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A few takeaways from the 55-45% victory for No in the Scottish independence referendum:

  1. The polls overestimated support for independence, just as in the 1995 Quebec referendum. Secession from a well-established democracy is extremely difficult due to voters’ risk-aversion and status quo bias.
  2. Scotland’s right to decide elicited salutary promises of decentralization from the British government. My book found that countries with legal secession saw more decentralization than countries without, and countries with legal secession never recentralized power in the post-World War 2 era, according to the measure of regional autonomy I used.
  3. While Westminster is likely to follow through on some additional powers for Scotland, they are not likely to approach anything like “devolution max.” For one thing, the Barnett formula will continue, suggesting the Scottish government’s budget will remain heavily dependent on transfers. For another, significant powers for Scotland will require wholesale constitutional reform, particularly to deal with the West Lothian Question, and there are many obstacles to a solution to that problem. Finally, the scale of No’s victory will reduce the urgency for British leaders to get something done. I will be very much surprised if a bill is produced to give Scotland autonomy equivalent to that enjoyed by, say, New Hampshire, let alone the Isle of Man.
  4. There’s going to be a lot of ignorant commentary about what this means for Catalonia. It means very little. Catalonia will proceed toward its own vote on independence. Secessionism isn’t contagious across borders, nor is declining secessionism. If anything, the No camp’s victory might persuade the Spanish government to allow a Catalan vote — but I wouldn’t count on it.

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Unless the polls are systematically biased or there is a late-breaking surge in support for “Yes,” the “No” campaign looks set to squeak by with a narrow victory in the Scottish independence referendum. On the betting markets, a “Yes” vote has plunged below an implied probability of 20%. What has this decline in the prospects for independence done to capital markets? In my last post on the subject, I found that British firms and the pound were nearly untouched by what was at the time significant momentum for “Yes,” but that a nine-firm Scottish equity index was hit hard. If those losses reflected unease about independence, then the latest news should have caused growth in my Scottish equity index.

The biggest decline in the Yes team’s chances actually came overnight September 11-12, when the chances of Scottish independence abruptly fell about 10 percentage points on the release of new polls in the evening of September 11. (For a full list of recent polls, see Wikipedia.) The Yougov poll showing “No” in the lead (a dramatic reversal from its previous poll) seems to have been leaked just before the closing bell on September 11.

betfair independence odds

Accordingly, I examine the performance of the Scottish equity index on the London Stock Exchange between 4:30 PM and 5:00 PM local time on September 11, when the odds of Scottish independence declined so rapidly. These are the nine stocks I include in the index: SL, SSE, FGP, WEIR, SGC, AGGK, WG, ADN, and MNZS. Of these, eight of nine rose on the poll news. Again, I weight by each stock by its market cap to create the index. The index rose 0.5% on the news, a rather small increase compared to the 1.7% decline after the shock Yougov poll showing “Yes” ahead. The overall patterns were pretty similar, though. The two transportation companies, Firstgroup and Stagecoach Group, were basically unchanged between the two. Energy-linked firms and Standard Life led gainers. Aggreko (temperature control systems) registered a small gain, and Aberdeen Asset Management a somewhat larger one.

Roughly a ten-percentage-point drop in independence likelihood led to a 0.5% gain in the value of Scottish equities, less than a third of the loss in Scottish equities after an eight-percentage-point gain in independence likelihood just a few days prior. On balance, these results suggest we should revise downward the costs of secession suggested by the prior post.

One objection to this interpretation might be that the leak of the Yougov poll just before the closing bell gave traders little time to respond. But this does not appear to be the case. The Scottish equity index was flat at the opening bell on September 12, suggesting that there was no new information for traders to consider.

Here are two more interpretations. First, betting markets are less liquid and well-capitalized than financial markets. The actual gain in the probability of Scottish independence after the first Yougov poll may have been greater than the immediate response on betting markets. Second, the shock of a poll actually showing “Yes” ahead may have led traders to overestimate the likelihood of Scottish independence, and perhaps even the costs of secession (in a moment of panic). Having been inured to the initial shock and its aftermath, traders then took later news with more equanimity.

Overall, though, the results are still suggesting net economic costs to Scottish independence. How much of the emphasis should be put on the “Scottish” part of that phrase and how much on “independence” remains a matter of debate, but clearly energy and financial firms are more affected than transportation and service ones.

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The Oxford Review of Economic Policy has a brand-new special issue on the economics of independence. The entire issue seems to be open-access right now, so check it out. (HT: Doug Irwin)

In Scottish news, polls have turned a bit against independence, and betting markets now price a “Yes” at around 22-24%. I will take another look at how this affected capital markets, and what that implies about the economics of independence, a bit later in the week.

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What can we learn from capital markets about the likely consequences of Scottish independence? A trio of recent polls has shown the “Yes” side to have pulled roughly even with “No.” With momentum on their side, it’s not unthinkable at all that “Yes” will pull it out, resulting in the first secession from a Western democracy since Iceland withdrew from Danish union in 1944. Most American commentators, from Paul Krugman to Tyler Cowen, oppose Scottish independence and forecast economic disaster for the new country. Are they right?

