Sean O'Grady: Split with Scotland would make for a messy divorce

Economic Outlook: The debt-to-GDP ratio of an independent Scotland might prove so large as to sink it financially before it was even born
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The Independent Online

Like all divorces, the one that eventually may befall England and Scotland will be messy and mired in arguments about money. ("England" is here shorthand for "whatever's left of the UK – England plus Wales, Northern Ireland, Cornwall and the Scillies. Probably"). Of course it's not certain. The victory of Alex Salmond's Scottish National Party (SNP) in the Scottish parliamentary elections was impressive, but the Scottish people are canny enough to distinguish between a Salmond administration that will help them resist the cuts, and outright independence. Support for that is about one quarter to one third of the electorate, and that doesn't guarantee an "aye" vote in 2014, the most likely timing for the referendum promised by the SNP.

Still, the possibility of an independent Scotland is an intriguing one, and a real one, in that way that hitherto unthinkable political events sometimes stealthily drift into reality. Another three years of cuts might just do it – and Scotland's reliance on public sector jobs is a problem. Much more likely, though, is a continuing erosion of Westminster's economic control of Scotland, although that may not be a plausible alternative.

At what point do separate powers over taxation, public spending, financial regulation, business and competition become so extensive that the idea of Scotland in the UK is no longer sustainable – if only because it brews up resentments in England? We may soon find out.

So Scotland a nation again, then. The first question would be what currency to adopt. Sterling is an option, theoretically. The Irish did this after the establishment of the free state in 1922, and that lasted until 1978. After a brief period of monetary independence, the punt gave way to the euro, and we all know what happened next; boom and bust. SNP politicians used to be fond of the euro, and pointed to the examples of Ireland and Iceland as what was achievable for a small dynamic financially adventurous nation at the edge of the EU. Of course, they're more circumspect about joining northern Europe's "arc of prosperity" now. Would the SNP promise a further referendum on whether to join the euro soon after a successful vote on independence?

Joining the euro is a much more realistic prospect in an independent Scotland than in the UK, and could be disastrous. Without the freedom to devalue the Scottish currency, Edinburgh would be trapped in the eurozone with deflation the only way to ensure competitiveness long term – and with the same baleful consequences as are now being experienced in Greece, Ireland and Portugal. The PIGS might then be Portugal, Ireland, Greece and Scotland rather than Spain, which appears to have escaped the contagion, for now. Such a prospect would complicate the independence referendum at any rate.

Scotland would, though, get full access to its oil, although that has been a declining asset, plus, within EU rules, its fishing rights. It could also capitalise on its superior education system, and promote the sort of low-tax environment that helped the Irish and the east Europeans win inward investment.

But there are weaknesses in Scotland too. It is no longer propping up the foot of the UK's economic league table – more prosperous than the West Midlands now, for example – but it is not about to join the BRICs, either. Scotland, for all its strengths, would be much more like an amalgam of Ireland and Greece than to Germany in its fundamentals; relatively uncompetitive, with a big undercapitalised banking sector and a nasty overhang of private and public debt.

Which brings us neatly to the second big question, of how much of the UK's national debt Scotland ought to take on. And, within that, how much of the debt related to rescuing the semi-nationalised Scottish-based Royal Bank of Scotland and, arguably the Scottish bit of the Lloyds/TSB/Halifax/Bank of Scotland combine. Either way, the debt-to-GDP ratio of an independent Scotland might prove so large as to sink it financially before it was even born; 100 per cent of GDP is well within the bounds, being about 10 per cent of the UK's projected £1tr debt and Scottish GDP at about £100bn.

Scotland's non-existent track record in managing public finances might also leave markets to impose an immediate "risk premium", meaning even higher borrowing costs, lower investment and lower consumption levels immediately. Apart from Edinburgh New Town, where there would be rush for handsome townhouses to serve as embassies and high commissions, property would be swiftly devalued. Short term, independence would be tough, until Scotland demonstrated its strengths.

Which raises the third question. How effective would the Scots be at managing their own affairs? No worse than the English, it might be said. At least part of the reason why its great banks got into trouble was because the regulators in London failed. Then again, Sir Fred Goodwin was very much a home-grown product of the Scottish financial establishment. The Scots are no longer obviously superior beings when it comes to finance. Geographical tensions and sectarianism are also threats to cohesion.

The economic risks then, for an independent Scotland are substantial, and probably prohibitive. Being a relatively small nation inheriting sizeable debts (through no fault of its own, beyond the fact that Britain had a Scot as Prime Minister and Chancellor running them up), and a large financial sector many times GDP, the chances of getting policy right are slimmer than they might be.

Which leaves the much more likely path of increased financial and economic autonomy within the UK: "fiscal federalism". We are moving towards that, with the Welsh and Northern Irish following the Scots' lead. The Scotland Bill now passing through Westminster will grant Holyrood further powers to vary taxes beyond the 3p in the pound currently available – a 10p variation in income tax, plus freedom for stamp duty on property, landfill tax, air passenger duty, and the aggregates levy.

In line with the recommendations of the Calman commission, an amount equivalent to the 10 per cent of UK tax revenues now allocated to Scotland will be deducted from the grant currently made to Scotland from the UK. If the Scottish Government simply applies a 10 per cent tax rate, it will theoretically end up with the same revenue as would have been the case had the proposal not been implemented. So it could vary income tax quite radically. Yet why should the English tolerate a neighbour with a much more benign tax regime if, as many perceive, they are subsidising that neighbour?

If fiscal federalism and independence are not viable, then Scotland might be better off staying where it is, although the momentum is against that.

Way back in the 1980s and 1990s Scottish Tories used to argue that devolution would inevitably lead to independence. It must be no comfort for the likes of Michael Gove to be proved right now. Will he, I wonder, have to apply for a work permit be allowed to keep his London-based job? And would he qualify under the immigration cap?

As I say, it will be a messy divorce.

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