LIKE most things in politics, referendums often raise more questions than they answer. And the ballot due to be held on Scottish independence this September is no exception to this rule. As we point out in this week’s print edition, several awkward questions over the financial consequences of Scottish independence have been raised this week. Will an independent Scotland be allowed to remain in the sterling area, or if not, would it honour its share of Britain's national debt? Might the new country not be allowed to join the European Union? And who will be responsible for the bailing out of Scotland's out-sized banks—whose assets are 12 times bigger than its GDP—if they run into trouble?
The fact that the creation of new states in Western Europe has been rare (recently anyway) may account for much of the uncertainty. Most new countries, further east, resulted from the chaos after the first and second world wars, or appeared after the breakdown of federal republics, such as Yugoslavia and the USSR. Such comparisons bear little resemblance to the case of Scotland if it achieves independence from Britain later this year.
However, historians and economists say there may be one historical parallel similar to Scotland's case today. Ireland’s split from Britain in 1922 shares some characteristics to that proposed for Scotland, financially speaking, according to a new paper* by Eoin McLaughlin at the University of Edinburgh and Nathan Foley-Fisher at the Federal Reserve. Rather like proposals for Scottish independence, the new Irish Free State, as it became called upon independence, was forced to take on some of Britain’s existing national debt—equal to around 60% of Irish GDP—including "land bonds" that had been accrued financing agricultural reform policies in Ireland since the 19th century. But the new state was also given a further debt guarantee by the rest of Britain, to help restore economic and political stability to Ireland following independence.
The paper finds, in an analysis of British and Irish sovereign debt yields during the period around independence, that over time British and Irish interest rates diverged, in spite of the debt guarantee. From the end of the first world war onwards, British and Irish bond yields followed different paths in spite of the fact they were both guaranteed by Britain’s government. And after Ireland defaulted on some of its debts to Britain in 1932—as Alex Salmond has threatened to do if an independent Scotland is not allowed to join the sterling area—the spread between British and Irish borrowing costs sharply rose. The existence of the debt guarantee did not prevent a gap appearing between borrowing costs for the two countries.
That did nothing to help the Irish economy after independence. Deteriorating economic relations in the 1930s over Ireland’s debt liabilities led to Britain imposing retaliatory tariffs on Ireland to recoup some of the money it was owed. The resulting “Anglo-Irish Economic War” depressed Irish GNP by up to 5.6%, according to research by Kevin O’Rourke at Oxford University—and the subsequent drift towards protectionism contributed towards several decades of comparative economic decline.
While direct comparisons between Ireland in the interwar period and Scotland after independence may well prove premature—the referendum has not been held yet—one lesson can easily be drawn. The separation of Ireland’s finances from Britain’s was "messy", as Mr McLaughlin points out, and the final details took decades to work out. The same could easily apply to Scotland, particularly as the world of finance was a much simpler place back then than the globalised world of today. Cutting a new country out of Britain could yet again prove much easier politically, than it is in financial or economic terms.
*N. Foley-Fisher and E. McLaughlin, “Irish land bonds: 1891-1938”, EABH Papers No. 14-01, January 2014.
