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Disunited Kingdom? Brexit, trade and Scottish independence

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Disunited Kingdom? Brexit, trade and Scottish independence

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In 2014, Scotland voted against becoming independent. But the UK’s decision to leave the EU has reignited the debate over Scottish independence. A majority of Scottish voters backed remaining in the EU (Sobolewska and Ford 2020) and the Scottish National Party has pledged to use the 2021 Scottish Parliament elections to seek a mandate for a second referendum. Although there is no guarantee the UK government will agree to a new vote, recent opinion polls show a majority of Scots favour independence (The Herald 2020).

In recent work, we analyse the economics of independence and how Brexit affects its costs and benefits (Huang et al. 2021). We seek to answer two main questions. First, how do the estimated effects of independence compare to the impact of Brexit on the Scottish economy? Second, would an independent Scotland be better off economically inside or outside the EU? 

We address these questions using a quantitative trade model to estimate how changes in trade costs affect trade flows and income levels. We do not consider other potentially important economic effects of Scottish independence, such as changes in investment, whether Scotland continues to use sterling as its currency and the fiscal implications of independence.

Scotland’s trade

To calibrate our trade model, we start by constructing a new dataset of Scottish trade at the sectoral level. This dataset is available to download from the Centre for Economic Performance website. As Table 1 shows, Scotland is a highly open economy that mostly trades with the rest of the UK. In 2017, the rest of the UK accounted for 61% of Scottish exports and 67% of Scottish imports. Scotland’s trade with the rest of the UK is around four times larger than its trade with the EU. 

Table 1 Scotland and rest of UK trade in 2017

Disunited Kingdom? Brexit, trade and Scottish independence 1

Source: Huang et al. (2021).
Notes: The table covers trade in goods and services. Scottish data combine both the onshore and offshore economies. Intra-UK share reports share of Scottish exports/imports going to the rest of the UK and share of the rest of the UK’s exports/imports going to Scotland.

Border costs

Independence would introduce a new international border between Scotland and the rest of the UK. Borders create barriers to doing business that increase trade costs. An extensive literature documents that border costs are economically important and have large negative effects on international trade (Anderson and Van Wincoop 2004). Comparing trade between Scotland and the rest of the UK with Ireland-UK trade, Comerford and Rodriguez Mora (2019) estimate that independence would increase trade costs between Scotland and the rest of the UK by 31%.

Consistent with this literature, we find that there is substantially more trade between Scotland and the rest of the UK than predicted by a gravity trade model that does not account for the political and economic union between the two regions. Figure 1 plots residual unexplained trade for Scotland and the rest of the UK with a sample of their major trading partners. The residual is calculated from a regression of log bilateral trade on log distance, importer and exporter fixed effects and dummy variables for EU membership, having a free trade agreement, and sharing a currency, language, land border or colonial relationship. The data cover 44 countries in 2014.

The size of the Scotland–rest-of-UK residual (labelled SCO-rUK) in Figure 1 implies there is six times more trade between Scotland and the rest of the UK than predicted by the gravity equation. For Scotland, unexplained trade with the rest of the UK is higher than with any country except Norway. For the rest of the UK, unexplained trade with Scotland is higher than with any other country. Using alternative estimation methods, we find that there is between 2.6 and 7.8 times more Scotland–rest-of-UK trade than predicted.

Figure 1 Scotland and rest of UK’s residual trade unexplained by gravity equation

Disunited Kingdom? Brexit, trade and Scottish independence 2

Source: Huang et al. (2021).
Notes: The figure plots the residuals from OLS estimation of a log-linear gravity equation controlling for distance, importer and exporter fixed effects and dummy variables for EU membership, having a free trade agreement and sharing a currency, language, land border or colonial relationship. For each country pair, the figure shows the average of the import and export residuals for log trade in 2014.

Modelling Brexit and Scottish independence

We model the effects of Brexit and independence using a multi-sector, multi-country trade model with input-output linkages based on that developed by Dhingra et al (2017). We calibrate the model using 2014 data for 27 sectors and four regions: Scotland, rest of UK, EU and the rest of the world.

Our analysis considers four counterfactual scenarios:

1. Brexit, but Scotland remains part of the UK.

2. Scotland becomes independent, but there is no Brexit.

3. Brexit and Scotland becomes independent, but remains in a common economic market with the rest of the UK.

4. Brexit and Scotland becomes independent, but rejoins the EU.

To model these scenarios, we need to take a stance on how independence and Brexit affect trade costs. It is uncertain how large the effect of independence on Scotland’s trade costs with the rest of the UK would be. Based on existing border cost estimates, in each scenario where Scotland becomes independent, we study an optimistic, low-border-cost case in which trade costs increase by 15% and a pessimistic, high-border-cost case where costs increase by 30%.

