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17 November, 2021

Is independence good for growth?

A country's quest for independence is often an emotional matter, but can going alone bring with it economic benefits too?

By Ben van der Merwe

At the height of the 2014 campaign for Scottish independence, First Minister Alex Salmond put forward the economic case for secession. By 2023, Salmond said, every household in Scotland could expect an “independence bonus” of £2,000 a year if they voted to leave the UK.

Barely an hour later, the UK government put forward its own assessment. If they elected to stay in the union, the assessment said, Scottish households could expect an annual “UK dividend” of £3,500 until 2034.

The two reports sparked a bitter row. The academic on whose work the UK’s assessment was based accused the government of manipulating data to inflate tenfold the expected costs of setting up the new government.

The Financial Times, meanwhile, described the Scottish government’s forecast as “nonsense”, pointing out that it rested on several optimistic assumptions about the trajectory of Scotland’s demographic and productivity growth, assumptions that it did not attempt to justify.

As the ferocity of the disagreement might suggest, these issues mattered for voters. A poll in 2013 found that 55% of Scots would support independence if they knew it would make them £500 a year better off, but only 15% would support independence if it required sacrificing £500 a year.

Two years later, it would be British nationalists arguing for the economic benefits of independence – this time, from the EU. The Brexit campaign even repurposed the Scottish National Party’s attack line, labelling the UK government’s dire economic forecasts for secession as ‘Project Fear’.

A new study suggests that secession on average tends to reduce GDP per capita by 20–30% in the long-run, with outcomes varying widely.

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Does economic growth matter to nationalists?

Nationalism has always had a complicated relationship with raw economic efficiency. Many European nationalisms, including the French and British varieties, emerged not from a deep well of popular feeling but from the necessities of state-building.

As US sociologist Charles Tilly has noted, the modern state emerged in large part as a result of military necessities. Large standing armies required broad and deep tax bases as well as a ready stream of loyal recruits. The deepening of internal markets also required an enhanced degree of national integration, whether in terms of infrastructure, currency, laws or weights and measures.

As economies developed, these issues became only more pressing. Furthermore, industrial production introduced far greater economies of scale, meaning that larger states in many cases enjoyed automatic efficiency advantages over smaller states.

The movement of powers of taxation and war from the local lord to a distant capital required a new form of legitimation, resting not on day-to-day experience but on what sociologist Benedict Anderson famously termed “imagined communities”.

Where strongly distinct linguistic and cultural communities had formed that were incongruent with these new boundaries, they were made to fit. Thus was the fate of the Welsh, the Catalans, the Basques and countless less-remembered European cultures.

In countries where political elites proved unwilling or unable to integrate their markets, such as Germany and Italy, nationalism emerged as the ideology of the new industrial class.

Integrative nationalism had a clear economic rationale. Larger markets are generally more efficient. They reduce transaction costs, like the costs of crossing borders or changing currencies, and allow for the emergence of much larger enterprises, which benefit from economies of scale. Larger states can also benefit from economies of scale, particularly in areas of infrastructure, public services, bureaucracy and national defence.

The EU is the clearest modern descendant of such nationalisms, insofar as it ultimately aims to forge a common European identity across the bloc.

Disintegrative nationalisms, which seek to divide an existing market, have run against these economic headwinds. Such movements, regardless of their political justifications, must grapple with both short- and long-term economic costs.

Independence has severe short-term costs

Regardless of the long-run costs and benefits, independence is practically bound to have short-term negative consequences for an economy.

The late Robert Young, a professor at the University of Western Ontario and author of How Do Peaceful Secessions Happen?, divided these into transaction costs, fiscal costs and the costs of uncertainty.

Transaction costs include the costs of setting up new state institutions, and can be particularly substantial in cases where no pre-existing subnational state institutions (such as parliaments, bureaucracies and militias) exist.

The estimation of transaction costs was central to the controversy over the economic effects of Scottish independence, and Salmond’s allegations of fear mongering. 

The UK Treasury’s estimate of a £2.7bn one-off cost for setting up the new Scottish government was based on an academic paper that had put the cost of setting up a major government department as £15m, which the Treasury then multiplied by 180 – once for every public body the Scottish government intended to keep after independence. 

The academic behind the original estimate criticised the British government’s calculations, emphasising that many departments would not need to be set up from scratch (Scotland has a devolved administration), and that most public bodies are not as large as major government departments.

Fiscal costs are the cost of replacing any fiscal subsidies provided by the former central government, whether through cuts to spending, increased borrowing or increased taxation. The magnitude of such costs depends, of course, on whether the region was a net contributor or net beneficiary from the old national budget.

In 2019/20, data from the Office for National Statistics shows Scotland’s public finances were in net deficit to the rest of the union to the tune of £16bn, or £3,000 per capita. These costs will also depend on the apportionment of national debt, an issue fraught with potential controversy.

An independent Scotland, for instance, would need to grapple with the UK public sector debt, which currently stands at about £1.9trn. A 2018 report by the Scottish parliament’s Sustainable Growth Commission proposed that an independent Scotland could agree to make an annual ‘solidarity payment’ to the UK government in order to service an agreed share of the national debt. The report estimated this annual payment at about £5bn.

Deciding whether Scotland’s share of the debt should be apportioned based on the share of funds spent in Scotland or on Scotland’s share of the UK’s GDP, geographic area or population is likely to be a sensitive topic.

"We strongly recommend that the tone and approach of Scotland to the rest of the UK in those discussions should be informed by the recent and ongoing difficulties created by the UK government’s approach to Brexit negotiations," the commission's report warned.

