Michael Keating: How can Scotland survive on its own?

To make the SNP's "arc of prosperity" a reality in an independent nation, decisions have to be made on taxes, the economy and social policy

SINCE the SNP's election victory last month, I have received calls from journalists around the world asking whether Scotland could survive as an independent state. The answer is simple. Scotland is a wealthy nation, as well equipped to survive as most in Europe. Its GDP per capita has varied between slightly above and slightly below the UK average over recent decades and, whatever the arguments about net fiscal flows between Scotland and England, they are rather small compared with countries like Germany, Spain, Italy or Belgium. The real question is not whether Scotland can survive but how it will manage and how well it would do.

Independence would give complete formal self-government to Scotland but in economic matters no modern nation is truly independent. They are enmeshed in complex international and supranational structures and must trade in world markets. The SNP prospectus for independence gives some recognition to this but they have a long way to go to embrace the full implications. They talk of independence providing new levers to manage the economy, of assuming full macro-economic powers. Yet they do not propose a Scottish currency, intending instead to enter the euro or keep the pound. Monetary policy (and hence interest rates) would then be set in Frankfurt and London, immediately removing half the macro-economic instruments. The other half, in the form of fiscal policy, would then have to adapt, as we have seen in the eurozone.

A flagship of the independence prospectus is the proposal to cut corporation tax to something like the Irish level in order to attract business investment. This also features as a more immediate objective in the proposals for fiscal autonomy or "devolution max". There is little evidence that this will have much effect in Scotland. Ireland in the 1970s was a largely pre-industrial country without much of an existing business tax base, so that incoming investment amounted to a large part of the yield. There was also a lot of footloose investment in the subsequent decade. In Scotland, such a cut would provide a windfall benefit for existing businesses without attracting much more. The argument that it would pay for itself depends on the implausible assumption that business activity would more or less double in a very short period.

In practice, there would be a sharp fall in revenue, which I calculated (before the recession) at some four per cent of Scottish Government revenue. Such a loss is difficult to reconcile with the SNP's vision of a social democratic Scotland, with universal services on a more generous basis than in England. On the contrary, given that the SNP do not propose to increase other taxes, it implies a cutback in state provision more radical than that currently being pushed through by the coalition at Westminster, as some of the advocates of tax-cutting will agree. The flaw in the SNP's "arc of prosperity" vision was to mix up very different economic and social models, low-tax and low-welfare Ireland to high-tax and high-welfare Sweden.

Yet Labour's "arc of insolvency" jibe was equally ill-aimed, as some northern European countries have been doing better than the UK, both in the long-term and in the current recession. These are not the low-tax states but rather the high-tax Scandinavian social democracies, with generous public services but an economic model to sustain them. The table, based on pre-recession data to avoid the distortion of recent events, shows that Ireland and the UK are the low-tax exceptions in northern Europe. The chart shows that this has no discernable effect on long-term growth. The outliers are Finland, which suffered catastrophically from the collapse of the Soviet Union but made a remarkable recovery, and Ireland, which steamed ahead from the late 1990s in what we now know was an unsustainable boom.

The success of the Nordic countries belies the argument that public expenditure and the taxation necessary to support it are always a drain on the productive economy. Depending on how the money is spent, it can be a form of productive investment. Cutting back the state, increasing social divisions and precariousness, on the other hand, can be very costly. We also have evidence that countries with less inequality do better, contrary to the idea that income differentials are necessary to drive growth.

It is often the case that smaller countries have bigger public sectors than larger countries because they lack the private firms and institutions of their big neighbours and this is true of Scotland as well as Scandinavia. Our poor record in private sector research, for example, is partly offset by a internationally-competitive record in the public sector including the universities. Small countries are less able to sustain competing producers in public services. This is a problem only for dogmatists who believe that doing something privately is inherently better. What really matters is how the money is spent and what we get for it.

Given the limitations on traditional macro-economic instruments, successful nations have paid more attention to productive economy, which includes both public and private sectors. Education is a vital factor in economic competitiveness and the recent evidence suggests that the early years are particularly important. Health is an important economic sector in itself (especially in Scotland) and a factor in improving labour productivity but it does not come cheap. Research and development are important, particularly the ability to apply research findings in production. In the long run, public investment can improve both private and public welfare, each building on the other.

Such a virtuous policy circle will not come about automatically. There is no magic pill that will resolve Scotland's economic problems, nor should we imagine that, left to its own devices, the market will do any better. Small successful countries have institutions that promote a sense of shared purpose, bringing together business, trades unions and civil society and sustaining the necessary partnership and compromise. This type of thing got a bad name in the United Kingdom when it was known as corporatism and since the 1970s has almost disappeared. Yet in small European countries it has made a comeback, in a less elaborate form, as social partnership or concertation. This enables small states to adapt rapidly and flexibly to external shocks without the mass unemployment that was the British way to adaptation in the 1980s. A shared identity and short lines of communication can give them an advantage over their larger counterparts although this does not always immunise them against collective folly, as we saw in Ireland. Building a capacity for innovation and adaptation within Scottish society would be an essential concomitant for any independence project.If we follow the low-tax scenario, there is a real danger that competitive tax-cutting within Europe or across what we used to call the British Isles, will provoke a "race to the bottom", as everyone tries to stay ahead but the consequence is merely a general fall in public service standards to the detriment of all. A more attractive prospect is a race to the top, with nations competing on the basis of high-productivity, high-wage labour and good public services. Here Scotland could both teach and learn from other nations, but only if we put aside wishful thinking and take some hard decisions.

• Michael Keating is professor of politics at the University of Aberdeen and author of The Independence of Scotland (Oxford University Press, 2009), Scottish Social Democracy (PIE/Peter Lang, 2007) and The Government of Scotland (Edinburgh University Press, 2010)