Let’s look at the behavior of capital markets in Britain since these polls’ release to find out. First, let’s set the stage by looking at how betting markets price the probability of Scottish independence. Unfortunately, there are no nice InTrade-style charts for implicit probabilities anymore, at least not that I can access from the United States. From oddschecker.com, I am able to pull odds from different exchanges from the beginning and end of each day. Looking at the markets with most liquidity, it looks as if the odds for independence moved from about 19.5% Friday night to about 25% Saturday night, after the release of the YouGov and Panelbase polls (the Panelbase poll suggested “No” might still have a small lead). On Monday morning the odds stood at about 23.3%. After the release of the TNS poll Monday evening (confirming the dead heat), the odds moved in to 26.0%.

Next, let’s look at the behavior of capital markets over this period. Here is how the pound has fared against the euro:

euros per pound

Not much of a correlation. To be sure, the pound fell against the euro when trading opened Monday morning, following the shock weekend poll from Yougov and the somewhat-reassuring poll from Panelbase, but the TNS poll released late Monday night appears to have had zero effect on the pound, even though it did have a small effect on the betting markets.

Now, the pound has fared a little worse against the dollar, because the euro has also dropped against the dollar. This may reflect that traders believe Scottish independence raises the probability of British exit from the EU. But this would not be a direct cost of Scottish independence, and it would ultimately be up to English, Welsh, and Northern Irish voters whether they want to withdraw from the EU.

What about the stock market?

dowftse

I’ve got the Dow in there for comparison (in green). So the FTSE fell about 0.3% on opening Monday, then drifted downward throughout the day, finally recovering all that ground except the initial 0.3% drop. On opening Tuesday after the TNS poll, it actually rose. As of this writing is down just about 0.4% from Friday’s close. This looks like a muted response to me.

But what about Scottish-exposed stocks in particular? I took the list of top 25 Scottish companies here and winnowed the list down to those listed as having Scottish ownership and being publicly traded. Nine companies fit that test. I then constructed a weighted average of their share prices at Friday close, Monday open, Monday close, and Tuesday open, the weights being each stock’s market cap according to investing.com. Recall that there were two surprise polls, one over the weekend and one released Monday evening, the former having the greater effect on betting markets.

The Scottish index I created lost 1.7% of its value on opening Monday morning, a noteworthy drop because it happened right away. It’s plausible to attribute this drop to the increased risk of independence. However, today it lost nothing on opening – in fact, it was up 0.1%. Still, the total loss to these nine firms’ market value amounts to about $800 million. The fact that there was no further response of capital markets to the TNS poll, even though betting markets did respond, weakens our confidence somewhat that investors are responding negatively to the prospect of independence, but let us work with the assumption that they are.

What would happen to these firms’ value if independence were dead certain? Expected utility analysis helps us here. They lost $800 million in value on an increase in the probability of independence of 5.5+2.7=8.2%. We can infer that an increase from 20% to 100% would wipe out $800 million*8/.6=$7.8 billion. That’s a fair proportion of their existing value: about 16%. Of course, investors are risk averse, and the very uncertainty of the outcome might be driving a fair proportion of the losses.

A closer look reveals that different stocks responded differently to the poll news. Two transportation companies, FirstGroup and Stagecoach Group, lost virtually nothing, and Aggreko, which rents temperature control systems, lost absolutely nothing. Financial and energy/power companies were pounded. An engineering company closely linked to the oil industry, the Weir Group, took a more modest 1.0% loss.

How to sum up? So far (more…)

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UK Labour MP and former Chancellor of the Exchequer Alistair Darling and Scottish First Minister and Scottish National Party MSP Alex Salmond last night debated independence for Scotland as part of the campaign leading up to a referendum on September 18. While the “Yes” camp remains slightly behind in the polls, they have been catching over the past several months, and it is likely that the vote itself will be close.

Watch the debate here. It features many themes common to debates over secession in the Western world: risk and uncertainty, self-determination, ideological distinctiveness of the secessionist region, and economic costs and benefits of independence. It’s a sparkling and entertaining debate; Mike Smithson of politicalbetting.com called it “by far the best TV debate there’s been in the UK.”

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The Government of Scotland has just released its 600-odd-page white paper on independence in advance of the September 18, 2014 referendum on the question. First Minister Alex Salmond and the rest of the pro-independence side have their work cut out, with the latest poll showing a 47-38% plurality in favor of “No.”

In part, the white paper aims to show that independence would not harm the Scottish economy. There is a debate between nationalists and the British government about whether Scotland would face a significant fiscal gap after independence. The Institute for Fiscal Studies says Scotland would face a long-run fiscal gap amounting to 1.9% of national income after independence, while the British government says Scotland would have to raise taxes 9% upon independence to fund the same benefit levels. Nationalists retort that they would change policies to save money. Nevertheless, like most political parties, they are only specific about the new benefits they plan to introduce after independence.

