Peter Jones: Don't bank on UK writing off debt

Published on Monday 13 June 2011 20:37

An independent Scotland might be faced with crippling financial problems from the very outset

DEBT, as everyone now knows painfully, can be an awful millstone around your neck as you struggle to earn a living. Too much debt can bankrupt you. Even a little debt cuts into your ability to balance household finances. So it is with countries and public finances, and if Scottish independence is to become a reality, then the SNP will have to tell us what Scotland will do with its share of UK debt.

Until a few years ago, this was a reasonably manageable problem. But then the bank crisis blew up, the economy went downhill and, as a result, the UK debt has ballooned to an enormous size. Why would an independent Scotland have to share in this cost when it was arguably incurred by a UK government?

The answer has nothing to do with arguments about who spent what, whether money was spent badly or well, or indeed where it was all spent. It has to do with who has loaned the money to the UK government. These are, in the main, banks, pension funds and foreign governments.

They have done so because UK government bonds have proved themselves to be safe investments. Because they are safe, they provide low rates of return – just over 3 per cent in the case of ten-year UK government bonds.

Investors buying these have almost a 100 per cent guarantee that they will get 3 per cent interest per year and all their money back after ten years.

These investors are, however, likely to be a bit concerned at the prospect of the UK government going out of business and two new governments coming into being – one for Scotland and the other for the rest of the UK (rUK). They will want to know whether they will continue to get their 3 per cent return and all their money back.

If there is any doubt about that, then the cost of new borrowing will soar, just as it has done with Greek government bonds, which now pay about 16 per cent on ten-year bonds. Dividing up the UK national debt and allocating clear responsibility for which government will pay what is, therefore, a vital question to be answered.

Moreover, it directly affects us. Any doubts about the repayment of UK national debt at the point of separation will cause the value of pension pots held by, for example, Standard Life, or the stocks of capital held by, for example, Royal Bank of Scotland, to plunge. It is not an esoteric matter. It has real importance for our own personal finances.

If you accept this conclusion – and I think it is inescapable – then it leads to the answer to the next question: what share of the UK national debt would Scotland take? Calculations made by the Institute of Economic Affairs, highlighted in The Scotsman yesterday, that a division should be based on the share of public spending Scotland receives are, frankly, nonsense.

Going down the route of trying to balance that, as was suggested by Professor David Bell, by calculating how much in oil revenues Scotland has contributed to the UK is an interesting idea, but a diversion.

Remembering that it is the investors in, or owners of, UK government debt who have to be satisfied, then the only division which will satisfy them is one that ensures the interest and the capital gets paid. Those payments come from only one place: a government's tax revenues.

This also means that the Scottish Government's hopes that Scotland's share of the UK population might be the defining factor used in a division of the UK government's debt are unlikely to be fulfilled. Just as when you are trying to get a mortgage, the lender is much less interested in how many people will be living in the house and more concerned about how much they will be earning, UK debt holders will also be acutely interested in the earnings capacity of the post-independence Scottish and rUK governments.

It points to a division which will be made on one of two criteria – Scotland's share of UK tax revenues, or Scotland's share of UK GDP, which measures wealth-creating capacity. Here, there is a complication. An independent Scotland aspires to control most of North Sea tax revenues. So you have to add in either offshore oil revenues to the tax share calculations, or offshore GDP to equivalent GDP sums. And there you have to negotiate the division of North Sea assets before you can come up with an answer to debt division.

This is a controversial question. Research I did some years ago on international law led me to conclude that Scotland's share of the North Sea would be based on a line running out from Berwick-upon-Tweed slightly northwards of due east.

This would, very roughly, give Scotland about 90 per cent of North Sea GDP and tax revenues. Fluctuations in oil and gas prices mean this does vary, from 84 per cent to 95 per cent in recent years, another complication which would have to be taken into account.

But assuming an average of 90 per cent, and doing some (very) rough calculations, this pushes Scotland's share of both UK tax revenues and GDP up to about 11 per cent.

This produces some very scary sums. For example, if Scotland became independent in 2015-16, it would start life with a national debt of about 160 billion which, given that 90 per cent of the North Sea would be part of the Scottish economy, would be about 100 per cent of Scottish GDP.

These are very rough, ballpark, figures. Politics will play a part (but only within the constraints set by UK government debt holders) in the negotiations. Here there is an interesting historical precedent.

When the UK last broke up – in 1922 with the creation of the Irish Republic – Irish negotiators accepted they would shoulder part of the UK debt. But the British government never enforced it, mainly because it was persuaded by one Winston Churchill that to do so would impoverish Ireland.

Churchill argued that Britain needed Ireland to be solvent because it was then one of Britain's most important export markets.

Whether Chancellor George Osborne will follow his illustrious Conservative predecessor remains to be seen, but I think it is a little unlikely, given how much Alex Salmond argues that Scotland will be richer with independence.