Small Nations: The Economics of Independence

Scotland’s recent referendum on independence resulted in a distribution of forty-five percent for and fifty-five percent against [1]. While unsuccessful, Scotland’s bid for independence may have given hope to other regions with desires for independence. Currently secessionist regions are relatively small, with populations of less than ten million. Examples include the Basque region, Catalonia, Quebec, and Flanders in Belgium. Outside of the Western world, Kashmir, Chechnya and Kurdistan have expressed interests in secession, although scheduling a vote in Kurdistan has taken a back seat given the pressing security concerns in the region.

Referendums and popular movements are showing that a population may exercise their right to self-determination. Political implications aside, if these small regions were to succeed in their quests for independence, what would be the resulting economic impact?

Michael Keating, professor of political science at the University of Aberdeen, highlights a key factor causing European regions to seek independence: “Given the decline of states’ abilities to manage their spatial economies, such regions are increasingly competing with each other for investment, technology, and markets, within European and global markets.”[2]  Recent referendums on independence have gained popularity following perceived unequal government contributions and austerity. Most regions with strong independence movements are comparatively wealthy and are net benefactors to government-subsidized programs rather than net beneficiaries. Keating describes alternative options for nations seeking independence within Europe: “By the 1990s, most nationalist parties had abandoned independence and substituted other formulations, emphasizing self-determination, insertion into Europe, or asymmetrical federalism.”[7] These alternatives may seem more feasible, however, following austerity measures many nationalist parties have reignited desires for independence.

Supporting Keating’s view is the increased support for Catalonian nationalists following the financial crisis’ heavy impacts in Spain. The march for a referendum on Catalonia’s national day attracted thousands this year, however, the vote for referendum was cancelled in October by the regional government following intense national government opposition. [3]

Catalonia is a vivid example of making a decision on independence based on unequal contributions to the state. Professor of economics, Josep Desquens, describes the economic situation in Catalonia: “Containing about sixteen percent of Spain’s population, [Catalonia] provides about twenty percent of its GDP and one-third of the total industrial production and exports…The regionalized investment of the Spanish state in Catalonia from 1982 to 1998 represented only about eight and a half percent of the total.”[4] These figures highlight the disparity between what Catalonia contributes to the state through tax revenue and what it receives through funding and spending by the state. The article elaborates on this lack of Spanish investment in Catalonia, approximating the fiscal imbalance between Spain and Catalonia: “The Catalan fiscal balance with Spain, showing not only a deficit (i.e. pays more than it receives back) but one of the highest of any region in the European Union…estimate the Catalan fiscal imbalance with Spain to be between seven and a half percent and ten percent of the Catalan GDP.” [5]

Furthermore, the situation in Quebec has particular relevance for nations seeking independence in Europe. Canada is divided into ‘have’ and ‘have-not’ provinces; Quebec, as a ‘have-not’ province, received almost 8 billion dollars in equalization payments in 2011. “The Quebec situation has become an international comparative case study (especially in comparison with Scotland, Catalonia and Wales) since world capitalism has given a greater role to regions, states and provinces,” explains Guy Lachappelle. [6]

To develop institutions and government programs requires time and investment, as programs such as education, health and social security would have to be developed from scratch following independence. Where would money to invest in institutions come from in a recently independent nation? The austerity measures which currently act as an impetus for secession in some regions would still have to exist, as the newly independent state would inevitably be forced to inherit some proportion of national debt as well as national assets. To begin nation building as indebted would be extremely challenging.

For Catalonia, Flanders and the Basque region, there is also the question of using the Euro. To join the Eurozone requires a lengthy application process, and an alternative currency would need to be circulated while their application is considered. During the decision making process, which would take at least a few years, an interim currency would severely affect trade. The possibility of not being allowed to use the Euro, or to be excluded from the EU, would be crucial in developing a newly independent economy in Europe.

For nations seeking independence outside of Europe currency is also a problem. There are two options facing a recently independent nation: retain the previous currency and rely on a foreign central bank through a monetary union, should they be allowed, or create a new currency and an accompanying central bank. Retaining the previous currency severely limits the benefits of independence due to a continuing reliance on the previous state. However, creating a new currency, even if it were pegged to the previous currency through a central bank, would cause investors to shift their money where conditions are more stable and risks are lower.