Still, there is good evidence that most Scots are not concerned about the fiscal issues relating to independence. After all, somewhere between 52 and 68% of Scots express support for either independence or “devo max” in polls. “Devo max” is a term used in the UK for full fiscal autonomy, under which Scots would pay no direct taxes to and receive no direct benefits from the UK government (everything would be negotiated between the Scottish and British governments). The strong support for at least devo max implies that Scots aren’t worried about suffering from a fiscal gap even when fully fiscally autonomous.

The dropoff in support from devo max to independence reflects that Scots are more worried about the foreign, monetary, and trade policy uncertainties attendant upon independence. A major bone of contention has been nationalists’ desire for a currency union. The “No” side insists that there is no guarantee the British government will accept a currency union. Salmond has said Scotland could repudiate its share of British debt if the British government didn’t accept a currency union.

The key sticking point in the currency union debate is that the nationalists desperately want Scotland to retain a say in the Bank of England’s monetary policy. Absent that desire, it would perfectly straightforward for Scotland to retain the pound. They don’t need a central bank: people, including the new independent government, could go on using the pound as usual. Indeed, a better threat than debt repudiation that Salmond could make would be for Scotland to abolish central banking, legal tender laws, deposit insurance, and financial regulation, and suck financial business out of London into Edinburgh. (A libertarian can dream, right?) But Scotland’s political culture is solidly left-wing, and any suggestion of going without a lender-of-last-resort wouldn’t fly with voters.

So as we have seen with previous referendums in Quebec, the “Yes” side will insist that all will go on as normal after independence: same treaties, same trade relations, same monetary policy. Meanwhile, the “No” side will play up the uncertainties. They won’t “talk down” Scotland, which would risk a backlash, but instead they’ll just keep saying “there are no guarantees” and attacking the nationalists’ plans as “unrealistic,” “uncosted,” and “amateur.” Steve Saideman notes that there is a tension between nationalists’ desires to “keep everything the same” and promise improvements after independence: secession is either meaningful or it isn’t!

The way to square the circle is that Scots want more left-wing policies than the British status quo on welfare rights, education, the environment, Europe, labor, and defense, but they also like the risk-pooling advantages of a larger state. They see no advantage in a new Scottish currency or a nonaligned foreign policy. Therefore, nationalists promise Scots what they want on the former set of policies while trying to assuage their doubts about the latter.

The figure below shows how Scottish nationalism has tracked left-right ideological change in the Scottish electorate, for UK general elections only. The blue line represents the vote share for secessionist candidates in Scotland: mostly Scottish National Party (SNP), but also Greens, Socialists, and some independents. The blue line represents the UK vote for center and right parties minus the Scottish vote for center and right parties (mostly Conservatives, but also UKIP, Unionists, and the like). In general the two lines correlate pretty closely; the only major exceptions are the 1979 and 1983 elections, when Scotland moved left relative to the UK as a whole, even as the SNP vote collapsed. Since then, the lines have correlated rather well. There is some reverse causation here, since the SNP is a left-wing party, but the fact that the nationalists have adopted a forthrightly left-wing platform tells us something. The bottom line is that Scotland’s move further to the left of the UK has helped promote the secessionist cause. (The spike in the 1974 elections was due to the discovery of North Sea oil, which the SNP politicized under the campaign slogan, “It’s Scotland’s Oil!”)

lefties & nats in scotland

Whether Scotland votes “yes” or “no” in the referendum will depend on how the pivotal voters trade off concern over future Conservative governance in Britain against the uncertainties of full independence. One reason why “no” appears headed for victory is that the Conservatives look set to lose the next UK election, and over the last two decades, Labour has looked like the natural party of government in Britain and has in fact moved British policy significantly to the left, at least on fiscal issues. Scottish voters have less to fear from union.

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British Prime Minister David Cameron and Scottish First Minister Alex Salmond have reached a deal on the upcoming Scottish independence referendum. It looks as if the SNP have gotten what they wanted in several respects:

  • 16- and 17-year-olds will be allowed to vote.
  • The referendum will be held in late 2014.
  • While the Electoral Commission will advise on the question, it will ultimately be up to the Scottish Parliament, controlled by the SNP.

The SNP have dropped plans to include a third option in the referendum, which would presumably have been “devo-max” or full fiscal autonomy with political union. As I have noted before, I think this is a missed opportunity for holding a ranked-ballot referendum and selecting the Condorcet winner. However, with no political party actually advocating the devo-max option, it was always unlikely that the referendum would include it. (And apparently the SNP was interested only as a way of splitting the anti-independence vote, i.e., not allowing ranked ballots.)

Reactions from around the UK:

  1. Guardian, “Scottish people would have voted for ‘devo-max.’ That’s why it’s not an option”
  2. Telegraph, “Alex Salmond ‘will have to defy history’ to win Scottish independence referendum”
  3. Politics.co.uk, “Scottish independence: Overconfident London could rue the day”
  4. Better Nation, “The Edinburgh Agreement”

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