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How might Scottish independence affect the costs of international trade?

If Scotland were to become an independent country, there would be a new international border with the rest of the UK. The additional costs that are inevitably created by borders would affect trade, making it harder for Scottish firms to do business with the rest of the UK.

Borders between countries create additional costs for businesses, which lead to lower levels of trade. As the rest of the UK accounts for over 60% of Scotland’s exports, the Scottish economy would be vulnerable to an increase in border costs should it become independent. But there is considerable uncertainty over how substantial the economic effects of introducing a border with the rest of the UK would be.

Focusing only on changes in international trade, independence would be expected to have a negative effect on the Scottish economy because of higher border costs. And rejoining the European Union (EU) would not necessarily offset the border costs of independence. This is because Scotland currently trades around four times more with the rest of the UK than it does with the EU.

How do borders affect trade?

International borders create barriers to doing business that economists refer to as ‘border costs’. These result from many factors, including import tariffs, customs ‘red tape’, regulatory differences between countries, limits on market access for services, restrictions on labour mobility, and cultural and social differences that reduce international communication. Consequently, trade costs between countries are higher than between regions within the same country (Anderson and van Wincoop, 2004).

Research shows that border costs are economically important and have large negative effects on international trade (McCallum, 1995). One study estimates that the border between the United States and Canada may increase trade costs between the two countries by 48% (Anderson and van Wincoop, 2003).

International agreements such as free trade areas, customs unions or the EU’s single market reduce the trade costs caused by international borders, but they do not eliminate them entirely. Even within the EU, many economic policies are country-specific – including taxes, labour market laws and regulation of many service industries – which creates border costs.

Analysis of goods trade finds that border costs between EU countries are 13% lower than those between countries where at least one of the partners is not a member of the EU. At the same time, border costs within the EU are still 23% higher than trade costs between US states, showing that there are border costs even within the single market (Comerford and Rodriguez Mora, 2019).

Evidence that EU membership reduces border costs explains why most economists expect Brexit to make the UK worse off (Sampson, 2017). The Scottish government’s own Brexit analysis argues that leaving the EU will reduce the nation’s GDP by increasing border costs between it and the EU (Scottish Government, 2018).

What is Scotland’s pattern of trade?

A challenge when studying Scotland’s economy is the lack of fully comprehensive trade data. Unlike independent countries, Scotland does not collect detailed statistics on its external trade. Export Statistics Scotland – produced by the Scottish government – provides useful survey-based data about onshore Scottish exports, but import data are relatively sparse. Measuring Scotland’s trade is complicated further by the convention that economic statistics are produced separately for the onshore Scottish economy and its offshore counterpart (oil and gas production).

Nevertheless, the data that are available provide a useful overview of the pattern of Scottish trade, which can inform discussions about the economic consequences of independence.

As Scotland is a small country, its economy is reliant on international trade. In 2017, exports accounted for 58% of Scottish GDP and imports for 60%. By contrast, in the rest of the UK, exports and imports each account for around one-third of GDP. Scotland’s most important exports are oil and gas, business services, and food and beverages (Huang et al, 2021).

The rest of the UK is by far Scotland’s biggest trade partner, accounting for 61% of Scottish exports and 67% of Scottish imports in 2017. These shares have remained stable over the past 20 years (see Figure 1). Scotland’s trade with the rest of the UK is around four times larger than its trade with the EU.

Figure 1: Share of the rest of the UK in Scottish trade

Source: Huang et al, 2021

Since Scotland makes up less than one-tenth of the UK’s economy, trade within the UK is relatively more important to Scotland than to the rest of the UK. Scotland accounts for only 10% of the rest of the UK’s exports and 9% of its imports (Huang et al, 2021).

Further, current levels of trade within the UK are higher than would be expected if Scotland and the rest of the UK were separate countries.

On average, trade flows between country-pairs are well explained by what economists call the gravity equation, which posits that trade is increasing in economic size and decreasing in trade costs (Head and Mayer, 2014). Consequently, the difference between observed trade and the level of trade predicted by gravity gives a measure of unexplained or ‘residual’ trade, which we can use to identify country-pairs with unusually high trade levels.

Figure 2 shows Scotland and the rest of the UK’s residual trade with a sample of their trading partners. The point labelled SCO-RUK in the upper right-hand corner shows residual trade between Scotland and the rest of the UK. For Scotland, the unexplained trade with the rest of the UK is higher than with any country except Norway. For the rest of the UK, unexplained trade with Scotland is higher than with any other country.

The size of the residual implies there is around six times more trade between Scotland and the rest of the UK than is predicted by the gravity equation. It is reasonable to conclude that at least part of this excess trade results from the fact that there is currently no international border within the UK (Huang et al, 2021).

