RaboResearch - Economic Research

Scotland: from troubled marriage to happy single?

Economic Report


The Scottish referendum has taken an interesting turn over the last few weeks. For the first time, there was a small majority in favour of independence according to the YouGov poll of the 1st of September. In this Economic Report, we present a general picture of an independent Scottish economy and the risks and opportunities Scotland will face if the Scots vote ‘yes’ to independence from the UK.

The Scottish economy in broad strokes

After separation, Scotland would have a relatively small economy compared to other EU countries. With 5.2 million inhabitants, an independent Scotland is comparable to Norway, Finland and Slovakia. In terms of GDP, it is also comparatively small (figure 1). In terms of GDP per capita (PPP) it ranks significantly above the UK average (figure 2), which is due to the high revenue from oil exploration. Without oil, the GDP per capita (PPP) is 3% lower than in the UK. However, even if the oil exploration revenues is included, Scotland still ranks below countries like Norway, Germany, the Netherlands and Luxembourg in terms of GDP per capita (PPP).

Figure 1: GDP in PPP and real growth rate
Figure 1: GDP in PPP and real growth rateSource: Macrobond, ONS, Rabobank
Figure 2: GDP/capita in PPP and unemployment
Figure 2: GDP/capita in PPP and unemploymentSource: Macrobond, ONS, Rabobank

The economy has a strong oil and gas sector, contributing almost 18.4 billion in added value to GDP (14%) in current prices. Its manufacturing base is broad in EU comparison, making up 15% of added value in the economy (figure 3)[1]. The UK’s manufacturing sector contributes just 10% in comparison. A number of sectors are closely related to the availability of oil and gas; coke, petroleum and petrochemicals make up about 20% of all manufacturing production, while rubber and plastics account for 4%. Shipbuilding, particularly of military vessels, is important, especially politically, due to a high degree of labour union organisation and historical significance. Scotland has a large construction sector, supported by a high amount of public fixed capital formation, which is twice as high (per capita) compared to the UK. Financial services traditionally make up a significant part of the economy, as Scotland has a large banking sector, though they do not match the share in GDP of the UK or the Netherlands (figure 4). Services make up 65% of the economy, which is relatively low compared to most other advanced countries (figure 5).

Figure 3: Break-down of Scottish added value
Figure 3: Break-down of Scottish added valueSource: ONS
Figure 4: Financial activities as share of GDP (%)
Figure 4: Financial activities as share of GDP (%)Source: Worldbank, ONS

Exports are mainly directed towards the UK (figure 6), which accounts for 65% of export value (goods and services). Next to the UK, the main export destinations are the US, the Netherlands, France and Germany (table 1.) Goods exports account for 51% of all exports, 13%-points of these are oil related and 5%-points are spirits and beverages. Services exports account for the remaining 49%, of which 17%-points are financial sector services. The current account surplus of Scotland is 5.5 bn. Pound Sterling, which is 0.3% of Scottish GDP.

Figure 5: Manufacturing and services as share of GDP (%)
Figure 5: Manufacturing and services as share of GDP (%)Source: Eurostat, ONS
Figure 6: Exports to UK and rest of the World by export category
Figure 6: Exports to UK and rest of the World by export categorySource: ONS

In terms of the labour market, Scotland (unemployment rate of 7.3%, figure 2) is broadly comparable to Northern European countries. The old age dependency ratio currently stands at 31.5% (compared to 25.9% for the UK and 26.8% for the EU as a whole), showing that for every pensioner, there are three individuals in the working-age population. This ratio will increase further when the population continues to age. Like in the UK and the rest of Europe, population is aging quickly, limiting the growth potential based on demographic factors.

Table 1: Key statistics Scotland
Table 1: Key statistics ScotlandSource: ONS, Wood Review

Public spending accounts for 45.1% of GDP, which is well below the EU average of 49.1% of GDP. However, the revenues are below average too, which would imply a considerable fiscal deficit in case of independence, even if we account for oil receipts. Oil reserves are expected to last for another fifteen years. The Scottish government has expressed its intention to create a sovereign wealth fund, similar to Norway’s. However, before the government can accumulate net wealth, it must balance its budget. Excluding oil receipts the current budget deficit is -12.2% of GDP. At this point it remains unclear what part of the current UK debt Scotland will inherit.