However, in Young's view the largest transition cost is likely to be the cost of uncertainty. A rupture with the institutional status quo inevitably causes some loss of confidence among investors, and this can have serious consequences for a fledgling independent state.

The cost of uncertainty

The most obvious and immediate impact of uncertainty is a rise in borrowing costs for the government. If creditors fear inflation, currency depreciation or default they will demand higher interest rates for their loans.

Investor uncertainty can also have damaging long-term consequences. More than any other economic actor, foreign direct investors constantly have their eyes on the long-term viability of a country's economic environment.

There is another kind of cost, however. Like divorces, not all secessions are alike. Some are settled amicably, if begrudgingly; others are fought bitterly to the end, at great cost to both parties.

War involves the destruction and diversion of physical and human capital on a potentially vast scale, as well as serious disruption to trade, investment and financial flows.

As well as fighting potentially costly wars of independence, secessionist states suffer from a far greater risk of civil war. This was evident most obviously in the collapse of the USSR and Yugoslavia but also the collapse of the Ottoman Empire and the recent history of South Sudan.

One possible reason is that independence frequently creates commitment problems between social groups in the new country. The lack of settled institutions or a mature political culture makes it hard for majority groups to credibly commit to the fair treatment of minorities.

The long-term effects of independence are less clear

Of course, any rupture with the status quo will almost inevitably give rise to transition costs. What matters in economic terms is whether there are long-term gains that justify the short-term costs.

There are a number of difficulties in assessing the long-run impact of independence on GDP, not least the fact that independence tends to be declared after several years of declining growth, as shown in the chart below.

From a simple look at the data, it is not clear whether independence succeeds in turning around an otherwise declining economy, or if the decline was an effect of the move towards independence, which afterwards simply led growth to resume its previous trajectory after years of economic chaos.

To get around this problem, a recent study simulated the likely growth trajectory for a large number of secessionist states in a scenario in which independence had not occurred. They then compared this with the actual growth trajectory of these countries, with the difference being the long-run effects of independence.

They found that, on average, independence reduced GDP per capita by 20–30% in the long run but that this varied considerably between countries.

While the average state may have lost out economically due to independence, states such as Kenya, Slovakia and Tunisia saw little change in their economic fortunes after independence, while others such as Libya and Gabon performed much better after secession.

One major factor shaping outcomes, the study found, was the prevalence of oil. Oil-rich nations performed much better after independence than others, a fact that chimes with an understanding of colonialism as resource exploitation.

The anti-colonial nationalisms of the latter 20th century not only saw the break-up of globe-spanning markets as a price worth paying for political emancipation, but in many cases suspected that the efficiency gains of union were outweighed by various forms of plunder.

What helps boost newly independent countries?

The study looked at a number of other factors associated with better or worse post-independence economic performance, finding several to be highly influential.

"One thing we looked at was the population size of these newly independent states, because one line of reasoning is that large countries benefit from economies of scale, but we didn't actually find a significant effect of population size, controlling for all the other variables," says Jakob Vanschoonbeek, who co-authored the study.

"What we did find is that newly independent countries that are more open to trade and have better access to richer foreign markets tend to perform better. Similarly, we find that being landlocked negatively affects post-independence economic performance, while being a member of a regional organisation such as the EU has strongly positive effects.

"We also found that more democratic secessionist states perform better but that whether the secession itself was peaceful or violent, or whether there was a financial crisis, doesn't have very significant effects.

"The Soviet break-up had the most harmful economic effects, on average, of any of the secessions we looked at – even more harmful than those during decolonisation.”

In Ukraine, for instance, GDP per capita (measured in real US dollars) remains 27% below where it stood in 1990, a result of the severe post-independence economic slump of the 1990s and the country's persistent stagnation since the 2008 financial crisis.

Had Ukraine continued on the growth trajectory of the 1980s, the researchers found, Ukrainians today would be earning more than double their current incomes.

Consider Poland, for instance, which also transitioned to capitalism in the early 1990s but without changing its borders. In 1991 Poland's GDP per capita was only 20% higher than Ukraine's. Today, it is 468% higher.

This might be counterintuitive, given that the hallmark of the Soviet break-up was rapid economic liberalisation and, to a lesser extent, democratisation – both factors found by the study to blunt the harmful effects of secession.

"One of the potential explanations is that the Soviet Union was a very integrated economic space, where there was a lot of internal trade between member states," says Vanschoonbeek. 

"The break-up suddenly disrupted all these value chains and trade relations, and there was a complete collapse of input-output relations."

Trade, then, seems to be the key to an economically successful independence movement. To achieve independence is to introduce a new border to the world, typically between yourself and your most important market, and therefore to court a collapse in trade volumes. 

Another study recently found, for instance, that Scotland’s trade with the UK is about six times larger than would be expected if the two were separate countries.

Their model predicts that Brexit will reduce Scottish per capita income by 2% in the long run, but that independence could raise this cost to between 6.5% and 8.7%. Even if Scotland rejoins the EU, the researchers expect long-run income per capita to be 6.3–7.6% lower than it would have been without independence and Brexit.

However, Vanschoonbeek is keen to stress one important caveat. "All our results are based on historical cases of state break-up," he cautions. "If you look at the countries that are in our sample, these are all less-developed countries.

"To my knowledge, there is not an example of a highly developed region within a country that successfully declares independence. It is unclear to what extent these results also extrapolate to highly developed economies declaring independence. 

“That is just one of the limits of doing empirical research – you can only work with what has actually occurred."

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