The announcement by the Chancellor, George Osborne, that there would not be monetary union between an independent Scotland and the rump UK is a game changer.
It comes one day after researchers, including myself, working on a major project on the Future of the United Kingdom and Scotland gave a briefing in Brussels on our findings so far. In it David Bell, of Stirling University, and I argued that the major uncertainties facing business are the EU, corporate taxation, income taxation and especially the currency.
In my own research, I have so far conducted 52 in-depth interviews with business leaders in medium and large firms across a variety of sectors. In a clear majority of these interviews, business leaders have indicated that it is uncertainty around the currency that poses the most significant risk for their businesses. Clearly, they are right to worry about the implications of Osborne’s announcement, and to wonder what this will actually mean in practice.
Go it alone
Under EU rules, for a country to join the euro, it must first demonstrate that it can run its own currency and central bank within the deficit and debt restrictions placed on it by the EU before it can join the European monetary union. In other words, the Euro in the short-term is not an option for Scotland.
Consequently, an independent Scotland would have to have its own currency. Its value would either be pegged to the pound or allowed to float freely on the international markets, which almost certainly would mean a devalued and more volatile currency. There is also the possibility that there could be some form of informal currency union, or “sterlingization”, which may have some attractions for business, but would still bring numerous challenges.
If the pound was unavailable to a post-independent Scotland, many businesses would have to make tough decisions on whether they could continue to base themselves in the country and the degree to which they maintained the same level of economic activity. Why? Because for a significant number of medium and large businesses in Scotland, most of their trade in the UK, often as much as 90%, is in the rump UK (rUK) rather than Scotland. This makes sense when you consider that the population of Scotland is 5m, but the population of the rUK is 58m.
Firms would, therefore, have to consider very carefully a range of different factors driving their businesses, but primary among them would be three things: how separate currency jurisdictions would impact on their ability to sell products and services to their customers; whether it makes recruitment and retention of high-value, skilled labour more or less difficult; and whether it creates or destroys shareholder value by decreasing or increasing costs and profitability. Global businesses whose customer base is also primarily global, however, might be less impacted.
Small firms in Scotland would not be immune to the implications of having separate currencies in Scotland and the rUK either. Firms that do any trading in the rUK would have to deal in two currencies, and there would be costs and time involved in exchanging, translating different prices from one currency to another and so on. The existence of a border can reduce trade, and some of these “transaction” costs associated with dealing in different currencies and jurisdictions help to explain why.
Economic fundamentals suggest that for countries to share a currency there needs to be agreement over deficits, debts and taxation. This may not be sustainable across two economies driven by different factors – and a Scottish resource-led economy would differ from rUK. This at the very least necessitates close co-ordination, if not integration. The euro crisis of recent years is evidence of this.
So, far from being an act of bullying or intimidation, as Nicola Sturgeon suggests, George Osborne’s announcement is underpinned by what is increasingly becoming a position supported by economic orthodoxy. That’s not to say that if the political will exists for a monetary union one couldn’t be made to work, for a time. But there are few examples, if any, where one has been made to work over extended periods of time without political integration.
Ethical considerations aside, if the Scottish government was to use this as an excuse to walk away from its share of the UK debt, the reaction from international markets would almost certainly be swift and brutal, and result in a poor credit rating for Scotland. This could then translate into uncertainty and volatility within the Scottish economy, which would in turn most likely reduce business investment, economic growth and jobs.
The UK government’s position on currency will undoubtedly be unwelcome news for the Scottish government. However, it would be wise to recalculate what this means for the independence project and, more importantly, for average Scots, and to build their case for independence from there.
So while the stated position of the Scottish government is to continue to use the pound sterling, some uncertainty has existed around whether the UK government would agree to such a pledge. The governor of the Bank of England, Mark Carney’s recent speech in Edinburgh, outlined the economic difficulties of monetary union without political union. The pressure is now on the Scottish government to outline its plan B, whatever that may be. But even with a plan B, adopting a separate currency in a post-independent Scotland, our research suggests, would likely to be problematic for a significant number of Scotland’s small, medium and large businesses.
The implications are that independence may well result in a drop of economic output, at least in the short and medium term. Cross-border trade would be diminished, and some medium and large businesses (who are responsible for most of Scotland’s jobs and national income), would choose to reduce their exposure to the country by migrating some of their activities to either the rUK or the EU. In the long-term, of course, anything is possible.
This article was first published on the ESRC’s Future of the UK and Scotland website.