[1] In the break-down, minerals have a smaller share in GDP than stated in the text. This is because the break-down is based on data that correct for price changes. Meanwhile prices have increased sevenfold, leading to a much higher contribution of minerals in the GDP in nominal terms.

The Great Uncertainty

When the outcome of the referendum is independence for Scotland, the new country will go into a period of considerable economic and political uncertainty. Two main issues will be at stake immediately: access to the EU internal market and the choice of a currency. It is highly likely that some firms, especially in the financial sector, will move to the UK to avoid the uncertainty of the various negotiations.

Table 2: Timeline from referendum onwards
Table 2: Timeline from referendum onwardsSource: Rabobank

The most immediate issue is the continuation of access to foreign markets, since around 81% of all Scottish exports are directed to EU countries (of which 65% alone to the UK). Therefore, unobstructed market access is vital for Scotland. This may not hold for oil exports since there will remain a demand for Scottish oil. Currently, oil related exports make up 10.4 billion Pound Sterling (15% of all exports). For other products, Scotland needs instantaneous access to the internal market upon independence. Though the Scottish government has vowed to join the EU, the negotiations about accession can only start upon independence. In the meantime, access to EU markets can be provided through negotiating a Free Trade Agreement (FTA). Talks on a possible FTA must be held alongside negotiations with the UK on the conditions of independence.

Upon independence, Scotland will also have to choose a currency regime. In theory there are four options:

  1. Enter into a currency union with the UK.
  2. Keep the pound but without a say in monetary policy.
  3. Adopt a newly created currency.
  4. Adopt the euro.

Both Labour, the Conservatives and the Bank of England have already declared that a currency union is not on the table, suggesting that this option is a highly unlikely outcome. The recent sovereign debt crisis in the EU proved that currency unions can only work when there is a strong policy consensus towards some form of a fiscal, economic and political union. The Scottish Independence annuls the existing fiscal framework with the rest of the UK and it is unlikely that either party will be willing to recommit to a common fiscal framework.

Adoption of the euro is only possible in the medium term. The Scottish government stated that it intends to join the EU within eighteen months, an estimate that is very optimistic according to analysts/experts. There are many reasons why this will take more time. Firstly, new members have to be welcomed by all existing members, as every individual member state has a right to veto. Therefore, Scotland is also dependent on a cooperative stance from the UK. In addition, a few countries in the EU have minorities that would like to become independent. Countries like Belgium or Spain would not like to create a precedent and may, therefore, be quite hostile towards a smooth proces to Scottish EU-membership. Moreover, joining the EU is not sufficient. Even when Scotland is allowed to join, it still has to meet the requirements for adoption of the euro. Its currency needs to have been in the exchange rate mechanism (ERM-II) of the European Monetary System for at least two years. So, for the time being, this is not a viable option. Consequently, in the meantime only option two and three are feasible.

Scotland could keep the pound without having a currency union with the UK. This has a number of severe disadvantages. Firstly, it would give up its monetary policy instrument without having any influence on UK’s monetary policy, though it would de facto have little influence over monetary policy in a currency union too. Loss of this instrument means that only fiscal policy can cool down an overheated economy or vice versa. This requires stronger fiscal responses throughout the economic cycle. Politically, this has always been very difficult. Moreover, the oil receipts will make government revenues more volatile as it is will be more dependent on oil prices. In addition, there is no central bank that can act as lender of last resort by creating money, which means that overnight liquidity assistance for banks will be difficult to provide. This increases the risk of financial instability. Moreover, banks will need to keep much greater reserves, and therefore, interest rates will be much higher. Scotland would, in essence, place itself on par with Montenegro, which unilaterally adopted the euro. Given the economic consequences of this option, we deem it not likely.

Adopting a newly created currency thus seems the only viable option, but this also has major drawbacks. Since a floating exchange rate will involve significant hedging cost, this will lead to higher funding costs for both the government and the private sector. In addition, there might be a liquidity premium due to the relatively small and illiquid financial market. A unilateral fixed exchange rate is vulnerable to speculative attacks as Scotland starts out without reserves. As a small country with a small current account surplus, it only accumulates the necessary amount of foreign reserves slowly. This makes it more vulnerable to speculative attacks on its new currency. Only if the central bank of the country to which the currency is pegged (i.e. Bank of England in case of the pound or ECB in case of the euro) is willing to defend the currency peg, Scotland might be able to fight off speculative attacks. Therefore, Scotland will need cooperation from other major central banks from day one onwards. Given the ambition of joining the EU in the longer term, it might be better off to cooperate with the ECB from the onset of independence. Moreover, the country will need technical assistance from foreign central banks in order to establish a new central bank.

