democracy, Economics, EU, latest, Spain
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A Balanced View of the Economics of Independence in Catalonia

by Angel Ubide, PIIE, September 15, 2015
Editor’s Note: In the light of the recent independence referendum in Catalonia, in which some 43% of the population took part despite police attempts to prevent the vote from taking place by means of violence, we are posting this 2015 article on the economics of the proposed secession.

Two years after voters in Scotland rejected independence from the United Kingdom, Spain faces the threat of breakup as Catalonia holds regional elections on September 27. The Catalan president, Artur Mas, leads a pro-independence coalition for these elections, Junts pel Si (Together for Yes), with a single aim: to start a process of independence culminating in secession in 18 months. Polls show the independence coalition achieving a narrow majority in Parliament, though with just 40 percent of the popular vote.

With its capital in Barcelona, Catalonia, a region of about 8 million people on the Mediterranean coast just below the Pyrenees, is one of Spain’s more prosperous regions. The pro-independence coalition argues that an independent Catalonia would be economically better off. In fact, a Catalan secession could wreak economic and political havoc in Spain and especially in Catalonia, throw the European Union into an existential crisis, and boost the incipient nationalistic and populist movements that have sprung up in Europe after the long recession. The pro-independence arguments, while held passionately, are biased, based on dubious assumptions and unlikely scenarios, or just wrong.

The process of unilateral independence, or just its persistent use as a political negotiating tool, would create uncertainty and impede Catalonia’s growth. Its recessionary impact means it could take years for Catalonia to regain its current level of GDP.

Background

The Spanish Constitution, adopted in 1978, three years after the death of dictator Francisco Franco, set in motion a process of fiscal federalism, allowing regions to gradually acquire the ability to govern themselves following decades of authoritarian rule. Regional politics in Spain ushered in debates about the speed of transferring powers. Today Spain is one of the most decentralized countries among advanced democracies. Almost two thirds of government spending is managed at the regional level, more than the maximum offered to Scotland after its failed independence referendum in 2014.

A highly controversial and botched attempt to negotiate a new Statute of Autonomy for Catalonia, which was approved in a referendum only to be later ruled unconstitutional in 2006, gave initial impetus to the independence movement.

The financial crisis of 2010 forced budget cuts throughout Spain. Most regions, including Catalonia, had a past of fiscal profligacy and lost market access, and the central government imposed stringent austerity on them as a condition for liquidity support. The Catalan government resorted to the tried and tested strategy of blaming a foreign enemy for its troubles, charging further that Spain “stole from Catalonia.” Independence was seen as an ideal political escape to mask its fiscal crisis.

Three fundamental arguments are invoked to support independence, each based on incorrect numbers or assumptions.

Argument 1: Spain steals from Catalonia

The pro-independence narrative maintains that Catalonia contributes too much to Spain and would save €16 billion (over 7 percent GDP) if it became independent. But that number ignores expenditures, such as army or border control, that an independent Catalan government would be responsible for. In fact, Catalonia does pay more to Spain than it receives mostly because its per capita income is higher, and its payments result from the country’s progressive taxation formulas.

Detailed analysis (link is external) that allocates revenues and expenditures based on its personal or regional nature shows that the excessive contribution of Catalonia is at most about €3 billion, or about 1.5 percent of GDP. Thus the size of the potential unfair treatment of Catalonia is small.

Argument 2: Growth would have been stronger in an independent Catalonia

The contention that an independent Catalonia would achieve faster growth outside Spain runs into three counterarguments.

First, no historical evidence supports this claim. Andres Rodriguez-Pose from the London School of Economics has studied the economic record of independence, mostly in Eastern Europe and the former Yugoslavia, and finds (link is external) that countries at best maintain their previous growth paths.

Second, no evidence suggests that institutions in Catalonia perform better than the Spanish average. Anecdotal evidence (link is external) suggests that corruption is as pervasive in Catalonia as in the rest of Spain. On a more scientific basis, the 2012 European Commission report (link is external) [pdf] measuring the quality of government in European countries and regions shows Spain ranked 13 out of 27 EU countries, while Catalonia ranked 130 out of 199 EU regions, thus in the bottom third of EU regions. Catalonia also ranked last among Spanish regions.

