An independent Scotland would be significantly better off than it is now, according to Professor Andrew Hughes-Hallett of George Mason University in two recent pieces in The Conversation. This is contrary to the view of the vast majority of independent professional economists.
I wrote a piece last month taking the opposite view, which Hughes-Hallett spent a considerable amount of time criticising for my choice of figures for a future Scotland’s fiscal deficit, among other things.
Although my Conversation piece was not about the different definitions of the fiscal deficit, his comments were very wide of the mark and I am happy to address them here. I will also tackle his oil projections and views on sterling monetary union post-independence, which were incorrect too.
Mind the gap
Obviously the projection for an independent Scotland’s fiscal deficit makes a big difference to your view of its economic outlook. In my Conversation piece I quoted a deficit for Scotland of -8.3% of GDP for 2012/2013, which was taken from Scottish government figures from March 2014 from the government expenditure and revenue Scotland (GERS) report. In his original Conversation piece, Hughes-Hallett quoted a deficit of “around 5.2% of GDP in 2013/14,” which he sourced from the UK government’s office for budget responsibility (OBR).
His preferred deficit was the current deficit, which excludes public investment, where mine is the net deficit, which includes it. Hughes-Hallett believes that the net deficit is misleading, but financial markets are not interested in accounting conventions about the importance of current spending – even if the mighty Germany follows such a rule. Financial markets are interested in the sustainability of fiscal positions and it is total borrowing that gives them the correct indication of sustainability. How are they to know if revenue generated from public investment will pay for itself?
Hughes-Hallett also claimed I excluded offshore revenue from my figure. But in common with many professional economists, my preferred measure is the net deficit number which actually includes offshore revenue (in this case a geographic share of offshore revenue, as opposed to one divided per capita between Scotland and the rest of the UK). It is also interesting to note that if one applies the same rule to oil negotiations as Hughes-Hallet applied to debt negotiations (taking a midway point between the current deficit with a per capita share of oil and that with a geographic share of oil), you can come to my deficit figure of 8.3% by a different route. This figure is also reflected in the most recent GERS report. Incidentally if you exclude oil revenues altogether, you get a deficit figure of 14%.
Hughes-Hallett went on to argue that the national accounts in a post-independent Scotland would look very different to those of today, such that his current deficit for 2016/17 could potentially be transformed into a surplus of 1% of GDP. In the absence of such accounts, he has to resort to conjecturing account items that might produce a surplus. But I can just as easily conjecture a post-independence scenario which will generate an even larger fiscal deficit number than that reported by GERs or the IFS. For example Hughes-Hallett ignored the 3% per annum raised borrowing that Scottish finance minister John Swinney has recently announced; the uncosted spending plans of the Scottish government and the further implications this will have for the country’s debt profile; and the proposed 3% cut in corporation tax.
He also assumed a negotiated share of debt of 50% of what Scotland’s share would be if it was calculated in proportion to population. But what if Scotland ends up paying 100% share of the debt? This doesn’t seem unreasonable if it does obtain the full geographic share of North Sea oil. And what if companies that raise a substantial amount of their revenue stream in Scotland prefer to pay their taxes to Westminster post-independence? Presumably also the assets of quantitative easing will be offset be a corresponding liability for the Scots.
So even allowing for offshore tax revenue, the fiscal deficit in an independent Scotland could easily rise by the 6.25% figure by which Hughes-Hallett predicted it would fall. This would give a deficit in the region of -11.45% of GDP, using Institute for Fiscal Studies figures; or -14.55% using Hughes-Hallett’s preferred figures. Such numbers would of course be even higher if Scotland failed to gain a geographic share of North Sea oil revenue. These are indeed truly scary numbers for a newly minted country.
Oil be damned
Hughes-Hallett and the Scottish government use the industry estimates of price and revenue from North Sea oil. There is no surprise there, since it is in the oil industry’s interests, as with any producers’ club, to talk up the price of the value of their members’ assets. Are Scottish taxpayers best served by this? I think not.
Given the volatility of oil prices, it is in the interests of the Scottish taxpayers to take their lead from an independent body such as the OBR. As far as I am aware, none of the members of the OBR are advisors to either the UK or Scottish governments.
Interestingly, this body earlier this month also downgraded its oil revenue projections for Scotland and noted that the revenues are around a third more volatile than those from other budgetary sources. Given how reliant Scotland would be on North Sea oil revenues, this simply underlines the fragility of its budgetary position after independence and particularly its long-term sustainability.
Cash and more questions
Perhaps the most remarkable statements in Hughes-Hallett’s piece were reserved for a sterling currency union. He claimed the Scottish government’s council of economic advisors working group in February 2013, “argued that the arguments for currency union [with rUK] were supported by the criteria for an optimum currency area.” These criteria, he said, came from a speech by Bank of England governor Mark Carney in January of this year.
Not only did he fail to show how Carney’s calculations could feed into a document written by Hughes-Hallett and his colleagues some 12 months earlier, he also failed to recognise that the benefits the governor ascribes from the monetary union can only continue post-independence if the convergence which underpins them continues to hold.
Clearly that cannot be the case for the reasons I noted in my original Conversation piece – divergent productivity and GDP per capita policies proposed by the Scottish government, and the various effects that will arise if Scotland becomes a net exporter of petroleum, which as Hughes-Hallett emphasised is a central element in the Scottish government’s budgetary policy. These effects will have a profound effect on the competitiveness of an independent Scotland vis-a-vis rUK.
As Hughes-Hallett noted, the currently constituted UK may well have been able to devalue sterling to stay competitive during past crises. But an independent Scotland in a sterling monetary union would have a fixed exchange rate with rUK, its main trading partner, and will therefore be unable to use “currency depreciations for short term competitiveness fixes” in the way that Hughes-Hallett said.
The chances of the survival of the pre- and post-independence monetary union are therefore completely different. I agree, however, that if Scotland no longer had a banking sector to speak of post-independence, it is unlikely that it would suffer a banking crisis as a consequence of the inevitable exchange rate crisis.