Uncertainty over both the currency and access to the EU internal market can prove to be very compelling reasons for companies, especially financial institutions, to relocate. The research company Capital Economics found that Scottish companies are trading at a discount and that the Purchasing Managers Indices (PMIs), a forward looking indicator of economic activity, have slipped relative to the rest of the UK. Moreover, RBS and Lloyds, the two largest banks based in Scotland, have announced they will leave Scotland if it becomes independent. 

Taking the long view

Despite all the uncertainty and its consequences, Scotland may turn out to be an economically viable country, albeit considerably poorer than it is now. This is due to a number of issues. Firstly, the country currently runs an implicit budget deficit. The oil receipts are insufficient to cover the difference. In addition a small country like Scotland runs the risk of Dutch disease. The resource exports put an upward pressure on the exchange rate, hurting competitiveness. This upward pressure can only be mitigated by investing oil receipts abroad, which means that they cannot be used to cover the budget deficit. Norway is a good example of a country that mitigates the Dutch disease by investing the oil revenue abroad. This strategy would leave Scotland with a budget deficit of 12.2% of GDP. This implies the necessity of strong austerity measures to diminish the current budget deficit, which will hamper growth and employment in the short run.

Another issue is foreign trade, which will likely suffer from the ‘border effect’. The border effect constitutes an unexplained decline of trade between regions which are separated by a country border. This effect persists even if we account for language and other dissimilarities. The border effect will reduce trade and cross-border migration between Scotland and the UK, reducing welfare disproportionally in Scotland as it is the smaller country. Also the decline of migration is harmful. Firstly, labour mobility serves as a macroeconomic stabiliser, when workers that become unemployed can move to areas with better prospects. This effect is stronger when there are more areas and these areas have the same institutional arrangements, e.g. labour laws. Currently, there are 285,000 more Scots living in the UK than vice versa, which may suggest that this effect has been in place. It could also partly explain the low unemployment rate. Secondly, labour mobility ensures an efficient distribution of production capacity across sectors, which increases allocative efficiency.

In addition to the border effect, there is also a market size effect. As larger markets lead to economies of scale, the size of the home market plays a considerable role in the choice of where to invest. If Scotland would be perceived as a different market than the UK, it may lose inward Foreign Direct Investment (FDI). The extent of this shifting perception is mainly contingent on Scotland having access to the EU market. If the market size effect occurs, it will hamper growth and capital formation. 

Concluding remarks

In the short run, a Scottish ‘aye’ (yes) on the 18th will usher a period of great uncertainty. This uncertainty will reduce Scottish economic growth and employment, especially in the financial sector. In anticipation of this effect, Scottish assets might decline in value which would create turmoil on financial markets. In the long run, potential economic growth may be reduced as a result of lower integration with the UK. Therefore, the Scottish are in for a bumpy ride. A Scottish yes may have a much wider impact, however. First, if the Scottish do well, their example may be followed by minorities in many other countries. Moreover, a Scottish breakaway from the UK will change the UK’s politics too, as Scotland is home to 40 of the UK’s 256 Labour Members of Parliament. In a UK without Scotland, the Conservatives will be the dominant party more than ever. Therefore, Scotland leaving the UK will greatly increase the chances of the UK leaving Europe, since the British will have their own EU-exit (Brexit) referendum should the Conservatives win the next UK elections in 2017. Therefore, the Scottish vote may also determine whether or not Great Britain will turn into Little England within a couple of years from now.


Audit Scotland (2011) Management of the Scottish Government’s capital investment programme. Auditor General for Scotland.

Jo Shaw (2013). Citizenship in an independent Scotland: legal status and political implications. Citsee Working Paper Series 2013/34.

Macnab, S.(2014). Scotland’s oil worth 12th of snp claims treasury. The Scotsman, 12 september 2014

Sir Ian Wood (2014). UKCS Maximising Recovery Review: Final Report. Woodreview, 12 september 2014.

Dahlgreen, W. (2014). Latest Scottish referendum poll yes lead. Yougov, 11 september 2014

Jurriaan Kalf
RaboResearch Netherlands Rabobank KEO
+31 (0)30 21 62666

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