These cost increases apply in the event that Scotland maintains a common economic market with the rest of the UK following independence. If Scotland rejoins the EU, its border with the rest of the UK would become one of the EU’s external borders, leading to additional trade barriers. We model the impact of Brexit on trade costs as in Bevington et al. (2019), who assume that UK-EU trade is based on a free trade agreement similar to the deal reached by the UK and EU in December 2020.

Results

Table 2 shows the impact of each scenario on real income per capita in Scotland and the rest of the UK. The estimates should be interpreted as long-run effects after all economic adjustment is complete, relative to a baseline where the UK remains in the EU and Scotland remains part of the UK. Because our model does not allow for trade to affect productivity, our estimates are likely to be a lower bound for the costs of Brexit and Scottish independence. Nevertheless, the estimates give a useful indication of the magnitude of potential changes in income levels and, most importantly, the relative costs and benefits of alternative scenarios.

Table 2 Effects of Brexit and Scottish independence on long-run real income per capita

Disunited Kingdom? Brexit, trade and Scottish independence 3

Source: Huang et al. (2021).   
Notes: Changes in trade costs between EU and regions that leave the EU following Brexit are modelled assuming a UK-EU free trade agreement as in Bevington et al (2019). Scottish independence is assumed to increase trade costs between Scotland and rest of the UK by 15% in the low border cost case and 30% in the high border cost case.

We draw two main lessons from the results. First, the negative impact of independence on Scotland’s economy is two to three times greater than the costs of Brexit. We estimate that Brexit reduces Scotland’s long-run income per capita by 2.0%. By contrast, the combination of Brexit and independence reduces Scottish income per capita by between 6.3% and 8.7%, depending on whether border costs are low or high and whether Scotland rejoins the EU. Independence hits Scotland’s economy harder than Brexit primarily because Scottish trade with the rest of the UK is four times larger than its trade with the EU.

The second lesson is that rejoining the EU would not offset the costs of Scottish independence. We find that the combined impact of Brexit and independence on Scottish income per capita is similar regardless of whether Scotland maintains a common market with the rest of the UK or rejoins the EU. While EU membership boosts trade with the EU, it also leads to additional increases in trade costs with the rest of the UK. These effects roughly offset, since the model predicts that an independent Scotland would have similar levels of trade with the EU and the rest of the UK. 

The analysis also highlights a paradox in the economic argument that Scotland should become independent in order to rejoin the EU. For an independent Scotland to be better off inside the EU, independence must destroy a sufficiently large share of Scotland’s trade with the rest of the UK that the EU becomes Scotland’s most important trade partner. 

But the more independence reduces trade, the greater its economic costs. In other words, for rejoining the EU to be economically desirable, independence itself must bring substantial economic costs. This logic explains why rejoining the EU is more attractive in the high border cost case than in the low border cost case. Yet, regardless of whether Scotland rejoins the EU, the losses from independence are greater in the high border cost case. 

Conclusions

To make an informed decision about the desirability of independence, voters need to know what its likely economic consequences would be. We find that the costs of independence to the Scottish economy are likely to be two to three times larger than the costs of Brexit. Moreover, rejoining the EU following independence would do little to mitigate these costs. At least from a trade perspective, independence would leave Scotland considerably poorer than staying in the UK.

References

Anderson, J E and E Van Wincoop (2004), “Trade Costs”, Journal of Economic Literature 42(3): 691-751.

Bevington, M, H Huang, A Menon, J Portes, J Rutter and T Sampson (2019), “The Economic Impact of Boris Johnson’s Brexit Proposals”, CEP Brexit Analysis No. 16.

Comerford, D and J V Rodríguez Mora (2019), “The Gains from Economic Integration”, Economic Policy 34(98): 201-266.

Dhingra, S, H Huang, G Ottaviano, J Pessoa, T Sampson and J Van Reenen (2017), “The Costs and Benefits of Leaving the EU: Trade Effects”, Economic Policy 32(92): 651-705.

The Herald (2020), “IndyRef2: New Poll shows 53% would back Independence as SNP set for Record Holyrood Majority“, 12 August.

Huang, H, T Sampson and P Schneider (2021), “Disunited Kingdom? Brexit, Trade and Scottish Independence”, CEP Brexit Analysis No. 17.

Sobolewska, M and R Ford (2020), Brexitland, Cambridge University Press.

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