Scotland: A proxy vote for independence?

The Scottish regional election on May 6 is potentially shaping up to have a big impact on the future of Scotland and the UK, as independence has returned to the top of the agenda. The Scottish National Party looks set to win by a considerable margin (figure 1), and is then likely to claim to have gained a new mandate for a referendum. The Conservative Party, officially the Conservative and Unionist Party, will in turn continue to make the case for the union. But even when prime minister Johnson denies Scotland a second independence referendum, or employs more heavy-handed tactics to suppress ‘Scoxit’ sentiments, the rift between Scotland and England looks set to widen. The Scottish regional election should be viewed entirely through this prism.

In September 2014, the Scottish people were asked in a referendum whether they wanted Scotland to become independent from the UK. The result was 55% to 45% against independence, with a turnout of 84.6%[1]. The outcome was in line with polling in the run-up to the vote, which showed steady but at times narrow support for "No" with a floor at around 45%. This has evolved since 2016. The polls now indicate that both “Yes” and “No” have a floor at around 40%, meaning that 20% of the voters are undecided and hold the keys to the country’s future. It suggests there is still everything to play for if a second independence referendum is being held.

[1] Opinion polling for the 2021 Scottish Parliament election, see here.

The Scottish National Party has to win the regional election first. The Scottish Holyrood parliament has 129 members and 73 constituencies. For this reason, voters will cast two votes: a first for a candidate in their constituency, and a second for a party list in one of Scotland’s eight regions. These second votes are distributed among the list candidates according to a D'Hondt system until seven members have been elected per region. Crucially, in this system, the number of seats that are already won in the constituencies are taken into account in the calculations for the list seats. It is explicitly designed to compensate parties that receive substantial amounts of votes in the constituencies, but hardly ever come in first in these races.

This so-called additional member system is designed to strike a balance between first-past-the-post and proportional representation. But it still benefits the Scottish National Party, as long as the election is seen as a proxy vote for independence. The SNP will dominate the 73 constituency seats and win the ‘independence vote‘, while the Conservatives, Labour and the Liberal Democrats split the unionist vote. Since there are more constituency seats (73) than list seats (56), it’s all but certain that the SNP will win this election.

A more relevant question is whether the SNP wins an absolute majority, as this would strengthen their claim that this week’s vote is de facto a vote for independence. This isn’t certain. After the big victory in 2011, the SNP won ‘just’ 63 seats in 2016, two short of an outright majority. The SNP grabbed 59 of Scotland’s 73 constituencies, but only picked up 4 out of the 56 “top-up”-seats in the regional vote. These mostly went to the Conservatives and Labour, the numbers two and three in the constituency vote. This is a feature of the D’Hondt system (not a bug!), and we will see a similar dynamic this time.

If the polls are a good approximation of the actual vote, there is about an even chance that the SNP wins 65 seats (or more). This scenario has been widely flagged. This means that as many voters will use their vote to prevent a new referendum as to try and secure one.

Why isn’t the pro-independence vote split?

The SNP is not the only pro-independence party contesting this election. The Scottish Greens also support independence, but as they are a smaller party, they only run in a few constituency races and focus on the regional list ballot. As they poll at 8-10% of the vote, they are expected to win more than a handful of these seats, and could therefore have a crucial role in securing a strong pro-independence majority.

A complicating factor is the Alba Party, the new pro-independence party of former SNP leader Mr. Salmond. Alba is not contesting any constituency races either, and Mr. Salmond claims his entry will actually bolster the pro-independence support by mopping up list votes that would otherwise be “wasted”. However, Ms. Sturgeon argues that her former mentor is trying to “game” Scotland's election system, and seeks to influence the SNP’s more moderate direction from the outside. Most polls indicate that Alba may not win any seats, as Mr. Salmond isn’t a very popular politician. But in the regions where SNP doesn’t win all the constituency races, if only some of their voters make the switch to Alba, it could be enough for the SNP to lose a seat or two without Alba actually picking up one.

In the EU referendum of June 2016, Scotland voted by 62% to 38% in favour of Remain, a sharp contrast with the vote in England or Wales. The subsequent historic break from the European Union is one of the reasons why the issue of Scottish independence has been put back onto the agenda. In the 2019 general election, the SNP dominated the Scottish vote. It won 48 out of Scotland’s 59 seats in Westminster, as it explicitly campaigned for a second independence referendum. Ms. Sturgeon then said there was a “renewed, refreshed and strengthened mandate” for a new independence vote.

This is easier said than done. Under the Scotland Act 1998, the Holyrood Parliament is not allowed to pass legislation relating to matters that are ‘reserved’ to Westminster. This includes “the Union of the Kingdoms of Scotland and England”, and the interpretation is that an independence referendum requires the explicit approval of Westminster. In the days after the December 2019 election, Ms. Sturgeon therefore requested a ‘Section 30 order’, which would temporarily allow the Scottish parliament to pass such legislation. This request was refused by prime minister Johnson, on the basis that the 2014 referendum was a “once-in-a-generation” opportunity.

Even so, the SNP continued to lay the groundwork for independence. In the first months of 2020, the Holyrood Parliament passed two legislative bills to make further preparations for a referendum. The SNP meanwhile maintains that it prefers to seek a legitimate way out, seeing this as imperative for acceptance at home and abroad. If the pro-independence parties win a majority, the SNP will therefore again request a Section 30 order, aiming to hold a second independence referendum in ‘the early part’ of this new term.

