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John McLaren: For Scotland’s future, money matters

Scotland's future currency has been a hot topic. Picture: TSPL

Scotland's future currency has been a hot topic. Picture: TSPL

  • by JOHN McLAREN
 

SCOTLAND must engage in an open debate on the merits of sticking with sterling, joining the euro or even forging its own currency, writes John McLaren

The past two weeks have seen a lot of action in terms of the emergence of more details over what Scotland’s fiscal and monetary policy might look like in the event of independence.

First, we had the Scottish Government’s fiscal commission proposal to stick with sterling. Then John Kay, a well-regarded economist and former member of the Scottish Government’s council of economic advisers, proposed that a separate Scottish currency may be necessary if an independent Scotland aspired to very different fiscal and social outcomes. That was followed at the weekend by the cut in the UK’s credit rating by Moody’s and a strong signal from the Treasury that Scotland could keep the pound, but only so long as it accepted budget constraints set by London.

What are we to make of these twists and turns for Scotland’s economic future? For a start, there are two principal currency options emerging: joining a new sterling zone or establishing a new Scottish currency.

The first option, that Scotland joins a sterling zone, may appear superficially attractive. However, as a relatively small player within that zone, Scotland’s influence would be limited, just as is the case currently. The idea that influence could grow post-independence seems a little perverse, and not just from the viewpoint of London, but also that of Belfast and Cardiff.

Such a monetary framework would allow an independent Scotland a greater degree of fiscal freedom than is currently possible.

For example, it could vary tax rates, but it would still be constrained by the overall spending limits imposed at the UK level. If Scotland wanted to have more generous benefits, or promote greater equality, then it would either need to raise taxes or cut other spending areas, such as defence or international affairs.

To argue for greater resources to promote greater equality necessitates an explanation of the source of such funds. For example, the use of increased borrowing to act as such a source is unlikely under the sterling zone option as, at the point of independence, it seems reasonable to assume Scotland would inherit a yet to be determined share of the UK annual borrowing and cumulative debt. Within the current UK fiscal plan of reducing the deficit and debt levels, it is difficult to see how the Scottish Government would get to a position whereby it is able to borrow any more, as it too would be constrained by this overall UK borrowing limit.

With regards to the current UK government’s austerity programme, the downgrading of the UK’s credit rating does not look to be a game-changing event, in terms of shifting the debate on austerity that the Scottish Government is seeking. While ratings agency Moody’s expressed concern over the UK’s slow growth, it also sees the political commitment to austerity spending cuts as being what “underpins the stable outlook on the rating” that now exists.

The second option is for a future independent Scottish government to accept that such a “satellite of sterling” relationship is too constraining and decide to go for a separate currency, as Kay has suggested. Such a position would indeed allow for greater freedom in terms of setting a new economic agenda to address inequality.

This currency option would not be unique. Currently, Norway, like Scotland a country with an economy heavily weighted towards the production of oil and gas, has its own currency and shares a border with a larger country, Sweden, which is, like the UK, within the European Union but outside the euro. Sweden is also its largest, non-oil trading partner. Of course, Norway is outside the EU, whereas Scotland is likely to stay within it, but it remains a relevant example for how this alternative arrangement might work successfully.

Scotland’s currency position is also complicated by the importance of North Sea oil to Scotland’s economic performance, and the influence of the internationally-set price of oil. Scottish policies may need to be different when reacting to permanent shifts in oil prices. Being without its own currency, and aligning with a non-petro currency, like sterling or the euro, may preclude the use of the most appropriate policies.

With a higher oil price, oil-exporting countries can expect higher growth and an appreciation in the exchange rate, while oil importers can expect slower growth and some depreciation in currency. Clearly, the impact of policies to deal with these varying effects would differ depending on whether Scotland had its own currency or was part of a new sterling zone.

A separate, though currently highly relevant, fiscal issue that would need to be resolved in the event of independence is Scotland’s position with regards to the UK’s EU rebate. If, as the Scottish Government claims, Scotland would be the sixth-richest country in the world in GDP per capita terms, then it could well be a significant net contributor to the EU budget.

As a result, Scotland would be likely to try to renegotiate its contribution position based on the fact that its gross national product, ie, what wealth stays in the country, is considerably lower than its GDP. This, and other factors, means that it is difficult to ascertain in advance what net contribution Scotland is likely to make. Meanwhile, the remainder of the UK would negotiate its own new rebate with none of it then coming to Scotland.

Another complicating fiscal factor is the role of any future oil fund. In the case of sticking with sterling, if an oil fund was established by an independent Scotland, it implies a future Scottish fiscal surplus. Were this to come about, how would a UK government treat this surplus/fund, in terms of setting its own borrowing targets? In effect, this is the reverse of the concern being expressed by some referendum commentators about current excessive Scottish borrowing.

Where does this then leave the referendum debate on key economic issues? First of all, it highlights the importance of understanding what independence actually means. The traditional 19th and 20th century European meaning of a separate country with its own regulations, foreign policy, immigration policy and economic policies is largely a thing of the past. This still leaves room for autonomous policy action, but often as a result of a negotiated outcome – be it with the UK or the EU or even wider.

These negotiations will involve trade-offs. A good example is the future Scottish currency, where the presumed stability benefits within the current sterling arrangement would be traded off against the ability for greater policy manoeuvrability.

None of the final policy decisions with regards to these issues are likely to be fixed in stone prior to the referendum, nor will they remain fixed even in the event of independence. Just as the debate in Scotland over whether it would be a good thing or not to join the euro has been a rolling one that shifts with events, so too will that on any future monetary and fiscal policy.

Pretending there is certainty of advantage around a particular policy route, as happened in much of Europe over the introduction of the euro, would be a mistake. An open discussion of the options in the months ahead would be more honest, more informative and more fruitful.

• John McLaren is an economist with the Centre for Public Policy for Regions (CPPR)

 

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