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Scotland: The Same, Only Better?
Confluence Investment Management
By Bill O'Grady, Kaisa Stucke
November 13, 2012

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As the Eurozone countries are trying to find the functional balance between national sovereignty and Eurozone-wide central control on the national level, fractures are also appearing within the nation states themselves. Additionally, the Northern European countries are questioning the extent to which they should be expected to bail out the Southern countries, while the wealthier regions of the nation states reason that they would be more efficient in managing their internal fiscal budgets.

During the boom years, the benefits of the economic union were substantial enough to make up for the compromises on the political, cultural and linguistic levels. However, with austerity measures sweeping across Europe, aspirations for independent cultural states have emerged. Several countries in Europe have witnessed political instability as regional leaders call for more autonomy, if not full independence. Catalonia would like to attain more economic and political independence from Spain; the Flemish region of Belgium aims to establish a new state; and Scotland is calling for a referendum to vote for its independence.

Scotland’s First Minister, Alex Salmond, and his Scottish National Party have been on the forefront of the push for secession. Although most Scots share this romantic vision of a self-sufficient Scotland, polls indicate that only a third of the population would actually vote for its independence. Mr. Salmond’s main intention is to convince Scottish voters that the country, outside the U.K., would be just the same as before, only better.

To better understand this development, we need to look at the history of the European tribes organized together into the current nation state of the U.K. We will briefly describe the region’s history, particularly as it relates to its union with England. The cultural differences between the two regions also need to be explored. We will then look at its current political process and the possible dynamics of the system proposed by the pro-independence party. We will conclude with wider implications for other European countries and the Eurozone in general.

Historically, Scotland has been divided between Scottish warring tribes but has also been under outside attack throughout its history. Although the country has a good amount of arable land, the cold climate is not favorable for growing crops. Although the Romans reached Scotland, they were never able to take over the country in its entirety. To defend against constant Scottish attacks, the Roman defense put up Hadrian’s Wall, the strongest fortification in Roman Empire history, with a lesser known Antonine Wall built as a second defense further north. The warring Scottish tribes united to successfully fight the Roman troops. Eventually the Roman Empire chose to withdraw, concluding that the wealth of the land did not justify the extensive garrisoning requirements.

After the Roman Empire, several groups, including the Irish and the Vikings, ruled parts of Scotland. But in the 10th century, the already weakened Scotland was conquered by England and most of the country was feudalized. Although Scotland had its own king, the kingdom reported to the throne of England.

In 1707, Scotland and England were united in a sovereign state called Great Britain. Industrialization and rapid city expansions brought economic growth with it. The economic benefits of uniting Scotland and England were attractive, as the move opened up the much-larger British market and also the markets of the growing British Empire. At the initiation of the union, England’s population was 5 times that of Scotland, but it was 36 times wealthier. Living standards in Scotland improved after the union, but still remained lower than England’s. In addition to economic divergences, the countries also have had a long history of cultural and religious differences. Scots maintained their own religious beliefs even after the union, and although the parliament was unified in London, the Church of Scotland and Scottish law and courts remained separate. Initially, the union was highly criticized among Scots (not unlike the current debate), as the hoped-for economic revival was not immediately forthcoming. Historically, there has been much cultural dislike between the two peoples, with the Scots accusing the Brits of interfering in their internal affairs.

After WWII, Scotland’s economic situation deteriorated due to increased global competition and inefficient industrial production. In the 1970s, the North Sea oil and gas fields were discovered and Scotland was able to realize significant economic benefits from it. At this time, the ideas of devolution and independence from England became more popular and the Scottish National Party (SNP) emerged. In 1979, a referendum for devolution was proposed, which failed to achieve the necessary 40% level of support. Again, in the late 1980s several policies were implemented that were viewed as anti-Scottish by the population and devolution became more popular. As a result, the 1997 referendum established an independent Scottish parliament. The Scottish National Party became the official opposition in 1999, then the minority government in 2007, and the majority government in 2011.

Cultural Differences
The diverse cultures and traditions between the regions have as much to do with the factions as the socio-economic differences. The economic and political dynamics receive a lot of attention, especially to what degree they contribute to the central budget, but the central issue here is one of cultural differences.

Scots, descended from proud tribes, foster a romantic vision of Scottish independence. The debate on independence has lasted for centuries, and is unlikely to be resolved with any political or economic tool. Cultural history is heavily referenced in the independence struggle, with the strongest tool in the pro-independents’ arsenal being the prevailing support for Scottish culture. In fact, Mr. Salmond has repeatedly said that his government will call for a referendum that is “made, built and run in Scotland.”

There’s been a long-term dissatisfaction among Scots regarding London-based rule. But as long as the economic benefits have been substantial enough, Scots have been willing to give up on their cultural heritage.

Current Crisis
The U.K. itself is currently debating its relationship with the EU as well as its relationship with Scotland. After joining the EU, social and employment protections were helpful to the U.K. The current PM, David Cameron, has indicated that he supports staying in the EU, but he would like to repatriate many powers from the European governments.

The U.K. is widely expected to hold a referendum on whether to remain in the EU after the general elections. The U.K. would be more likely to vote yes on its own secession if Scotland was to leave. Scotland has historically voted with the Labor Party, which currently seems to support staying in the EU, and Scotland leaving would mean a significant loss of votes for Labor.