This leaves Boris Johnson the choice to accept or refuse this request. He has emphasized several times –for what that’s worth– that he embraces unionism and would never agree to another referendum. We would also note that his government has been very unilateral in the ways it made crucial political decisions. The events of the past couple of years have led to a much more assertive sort of ‘unionism’ rather than the more pragmatic intergovernmental relationship between Westminster and the three devolved administrations.

The tightened grip of Westminster has the potential to backfire. If the prime minister does indeed not agree to an independence vote, the SNP may decide to still move forward with the referendum and to adopt an even more confrontational approach. The risk is that the genie can’t be put back in the bottle, that the SNP feels compelled to go rogue under pressure from hardliners, and that it will ultimately consider to hold a unilateral referendum. This will then have little legitimacy –as it could be boycotted by unionist parties– and lead to a constitutional collision and protracted political uncertainty.

With the Brexit debates still fresh in everyone’s minds, the UK government will have to perform impressive mental gymnastics to argue the economic case in favour of the union. Simply put: if the United Kingdom is better off out of the European Union, as it says, why would Scotland be worse off when it leaves the United Kingdom?

This is indeed illogical, so it’s reasonable to expect that the UK government wants to shift the debate to matters such as culture and identity, as this has worked out well with Brexit too. Conversely, the SNP has opportunistically rebranded itself as a Europhile party, making an explicit connection between Scottish independence and a closer relation to Europe and its institutions, potentially even membership of the European Union. This is easier said than done: fact is that more than 60% of Scottish exports go to the rest of the United Kingdom (see figure 4), only 20% goes to the European Union, and 20% to the rest of the world. A reorientation of these economic relationships will have significant ramifications for the Scottish economy.

Border problems

Ms. Sturgeon boldly claims that “Nobody in the SNP wants to see a border between Scotland and England”, but this is exactly what will happen if Scotland indeed wants to re-join the European Union. Just as Brexit created a trilemma with the Irish border, Scottish independence will create one with the Scottish border. It can’t be emphasized enough that it is impossible to have Scottish independence from the UK, Scottish membership of the EU, and the absence of a border between Scotland and the rest of the UK. The big difference is that border infrastructure between Scotland and England is not at odds with any international treaties.

If Scotland is indeed aspiring to be an EU member state, it will have to apply the EU’s Common Commercial Policy, and the border between Scotland and England would become an external border of the EU market. The EU would then demand checks and controls at this border, which will create economic costs for Scotland that are similar to the ones that were identified with Brexit (e.g. an increase in trade frictions, higher prices and fewer export opportunities). The benefit is that Scotland will increase its access to the wider EU market, but given the larger distance this isn’t enough to compensate for the losses that result from reduced Scotland-UK trade.

There will be a very difficult debate on fiscal matters too. If the SNP’s push for independence leads to fiscal autonomy, Scotland would need to negotiate with the rest of the UK how its assets and liabilities are shared. This distribution will in turn affect the future fiscal outlook. In fiscal year 2019/20, Scotland’s net fiscal deficit was 9.4% of its GDP if the North Sea oil and gas revenues are excluded, or 8.6% if these are included. This relates to a UK fiscal deficit of 2.6% of GDP. Note that the net fiscal balance also adds in net investment (i.e. capital expenditures minus depreciation) to see how spending matches with revenues. One thing stands out: if net oil and gas revenues fall over the long run, as the energy transition continues, then the fiscal challenges facing Scotland will increase. It goes without saying that this will be a complicating factor.

In the past five years, (the prospect of) Brexit has proven to be a major driver behind the movements in sterling, either through changes in market sentiment, perceived political risk, or the UK’s economic fortunes. So far, this hasn’t been the case for (the prospect of) ‘Scoxit’.

If we go back to 2014, and zoom in on the weeks before and after the Scottish independence referendum, the spikes in implied and eventually realized volatility were fairly modest too. It wasn’t much of an issue: EUR/GBP traded as high as 0.80 in the days before the Scottish referendum and eventually ended the week at 0.788 (figure 6 and 7). Of course, the polls in the run-up to the vote were firmly in favour of “No”, and this has been a contributing factor to the market’s composure.

The market seems to be relaxed now, too. For one, the polls on Scottish independence are much more balanced then they were a few months ago (see again figure 2). This is probably a function of the strong vaccine roll-out, for which the prime minister is apportioned a large share of the credit, and the expectations of a better pace of growth this year and next. That said, the pound has also been confronted by a round of headlines regarding sleaze in government circles.

To borrow an overused quote from Hemingway’s The Sun Also Rises, these are the kind of changes that happen “gradually, then suddenly”. This would imply that the pound will continue to ignore the independence issue until it suddenly can’t ignore the issue anymore. As the prime minister says he won’t allow a referendum, most market participants tend to dismiss the risk. However, we would note that this issue doesn’t go away that easily: the SNP already seems to be toying with the prospect of an ‘illegal’ referendum and making Westminster take them to court. If such a scenario becomes indeed likely to unfold, the pound would have to take notice, and we’ll adjust our forecasts accordingly.