate headquarters within its boundaries in ways that it might and probably would have been able to do as an independent country. There are no large tourism businesses based in Scotland. 

       Another industry in which Scotland has a potential competitive advantage is premium food and drink.   Scottish products are at the top end of the market for these commodities.   Scottish salmon, beef, shellfish, whisky are highly prized and highly valued around the world.  It is surely odd that Scotland combines some of the best food products in the European Union with the least healthy diet in the European Union.  Unless we address that disjunction Scotland cannot be as successful as if in developing competitive advantages in food production and export. There is probably no product of any kind in global markets as clearly identified with a single country as whisky: customers routinely ask simply for a Scotch.  Yet the two largest producers of Scottish whisky are Diageo –  with a minimal headquarters presence in Scotland and Pernod Ricard – a company whose name conveys immediately that its owners live not only outside Scotland but outside the United Kingdom.   That said,  the arrival of Diageo and Pernod Ricard in the Scottish whisky industry has revived a sector which was previously in decline.   The takeover by Guinness of the Scottish based Distillers’ Company in 1986 put an end what is probably one of the worst and longest sagas or mismanagement in British business history. 

       A saga with wider lessons.  Both whisky and banking are stories of loss of competitive advantage through management failure, and responsibility for these failures is located in Scotland, not outside it. Scotland has failed to develop sufficient new strong businesses.  That observation may relate to my comments about morbidity and mortality.   

       There are some emerging areas.  Scotland has some competitive advantages in energy services that have been developed round the growth of North Sea oil production.  Another area of specialism in Scotland is life sciences – or medical related activities.  Scottish doctors have had a reputation around the world for at least two hundred years.  Not only is Scotland still a major centre for medical training but a variety of spin off businesses have developed around that particular sector.  It is possible that an independent Scotland could develop the kind of competitive advantages in particular businesses that would enable Scotland to compete as an independent state effectively in global markets in the way I have described for other prosperous small states.  What is needed is a climate of enterprise and entrepreneurship within Scotland.

       The recent history of Scottish entrepreneurship is an interesting one.  A number of successful new Scottish companies have been created, such as KwikFit, Stagecoach, and Clyde Blowers:  mostly by idiosyncratic individuals outside the traditional educational ladder climbed by “lads o’pairts’ who went on to Edinburgh or Glasgow Universities from Scotland’s famous academies.  Among more conventional middle class products of the Scottish education system, many people who have been successful in business.  An independent Scotland might offer an environment more conducive to the development and retention of such individuals in future.  That question is key to whether and independent Scottish state could develop a more effective business sector. 

       So the result of independence could be a much more vibrant economic environment.  It is hard to deny that devolution has led to some revival of Scottish identity and self-confidence, and independence might do more.  But independence might evolve in a different way.  Scotland – and especially Glasgow and west central Scotland suffered in the twentieth century from a municipal socialism which, initially idealistic and well-intentioned, became reactionary and mildly corrupt, in a way that damaged both individual aspiration and business enterprise.  Small countries are also vulnerable.   Crony capitalism which produced such disastrous results in other west European economies such as Ireland or Iceland.   It is not difficult to see how a combination of the two might have a baleful effect on any kind of entrepreneurial culture.  It is on the balance of these two forces – the greater dynamism of a more self confident state, the complacent self-congratulation too often characteristic of Scottish culture – that the economic progress of an independent Scotland would likely depend.