Third, Catalonia’s potential growth benefited massively from the 1992 Olympic Games, which were financed mostly by the Spanish State and the City of Barcelona, with a minor contribution by the Catalan government, and which opened up new parts of the city with civil infrastructure investments. Research (link is external) conducted by the University of Barcelona and the City of Barcelona shows that this spending not only boosted the economy before the games but also provided long-lasting benefits. For example, Barcelona moved higher in the “best city to conduct business” ranking.

Argument 3: “Catalexit” would be positive

The pro-independence camp maintains that an independent Catalonia would be viable, but this contention overlooks how the change in the status quo will bring a long, uncertain, and economically costly transition process, transforming the Catalan economy, reducing its GDP, increasing the volatility of per capita income, weakening its financial system, and increasing the cost of capital.

For example, the European Union rules hold that if a region becomes independent, it must start the process of EU accession from scratch. Catalonia’s GDP is about the same as Greece’s, but its population is smaller and it has no geopolitical value that would compel the European Union to make an exception to the rules. The Greek crisis has shown that the European Union is firmly against political moral hazard. Therefore, Catalonia would have to build new institutions and meet the EU and euro entry criteria during a long transition period, increasing uncertainty that would weaken growth.

Catalonia runs a large trade surplus, but it is mostly with Spain (about 10 percent of GDP), while it runs a large trade deficit with the rest of the world (about 4 percent of GDP). Independence would trigger the so called “frontier effect” (regions trade more with regions in the same country than with regions across a national border). Analysis (link is external) of differences in trade between the Canadian provinces and US states, or between Spanish regions and Portugal, suggest a potentially large drop in trade between Catalonia and the rest of Spain, about 50 to 70 percent, that would erase Catalonia’s trade surplus, resulting in a decline in Catalan GDP as much as 10 percent.

In addition, most large Spanish and multinational corporations headquartered in Catalonia would probably leave in order to remain inside the European Union. Anecdotal evidence suggests ongoing planning along these lines. Something similar happened in Scotland, where large firms and banks made clear they would relocate if the independence referendum had won. Quebec has suffered the loss of many headquarters because of its decades-long push for independence, and Quebec firms have suffered (link is external) [pdf] an “independence risk premium” in their stock valuations and higher capital cost for firms. Were something similar to happen in Catalonia, the fiscal base would contract and tax revenues would fall, offsetting any savings from independence. A smaller and less diversified economy would also become more volatile to external shocks.

Before being recognized as an independent state, Catalonia would remain inside the euro (as part of Spain), but the uncertainty would likely trigger deposit outflows in the banking sector, as happened in Greece. Once independent, Catalonia would have to create its own central bank and currency. With no institutional history, its new currency would likely be weak and interest rates and inflation high. It could still use the euro, as a euroized country similar to Kosovo or Montenegro, but at the cost of losing control of its monetary policy. The branches of Spanish banks in Catalonia could continue to receive liquidity from the European Central Bank (ECB) via their Spanish owners, but the ECB and the single supervisory mechanism (SSM) would likely adopt a very bearish assessment about the availability of eligible collateral and the solvency of these branches. Catalonia doesn’t have market access and it is rated BBB–. If the liquidity support from Spain becomes doubtful, this rating will certainly be downgraded, even if Catalonia repudiates its share of Spanish debt. Overall, monetary and financial conditions will be tighter in an independent Catalonia.

Markets are starting to move in response to talk of independence. The spread of Catalan bonds has increased to around 200 basis points over Spain and around 325 basis points over Germany, and these spreads will surely skyrocket in the event of a victory of the pro-independence coalition.

Conclusion

These are not extreme or unrealistic scenarios. These are just observations based on economic theory, recent events, and historical evidence, under the assumption that current legislation will be respected.

The bottom line is that legal, institutional, and economic factors combine to make clear that the independence process would generate uncertainty and kill growth—for Spain and even more so for Catalonia.

Catalonia has thrived in Spain. The rational alternative to independence would be to update the Spanish fiscal federalism regime. A negotiated constitutional reform after the Spanish general elections is the best solution for all parties.


This is an edited version of remarks by the author at the event “Political Economy of Catalonian Independence,” held September 9, 2015, at the Peterson Institute for International Economics.

 

22 Comments

  1. rehmat1 says

    On October 12, 2012, Soeren Kern posted an article at Gatestone Institute website, entitled, “The Islamic Republic of Catalonia”.

