Scotland’s vote against independence has restored some certainty to the UK’s economic recovery, but moves towards greater devolution are likely to reshape Britain’s economy and public finances in the years ahead.
In the short term, the No vote has maintained the status quo and averted the scenarios that investors and economists most feared: a plunge in the pound, capital flight from Scotland and a period of deep uncertainty that could have undermined Britain’s recovery.
Economists think some pent-up demand could be released now those risks have abated, particularly in Scotland, where some business investments and house purchases had been put on hold. Since Scotland’s economy only represents about 8 per cent of the UK’s, this removes a risk that the wider recovery would stall rather than making a big difference to headline growth.
Many City economists emailed clients on Friday morning expressing greater confidence in their upbeat near-term economic forecasts for the UK. “Back from the brink” was the subject line from one economist. The consensus is for the economy to grow 3 per cent this year.
The vote has made investors more confident in their assumption the Bank of England will start to raise interest rates in March next year. Meanwhile, by keeping Scotland’s relatively pro-European voters within the UK, the vote also reduces the chance of “Brexit”, a British exit from the EU.
But as David Cameron made clear on Friday morning, all political parties will seek to agree a new constitutional settlement that is likely to reward successful nations and regions in the UK while forcing the less successful to face the consequences.
Economists on Friday noted that the plans for greater devolution were yet to be thrashed out. “The near-term outlook for the economy on both sides of the Scottish border has brightened following Scotland’s decision to remain part of the UK,” said Samuel Tomb, an economist at Capital Economics, on Friday morning. “But despite the No vote, the UK economy will continue to be buffeted by uncertainty about its political future over the next couple of years.”
The broad contours of further devolved tax raising powers are evident from the 2012 Scotland Act, which already gives Scotland significantly greater autonomy in its public finances from 2016.
Under the Act, the Scottish government will gain the power to raise or lower all income tax rates by up to 10 percentage points. A potentially more significant change gives Scotland a direct stake in the success of its economy.
At present, the nation is fully insured by the rest of the UK if revenues from income tax collected from Scottish residents do not match the growth of the rest of the UK. Once it gains the new powers, Scotland will be subject to “fiscal risk”, benefiting if Scottish tax revenues grow faster than those in the UK, but suffering the consequences if the Scottish economy fails to perform as well as the UK average.
Professor David Bell of Stirling University says, “increased fiscal risk is an inevitable consequence of moving towards greater fiscal autonomy”.
All three political parties have promised an accelerated timetable to give even more tax and spending powers to the Scottish people. On Friday morning, prime minister David Cameron said those commitments would be “honoured in full”.
Both the Conservatives and the Liberal Democrats have said they would hand over full control of income tax to a Scottish government. The Lib Dems have also suggested devolving inheritance tax and capital gains tax. Labour has been less radical, offering only extra leeway within income tax bands.
The effect of devolving further taxes will add to the responsibility of Scotland to ensure tax revenues do not slip behind the UK average. The same would apply for other nations and regions, such as London, which might want similar powers.
The initial budget for Scotland and other nations will still be set by the Treasury and subject to negotiations amid longstanding complaints that the allocation of public spending across Britain is unfair.
“The UK will become a looser union over the coming years,” said Rob Wood, an economist at Berenberg, on Friday. “The economic impacts of that backlash do not have to be huge and there will also be opportunities . . . Devolution, if implemented well, could bring benefits, while an English parliament, if politicians set one up, may be more business friendly.”