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The economics of Scottish independence look more difficult

  • The interactions between Brexit, the deterioration in Scotland’s fiscal situation and the continued lack of an easy option for the currency have made the economics of Scottish independence even more challenging than at the time of the first referendum in 2014. This doesn’t mean an independent Scotland couldn’t be an economic success. But it would require Scotland to put in place credible plans to cut the budget deficit. The resulting fiscal squeeze would restrain economic growth and mean that in its first 5-10 years, an independent Scotland is more likely to fall further behind the rest of the UK than catch it up.
  • The Scottish government is intensifying its push for Scotland to leave the UK and become an independent country. There are even some signs that the UK government’s reluctance to grant a second independence referendum is softening. There’s no reason why in the long run an independent Scotland couldn’t be an economic success. Ireland, Denmark and Sweden are similar in size and have higher GDP per capita than the UK. But there are three reasons why the economic transition to an independent Scotland in the short term is now even more challenging than when Scotland voted against independence in 2014.
  • First, Brexit means Scotland would now need to choose whether to have closer trading relations with the rest of the UK (“rUK”, where 60% of its exports go) or with the EU (where 19% of its exports go). This wasn’t an issue before Brexit as Scotland and rUK were both in the EU, so after independence the trading arrangements would have remained the same. The SNP’s desire to rejoin the EU implies Scotland would choose to be closer to the EU than rUK. This risks introducing trade frictions on Scottish exports that are equivalent to 31% of Scottish GDP to reduce frictions on exports equivalent to 10% of Scottish GDP.
  • Second, the structural deterioration in Scotland’s fiscal position since 2014 means that it’s even more important that Scottish policymakers put in place a credible plan to cut the budget deficit. We estimate that an independent Scotland would start with a budget deficit of 9% of GDP and a debt to GDP ratio of 100%. Importantly, public debt is likely to be denominated in sterling. Even if we assume that the financial markets judged Scotland’s fiscal plans as credible as the UK’s, a fiscal squeeze of 0.9% of GDP may be needed in each of the first five years (4.5% in total) to stabilise the debt to GDP ratio. If Scotland’s borrowing costs were 1.0 ppt higher than rUK’s, the fiscal squeeze would need to be 5.5% of GDP. Credibility is key as that contains bond yields and limits the size of the fiscal squeeze and the resulting drag on GDP growth.
  • Third, leaving the UK’s currency union would be no easier than in 2014. Because an independent Scotland would be less productive than rUK, Scotland’s real effective exchange rate (REER) may need to weaken by about 5%. If Scotland launched its own currency, this would come via a fall in the nominal exchange rate. Monetary and fiscal policy would then need to tighten to prevent a vicious circle of rising inflation and an ever-weaker currency. If Scotland kept the pound, pegged its new currency to the pound or adopted the euro, the lower REER would come via an internal devaluation (i.e. a relative fall in domestic prices). This would lead to lower wage growth and higher unemployment as firms cut costs. The size of the required adjustment in the REER is not big and is no bigger than in 2014. But it would make the necessary fiscal adjustment harder – either because a weaker exchange rate would increase the local currency value of sterling-denominated debt or as internal devaluation would increase the debt burden in real terms.
  • Overall, for Scottish independence to be a success there needs to be clear and credible plans for trade, fiscal policy and the currency. The scale of the policy challenge and the necessary fiscal adjustment makes it more likely than not that an independent Scotland would fall further behind rUK in the immediate aftermath of independence.

The economics of Scottish independence look more difficult

Brexit and this year’s Scottish election have reignited the debate on Scottish Independence. In this Focus, we consider how the economic situation has changed since Scotland voted against independence in 2014 and what independence might mean for Scotland’s economy and for the rest of the UK (rUK).

Brexit puts independence back into focus

The 55:45 vote in favour of staying in the UK in the first Scottish independence referendum in September 2014 should have put the issue to bed. But Brexit brought it back into focus as in the 2016 EU referendum Scotland voted to stay in the EU while rUK voted to leave. And during most of last year, the polls suggested that for the first time since 2015 a majority wanted independence. (See Chart 1.)