    “A successful push for independence in the Spanish autonomous region of Catalonia would lead to the establishment of a country with the third-largest percentage of Muslims in Western Europe, just behind France and Belgium, and far ahead of Britain and Germany. An independent Catalonia, with its capital in Barcelona, would also be home to the largest concentration of radical Islamists in Europe,” wrote Kern.

    https://rehmat1.com/2017/10/10/the-islamic-catalonia/

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  2. “It could still use the euro, as a euroized country similar to Kosovo or Montenegro, but at the cost of losing control of its monetary policy.”

    More importantly it’s fiscal policies would be hamstrung by not having its own currency to spend.

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  3. I respectfully urge a dose of skepticism and perspective on the commenters.

    From my admittedly skeptical Greek POV, I note Soros’ interventions in Catalunya and the fact that breaking up Spain serves both the EU’s anti-sovereign, pro-region “divide & rule” agenda; and also Wall Street’s – by breaking the back of the Spanish world’s HQ [Spain] in the same way they so successfully broke the Portuguese empire in 1972. Thus both sides serve different oligarch’s interests – with breaking off Catalunya now strengthens the EU’s agenda just as it starts to publicly crumble.

    It is important to remember in this context that the EU is not an independent entity but headquartered in Washington.

    Finally, to what degree might Madrid EU Federalist puppets be colluding with the Pro- Independence movement? It was not the vote but the unnecessary police violence that brought Catalans out on the street – after the vote – and (reportedly according to the MSM) switching sides. The Pro voters until now were a minority.

    Meanwhile, an interesting link:
    What Next for Catalunya: out of Madrid’s frying pan into NATO’s fire?
    Tony Cartalucci
    https://www.sott.net/article/364029-Whats-next-for-Catalan-independence-out-of-Madrids-frying-pan-into-NATO-fire

    two quotes:

    “For NATO, Catalonia as a new member-state of NATO – while Spain continues its contributions to NATO – is a case of two for the price of one. Two nations carved out of one, in which both must dedicate a percentage of their respective GDP’s to military and NATO spending, and two nations now both weaker divided apart than united together to influence or oppose the larger collective agenda of NATO set by its much larger and more powerful members….”

    “As to why Catalan politicians expect the Catalan people to believe NATO membership is essential, one reason cited often is “terrorism.” Conveniently – and just in August in the lead up to the referendum – terrorists carried out two vehicle-ramming attacks, killing 14 pedestrians.”

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    • Carnyx says

      I note Soros’ interventions in Catalunya and the fact that breaking up Spain serves both the EU’s anti-sovereign, pro-region “divide & rule” agenda;

      You realise the EU is massively hostile to Catalan independence, it has failed to condemn the police violence against the referendum, it has supported Madrid in claiming the referendum is illegal. France has announced that it will not recognise Catalonia if it becomes independent and Donald Tusk has pleaded with the Catalans not to declare independence on the grounds it’s “bad for Europe”. The claim that Catalonian nationalism is an EU plot to undermine sovereignty is patent nonsense.

      Soros’s Open Society Foundation has contributed a whole $52 000 to two organisations associated with the Catalan Generalitat, that’s peanuts and neither of the recipiants are direct independence campaigning organisations, one recipiant was funded only to hold a one day conference on xenophobia. Soros naturally wants to maintain some relations with potential govts in the west, especially in Spain where he’s invested in the property market. This all proves SFA about Catalan nationalism being a globalist plot.

      http://www.lavanguardia.com/politica/20160816/403969314802/george-soros-diplocat-financio.html

      As for NATO membership, what do you expect? Do you think independence movements in Western Europe want to make any more powerful enemies than they already have? Do you expect them to play the role against the US that Georgia did against Russia? Despite the SNP in Scotland changing policy and ending it’s opposition to NATO membership Obama still spoke out against independence, as did EU figures like Barroso, the entire British MSM alongside, Blair and his crew. Major arms manufacturers like BAE Systems spoke out against it, George Robertson former Secretary General of NATO spoke out as did Carl Bildt Sweden’s very anti-Russian former PM and foreign minister. As far as they are concerned such movements were only supposed to occur in former Soviet satellites.

      https://www.theguardian.com/politics/2014/apr/08/scottish-independence-lord-robertson-uk-global-status

      As far as I can see, the knee jerk charges that all and every independence movement is a “globalist plot” ain’t much better than the older allegation that Scottish independence is a “Papist plot”, although with weaker evidence.

