Peter Jones: How Union works eludes all parties

Alex Salmond claims Scotland doesn't get the benefit of funding 25,000 modern apprenticeships. Picture: Stuart Cobley
Alex Salmond claims Scotland doesn't get the benefit of funding 25,000 modern apprenticeships. Picture: Stuart Cobley
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Smith’s Commission faces a daunting task when no party seems to understand UK’s economic system, writes Peter Jones

Fascinating to see that the Scottish Government is still campaigning away for independence even though the referendum has happened and the Scottish people said no. Fascinating also, that the unionist parties still don’t fully understand what they actually stand for. The disconnect with reality on both sides means that the Smith Commission could well be headed either into a cul-de-sac or over a cliff edge – which isn’t yet clear.

I say “could” because fortunately when Lord Smith began his heroic task of trying to find a package of additional powers for the Scottish Parliament that all sides could mostly agree with, he did quite firmly set out that the process should be principles-led. If the principles are logical and clear, and everything in the eventual package adheres to them, then it should work.

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But the parties keep trying to divert the process away from them. Last week, Alex Salmond gave a good example of that in his speech to the Scottish Trades Union Congress.

He said: “For example, we [the Scottish Government] fund more than 25,000 modern apprenticeships each year, but the savings from lower unemployment benefit go straight to Westminster. Greater powers over welfare and taxation – true home rule within the United Kingdom – would allow us to retain those tax revenues and welfare savings. Scotland would reap the benefits of our social investments.”

It sounds good, even in principle. The principle is that if Scottish politicians control nearly all welfare and taxation, then they have an incentive to fund such schemes as modern apprenticeships because they reap the rewards of paying out less in welfare spending and recouping more in income tax and national insurance. The people benefit by being productively employed and are therefore happier.

What could possibly be wrong with that? Quite a lot, actually. It only works if you believe, as nationalists do, that there are only rewards from independence and no risks. The corollary of Mr Salmond’s argument is that if modern apprenticeships can’t be funded, then the welfare bill rises and the tax earnings fall.

It is not just history that tells us that these things do happen, but contemporary events. As Brian Wilson eloquently reminded us on Saturday, prices of North Sea crude have now fallen by more than 20 per cent since June. As I write, it is trading at around $86/barrel, 24 per cent, or nearly one quarter, below the $113/barrel price Mr Salmond averred during the campaign was a “cautious” forecast.

Every month that these low prices persist costs hundreds of millions in tax revenues. Every three months, and you can start counting the cost in billions. If they last longer, then you have to worry that companies will cancel investment in more North Sea production and pull out, as some were rumoured to be contemplating even before this price slide began. Then, not just tax revenues, but also jobs would disappear.

In economics jargon, this would be an “asymmetric shock”, an effect which hits one part of a country badly, but not the other parts. In fact, the economy of the other parts would benefit from lower fuel prices, as would Scotland, but only as an offset to the much larger oil price shocks.

Within the present union, Scotland is insulated against such a shock. Holyrood does not suffer a fall in the revenues it has to spend and neither does it face an increased welfare bill. These costs are borne by the rest of the UK.

That’s how the Union works – rewards are shared and so are the risks – something which the unionist parties don’t seem to fully understand. If they did, then there would have been a rapid response to Mr Salmond’s STUC speech.

If continuation of risk and reward-sharing is one of the principles which makes the Union work and which Lord Smith accepts (I cannot see how he would reject it) then other principles follow.

One is that there has to be a financial equalisation mechanism operating in two different ways. The first is to ensure all parts of the UK have available to them the same level of per capita public spending once local circumstances such as different population densities and ethnicity mixes (factors which affect the cost of delivering public services) are taken into account.

It means that rich areas of the country, such as London and Scotland, should probably pay relatively more in per capita taxes than poorer areas such as Wales and Northern Ireland. It is a form of progressive taxation, but operating geographically in order to achieve greater socioeconomic equality.

In time, assuming politicians responsible for the poorer areas do their jobs properly, the prosperity map should even out and there should be less need for this form of resource transfer between different parts of the country.

The second way that financial equalisation should work is to provide resources to deal with the kind of asymmetric shock outlined above. Essentially, this has to operate mainly through the welfare system, but there could also be transfers in other ways, say, to finance construction work if there was a localised downturn in that sector.

This is why devolution of income tax and the welfare system – much of the home-rule scenario praised in Mr Salmond’s STUC speech – won’t work. If Scotland was to suffer an asymmetric shock from a prolonged oil price slump, as now seems possible, it would be hit by a triple whammy of falling oil revenues, declining income tax revenues, and a rising welfare bill. The remaining bit of the Union’s equalisation mechanism – the Barnett formula – would be responsible for such a small part of overall Scottish public spending that it could not fill the huge gap between spending and revenues that would open up, and nor is it designed for that purpose.

Lord Smith needs to ask some hard questions about these principles when he meets the political parties tomorrow. To resurrect a phrase from 1980s devolution debates, a new devolution settlement needs to be an all-weather one – capable of dealing with the sunniest and the most miserable of economic times.

Much of what has been put forward by the parties so far does not meet that objective, all having elements of cul-de-sacs and cliff edges in them. Lord Smith has some very tricky steering to do.