Small Economy Insights for a Post-Brexit Scotland

Dr David Skilling is Director at Landfall Strategy Group, a Singapore-based economic and political research and advisory firm – see @dskilling on twitter,

The Brexit vote places Scotland in a challenging situation. A hard Brexit would risk Scotland’s market access to the EU, the destination of 15% of its exports.  However, 64% of Scotland’s exports also flow to the UK, which has implications for Scotland separately structuring an ongoing EU relationship.

The exact implications of Brexit are obviously contingent on the negotiations between the UK and the EU, as well as policy choices that are made in the UK. But however this plays out, Brexit was a strategic mistake and will impose significant costs on the UK.  And at a practical level, the process of negotiating and implementing new trade agreements takes many years, even assuming that there is the political will in other countries to do so.

However, there are ways in which Scotland can respond to mitigate some of these costs, and potentially to generate some new opportunities. To provide a perspective on these issues, this note offers some observations from other small economies. In particular, both New Zealand and Singapore are instructive examples for Scotland in terms of how small economies responded to being set adrift from major trading partners.

The Experience of New Zealand

New Zealand is a small, remote country with a substantial agriculture sector. Because of the strong political relationship with Britain, the absence of a natural regional hinterland, and the development of refrigerated shipping in the 1880s, New Zealand developed a ‘protein bridge’ with the UK on the other side of the world.  By the 1930s, over 80% of New Zealand’s exports were sent to the UK.

Even though this export share had reduced to about 40% by 1970, the decision by the UK to enter the then-EEC in 1973 and jettison New Zealand’s preferential market access was a material economic shock. New Zealand’s response was to aggressively diversify into new markets and to secure trade deals with as many countries as possible.  This began with Australia in the late 1970s, and extended into Asia, the Middle East and the Americas (and ironically, now with the EU).  This has required substantial, sustained investment over decades, and is still work in progress.

New Zealand has been active in signing formal free trade agreements (FTAs); for example, it was the first developed country to sign a FTA with China, in 2008. However, small countries face challenges in securing FTAs with larger economies.  An FTA with the US, for example, has not been achieved.  And there is also now an understanding that FTAs are only the start of the journey; formal market access has not automatically led to stronger international growth by New Zealand firms.

To complement this exercise, there has been a sustained effort to develop a broader economic footprint through trade promotion and diplomacy. Over the past 20 years, this has had a particular focus on the Asia Pacific (now New Zealand’s major economic markets).  The UK now accounts for just 5% of New Zealand’s exports; and Australia and China represent about 20% each.

Interestingly some of this has been done jointly with Australia, an economy ~7x the size. But this has not always been straightforward given that national interests are not always aligned; New Zealand and Australia compete as well as collaborate with each other.  In many cases, New Zealand has charted its own course.

The Experience of Singapore 

The second example is Singapore. Singapore exited the Malaysian Federation, and became an independent state, in 1965. The story of how Singapore moved from ‘third world to first’ in a generation is now well-known, but at the time there were significant doubts about the economic viability of Singapore as a small city state.  At the core of Singapore’s strategy was to position Singapore as an attractive location for regional production and expansion.  Singapore is now a significant Asian hub for many companies, and a major financial, business and logistics centre.

As with New Zealand, Singapore has also been very deliberate about developing a portfolio of relationships. Regional economic integration has been central to this endeavour.  Singapore has a web of trading agreements in its region and beyond: ASEAN is the centre-piece, but it also has agreements with China, India, Japan, as well as the US, Australia and others.  These agreements tend to reinforce existing economic relationships.  Singapore is one of the world’s most internationally integrated economies in the world, with exports at about 190% of GDP.

Prior to the Brexit vote, I argued that ‘Brexit would not make Britain the Singapore of Europe’.  Singapore has had to work very hard to establish the relations it now has, and regional integration is at the core of its success.  Although it has diversified beyond its region, integration into Asia is the foundation for the economic model.  In this sense, Brexit is the antithesis of the Singapore approach.

Lessons for Scotland

The international small advanced economies experience suggests three implications for a post-Brexit Scotland.

First, any reduction in regional economic integration will be costly. The ability to access proximate markets matters for small economies.  And so efforts to maintain EU (and UK) market access are very important for Scotland.

Second, a common message across small advanced economies is the importance of diversification of economic relationships. The regional economy continues to matter disproportionately, but small economies increasingly recognise the need for a greater degree of balance in their portfolio of markets.  Deliberate efforts should be made to support a rotation into non-European markets, even while retaining access to the EU.

Third, constraints on market access should be addressed by building positions of strong competitive advantage that offset tariffs and other trade barriers.  The New Zealand experience, and that of other small advanced economies, suggests that formal market access is often not the binding constraint on international expansion. To an increasing extent, small economies compete on non-price dimensions.  Scotland’s economic strategy should be aimed at supporting Scottish firms to develop this type of competitive advantage in global markets.

Brexit is clearly an unwelcome challenge for Scotland. The international small economy experience suggests that a deliberate, aggressive strategic response is required.  But there may be a silver lining to the Brexit cloud if it motivates actions that further sharpen Scotland’s competitive positioning in regional and global markets.