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  4. I don’t know enough about the economic situation of either Spain nor Catalonia to comment upon the authors conclusions, however if a sizeable proportion request a referendum it should be granted. Government should be by the peoples consent. The Spanish debacle we are witnessing re-enforces the narcissistic reality of so many current governments and institutions. The hypocrisy of the Spanish government and the EU is all too clear.

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  5. “The financial crisis of 2010 forced budget cuts throughout Spain.” No it didn’t. The Spanish government, just like the British one, CHOSE austerity.

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  6. Carnyx says

    It could still use the euro, as a euroized country similar to Kosovo or Montenegro, but at the cost of losing control of its monetary policy.

    How exactly is this different from say being in the Eurozone as part of Spain? He’s actually presenting the current status quo as a negative result of independence!

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    • Ubide does explain how Catalonia would lose control of its monetary policy in a way that makes European Central Bank control over Catalonia’s monetary policy even more severe than it would be if Catalonia stayed with the rest of Spain.

      … Once independent, Catalonia would have to create its own central bank and currency. With no institutional history, its new currency would likely be weak and interest rates and inflation high. It could still use the euro, as a euroized country similar to Kosovo or Montenegro, but at the cost of losing control of its monetary policy. The branches of Spanish banks in Catalonia could continue to receive liquidity from the European Central Bank (ECB) via their Spanish owners, but the ECB and the single supervisory mechanism (SSM) would likely adopt a very bearish assessment about the availability of eligible collateral and the solvency of these branches. Catalonia doesn’t have market access and it is rated BBB–. If the liquidity support from Spain becomes doubtful, this rating will certainly be downgraded, even if Catalonia repudiates its share of Spanish debt. Overall, monetary and financial conditions will be tighter in an independent Catalonia …

      Like

      • Carnyx says

        He’s saying that Catalonia would lose control of something they don’t have control over at the moment, they might only gain such control if they had their own currency, but he presents that as negative thing too. No Eurozone member has control of interest rates and the EU can’t close down Catalan branches of private Spanish banks en masse.

        Ubide’s article is far from “balanced”, in fact it’s a carbon copy of the Project Fear arguments that were used in the Scottish indyref, the only bit missing is the argument that attempted to imply having oil revenues was a terrible thing for a country to have. He’s obviously hoping people outside the Scottish indy movement aren’t familiar with the counters.

        Then there’s the bit where he compares Catalonia to Greece, simply on the basis of GDP although Greece has a larger population and isn’t in fact a newly independent EU member, waving Greece in our faces is purely for rhetorical purposes, that doesn’t indicate “balance”. Greece was forced to accept austerity by shutting down liquidity to Greece’s central bank, Catalonia doesn’t have one yet, they can’t do the same to all of Spain just to get at Catalonia, and if it had their own currency they couldn’t anyway. They could also have their own currency and peg it to the Euro, which would minimise cross border risks.

        He speculates on growth in newly independent countries based on studies of former Yugoslavia, i.e. a warzone and even then the study implies growth returns to previous projectories, which contradicts his argument it will dramatically decline. He speculates iCatalonia’s cross border Spanish trade based on trade between Canada and the US, which are different currency zones, when Catalonia is most likely to continue with the Euro. Trade tends to follow established relationships between suppliers, therefore trade between Catalonia and Spain isn’t likely to drop as dramatically as he’s pretending, especially if they are using the same currency. He doesn’t explain that the cross border risks he’s talking are brought about by sudden currency changes.

        Lastly the EU doesn’t have any regulations on seceding territories within member states, but no EU territory can just get kicked out, millions of EU citizens cannot be denied their rights overnight. All territories leaving the EU must do so through years of negotiations, as the UK is currently engaged in and as Greenland did in the 80’s after gaining independence from Denmark. Places like Scotland and Catalonia are already full EU territories whose laws and standards are already matched and integrated with the EU, neither would be starting “from scratch” because no laws would need to be reformed. After Brexit the EU suddenly changed their tone on Scotland and started implying iScottish EU membership would be fast tracked, they are making it up as they go along. It’s equally unlikely that they will instantly shut down Catalan single market access over night, does Germany want to take back all it’s unsold cars in Catalonia and take all the Cava off their supermarket shelves?

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  7. Earl of Suave says

    Ahem, the neoliberal “Peterson Institute for International Economics” and Angel Ubide, a Goldman Sachs banker?
    Seriously?