Figure 2: Scotland and the rest of the UK’s residual trade unexplained by gravity equation

Source: Huang et al, 2021

How might Scottish independence affect border costs?

If Scotland were to become independent, there would be a new international border cutting across the UK. This would increase trade costs between Scotland and the rest of the UK.

Available evidence suggests that border costs would increase even if, following independence, Scotland and the rest of the UK maintain a common economic market comparable in scope to the EU’s single market (Santamaria et al, 2020).

It is highly uncertain how large the increase in border costs between Scotland and the rest of the UK would be. Economic studies of independence have assumed that border costs could increase by 15-30% if Scotland remains in a common market with the rest of the UK (Comerford and Rodriguez Mora, 2019; Huang et al, 2021). This is similar to the expected effects of Brexit on trade costs between the UK and the EU (Scottish Government, 2018; Bevington et al, 2019).

But the exact size of the cost increases is unknowable and would depend on what policies the Westminster and Holyrood governments were to adopt following an independence vote. In any event, it is likely that border costs within a common market between Scotland and the rest of the UK would only emerge slowly over a generation or more due to the gradual erosion of existing cultural, social and business ties.

How would border costs affect Scotland’s economy? Higher trade costs increase import prices and reduce export opportunities, leading to falls in economic output. Consequently, border costs would have a negative effect on the Scottish economy (all else remaining equal).

Putting a number on the size of these losses is an imprecise art, but researchers have estimated that the combination of Brexit and Scottish independence could reduce Scottish income per capita by between 6% and 9% (Huang et al, 2021). These numbers are two to three times worse for the Scottish economy than Brexit because Scotland is more reliant on trade with the rest of the UK than with the EU.

It is important to remember that these estimates only consider the trade effects of independence. They do not take account of potential consequences of independence, such as changes in investment flows, immigration policy, fiscal transfers between Westminster and Holyrood, Scotland’s currency or divergence in other areas of economic policy.

Ireland’s experience shows that countries can successfully change their economic model following independence, but also that adjustment is a slow process.

Should an independent Scotland rejoin the EU?

After becoming independent, Scotland would face a choice over whether to rejoin the EU or to remain outside the EU in a common market with the rest of the UK. Could becoming a member of the EU offset the losses resulting from the introduction of a border with the rest of the UK?

Rejoining the EU would remove the customs and regulatory border between Scotland and the EU created by Brexit, and it would boost Scotland’s trade with Europe. But this benefit would require a ‘harder’ border with the rest of the UK.

If Scotland were to rejoin the EU, its border with the rest of the UK would become one of the EU’s external borders. As the UK is no longer part of the EU’s single market or customs union, this means that cross-border trade would be subject to customs checks and other border barriers. In addition, physical border infrastructure would probably be required at crossing points between Scotland and England. Scotland would also have to abide by EU regulations and economic policies, further raising border costs due to the likelihood of regulatory divergence between the EU and the rest of the UK (Hayward and McEwan 2022).

Since the increase in border costs between Scotland and the rest of the UK would be greater if Scotland rejoins the EU than if it remains in a common market with the rest of the UK, an independent Scotland would face a trade-off. Should it put trade integration with the EU ahead of integration with the rest of the UK?

A good rule of thumb is that borders are less costly when they affect less trade. This suggests that as long as the rest of the UK remains Scotland’s most important trade partner, Scotland would be better off prioritising integration with the rest of the UK, which means staying outside the EU.

Research that accounts for expected changes in trade patterns following independence concludes that rejoining the EU would not offset Scotland’s economic losses from increased border costs with the rest of the UK. Estimated declines in Scottish income per capita, due to changes in trade following independence, are similar regardless of whether or not Scotland rejoins the EU (Huang et al, 2021).

Another recent publication also shows that Scottish independence is likely to reduce output and trade with the rest of the UK through increased border costs (Figus et al, 2022). But, in contrast to the study mentioned above, this analysis considers a scenario where rejoining the EU does not increase border costs with the rest of the UK more than staying outside the EU does. Consequently, it finds that rejoining the EU may partially reverse the economic effects of increased trade costs with the rest of the UK.

At least from a trade perspective, EU membership would not be a panacea for the economic challenges that independence would create by increasing border costs with the rest of the UK, Scotland’s largest market.

Where can I find out more?

Who are experts on this question?

  • David Comerford, University of Strathclyde
  • Jose Rodriguez Mora, University of Edinburgh
  • Thomas Sampson, LSE
  • Marta Santamaria, University of Warwick
  • Patrick Schneider, LSE
Author: Thomas Sampson
Editors' note: This article is part of our series on Scottish independence - read more about the economic issues and the aims of this series here.
Photo by hunt-er from Pixabay
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