Chart 1: Should Scotland be Independent? (%)


Sources: YouGov, Capital Economics

What’s more, May’s Scottish elections gave a majority of seats to the pro-independence Scottish National Party (SNP) and the Green Party, who have since entered an agreement to “secure a referendum on Scottish independence…within the first half of the five-year parliamentary session”. With the session due to run from May 2021 to May 2026, they are seeking a second referendum by late 2023.

Of course, a second referendum isn’t within the gift of the Scottish Parliament as it would need to be granted by Westminster. And in January, Boris Johnson said he viewed the 2014 referendum as a “once in a generation event”. That said, in August Michael Gove said “if…there is clearly a settled will in favour of a referendum, then one will occur.” And Westminster’s Scotland Secretary, Alister Jack, defined a “settled will” as “60% of the [Scottish] population wanting a referendum”. The polls currently sit at 42%. Even so, this appears to represent a softening in Westminster’s position.

There is no way of knowing if, when and how a second referendum would happen. So the rest of this Focus is based on the assumption that there is a referendum, that Scotland votes to leave the UK and that Westminster grants independence. If that were to happen, how would Scotland and rUK fare?

Don’t write off Scotland

It’s important to be clear that an independent Scotland could be an economic success. Its population is similar in size to other small Northern European countries, such as Ireland, Denmark and Sweden, all of which have significantly higher GDP per capita than the UK. (See Chart 2.) There is no reason why Scotland couldn’t achieve similar prosperity. After all, it shares many of the same advantages of strong institutions, world-class universities and openness to trade and investment.

Chart 2: GDP Per Capita, 2020 (US$ PPP Rates)


Sources: Refinitiv, Irish Central Statistics Office, Capital Economics

However, while an independent Scotland might ultimately prosper, the economic transition is likely to be long and difficult. It’s worth keeping in mind that for many years after independence in 1922, incomes in Ireland lagged well behind those in the UK. Ireland’s outperformance only began following a wave of deregulation in the 1990s. (See Chart 3.)

Scotland versus rUK

Many of the challenges that an independent Scotland would face stem from the economic ties that bind it to the UK – and the differences that would necessitate a substantial adjustment after independence. Table 1 fleshes out these factors. The 5.5 million people in Scotland make up 8.1% of the 67.1 million people in the UK. But because Scotland’s GDP makes up 7.8% of the UK’s GDP, Scotland’s GDP per capita of £30,013 is lower than rUK’s of £31,616. (See Table 1.)

Chart 3: GDP Per Capita (US$ PPP Rates)


Sources: Refinitiv, Irish Central Statistics Office, Capital Economics

The sectoral make-up of the Scottish economy is broadly similar to that of the UK, although industry accounts for a slightly larger share of GDP in Scotland and services accounts for a slightly smaller share. But there are two key differences.

First, Scotland is more open than rUK. Its exports are the equivalent of 48% of its GDP versus 25% for rUK. Second, its public finances are weaker. Scotland’s public sector spends more per person than rUK and collects less tax per person, resulting in a bigger budget deficit. In 2020/21, the pandemic contributed to Scotland running a budget deficit worth 22.4% of its GDP compared to rUK’s 10.7%.

And there is one obvious, but crucial, similarity – Scotland and rUK are in a currency union as they both use the pound.

Table 1: Selected Economic Indicators




Population (Millions, 2020)




% UK Population (2020)




Nominal GDP1 (£bn, 2020)




% UK GDP (2020)




Nominal GDP Per Capita1 (£, 2020)




Real GVA (% y/y, 2015-19)




Industry % Nominal GVA (2019)




Services % Nominal GVA (2019)




Exports % Nominal GDP (2020)




Imports % Nominal GDP (2020)




Budget Balance1 (% GDP, 2020/21)




Govt. Spend. Per Capita1 (£, 2020/21)




Govt. Rev. Per Capita1 (£, 2020/21)




Unemployment Rate (%, 2015-2021)




1 Including North Sea oil activity, split by geographical share

Sources: ONS, Scottish Government, Refinitiv, Capital Economics

Accordingly, independence would require policymakers in Edinburgh to make difficult policy choices in three key interdependent areas:

  1. Borders and the economic/trading relationship with rUK and the EU.
  2. Fiscal policy and debt burdens.
  3. Currency and exchange rate regime.