    Like

  8. paulcarline says

    The author simply misses the point. The entirely legitimate quest for independence stems from the urge to determine ones own fate – both as individuals and as a community with a distinctive history, traditions, language etc. Purely economic considerations are secondary. People may choose to be poorer if that is the consequence of becoming freer. The Spanish state does not have the right to enforce obedience or subservience to itself – and still claim to be a democracy, as the king did. The Catalan situation is a test case for real democracy. The people come before the state.

    Liked by 1 person

    • The argument for secession has, from the very start, been sold to the Catalan public in economic terms, with the claim that Catalans contribute an unfair amount to the federal budget. The whole notion of “determining one’s own fate” is utterly irrelevant in this context, especially since Catalonia already has autonomy (Spain is the loosest possible of federations, far less centralized than the USA or Germany, say).

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      • Respectfully that’s no longer the point – Madrid lost legitimacy the second they ordered the brutal repression by police – the story is now over & an independent Catalan State is already a foregone conclusion. The story of economics here are based on foolish assumptions as Catalonia will be bigger than Ireland with a lot more advantages. The arrogance if such authors makes me sick.

        THE ELEPHANT IN THE ROOM is that the EU & the Euro are dead men walking.

        If we go back to “EEC” everything after a while will work out just dandy for the masses that have been screwed over by the Elite.

        Liked by 2 people

        • The same argument — that the federalists had lost the moral high ground by their excessive response — was used when Ottawa declared a state of emergency in Quebec, evoking the War Measures Act back in 1970. Today, the separatist movement in Quebec is long dead.

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          • paulcarline says

            So? What does that prove? Each case has to be taken on its own merits. Is Donbas ‘separatism’ invalid?

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            • Deposited says

              While I feel I know too little about the situation to take a side on this, I would respectfully point out that the resemblance between Donbass and Catalonia is misplaced. If, for instance, Catalonia had much closer relations with, say, France than with the rest of Spain, and if Spain then decided to leave the EU and NATO, then your analogy might carry more weight.

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      • paulcarline says

        That may well be true. It was also a major issue in the Scottish independence referendum. Unfortunately, that’s how politicians often/usually play it – appealing to people’s selfish interests. Remember Macmillan’s disgusting “You’ve never had it so good”.
        That doesn’t mean that’s what motivates the Catalans – or the Scots. A Gaelic-speaking Scot would not be subject to abuse in a London pub – but Catalans are in bars in Madrid.
        If Spain were like Switzerland – in which each canton is sovereign (even the smallest, with only some 16,000 inhabitants) and decides its own tax rates and much else, and where all four national languages have equal status – perhaps Catalans would be happy being part of a confederation. That’s not the case in Spain.
        This excellent article by Wayne Madsen gives an insight into some of the many reasons Catalans might not be happy being part of a country with such a historical legacy – including its king:
        http://www.greanvillepost.com/2017/10/09/kings-and-queens-to-be-consigned-to-decks-of-playing-cards/

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        • Deposited says

          Yes I do remember Macmillan’s mantra. I would have opposed Macmillan at the time (and even now) but as politicians go he was much better than the current mob (as in gangsters). He was right – Britain had had the 1920s – years of industrial unrest (rightly so) – followed by the 1930s – great depression – followed by 1940s – war and rationing. So at the time he spoke, Britain had come out of rationing and incomes, and wealth inequality were declining. It was not until the late 1970s that things started to change for the worse in that respect, accelerating under Thatcher of course. Macmillan also presided over the painful process (on all sides) of the dismantling of the Empire (“Winds of change”). It was never going to be easy, and the British Government was often on the wrong side of history, but he was one of those who realised it had to happen and facilitated it.

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    • An irony that has arisen is that Madrid’s decision to send police to polling places in Barcelona and elsewhere to harass and drag away voters is that many voters who would have voted No decided to stay at home. This meant that those voters who did go were likely to vote Yes to independence.

      Some polling done by the Generalitat de Catalunya (Centre d’Estudis d’Opinio) – this is the Catalan government’s own centre of opinion studies – before the referendum had indicated that less than half the voters wanted independence.
      https://elpais.com/elpais/2017/07/21/inenglish/1500633835_182589.html
      http://www.politico.eu/article/catalonia-independence-spain-support-for-drops-poll/

      Apparently voter turnout on the day was low even as 90% of those who voted, voted Yes.

      So Rajoy’s government ended up with the result it didn’t want as a consequence of its actions. Now that’s what we’d call stupid.

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