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Scottish independence is not bad economics, so ignore the voices of doom

Why the doomsayers are wrong about post-independence Scotland. StockCube

I recently wrote a piece for The Conversation in which I argued that for several important reasons, an independent Scotland would not be worse off than it is now – contrary to the views of a majority of independent professional economists that were published in a survey. A few days later Professor Ronald MacDonald of the University of Glasgow wrote a piece in response, contending that my arguments were incorrect. For the good of the independence debate, I thought it deserved a detailed reply.

The reality of the national accounts

My first argument was that most economists are modelling Scotland’s post-independence position based on the national accounts as they are currently set up, rather than removing various revenue and expenditure flows that would disappear, such as subsidies to UK pensions and debt interest payments made to the treasury. MacDonald questioned the substance of some of these flows, while indicating that a swing from a fiscal deficit in excess of 8% last year to a fiscal surplus of 1% this year if we were independent was unlikely.

I was disappointed to see that he had fallen under the spell of the same mistakes as the UK treasury has made. The source for my estimate of the existing fiscal deficit was precisely the same as his: OBR estimates made a year ago for 2013-14. The difference is that I did not include public investment (known as “public capital formation”) in the deficit figure. This is the convention in national accounting because those investment expenditures will be repaid out of future revenues, not current revenues, just like any business investment.

Current revenues measure the ability to pay for current spending. This is the “golden rule of public finance”, a rule enforced in Germany (and the UK until 2008), in which borrowing is only allowed for public investment. It is the yardstick by which all other countries are judged, and a simple way to allocate financial responsibility to the generation that benefits from the expenditures being made. The capacity to withstand future fiscal problems is then judged against the existing debt burden, which in Scotland, by any measure, is smaller than that of the UK, relative to GDP.

The other difference is that, unlike MacDonald, I include offshore GDP for calculating the size of the deficit ratio as a proportion of GDP since those revenues would be available to pay the debt of an independent Scotland. If you don’t include offshore GDP in the deficit ratio, it would be the equivalent of saying that part of the UK’s export earnings (the finance sector, for instance) should not be counted in its GDP numbers on the argument that they arise from outside the UK itself.

Leaving City of London out of UK GDP figures would be ludicrous. Alexander Kachkaev, CC BY-SA

If global earnings in finance sector of the rest of the UK were 10% of GDP, doing this would raise the deficit ratio (including public investment) from 6.5% to 7.5%. To leave offshore GDP out of the figures for an independent Scotland raises the issue of why Scotland should be held to different standards than everyone else.

On the specifics of the fiscal flows that MacDonald challenged, the options on debt interest payments have been widely discussed, but remain subject to negotiation. If no debt is transferred, the budget savings would be £5bn; if the transfer were in line with the population share, the saving would be zero. A midpoint of £3bn, corresponding to historical debt, is a likely compromise.

My figures on taxes repatriated from cross-border commuters come from a 2008 report by Oxford Economics. The implicit subsidies to the rest of the UK’s pensions and housing benefits can be traced through reports by the National Institute of Economic and Social Research and the Institute for Fiscal Studies. Defence restructuring is from Scottish Government announcements. The numbers may be estimates, but there is no gainsaying those points as such.

MacDonald meanwhile argued that these budgetary gains would be offset by the fact that BP would continue to pay its North Sea taxes in London. Why would that be the case in an independent Scotland? And why only BP?

But this argument is to miss the central point. Whatever figure you want to take as the initial deficit, if you reconstruct Scotland’s national accounts to take independence into account, it implies that the fiscal deficit would fall by about 6.25 percentage points. If we started from the 8.3% deficit that was published for 2012/13 rather than, say, the 5.2% figure forecast by the Institute for Fiscal Studies for 2016/17, we would end up at a deficit ratio of about 2% – compared to 6.5% for the UK, or about 3% for Germany in the same period (all figures including capital expenditures).

Oil revenues may increase, if slowly

My second argument was that the UK government’s outlook for North Sea petroleum draws a trend from a couple of bad revenue years. MacDonald essentially argues that this will never happen.

In fact, I draw my North Sea revenue forecasts from the industry body Oil and Gas UK. They reflect a rise in output to be expected from the industry’s £14bn investment over the past financial year. Oil companies don’t invest for no reason, and industry forecasts are likely to be better informed than most -– at least better than the OBR, whose forecasts have proved wildly inaccurate in the past.

On the related question of what will happen to the world economy, which again led MacDonald to counsel caution, the slowdown in the UK, EU and US that worries him also may never happen. These economies are expected to slow down briefly in 2014, but speed up from 2015 onwards. Independence, if it comes about, is not due to take effect until 2016. Gloomy forecasts like MacDonald’s are therefore, in reality, arguments that reflect what may happen without independence, not with it.

Pounding the truth into you

Finally we come to the currency union question. In a previous report the Council of Economic Advisors’ working group argued that the arguments for currency union were supported by the criteria for an optimum currency area. MacDonald questioned whether the criteria had been selected to favour independence.

Mark Carney is the source of the optimum currency area argument. Jonathan Brady/PA

It is worth pointing out that the optimum currency area calculations were in fact supplied by Bank of England governor Mark Carney in a speech in January), not by the working group. So if anyone filtered the criteria in order to show results more favourable for independence, it was governor Carney and his staff – hardly a likely event! Instead they show that a Scotland-rUK currency union satisfies those criteria better than the US or Canadian currency unions, and far better than the European currency union.

Fiscal rules and banking union membership remove the chances of a separate financial crisis. There are only two ways such a crisis can happen in a currency union: a sterling crisis, or a Scottish banking crisis. The first, as nearly hit us in 2009-11, would involve the rest of the UK and others just as it did then. The resources for resolving it would be the same, with the same chance to use external currency depreciations for short term competitiveness fixes. So the chances of survival are the same.

And with the Scottish banks largely owned and operated in England under the “reincorporation” requirements brought in by the 2013 Financial Services (Banking Reform) Act, Scotland would not be affected alone or even majority affected if there were a domestic banking crisis.

Indeed that is the whole point of banking union membership. The only difference is that Scotland would be part of a larger and more effective resolution mechanism, with banking assets under Scottish supervision being about 12 times smaller than usually supposed. Denmark has taken exactly this route in its currency union with the euro. In other words, the chances of survival and at a proportionate cost are if anything higher than they are now.

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