The challenges in all three areas are as tough or even harder than they were at the last referendum in 2014.

Borders – Brexit created a tougher choice

Trading terms are always going to be economically important for an open economy like Scotland, whose exports are equivalent to 45% of its GDP. The Scotland/rUK border is especially important as 60% of Scotland’s exports (equivalent to 31% of Scotland’s GDP) go to rUK. But the Scotland/EU border isn’t irrelevant either. Although only 19% of Scotland’s exports go to the EU, compared to the UK’s 45%, the importance of Scottish exports overall mean that’s still equivalent to 10% of Scotland’s GDP. That’s similar to the UK as exports to the EU are equal to 14% of GDP. (See Chart 4.)

Chart 4: Goods & Services Exports by Destination (2018)


Sources: Export Statistics Scotland, Capital Economics

None of this mattered before Brexit. At the time of the last independence referendum in 2014, both Scotland and the UK were in the EU. Accordingly, independence wouldn’t have created any new trading borders. Instead, Scotland, rUK and the EU would all have been in the EU’s single market and the trading arrangements would have been the same as before independence.

However, Brexit has meant that Scotland and the UK are now both outside of the EU. So if Scotland left the UK, Scottish policymakers would need to decide if they want to prioritise trading arrangements with rUK or the EU.

There are two options. If Scotland wants to keep the current frictionless trade with rUK, then it would need to keep the current barriers to trade with the EU. If Scotland wants to have freer trade with the EU by rejoining the EU, then it would need to accept some barriers to trade with rUK.

The SNP’s commitment to “rejoining the EU as soon as possible” implies Scotland would choose the second option. But even if we put aside the fact that this would create trade frictions on 60% of Scotland’s exports in order to ease frictions on 19% of its exports, rejoining the EU would not be seamless.

EU law states that only independent countries can apply for membership. That means Scotland would probably have to conclude its separation negotiations with rUK before it could even apply to become an EU member. And typically there is a five year gap between applying and becoming a member. As such, Scotland may have to spend some years outside both the UK’s and the EU’s trading regimes. In 2014, this wasn’t a worry as it was assumed that Scotland’s membership of the EU via the UK would just switch to a EU membership in its own right.

It is still the case, though, that if Scotland joined the EU it would have to commit to adopting the euro at some point. Admittedly, that can be deferred for many years, as has been the case for some of the newest EU members in Central and Eastern Europe. But the failure to provide a clear answer to the question of what currency an independent Scotland would use was one reason why independence was rejected in 2014. And now the currency issue (which we return to later) is intertwined with the question of whether Scotland wants to align its trading arrangements closer to rUK’s or the EU’s.

In the long run, it may not matter much if Scotland chooses to be closer to the EU or rUK. But the border issue does make the economic transition to an independent Scotland more challenging in the short term than it would have been before Brexit.

A credible plan for a fiscal squeeze

The outlook for fiscal policy is the second area when the economics of independence have become more challenging since the first referendum in 2014.

We’ve already highlighted how in 2020/21 Scotland’s budget deficit was 22.4% of its GDP compared to rUk’s 10.7% of GDP. Of course, both Scotland’s and rUK’s budget deficits have blown out due to the pandemic, the bulk of which we think will prove temporary. (See here.)

But Scotland’s budget deficit has always been bigger than rUK’s – and the gap has widened since 2014. This suggests that Scotland’s structural deficit (i.e. the deficit excluding any temporary influences related to COVID-19 and the economic cycle) has deteriorated relative to rUK’s.

