The Cost of Political Uncertainty: Evidence from Catalonia

Which are the economic costs of more autonomy and independence? Using four main events that have characterized the relationship between Catalonia and Spain during the last decades, Vincenzo Galasso provides evidence that political uncertainty may be detrimental to the business environment.

A quest for independence surfaces in many regions of Europe (e.g., Scotland, Catalonia, South Tirol). A strong regional identity may create a demand for independence from a culturally different central state, particularly when linguistic, religious or historical differences are present. Economic reasons matter too. Independence allows regions to target welfare and public programs, such as education, to local needs and culture, and to stop fiscal transfers to poorer regions. Yet, access to larger domestic markets and cost sharing in the provision of national public goods may be lost with independence. 

In the last two decades, globalization has reduced the economic cost of independence. Potentially, supranational institutions, such as the WTO and the EU, may guarantee access to international markets also to regions seeking autonomy. Moreover, the recent economic crisis has made inter-regional fiscal transfers more salient, increasing the demand for more fiscal federalism and decentralization.

Yet, the transitions towards more autonomy requires a negotiation between the central state and the region seeking autonomy that may create political tensions. Negotiated agreements typically produce shared fiscal and policy authority that create uncertainty. The sharing of legal and administrative responsibilities may lead to more bureaucracy and even higher taxes, if double or joint (regional and central) fiscal burdens are imposed. More importantly, a much deeper political uncertainty follows radical, unilateral moves towards full independence. Access to (previously) domestic markets and public procurements has to be re-discussed with the central government. Access to foreign markets depends on international treaties and requires negotiations with international organizations (the EU, in the case of European countries, or the WTO), in which national entity may veto the demand of seceding regions. Hence, unilateral quests for independence create large uncertainty about economic outcomes that depend on political negotiations and that affect companies located in the seceding region. 

To address these issues, our empirical analysis exploits the sequel of political and legal events in the Spanish-Catalan relation over the last two decades. This represents the perfect environment to analyze the effects of political uncertainty associated both with inter-governmental negotiation for more autonomy and with unilateral quest for independence, for several reasons. First, Spain belongs to a highly integrated economic area — the EU and the Eurozone. While seeking independence from Spain, some pro-independence politicians may expect to keep access to the EU market and to maintain the common currency — the Euro. Second, Spain features a high level of intergovernmental conflict between the central state and the regions, particularly Catalonia. Third, this long sequel featured periods associated with different degrees of political uncertainty. Between 2003 and 2006, the Catalan and the Spanish governments negotiated a new Catalan Statute that modified the sharing of legal and administrative responsibilities between Catalonia and Spain. Limited political tension surfaced at this time. Uncertainty was mostly related to whether a perspective double tax collection would lead to more bureaucracy, higher taxes, or to favoring Catalan or Spanish players. A ruling of the Spanish Constitutional Court in 2010 that modified the Statute largely limited this uncertainty. Yet, a strong demand for independence emerged during the Great Recessions. In 2017, the Catalan government promoted a referendum on independence, which was declared unconstitutional by the Spanish Constitutional Court. Political uncertainty mounted. The associated economic uncertainty concerned future access of Catalan firms to the Spanish (and EU) markets and public procurements, in case of independence. The referendum took place on October 1st 2017. Few weeks later, the Catalan Parliament declared independence, but the Spanish Senate transferred all powers on Catalonia to the Spanish Government and called for snap elections.

To examine the perceived costs of political uncertainty, we exploit survey data from the Catalan Barometer of political opinions. We focus on the preferences of entrepreneurs and of individuals with a Catalan background (born in Catalonia or from Catalan parents) over the Catalan Statute, in 2005, and over Catalan independence, in 2017. In forming their preferences, entrepreneurs are more likely to consider the effect of uncertainty on the business environment, while people with a Catalan background may care more for cultural and linguistic factors. Our findings suggest that entrepreneurs favored the status quo over Catalan independence, while individuals with Catalan parents preferred fiscal decentralization and independence.

To evaluate the economic effects of political uncertainty, we use an event approach methodology that estimates the immediate stock market reaction to the occurrence of relevant events. Under the assumption of efficient capital markets, any new information provided by these events on the future economic perspectives of Catalan and non-Catalan Spanish firms should immediately be reflected in their stock market prices. We focus on four main events that were unanticipated or whose outcome was ex-ante uncertain: the approval of the Catalan Statute by the Spanish Parliament on May 2006; the 2010 ruling of the Constitutional Court emending the Statute; the 2017 Catalan referendum of independence, and the subsequent Catalan Parliament declaration of independence, followed by the Spanish Senate response. We measure the (abnormal) stock market reaction for Catalan and non-Catalan Spanish listed companies. Our empirical evidence suggests that Catalan firms in the tradable sectors posted negative returns after the initial approval of the Catalan Statute by the Spanish Parliament, but positive returns after the ruling of the Constitutional Court. The political uncertainty associated with the October 2017 events prompted even stronger stock market reactions. Large negative abnormal returns emerged for Catalan firms after the referendum. Our analysis identifies also large positive abnormal returns after the contemporaneous declaration of Catalan independence and the reaction by the Spanish Senate. As expected by the entrepreneurs, the political uncertainty associated with more autonomy and independence may be detrimental to the business environment.

About Post Author

Vincenzo Galasso

Vincenzo Galasso is Professor of Economics at Bocconi University, Milan; Director of the Analysis in Pension Economics unit of the Baffi-Carefin Center, Research Fellow at the Center for Economic Policy Research (CEPR), London at the CES-Ifo, Monaco, at IGIER, Milano, and at the Center for Economic and Political Research on Aging (CEPRA) at the University of Lugano, Switzerland. He is co-Editor of the European Journal of Political Economy, and of the Journal of Pension Economics and Finance. His research deals with political economics, aging, social security and the welfare state.