The Irrationality of Independence

Op-ed in El Pais

September 28, 2014

We were lucky. In the Scottish independence referendum a few weeks ago, rationality prevailed. The psychology of the process of complex decision making shows that humans are often unable to properly assess the risks they face. When the variables at stake are many and complex, the human brain is not able to convey a clear and concise verdict, and sometimes decisions are guided by intuition and feeling, often in an inefficient and irrational manner, accepting excessive risks. According to the statements of Scottish voters during TV debates on election night and the analysis by Lord Ashcroft of the referendum outcome, those who voted against independence argued that they were afraid to risk their economic present in return for an undefined and extremely uncertain future. In other words, they reasoned based on probability weighted outcomes and decided it was not worth changing a good present for an uncertain future. Those who voted in favor of independence said they did not want to be ruled by the conservatives and wanted the issues affecting Scotland to be decided in Scotland. Voters addressed the same problem in two very different ways: economic welfare versus political sentiment. Perhaps this explains why the opposition to independence increased proportionally with the age of the voters: The young believe they have little to lose (which is not true, because they have the best years of their lives ahead); the elderly make a more careful calculation of costs and benefits.

The authorities must tell the public the truth about the possible consequences of independence, so that they can decide rationally.

From the point of view of decision making under uncertainty, an independence process—except in extreme cases that serve to escape the abuse of human rights or a failed and ruinous economic model—has a negative future expected value, because the only certainty it offers is a long and irreversible process of high uncertainty and high transition costs. Gordon Brown, in his speech a few days before the vote, put it clearly: "Independence promises an economic mine field, where problems can explode at any time, an economic trap from which, perhaps, you can never escape." The odds of the economic success of a small country that has become independent are extremely uncertain. Politicians can tell a thousand different stories, but the honest answer is that nobody knows what could happen. Having enjoyed vibrant economic growth in the past does not guarantee anything, as the future economic environment will be completely different—that is, after all, the purpose of independence. This is a case where the old adage that past financial success does not guarantee future returns applies particularly well.

In the case of Catalonia, the future depends on many variables beyond the control of the leaders who promise a brighter independent future. What currency and exchange rate regime will be adopted? What will companies, especially banks, do if the region becomes independent? Will they stay or flee, as the Scottish banks said they would have done had the "yes" campaign won? Let us not forget that the decision of foreign companies to establish themselves in Catalonia is based mainly on gaining access to Spain and the European Union. What will happen to trade agreements and exports? What risk premium will markets apply to an economy that decides to separate, boasting about civil disobedience as a legitimate means to an end, with a shadow of apparently broad institutional corruption? What rating will the rating agencies assign? Some investors are, logically, starting to include clauses that may void contracts in case of independence. There are many scenarios in which a small and undiversified economy, with a debt-to-GDP ratio of at least 100 percent, few exchange rate reserves, and little institutional history of credible economic policymaking, could be doomed into a lengthy period of uncertainty, weak and volatile economic growth, very tough fiscal adjustment, and possibly an International Monetary Fund stabilization program.

In this context, independence is equivalent to gambling your savings, job, and pension to the lottery, something no one would rationally do, as it has negative expected value. If so, why do some politicians insist on independence? Maybe because for them, for the politicians, it is rational—it is a decision with positive expected value. Remember the first law of politics: The most important issue is my reelection.

In the Spanish case, the issue has to do in part with the idiosyncrasies of the electoral system. Regional politicians in the larger regions have enjoyed the privileged position of being minority coalition partners in national governments while offering regional voters ever increasing levels of devolution (with no parallel increase in fiscal responsibility, a really sweet deal). But what happens when the devolution process is completed? Remember the second law of politics: I would rather have the issue than the solution. At that point regional politicians must go further, because they can't prosper without promising further devolution. This led to a push for a new regional Statute of Autonomy of Cataluña in 2006, which exceeded the boundaries of the Spanish constitution and, after having been approved in referendum in Catalonia, was subsequently partially derogated by the Spanish Constitutional Court in 2010. The mismanagement of that process is at the origin of the independence movement. When the euro area crisis hit and the Catalan government had to cut spending drastically in a politically costly way, blaming Spain for the austerity was an easy and opportunistic political strategy. The independence process has really very little to do with improving the welfare of Catalonia or Spain.

Part of the debate concerns the need to review the Spanish fiscal federalism structure, a long overdue process. Spain already has one of the most decentralized fiscal systems in the Organization for Economic Cooperation and Development, with more than half of public spending managed at the subnational level (the United Kingdom, for example, merely has half the Spanish budget decentralization; the powers that London has offered to Scotland in the Devo-Max proposal are lower than those Catalonia already has). The review of the fiscal federalism structure must consider both the regional policy needs but also the impact of further decentralization on the Spanish economy. Empirical evidence shows very mixed results regarding the impact of fiscal decentralization on economic growth. It seems that the effect is clearly positive only in countries that start from a very low level of decentralization, and that the effect is ambiguous or negative in countries with an already high level of decentralization. It is certainly possible that with greater decentralization there is a suboptimal focus on the welfare of the whole country (think of the present euro area, urgently needing a strong fiscal expansion but with no country willing to carry it out). This is a topic to be discussed carefully, calmly, and without haste.

Hopefully sanity will prevail, and there will be no independence referendum in Catalonia. But if there is, the authorities must tell the public the truth about the possible consequences of independence so that they can decide rationally. Do not take advantage of the economic downturn, which always incites change. Do not create false conflicts by saying that "Spain is robbing Catalonia," because it is not true, or by saying that there is a linguistic problem—difficult to believe, given the tremendous difficulties faced by those who prefer schooling in Spanish. Do not ask the public if they are in favor of independence within the European Union, when it is clear that EU membership will not be possible in the foreseeable future. Confess that independence is equivalent to gambling their savings, their jobs, and their economic future to an uncertain lottery. The public deserves to understand what is at stake.