For example, in the five years before the 2014 referendum, Scotland’s budget deficit was on average 8.5% of GDP and rUK’s was 4.5% of GDP. So Scotland’s deficit was 4.0 percentage points (ppts) bigger than rUK’s. But in the following five years, rUK’s budget was on average in balance while Scotland’s deficit widened to 9.2% of GDP. The gap between the two widened by 5.2 ppts. (See Chart 5.)

Chart 5: Budget Balance (As a % GDP)


Source: Scottish Government

The bulk of this apparent deterioration in Scotland’s structural budget deficit is a result of the shrinking in its tax base due to the lower oil price. In 2014, the oil price had been over $100 per barrel for three years. This meant that in the five years before 2014, Scotland’s North Sea tax revenues were bringing in the equivalent of 4.0% of Scotland’s GDP per year. But in the past five years, they have brought in the equivalent of just 0.5% of GDP a year. (See Chart 6.)

As we don’t expect oil prices to rise back to $100 per barrel on a sustained basis, this suggests that changes to the tax base mean that Scotland’s structural deficit may be something like 3.5 ppts of GDP bigger than at the time of the first referendum in 2014.

Chart 6: Scottish North Sea Tax Revenues (% of GDP)


Sources: Scottish Government, Capital Economics

There has also appears to have been a structural rise in public expenditure in Scotland relative to in rUK. Again, it is best to ignore the surge in spending during the pandemic, most of which will probably be temporary. But in the 10 years before the SNP came to power in 2007, public expenditure as a share of GDP in Scotland was 5.0 ppts higher than in rUK. In the 12 years between 2008 and 2019, the divergence widened to 6.0 ppts. (See Chart 7.)

Chart 7: Total Public Expenditure (As a % of GDP)


Sources: Scottish Government, Capital Economics

In other words, a reduction in the tax base and an increase in public spending means that Scotland’s structural deficit has significantly worsened since 2014. Once the temporary effects of the pandemic have passed, an independent Scotland may be saddled with a budget deficit of around 9% of GDP.

To complete the fiscal picture, we also need to consider what level of public debt an independent Scotland would start with. The key point is that an independent Scotland would have to assume responsibility for its “fair share” of the UK government’s £2.1 trillion of public debt.

We shouldn’t rule out the nuclear option that Scotland refuses to accept any of the debt. But it is more likely that an agreement is reached to split the debt.

One option would be to split it on an “historic” basis. This would calculate the sum of past fiscal deficits on the basis that tax revenues from North Sea oil and gas should be attributed to Scotland rather than to the UK as a whole.

Another option would be to split it on the basis of population. This is what happened in the relatively amicable split between the Czech and Slovak republics in 1993. This would probably be the most likely outcome if Scotland became independent. The general principle is that physical assets belong to the state in which they are situated, while the debt is divided in line with the relative population size. Given that Scotland has 8.1% of the UK’s population, it would inherit about £170bn of the UK’s current £2.1trillion debt pile. That would be equivalent to 98% of Scotland’s pre-pandemic level of GDP in 2019/20.

An independent Scotland may therefore start its life with a budget deficit of about 9% of GDP, a primary deficit of around 6% (as Scotland’s debt interest costs have averaged 3% of GDP in recent years) and a public debt to GDP ratio of almost 100%. In 2014, an independent Scotland would also have started life with a budget deficit of close to 9% of GDP, but the debt ratio would have been a smaller 80% of GDP.

Given the bigger size of the budget deficit and the higher debt ratio, it’s even more important that the Scottish government sets out a credible plan to cut borrowing over time. Otherwise it could face a sharp and destabilising rise in debt servicing costs. The government’s commitment to such a plan is as important as the plan itself – a programme to narrow the deficit gradually over several years that has broad political support is more likely to curry favour with bond markets than an aggressive plan to narrow the deficit that is built on shaky political foundations.

