Nicholas Tsagourias: Sharing the debt burden

Michael Collins studies the treaty that set up the Irish Free State
Michael Collins studies the treaty that set up the Irish Free State
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THE thorny question of how the UK’s massive debt will be apportioned if Scotland votes for independence from the UK will have to be faced sooner rather than later, writes Nicholas Tsagourias.

If Scotland were to become independent, the question would arise as to how UK public debt would be apportioned between Scotland and the remaining UK (rUK). This is a very important question, because the way public debt is to be calculated and apportioned will not only affect the economies of both countries, but will also affect their international financial standing.

Consequently, it is important to reach a negotiated settlement before independence is declared, but the negotiations will inevitably be complicated and tough and, for this reason, protracted. Yet any delay or extended bargaining will cost both states financially.

In such a context, does international law provide any guidance? Article 40 of the 1983 Vienna Convention on Succession of States in Respect of State Property, Archives and Debts provides that the seceding state should assume an equitable proportion of the general debt, also taking into account the assets transferred to that state.

Although the Vienna Convention has not yet entered into force, in some respects it reflects international practice, as it is the case with the principle of equity in the apportionment of debt. To give an example, when the Irish Free State seceded from the Union, the 1921 treaty between Great Britain and Ireland apportioned debts on the basis of the principle of equity (Article V of the Treaty).

The Vienna Convention does not however say anything as to how an equitable division of public debt is to be determined. Instead, a number of debt division methods can be distilled from international practice.

Before presenting the most common methods, it is necessary to explain what constitutes a state’s public debt. According to international law and practice, a state’s public debt consists of the national, local and localised debt. National debt is the debt incurred by the central government and is unrelated to any specific state territory. It is the debt contracted by the central government and chargeable to the treasury. Local debt is the debt contracted by a territorial authority (for example Scotland) and, provided that the debt is identifiable and quantifiable, it is transferred to that territory after secession. Localised debt is the debt incurred by the state, but is used for a defined territory (for example, Scotland). Localised debt belongs to the state unless it exclusively benefited that territory, in which case it will be transferred to that territory after secession.

As far as the national debt is concerned, one could say that, strictly legally speaking, the new state has no legal obligation to assume any portion of that debt because of the principle of privity of contracts. For example, Scotland has no liability toward UK creditors, because it is the UK that is party to the relevant contracts. However, such an attitude will affect the credibility of the new state, which may be punished by the markets or other states. For example, when Ukraine refused to share some of the USSR debt, she was denied credit for four months until she changed policy.

The trend, as confirmed by international practice, is for the seceding state to assume an equitable portion of the national debt, but the method used to apportion the debt can produce different results. One method is the per-capita one, according to which the debt assumed by the seceding state is proportional to its population. If the population of Scotland is roughly 8.4 per cent of the UK’s, then 8.4 per cent of the UK national debt will be transferred to Scotland. How the national debt is calculated is critical, because this will affect the amount assumed by each state.

If the UK national debt is approximately £1 trillion (this amount corresponds to the public-sector net debt), Scotland will assume approximately £84 billion, but if other liabilities are added, for example future pension liabilities, PFI liabilities, etc, the national debt will increase to £2trn (this figure is based on the 2010 Whole of Government Accounts as published by the HM Treasury). If a proportion of those liabilities is added to the transferred public-sector net debt, the total debt assumed by Scotland will be £171.8bn in 2012 figures, according to the David Hume Institute.

A problem with the per capita method is the timing and the method of measuring the population of Scotland and the UK. Will the population of Scotland be anyone living in Scotland at the time of the referendum, or at the time of the declaration of independence?

If people move to Scotland because of the promised prosperity, Scotland will have lower per-capita percentage of debt than the UK, but it can also go the other way. Be that as it may, what is even more important is the debt/GDP ratio. This leads us to the second method of allocating national debt, which takes into account the gross domestic product. According to this method, the debt assumed by the new state will be equivalent to its share of the GDP. For example, if Scotland’s share of the UK’s GDP is 10 per cent, then it should assume 10 per cent of the UK’s national debt and, depending on the amount of UK national debt, the transferred debt can be £100bn or double that amount.

There are certain problems with this method as well. For example, which GDP figures should be used? Of the year the referendum took place, the year independence was declared, or an averaging one? And if the latter, over what period?

Another method of allocating national debt is the historical benefits one, according to which a new state assumes a share of the public debt which is equivalent to the net benefits it received. Net benefit is the excess of expenditure over revenues with regard to the seceding state [Scotland]. It means that if Scotland is a large net beneficiary, it will assume a bigger portion of the debt. Yet calculating net benefits is complicated and depends on the availability of specific data and the period over which data are analysed.

In addition to its share of the national debt, Scotland will be fully liable for any debt it contracted as Scotland, as well as for any debt incurred by the UK in order to support Scottish areas or projects. Regarding the bail-out of RBS and the former HBOS, calculating the debt arising from the rescuing of these banks is rather complicated, since that debt or part thereof can be sold before independence. Concerning the remaining debt, according to some, it should be added to the national debt, because the banks were regulated by the central government, whereas for others, it should be transferred to Scotland because those banks have their headquarters in Scotland. In my view, even if this debt is localised, it should be added to the national debt because it benefited the whole country and not just Scotland.

In order to conclude, apportioning the rUK public debt in an efficient and equitable manner is very important for the economic wellbeing of both Scotland and the UK. A negotiated agreement before independence will be for the benefit of both countries. In such negotiations, external creditors should be involved. They have an interest in both Scotland and the rUK being able to service their debts, and for this reason they should participate in the negotiations. It is also important that, as part of the negotiations, the parties consider methods for resolving disputes that might arise with regard to the apportionment of public debt.

• Nicholas Tsagourias is professor of International Law and Security at the University of Glasgow.