Wednesday, 17 September 2014

Mechanisms for economic gains from independence #3

#3 Spillovers from statehood and location of central government

My own favourite mechanism for possible economic benefits from independence (relative to being a peripheral region of a larger country) is the positive externalities that may accompany the very fact of statehood.

As soon as a region is a country, international companies treat it differently. Many need to base at least a small office, with at least some local autonomy, to ensure legal compliance and appropriate marketing. The direct economic effects of this are that these international companies incur extra costs, and the new small country experiences extra private demand and public revenues from this local employment. These direct effects are likely negative in the aggregate (the company has incurred extra costs), but are likely positive within the new small country.

As soon as a region is a country, it both sends out and receives diplomatic staff. On the assumption that it sends out as many as it receives, the direct economic effects of this are zero: the government is paying salaries to the diplomatic staff that it sends out into the world, and roughly this amount extra of private demand is added to the local economy from the diplomatic staff that it receives from the rest of the world.

As soon as a region is a country, the status and responsibility of government officials and civil servants is enhanced. The Institute for Government's Robyn Munro reports in the LSE's British Politics and Policy blog that "In the event of independence the Scottish civil service would ... require ... a rebalancing of the grades and experience levels of its employees. ... UK department staff based in Scotland are drawn disproportionately from the lower grades (AA, AO and EO), with few senior civil servants." Under the assumption that fixed costs in public good provision are neglible (*), and the further assumption that the current bill paid by Scottish taxpayers funds current civil servant employment in Scotland, then on independence with the same level of public good provision, Scotland would need fewer civil servants overall, but more at senior grades. The direct economic effect of this is zero: the same government expenditures and the same private spending power.

These three changes provide no great direct overall economic boost or cost to the new small independent country. However, they are associated with indirect economic effects which should be beneficial:

# Firstly, the local offices of international companies are a source of informational feedback: local demand is more fully understood, and the company is more likely to have the capacity to respond to this information.

# Secondly, as a junior civil servant, interaction with senior colleagues within the same building rather than them being 600 miles away in London is likely to boost human capital accumulation.

# Thirdly, growing companies need to discuss their business with government - particularly with senior people who have the authority to effect any changes needed. Being able to have these discussions in Scotland means that these companies, as they grow, are more likely to stay in Scotland. If they have to go to London every time they need to have a meeting, they might as well base themselves in London. Further, growing companies need the full range of business support services. Government procurement by an independent state on advertising, legal services, research and analysis etc mean that these services are much more likely to be available locally. Gordon Young, the publisher of The Drum, describes this business ecology effect well in relation to the marketing industry.

# Fourthly, these three changes, as well as the increased propensity for growing companies to stay in Scotland, provides visible job opportunities at senior and high status grades. This is likely to mean that school levers and graduates in Scotland are less likely to automatically assume that London is the place to go for a high status career, and it is likely to provide the pull for increased high ability immigration. Many high status roles, leads to many high ability candidates applying for roles, which increases the chances, for a firm to find an appropriate hire, which lowers the costs of doing business. This is the beneficial effect of "thick markets". In peripheral regions with no autonomy, we find truncated talent distributions (because the talent leaves) which makes them unproductive and therefore unattractive to talent. To break this cycle you need to provide opportunities for talent.

(*) Deaner & Phillips (2013) [Section 5.1 ‘Spending by service area – how might it change?’ on page 62 and 63] do not find any evidence of scale economies when looking across Europe at the costs of providing public services in countries of different sizes.

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