At the heart of the Scottish referendum campaign is the question of whether Scotland could really thrive as a small European state. At one time, the nationalists pointed for inspiration to the “arc of prosperity” of small northern European countries. After the crash of 2008 brought down Ireland and Iceland, their unionist opponents lampooned the “arc of insolvency”. Both images were profoundly misleading.
Small countries lack the powers of big states and are vulnerable in global markets but they can do rather well if they are able to adapt flexibly to the markets. Being small, with shorter lines of communication and a shared sense of purpose, they may even adapt better than larger states – but they do so in different ways.
The “market liberal” model entails bending to global markets, keeping taxes down, having a small state and deregulating labour markets. Such states can adapt quickly but experience huge economic upswings and downswings and big flows of people in and out. They have high levels of inequality, which can be bad for growth.
The social investment model combines high levels of public spending and a large state with high taxes. Public expenditure is seen not as a drain on the productive economy but as part of it, since it includes education, research and infrastructure, all of which are vital to a modern advanced economy. A social democratic variation of this emphasises equality and social cohesion.
Broadly, the Baltic states have opted for the market liberal model while the Nordic countries have gone for the social investment model. They have combined this with a social democratic commitment to universal services and low levels of social inequality.
There are advocates of the market liberal model in Scotland but it is difficult to imagine the drastic pruning of the welfare state that this would entail. On the contrary, the two main parties and most of civil society are committed to a social democratic road.
The Scottish government’s independence White Paper clearly envisages a social investment model. Yet it combines this with promises of cutting corporation tax and air passenger duty and otherwise keeping taxes in line with those in the rest of the United Kingdom. The council tax has been frozen now for seven years. If UK governments are really set on dismantling the existing welfare state, this will not hold.
Ireland also tried to combine the market liberal and social investment models, which is now widely seen as a weak part of its growth model, apparent even before the crash.
Social investment states are also characterised by a distinct way of making policy. The old “corporatist” mechanisms, under which business, unions and employers settled national plans, have gone but there is a continued tradition of social partnership. In Scotland, these mechanisms were dismantled in the 1980s and have not been rebuilt since. The Scottish government proposal to cut corporation tax by three pence below whatever the UK government sets, without asking anything at all in return, suggests that any partnership would be on business’s own terms.
Flexibility will be key
Successful small states are also characterised by government that can learn quickly and respond flexibly to change. Scottish government has improved its policy capacity since devolution but there is still a long way to go, especially in linking budgetary decisions to strategic objectives and in making “preventive spending” a reality.
Scotland could be a success as a small independent state but merely becoming independent would not give it the “levers” to succeed. A lot of internal change would be required, as would hard policy choices. The Nordic states have high levels of economic performance and social cohesion but the social investment model, in its social democratic version, is not cheap.
This all poses hard questions, not only for the SNP but for Scottish Labour. A social democratic and social investment state could be achieved under extended devolution but it would still require Scotland to pay the cost in order to recoup the benefits.