An independent Scotland would have a stronger economy than you might think

Are economists selling Scotland short? swissmacky

A large majority of independent professional economists believe Scotland would not be better off if it were independent, according to a recent survey. A smaller majority believe the rest of the UK would be acting in its own best interests if it tried to rule out a formal or informal monetary union with an independent Scotland.

Both beliefs are wrong, for rather simple reasons. First, to determine if Scotland would be better off or not, one has to reconstruct the national accounts to show what they would look like if Scotland were independent. This is because a number of the revenue and spending transfers between Scotland and the rest of the UK would either cease or would be returned to the parent economy. Reallocating those spending or tax flows is likely to change Scotland’s budget balances significantly, and in Scotland’s favour.

This point is now generally acknowledged in relation to oil and gas revenues, and sometimes with respect to debt interest payments; but not with respect to the many other transfers and subsidy reversals that need to be included.

Most economists continue to use the national accounts as they are now set up –- which is to rely on a number of revenue and expenditure flows that will no longer exist after independence. Insofar as their projections are gloomy and show Scotland worse off, those economists are in fact showing how the Scottish economy would look under a continuing union. Ironically they are actually making the case for independence rather than against it.

It works like this…

To make the point specific, the office of budget responsibility estimated Scotland’s current fiscal deficit to be around 5.2% of GDP in 2013/14 – that is for current spending relative to combined offshore and onshore GDP (which is the revenue stream currently available to pay for current spending or borrowing). Many analyses quote a larger deficit because they include capital spending (to be paid for out of future revenues), and then exclude offshore GDP even though that is an obvious source of finance for borrowing.

Under independence this deficit figure would have North Sea revenues added to it; and then the repatriated taxes from cross-border commuters (£1 billion); the return of subsidies currently made to pensions in the rest of the UK (£1bn); the return or part-return of debt interest payments currently made to the UK treasury (£3bn on historical debt); plus the gains from defence restructuring (£0.5bn); a rebate of Scotland’s share of the quantitative easing assets held at the Bank of England (£1bn); and the return of subsidies to housing benefit (£0.5bn).

These figures are mainly my estimates. Taken together, they imply that the reallocations that come with independence would generate not a deficit but a small budgetary surplus of around £1.5bn or 1% of GDP. And they are standard adjustments to the existing budget calculations.

North Sea drop is temporary

The present fall in North Sea revenues is sometimes held up as a reason against independence, but can actually be explained by two factors. First, the world has just come out of the largest recession since the 1930s. One would expect demand to have shrunk to 2012 at least, the year the world recession is commonly said to have ended, bringing down revenues at the same time.

The special feature about oil and gas is there are no storage problems; they can both be stored in the ground at no cost in periods of reduced demand, meaning that revenues are not propped up by the need to shift the product at any price.

North Sea oil revenues have had a hard time of late. vitstudio

Second, there was an additional tax surcharge imposed in 2011 and 2012 which reduced earnings per barrel of oil pumped. Producers would again have stored their oil/gas until the surcharge was lifted.

Taking these points together, it would be reasonable to expect North Sea revenues to recover from £3.2bn in 2013/14 to, say, £4.5-£5bn by 2016-20 in line with the industry’s own forecasts. (The OBR had earlier predicted revenues of £3.2bn for 2016/17 while the Scottish government had predicted £6.8bn).

Currency union will happen

As for the arguments for and against currency union, they are best seen through the lens of game theory. These games show how the best outcomes that each player could expect to achieve for themselves without cooperating, accommodating or otherwise making concessions to the other player, would change from what they are at present. In this case, the UK and Scottish governments are engaged in a series of interacting policy games which impinge upon each other in the political arena, in the economic arena, and via the location decisions made by firms.

The currency choice is a case in point. If there is no formal currency union, Scotland will be able to improve its current position whereas the rest of the UK would inevitably suffer worse outcomes. To see this, one has to realise that the UK government can do nothing to prevent Scotland taking the pound if it wishes, any more than the US government can do anything to stop Ecuador using the US dollar; or the EU can stop Montenegro using the euro.

All the UK government can do is deny Scotland influence over policy at the Bank of England. But that just reproduces the existing position for Scotland. Given independence, or indeed fiscal autonomy under a “devo-max” scenario, the only difference would be that Scotland gets to add tax powers to the existing monetary policies.

Scotland would therefore be unambiguously better off: more policy instruments to reach the same targets – instruments that can now be designed to fit Scotland’s specific needs, rather than to fit the UK average.

On the other hand the rest of the UK would definitely be worse off; no better off since monetary policy would be set in the same way as now, but worse off to the extent Scotland uses its new tax powers to its own advantage rather than the UK’s advantage. The UK would also lose net revenues, making existing net public debt and deficit positions worse. This being the case, it would not be in the rest of the UK’s interests to deny Scotland a currency union – especially before a tight UK election.