Scotland's Economic Performance and the Fiscal Implications of Moving to Independence

By McLaren, John; Armstrong, Jo | National Institute Economic Review, February 2014 | Go to article overview

Scotland's Economic Performance and the Fiscal Implications of Moving to Independence


McLaren, John, Armstrong, Jo, National Institute Economic Review


Scotland's economic performance and fiscal make-up are key elements in the debate leading up to the forthcoming referendum on independence. However, in terms of understanding Scotland's economic performance, the situation is complicated by the high degree of overseas ownership, especially with regards to North Sea activity, and the importance of a natural commodity, oil. This makes the use of traditional measures of economic performance, like GDP or GDP per capita, less relevant than for most countries and suggests a greater need to use both constant price and cash GNI, neither of which are currently available. In terms of its fiscal balance, Scotland's independence would require taxes derived from its offshore (North Sea) activity to be sufficient to offset the extra monies (in per head terms) currently transferred from the rest of the UK (via the Barnett formula system) in order to pay for the current level of public services. Based on current projections, such North Sea related tax revenues would amount to less than the likely Barnett transfer, leading to a net loss in funding at the time of independence. Under such circumstances the question of whether or not Scotland could afford to initiate the building up of an 'Oil Fund', is largely a redundant one. However, uncertainties over both future oil and gas revenues and over the continuation of the existing Barnett system make it difficult to predict with any great certainty whether Scotland would see a longer-term net fiscal gain or loss post-independence. Apparent inconsistencies between official GNI and Scottish revenue figures also means that the existing fiscal balance position remains open to question.

Keywords: Scotland; referendum; independence; growth rates; fiscal balance; oil fund

JEL Classifications: E01; H60; R50

I. Introduction

The forthcoming referendum on Scottish independence has highlighted the need for a better understanding of how the Scottish economy has performed historically and how its future performance might feed through to both sides of its fiscal balance. Up to now, much of the debate has been flawed by the use of inappropriate or inconsistent measures of Scottish economic output and prosperity. Onshore Scotland (which includes its network of islands) has a similar economic structure to onshore UK and comparing its performance with the UK and other nations is relatively straightforward. However, when defined as an independent state, Scotland takes on most of the North Sea sector that produces oil and gas, which substantially impacts on its economic structure and performance.

There are a variety of ways to measure the size (and growth rate) of the economy. One of the most commonly used is constant price (i.e. inflation adjusted) Gross Domestic Product (GDP), the value of all final goods and services produced within a country's borders. However, it is not unusual for the GDP measure of a small, open, developed economy to be distorted by substantial net overseas in- or out-flows of income. As a result, another measure is also often cited, namely, the Gross National Income (GNI), the value of all final goods and services produced by enterprises owned by a country's citizens. The main difference between GNI and GDP is that the latter defines its scope according to location, while the former defines its scope according to ownership.

To make matters even more complicated, Scotland exhibits not only this 'international flows' impact, from its high degree of overseas ownership in areas such as oil and gas, energy and the drinks industry, but also from a 'natural commodity' impact effect, arising from North Sea revenues. While the effect of the former impact can be taken into account by considering constant price GNI levels or growth rates, the effect of the latter impact requires an assessment of cash terms GNI. In other words, no single measure fully captures Scotland's economic performance.

Most analyses of the Scottish economy do not recognise these complications.

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