The fiscal squeeze would need to be sizeable even in some favourable circumstances. If the structural primary budget deficit were 6.0% of GDP, Scottish GDP were to grow at 1.5% a year in real terms, Scotland had an inflation rate of 2.0% and the Scottish government delivered a credible plan that allows it to borrow at similar rates to the rUK government (we assume 2.0% for 10-year bonds), then a fiscal squeeze of around 0.9% a year for five years (4.5% of GDP in total) would be needed to prevent the debt to GDP ratio from rising after five years.

However, if the Scottish government was forced to borrow at a 100 basis point (bps) premium to the rUK government (i.e. Scottish government 10-year bond yields were 3.0% compared to rUK yields of 2.0%), and the other assumptions were the same, to stabilise the debt ratio after five years the fiscal squeeze would need to be 1.1% a year (5.5% of GDP in total). (See Table 2.) For every 100bps increase in bond yields, the fiscal squeeze each year would need to be 0.2ppts of GDP bigger and the total squeeze over five years would need to be 1.0 ppt of GDP bigger.

Table 2: Sustainability of Scottish Public Debt

Credibility of Scot Govt fiscal plans

As Credible as rUK

Less Credible than rUK

Economic Assumptions:

Primary Budget Deficit (% GDP)



Real GDP (%)



Inflation (%)



10-Year Bond Yield (%)



Fiscal squeeze to stabilise debt to GDP ratio:

% GDP p.a



% GDP over 5 years



Source: Capital Economics

So even if the bond markets were willing to lend to Scotland at the same rate as to rUK, Scotland may need to start its life as an independent country with a fiscal squeeze amounting to something like 4.5% of GDP over five years. And if the bond market demanded a premium to lend to Scotland, the total fiscal squeeze would need to be even bigger. Credibility is key. The more credible the plan, the smaller the required fiscal squeeze.

The situation is complicated as an independent Scotland would inherit public debt from rUK denominated in pounds. This means that the sustainability of Scotland’s public debt also depends on the currency issue as that would determine the value of the public debt Scotland inherits from the UK. This brings us to the third area where the economics of independence are at least as challenging as in 2014.

Currency & exchange rate regime – no easy option

If Scotland leaves the UK, it will also need to decide if it leaves the UK’s currency union. An independent Scotland would have two currency choices. Neither is more palatable than in 2014. And both will undoubtedly involve a weakening in Scotland’s real effective exchange rate, which would exacerbate its fiscal challenges.

The first option is for Scotland to use an established currency. This would probably mean keeping the pound, either with or without the explicit agreement of the rUK government. Keeping the pound in some form would have the advantage of Scotland being able to piggyback on the monetary credibility of the Bank of England. It would also limit exchange rate risk and transaction costs for Scottish firms trading with rUK.

But it would also require Scotland to leave control of monetary policy with the Bank of England. This could limit the ability of Scottish policymakers to respond to economic shocks specific to Scotland. It would also presumably mean that the Bank of England would have to act as a lender of last resort for Scotland. As this means that the rUK government would ultimately be on the hook for the debts of the Scottish government, the rUK government may insist on overseeing Scotland’s fiscal management – thereby undermining Scotland’s independence.

Without such an agreement, Scotland would be vulnerable in a crisis as there would be no institution to backstop its bond market or its banks. This could be a particular problem for Scotland as its financial sector is so large. (Scottish bank assets are roughly 1,250% of Scotland’s GDP compared to 492% for the UK.) As a result, an independent Scottish government may struggle to support its banks in a financial crisis. This risk could result in some Scottish banks leaving Scotland for rUK after independence.

In theory, Scotland could use the euro instead. This would leave it less reliant on rUK, provide it with more control over fiscal policy and mean the European Central Bank (ECB) could be the lender of last resort. But it would also mean handing over control of monetary policy to the ECB. And as Scotland’s economy is more synchronised with the rUK economy than the euro-zone’s, inappropriate policy settings could lead to Scotland’s economy either overheating or being held back. And to use the euro Scotland would need to join the EU, which we noted earlier is not as straightforward now as it would have been in 2014.

