The recent publication of an extensive survey of leading economists by the Centre for Macroeconomics showed that an overwhelming majority did not think Scotland would be better off if it were independent. A majority also indicated that ruling out a sterling zone currency union post independence is in the rest of the UK’s best interests.
In a recent contribution to The Conversation, Andrew Hughes-Hallett, a member of the Scottish government’s fiscal commission working group (FCWG), argued that the respondents to the survey were wrong on both counts.
He relied on three points to support his contention: that the nature and size of the fiscal deficit in Scotland would be different post-independence; that petroleum revenues are on an upward trajectory, which would further underpin an independent Scotland’s fiscal position; and that it would ultimately be in the UK’s best interests to agree a sterling monetary union, once you took game theory into account.
Let’s get fiscal
On the first point it was argued, “one has to reconstruct the national accounts to show what they would look like if Scotland were independent”. This clearly is not done in the article, and there is no source reference to indicate it has been done elsewhere. So resort is made to constructing some numbers that the author believes would underpin an independent Scotland’s fiscal position. He argued that this would produce a fiscal surplus of 1% of GDP post-independence, which contrasts with a deficit of 8.3% for 2012/13.
The numbers used to generate this surplus are, for example, repatriated taxes of £1bn from “cross border commuters”. No justification is given for the construction of this number. Presumably, it would be hugely offset by the fact that BP would continue to pay its taxes on North Sea oil revenue in the rest of the UK rather than in an independent Scotland.
It is also argued that the return of debt interest repayments would save £3bn. But what about the £6bn of annual debt payments the National Institute of Economic and Social Research has calculated an independent Scotland would have to pay to treasury? Scottish finance secretary John Swinney intends to increase borrowing by 3% per annum in an independent Scotland. This presumably is also not factored in to the figures used to generate a fiscal surplus.
Oil take the low road
North Sea oil revenues are also projected to be more buoyant than in some independent estimates, such as those of the Office of Budget Responsibility. Hughes-Hallett attributes the present fall in revenues to both the severity of the recent recession and the contention that oil producers have simply left oil in the ground in the North Sea due to a tax surcharge imposed in 2011 and 2012. From this it is conjectured that North Sea oil revenues will recover from £3.2bn in 2013/14 to £4.5bn-£5bn by 2016-2020.
But there are significant factors that could point to oil prices remaining depressed and indeed heading in a southerly direction. For example, the fracking of oil and gas in the United States may soon mean it overtakes both Saudi Arabia and Russia as a hydrocarbon producer. This will undoubtedly have implications for the price of oil.
There are also growing signs that the recovery from the great recession may stall both because of recent poor growth figures in the US and the EU; and from concerns that any nascent growth that we observe today in the world economy is, as the IMF has recently documented, being driven by a worldwide housing bubble which needs to be burst.
Oil prices are volatile and any sensible risk assessment should take a cautious risk-averse view of where they are headed. This is what the Office of Budget Responsibility tries to do in its studies. Taking all of the above together, I believe that an independent Scotland will have a significant fiscal deficit, a finding supported by all independent analysts.
The pound won’t abound
The Scottish government’s preference is for a sterling monetary union post-independence and it argues this is based on the work of its fiscal commission working group. In its report last year, the group used the so-called optimum currency area criteria to argue in favour of a sterling currency union. But as I and others point out, the group simply chose the criteria that gave them this result and ignored the criteria which would lead them to a very different result.
For example if an independent Scotland were to have a geographic share of North Sea oil, as planned, it would become a net exporter of hydrocarbons and its biggest trading partner would become a net importer of hydrocarbons. That means that Scotland would be subject to asymmetric shocks in periods where the oil price became unduly strong or weak, which would mean it would not be an optimum currency area with the UK.
The Scottish government has also indicated that it would attempt to increase both productivity growth post-independence and also grow GDP per capita at 3% per annum. Part of the justification for a currency union is in terms of having similar levels of productivity and GDP per capita; if the Scottish government changes these, it would make Scotland inconsistent with the union and would mean that the currency area would no longer be optimum.
It is presumably for these reasons that Hughes-Hallett has now abandoned the optimum currency area analysis used by the group and uses the “lens of game theory” to justify a sterling currency union. The nub of the argument seems to be that if Westminster did not accede to an independent Scotland being part of a sterling monetary union, Scotland could adopt the pound anyway along the lines of the way Ecuador uses the US dollar or Montenegro the euro. By doing so, he claimed, Scotland would be “unambiguously better off: more policy instruments to reach the same targets.”
But an informal form of sterlingisation – the Panama option – is a vastly inferior option to a formal monetary union, as indeed the fiscal commission working group recognises. Yet it suffers from the same basic problem of exchange rate fixity and the inability to address changes in competitiveness. As Paul Krugman and others have argued, a key reason why currency unions, and other forms of fixed rate systems, break up is that such currency locks cannot cope with the competitiveness strains placed on them.
Taking recent IMF numbers for the costs of currency crisis, it is straightforward to show that maintaining the sterling zone currency union would cost an independent Scotland in the region of £25bn-£35bn, but could easily cost two to three times these numbers. The cost to the UK would be even greater. You don’t need to be a game theorist to work out that such a currency union is not in anyone’s interests.
On the other hand if Scotland did choose the inferior and informal Panama option, the costs of the inevitable currency crisis would presumably be borne by the Scottish taxpayer. In that situation, rUK would be unambiguously better off.