In Scotland, the current polls indicate that the population is about equally divided among groups that would like to leave, stay or prefer increasing independent powers for the country. The SNP is seeking independence with a “social union.” The pro-unionists are implying that even if Scotland remains in the union, more independence would be given to the country. In fact, several U.K. political parties have proposed more favorable devolution packages without full independence.

Currently, the U.K. has said that an independent Scotland would not be allowed to keep using the British pound. Also, questions of national debt and national defense would need to be resolved. This would likely involve years of legal disputes. It is also interesting to note that although Scottish leaders have called for independence, they are trying to delay the referendum until 2014, with a promised white paper detailing the mechanics of separation not to be published until next year. In addition, some critics have accused Mr. Salmond of shifting the blame for Scotland’s economic difficulties to London to distract voters from his own government’s shortcomings.

The public discussions between Scottish and British leaders could also hurt the pro-independence movement, as the British government has demonstrated willingness to find an outcome that would be workable for both sides. In sharp contrast to this is the refusal of the Spanish government to allow a referendum. In Spain the constitution does not allow for a regional referendum, but in the U.K. only London has the authority to call a referendum, and the current government has indicated its willingness to do so.

Mechanics of a Possible Separation
Salmond has assured for years that if Scotland was to break away from the U.K. the country would still remain in the EU. However, it now appears that this would not be the case. Quite the opposite, Manuel Barrosso, the president of the European commission, has indicated that any new state, including Scotland, must apply to join.

Internally, Mr. Salmond has lost a lot of trust over the misinformation on the terms of Scottish membership in the EU. He is now indicating that he cannot further comment on the matter, as he has started an investigation and the results will be published next year in a white paper. This lack of clear communication of objectives and procedures makes it less likely that Scottish citizens would vote for secession from the U.K.

If Scotland does succeed in establishing an independent state, international precedent suggests that the most likely course would be that the U.K. ex-Scotland would maintain all of the U.K.’s current international seats and relations. Scotland would have to be ratified as a country and then apply for membership into different international organizations. For example, when the Soviet Union broke apart, the Russian Federation maintained its membership in international organizations, including the U.N. Security Council, whereas the newly created states had to apply for membership. The same was true in the dissolutions between India and Pakistan, Eritrea and Ethiopia, and Ireland and the U.K. Only the split-up of Czechoslovakia created two separate countries, and in that case the split was amicable.

Although there are no formal EU rules for national separation, the general language would suggest that the factors considered are whether the country has maintained the central government along with most of its population, territory and armed forces. In this case, the U.K. would also retain most rights.

However, even if and when Scotland would apply, the application would likely be fast-tracked. The full application process would likely take between two and four years, but the more urgent matters would receive some sort of a temporary fix. A possible option could be joining the European Free Trade Association (EFTA). EFTA encompasses Norway, Iceland and Liechtenstein, as they share an internal market with the 27 EU members without being part of the union.

In the end, the vote of the member states will determine the possible membership path for Scotland, more so than the letter of law. Some of the countries have an interest in making sure that the process would not be easy for Scotland. Spain and Belgium are likely to vote against Scottish membership in order to set a precedent for Catalonia and Wallonia.

Eventually Scotland would be admitted to the EU, since the chief principle of the institution is to extend the union to all western democratic countries in Europe. However, all involved parties realize the dis-proportionality of the argument to each side. For Scotland, the resolution of the negotiations is crucial, but for the other parties involved the outcome is a mere distraction.

Wider Implications
Although the Scottish leaders are talking about independence, they know the most likely outcome would be more fiscal autonomy for the region.

So, the real issue here is establishing a precedent for other European nation states as well as for the Eurozone in general. If a region of a country is allowed to secede because its citizens believe that they would be better off economically and fiscally by themselves, then it also has far-reaching implications for the current inter-country transfers. The northern Eurozone countries could use the same argument to leave the union.

Scottish independence could also open the door to further cultural break-ups within Europe, as historically, countries were formed based on economic and political forces, not based on cultural integration. Globalization fuelled economic integration, making it more expensive for any nation to remain outside of international treaties. However, the current reality is that the EU is willing to expand the union to include new, smaller countries. These potential smaller entrants may benefit from disproportional representation in Brussels relative to their population and economic influences. Furthermore, they could still enjoy the protections from other international organizations.

Despite the possible ripple effect, some proponents of separation argue that geopolitical dynamics and international organizations have shown in the past 20 years that they could adjust to more drastic and unforeseeable nationhood claims, as seen with the break-up of the Soviet Union and the emergence of new nations.

Although the underlying cultural desires for a self-sufficient Scotland still exist, the economic benefits of Salmond’s plan have not been clearly demonstrated. Thus, we do not believe that the Scottish referendum would achieve the necessary support to establish an independent state, and instead the likely outcome would be more autonomy for the region.

Bill O’Grady
Kaisa Stucke
November 12, 2012

This report was prepared by Bill O’Grady and Kaisa Stucke of Confluence Investment Management LLC and reflects the current opinions of the authors. It is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice. This information does not constitute a solicitation or an offer to buy or sell any security.



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