The second option is for Scotland to set up its own central bank and issue its own currency (the Scottish pound perhaps). This would bring major economic benefits. Scotland would be able to pursue monetary policy tailored to its needs and a Scottish central bank would issue the currency and act as a lender of last resort.

However, the Scottish government would need to establish credibility in its new currency. This is a particular concern in the context of the fiscal challenges that an independent Scotland would face, which we highlighted earlier. Without credible fiscal and monetary policies, it is likely that a Scottish pound would weaken. The resulting boost to inflation would add to the pressure for the currency to weaken further, and risk setting in train a vicious cycle of an ever-weakening exchange rate and ever-rising inflation.

One way to impose discipline on policymakers would be for Scotland to adopt some form of fixed exchange rate. A conventional currency peg with the pound would require Scotland’s central bank to set monetary policy in line with the Bank of England. (This is similar to the way the National Bank of Denmark tracks the policies of the ECB.) This would provide an anchor for monetary policy and help establish confidence in the currency.

Going one step further, Scotland could adopt a currency board. This would require every unit of domestic currency (the Scottish pound) to be backed by an equivalent unit of foreign exchange reserves (such as the pound). A currency board imposes additional discipline on policymakers since a country needs to run external surpluses in order for the domestic money supply and foreign exchange reserves to grow. This in turn requires sustained fiscal discipline stretching over many years. This is the arrangement that Ireland first used from 1927 after its independence in 1922.

The bottom line is that there are no easy choices. At one end of the spectrum, Scotland could keep the pound but hand over control of monetary and fiscal policy to the rUK government. At the other end of the spectrum, it could use its own currency and retain policy independence, but would need to commit to a credible plan of fiscal retrenchment to avoid a series of currency crises. Even adopting a currency board, which would impose fiscal discipline on policymakers, would remove sovereignty over policy and undermine independence.

The most important point is that whatever currency arrangement Scotland chooses, its real effective exchange rate (REER), which is the nominal exchange rate adjusted for relative inflation between Scotland and its trading partners, would probably have to weaken. This is because Scotland is less productive than the UK and would probably be perceived to be become even less productive after independence (due to the possibility of more trade frictions at the Scotland/rUK border). And a weaker REER would make Scotland’s fiscal position even more challenging.

There are two ways that a country can engineer a weaker REER. The first is through a depreciation in the nominal exchange rate. This is probably what would happen if Scotland established its own floating rate currency. This would help restore external competitiveness for Scotland’s exports, but higher import costs would cause an initial rise in inflation. This would need to be met with tighter monetary and fiscal policy in order to bring inflation back down and ensure that the benefits of a weaker nominal exchange rate are not eroded by higher domestic prices.

The second way that the real exchange rate can adjust is via an internal devaluation. If the nominal exchange rate is unable to fall because it is pegged or the country is in a currency union, then Scotland would have to restore external competitiveness by cutting its labour costs/prices relative to its trading partners. This normally involves very low wage growth, fiscal restraint and high unemployment.

This is exactly what happened to Spain, Greece and some other Southern European economies during the Global Financial Crisis (GFC). The UK was able to restore its competitiveness by a devaluation of the pound. (See Chart 8.)

But as Spain was in the euro-zone’s currency union, it didn’t have this option. It had to undergo a painful internal devaluation, which resulted in a prolonged period of high unemployment. (See Chart 9.)

Chart 8: Real Exchange Rates (Jan. 1999 = 100)


Source: BIS

Chart 9: Unemployment Rate (%)


Source: Refinitiv

Something similar, although perhaps not on quite the same scale, would probably happen to Scotland if it kept the pound or pegged its currency at a level above where it should naturally be.

After all, Scotland is less productive than the rest of the UK, which means that the REER would need to weaken to compensate. According to the ONS data on real output per job filled, in 2019 Scotland was about 3.5% less productive than the UK. That’s similar to the situation in 2014. (See Chart 10.)

