Scotland’s threat to Europe

Small as Scotland’s economy might be, a “yes” vote in its Sept. 18 independence referendum would have profoundly negative implications not simply for Scotland’s long-term economic prospects, but also for the rest of the United Kingdom and for the eurozone. For this reason, one has to hope that cooler heads prevail at next week’s referendum and that the Scottish electorate does not allow itself to be seduced by the sirens promising a brighter economic future outside the United Kingdom.

To say that a yes vote would be a highly risky proposition for the Scottish economy would be an understatement. To be sure, Scotland might derive some immediate economic gains from a larger share in the North Sea’s dwindling oil revenues or from a decision to walk away from its share of the United Kingdom’s sovereign debt obligations. However, as Greece’s recent sad experience within the euro would amply attest, those gains are more than likely to be dwarfed by the disadvantages of having to use another country’s currency without having either one’s own central bank or a fiscal backstop. They are also likely to be dwarfed by the negative consequences of heightened capital outflows from Scotland’s banks for want of a lender of last resort as well as by a likely shift of the country’s financial institutions toward the greater stability that London might offer.

{mosads}Beyond Scotland, the main loser from a yes vote would be the rest of the United Kingdom. This would be partly the result of direct economic factors, but more importantly, it would be the result of the likely tectonic changes in the United Kingdom’s political landscape that would flow from the dissolution of the union. Among the economic costs for the United Kingdom from a yes vote would be a lesser share of North Sea oil revenues; the need to shoulder the entirety of the U.K.’s sovereign debt without Scottish support; the consequences of a heightened degree of domestic political uncertainty; and the negative impact through very close trade links from exposure to a Scottish economy that is likely to find itself in recession.

The longer-term economic costs to the United Kingdom would be all the greater from the tectonic changes in the country’s political landscape as a result of a yes vote. Prime Minister David Cameron would almost certainly lose his job for the role that he played in bringing the United Kingdom to this pass, as would Opposition Leader Ed Miliband for his role in losing Scotland’s many Labor Party members in the U.K. parliament. At the same time, the changed composition of the British parliament in favor of the Conservatives would heighten the probability both that the Conservatives would win the 2015 election and that they would deliver on their promise of an up-and-down referendum in 2017 on the United Kingdom’s continued membership in the European Union. Not helping matters would be the likely boost to the fortunes of Nigel Farage’s anti-European U.K. Independence Party (UKIP).

The fallout from a Scottish yes vote is unlikely to be confined to the British Isles. Separatist movements across Europe would gain encouragement from Scotland’s bold move, which could inject further uncertainty into Europe’s already fragmenting political landscape. The most serious and immediate threat in this respect is that of Catalonia, where the Spanish government is already in a tense standoff with Barcelona over its intention to hold a non-binding referendum in November 2014 on the question of Catalonia’s independence.

The Scottish referendum is not occurring at a good time for Europe. The European economic recovery has again run out of steam, geopolitical risks from the Russia-Ukraine crisis are continuing to impact European investor confidence, and Europe’s politics continues its process of gradually fragmenting. The last thing that a fragile Europe needs right now is new shockwaves from a Scottish economic crisis. For that reason alone, one has to hope that the Scottish electorate does the right thing and votes “no” to dissolving its 300-year old union with the rest of the United Kingdom.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.