Patrick Grady examines the effect of uncertainty and loss of investor confidence if Quebec were to separate from Canada. “Real output in Quebec could easily be depressed in the short run by as much as ten percent and in the long run by five percent. In the short run, the output loss would be triggered by a crisis of confidence resulting from separation.” [8]

Similar options and impacts exist for the issue of whether an independent region would be part of a customs union. Developing a customs union with the former parent nation would limit the newly independent state’s sovereignty over tariffs and quotas. Free trade agreements with border controls between regions could be a possibility, however both options are unlikely to be agreed upon by the original state. Grady illustrates why such arrangements would be unlikely using examples of goods that Quebec supplies to the rest of Canada, such as electricity sourced in Nova Scotia sold by Hydro-Quebec, and dairy from government-subsidised farms. Grady explains why a free trade agreement between Canada and an independent Quebec would be unlikely: “Most of what Quebec sells to the rest of [Canada] could be bought elsewhere – in many cases at considerably lower cost.” [9]

The inability to form a customs union or free trade agreement would cause severe declines in foreign investment. A fall in investment would affect employment, and the creation of a new currency would create uncertainty resulting in capital flight. The loss of investment and increased unemployment highlights the crux of the independence debate: what would the economy be founded upon? Even well-established industries would be at risk following independence, as investors will be unlikely to remain in such uncertain territory.

Currency instability following independence would affect the cost of imports and exports. Currency would depreciate, making exports cheaper and imports more expensive. The increase in the price of imports would be an issue for imported necessity goods. Although an independent nation could strive to be self-sufficient, these small nations would run the risk of being extremely inefficient or requiring subsidies. Exports from resource-based economies, as well as manufacturing or financial industries would be heavily affected by a currency depreciation. Economies that would rely heavily on oil exports post-independence are just one example, such as Scotland and Kurdistan. The current moratorium on direct sales of Kurdish oil severely limits revenues and would need to be lifted post-independence for economic viability. Oil revenues in Scotland are currently declining, which many considered to be a major blow to the unsuccessful Scottish independence campaign.[10]

Given the combination of institution creation, currency, uncertainty, falling investment affecting industry, and increased unemployment, GDP would inevitably fall. A fall in GDP would increase the burden of inherited national debt and make institution creation more challenging. These consequences could be overcome in the long run, but do the costs of independence outweigh the benefits? For nations within Europe, the possibility of increased self-government and integration in Europe without independence seems a more stable option. For nations seeking independence outside of Europe, guarantees of monetary unions and trade agreements would be needed to ensure economic stability and the viability of their independence project.

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Works Cited

[1] BBC News. “Scottish Referendum: Scotland votes ‘No’ to independence.” http://www.bbc.com/news/uk-scotland-29270441 (accessed September 30th)

[2] & [7] Keating, Michael. “European integration and the nationalities question.” Politics & Society 32.3 (2004): 367-388.

[3] Agence France-Presse. “Catalonia looks for alternatives after cancelling independence referendum.” http://www.theguardian.com/world/2014/oct/14/catalonia-cancels-referendum-on-independence-from-spain (accessed October 14th)

[4] & [5] Desquens, Josep. “Europe’s Stateless Nations in the Era of Globalization: The Case for Catalonia’s Secession from Spain.” The Bologna Centre Journal of International Affairs (Spring 2003).

[6] Lachapelle, Guy, and John E. Trent, eds. Globalization, Governance and Identity: The Emergence of New Partnerships. PUM, 2000.

[8] & [9] Grady, Patrick. “The economic consequences of Quebec sovereignty.” (1991): 143-162.

[10] Ping Chan, Suzy. “North Sea oil revenues will decline more sharply, says OBR.” The telegraph. http://www.telegraph.co.uk/finance/economics/10959241/North-Sea-oil-revenues-will-decline-more-sharply-says-OBR.html (accessed September 30th)