Chart 10: Scotland Productivity (Real Output Per Job, 100 = UK Productivity)


Source: ONS

Based on our analysis that for an upper-middle country like Scotland every 1 ppt decline in productivity is consistent with a 0.5-1.0 ppt decline in the REER, Scotland’s REER may need to weaken by 1.75-3.5%. In reality, though, the REER would probably weaken by more than that. That’s because, partly due to the possibility of more trade frictions at the Scotland/rUK border and the fiscal issues we’ve already discussed, there would be a perception that for some years an independent Scotland would be even less productive relative to the UK.

As such, it seems reasonable to assume that the REER would need to weaken by at least 5%. That wouldn’t be a huge adjustment. To put it into context, the pound fell by 15% after the Brexit Referendum in 2016 and Greece endured an internal devaluation of 30% after the GFC and 2011/12 euro-zone debt crisis.

Even so, the feedback loop from a weaker REER to the fiscal situation would provide another headache for Scottish policymakers. If the REER weakens because the nominal exchange rate falls, then the local currency value of the sterling-denominated debt that Scotland would inherit would rise. Likewise, if the REER weakens because domestic prices fall, then the real value of that debt increases.

Either way, leaving the UK’s currency union would require Scottish policymakers to commence a period of fiscal restraint in order to give credibility to the new currency arrangements. What’s more, the perceived deterioration in Scotland’s productivity relative to the UK’s means that a weakening in Scotland’s REER would exacerbate the fiscal problems. Of all the economic issues hanging over independence, the question of how Scotland will manage its currency remains the most difficult.

The implications for Scottish businesses

Businesses will be concerned about three main things; access to their customers, access to a lender of last resort and future tax rises. The further an independent Scotland moves from rUK, the more likely that some businesses based in Scotland move to rUK instead.

Keeping the pound and an open border with rUK would presumably be best for most Scottish firms, who have many of their customers in rUK. This would mean the Bank of England continues to act as a lender of last resort and it would minimise any disruption to trade across the Scotland/rUK border. This may mean fewer businesses feel the need to move south, although for some this would look like Scotland independence-lite.

Credible fiscal and lender of last resort plans would be crucial if Scottish policymakers decided to establish a new currency. The fear would be that Scotland’s new independent institutions couldn’t afford to back the banks in a financial crisis and/or that Scottish policymakers wouldn’t take control of the public finances, which may lead to high corporate taxes in the long run. Those arrangements may prompt many more businesses to move to rUK.

Adopting the euro would eventually provide Scottish businesses with a lender of last resort, some fiscal discipline and a comparative advantage of being a hub between the EU and rUK. But as it may involve Scottish businesses being outside both the rUK’s and the euro-zone’s trading arrangements for a few years (as Scotland would probably have to leave the UK before it even could apply to join the EU), some Scottish businesses may still be tempted south.

The one thing we do know is that businesses don’t like uncertainty. And when the outlook is more uncertain, they tend to invest less. So much depends on whether Scottish policymakers are able to provide clear and credible plans for the border, fiscal and currency arrangements well in advance.

The implications for financial markets

The reaction of the financial markets to independence would probably occur in two phases. First, the markets would price in a risk premium to UK assets in the run up to the referendum and immediately afterwards a vote for independence. Second, once the markets have a better idea of what independence will look like, they will price in some longer-term implications.

As soon as a vote on independence were to become more likely, the markets would presumably price some uncertainty into UK assets. There is some loose evidence that when it became more likely that Scotland would vote for independence in 2014, the pound weakened. (See Chart 11.)

Chart 11: £/$ & Scottish Independence Polling


Source: YouGov, Refinitiv

As this extra uncertainty would probably weigh on corporate earnings and business investment (which may prompt the Bank of England to keep interest rates lower than otherwise), UK gilt yields may be lower than otherwise and equity prices of Scottish businesses may also be lower than otherwise, although the weaker pound may support the FTSE 100 as a whole.

