Spain and the UK – Between the Sword and Wall?

catalonia-200x200The title of this post comes from a timely new paper on the likelihood of Catalan independence. Published by the University of Sydney as an Economics Working Paper, which you can access here. The full title is Between the Sword and the Wall: Spain’s Limited Options for Catalan Secessionism. The authors do not argue for independence or secession, but use a game theory approach to suggest that independence for Catalunya is not just possible, but an optimum outcome for Spain, Catalunya and the EU.

This conclusion is based on three assumptions. One, that there is a credible demand for independence, ie polls indicate that the pro-independence campaign has a good chance of winning the referendum. Two, the demand for independence is primarily or at least to a very large extent economically driven. Simply put, the proponents of independence believe independence would make the new country better off. Thirdly, there is no threat of violence to stop independence. While the first two assumptions are very much in line with the situation in Catalunya, the third assumption may strike many as an assumption too far. However the authors present a convincing case for this, by arguing that the use of violence to suppress a peaceful democratic vote would be so damaging and disruptive for not just the Spanish economy, but for the eurozone as a whole that it can effectively be ruled out.

Since the demand for independence is primarily driven by demands for greater economic powers the first option for the Spanish government would be to try and “buy-out” a proportion of the electorate by offering a better funding model favourable to Catalunya. This is unlikely to happen. Neither of the two main Spanish parties, the Conservatives and the Socialists, have shown any serious interest in this option. Furthermore as the authors point out, the cost of “buying-out” Catalunya may be too high a cost for Spain in its current economic situation. The Spanish government is probably too dependent on the tax revenues coming from Catalunya to be able to afford to forego this in order to keep Catalunya in Spain. It is worth noting that it was the failure of a previous attempt to agree a new funding package that led to the current wave of pro-independence support.

If Spain cannot or will not offer Catalunya a new deal, then the referendum goes ahead. In this scenario there is likely to be a greater chance of a Yes vote for independence. In which case, according to the authors, the Spanish government would be forced to negotiate independence. At the moment the main deterrent used by the Spanish government is the claim that an independent Catalunya would not be internationally recognized and therefore excluded from the EU. However as the authors demonstrate this is a non-credible threat. The key point is that a newly independent Catalunya would have some powerful weapons at its disposal. The rest of the EU needs Catalunya as a transit space for much of its trade with Spain and North Africa. More importantly the threat of exclusion from the EU would be met by the threat of not accepting a share of Spain’s debt. This, plus the loss of Catalan tax revenues would put Spain in the perilous position of becoming bankrupt, seriously endangering the euro and the EU. Thus there would be enormous pressure from within Spain and from the rest of the EU for Spain and Catalunya to reach a swift agreement. An agreement based on full membership of the EU for Catalunya in return for the Catalans accepting a proportional share of Spain’s national debt.

Could something similar happen in Scotland? As the UK is not in the eurozone, Scottish independence poses no threat to the euro. However the importance of the national debt is something that would be relevant in negotiations over Scottish independence. A recent paper on Scottish Independence and the UK’s Debt Burden from the National Institute of Economic and Social Research demonstrates that “in all cases, the UK’s debt to GDP ratio will rise, with possible consequences for its credit rating. At the same time, Scotland’s debt burden will be lower than the UK’s in all cases.” This is the scenario if Scotland becomes independent and agrees to take on a proportional share of the UK’s debt. Just imagine how bad it would be for the rUK if Scotland didn’t agree to this. Once again we have evidence that Scotland has some important cards to play in the event of negotiations.

In general terms while the UK may not be in quite as parlous a state as Spain, the future economic prospects for the UK are far from rosy. In fact one can argue that the UK needs Scotland more than Scotland needs the UK. The loss of tax revenues from Scotland, including from the North Sea, would in all likelihood seriously worsen the rUK’s debt and current account. This probably explains why none of the main UK parties have ever considered granting full fiscal powers to Scotland. Despite all the bluff and bluster coming out of Westminster, the rUK cannot afford the option of Devo-max. As in Spain the only choice is between the status-quo and independence. For more and more people the status-quo is becoming a very unattractive option. From now on the ball is firmly in the courts of London and Madrid. We await with interest to see if they come up with anything positive.

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