Immediately after a vote for independence, these moves would probably go further. The experience after the UK voted to leave the EU is a useful precedent, although the moves would surely be on a smaller scale if Scotland voted to leave the UK. After Brexit, the pound fell by 15% and stayed weak until the UK-EU negotiations concluded nearly five years later. (See Chart 12.) 10-year gilt yields fell by 50 basis points as the markets priced in lower interest rates. The FTSE local suffered, while the lower pound boosted the FTSE 100 by 12%.

Chart 12: Pound Exchange Rates


Source: Refinitiv

It may be reasonable to expect the initial moves to be a third or half as big if Scotland voted for independence. For example, the pound may weaken by 5-7%. What’s more, if Scottish independence raised questions about the longevity of the rest of the UK’s union, there may be some extra downward pressure on UK assets.

What happens further ahead depends on the arrangements for the borders, fiscal policy and the currency. We have already highlighted that after independence Scotland’s REER may need to settle at a level about 5% lower than before independence. If Scotland established its own currency, then the Scottish pound would probably weaken. If Scotland eventually adopted the euro, the weakening in the REER would need to come through via lower wages and prices in Scotland.

(Note these moves are relative to before independence. So if the Scottish pound had already weakened by more than than 5% immediately after the vote for independence, in the longer term the Scottish pound could in fact strengthen a bit.)

If Scotland were to issue its own government bonds, they would probably initially have higher yields than rUK gilts. How much higher would depend on the credibility of the Scottish government’s fiscal plans. The more the markets believe in Scotland’s fiscal discipline, the smaller the premium between rUK and Scottish yields.

If Scotland were to assume a share of the UK’s current public debt in line with its population, then because Scotland makes up a larger proportion of the UK’s population than it does its GDP, rUK’s debt to GDP ratio would decline. But as it would fall by less than 1ppt, this mathematical effect is unlikely to make much difference to rUK gilt yields.

Scottish equities may struggle during the economic transition to independence, particularly as to make a success of independence Scottish policymakers may need to raise corporate taxes to keep the fiscal position in check. The FTSE 100 may not necessarily be worse off in the long term since a good chunk of its earnings are derived from overseas.

How would Scotxit differ to Brexit?

There are three reasons why the economic transition to an independent Scotland would be more challenging than the UK leaving the EU. First, trade flows show that the rUK and Scottish economies are more intertwined than the UK and EU economies were. Second, Scotland and the rUK are in a currency union. Currency arrangements and lender of last resort issues were not relevant when the UK left the EU as the UK already had the pound and the Bank of England. Third, Scotland would be starting life as an independent country without the fiscal credibility the UK had when it left the EU.


Scottish independence need not be a disaster in the long term. But the economic transition to an independent Scotland would be more challenging than Brexit and most of those challenges are now either bigger or more complex than at the time of the 2014 referendum.

To aid the transition, Scottish policymakers would need credible arrangements for the currency and credible fiscal plans to support those currency arrangements so that bond yields are kept low. Such fiscal discipline would surely restrain economic growth for a number of years after independence.

What’s more, the situation could be made even worse if Scotland became independent at a time when global inflation and bond yields were rising, as that would put the public finances of the fledging nation under further pressure.

So while independence may eventually be an economic success for Scotland, the need to fiscal restraint means that Scotland’s economic growth rates would probably be fairly subdued for the first 5-10 years. This doesn’t mean Scotland shouldn’t be independent. It just means that Scotland may decide if a challenging economic transition is a price worth paying to be in control of its own destiny.

The disruption to the rUK economy would be much smaller and much more manageable. Instead, the legacy of Scottish independence for the UK could be an increase in the desire for independence in Wales and for the reunification of Ireland. So Scotland’s independence could sow the seeds for a bigger break-up of the UK.

Paul Dales, Chief UK Economist, +44 (0)7939 609 818,
Neil Shearing, Group Chief Economist, +44 (0)7956 581 123,