Alex Salmond’s idea of a sterling union is one route for an independent Scotland to go economically but it poses more questions than it provides answers, writes Brian Ashcroft
IT IS good to see George Kerevan bearing up well under fire with his good-humoured article (Scotsman, 3 February) responding to recent criticisms of his views on the Scottish economy post-independence by John McLaren and myself. He concludes that what we “are contesting is not the economics of independence but of the transition to independence – an admittedly complex period. In doing so, they ignore – deliberately? – the policy mix that could transform the Scottish economy permanently”.
Nothing could be further from the truth.
Indeed, as Alf Young notes (Scotsman, 4 February), “already we are into the meat of the issue. What independence might look like. What key ends it would pursue”.
The future of the Scottish economy post-independence depends crucially on the choice of currency, the costs of government borrowing, the stability of oil revenues and other dimensions of the “policy mix”.
The debate so far, including the contributions from outside Scotland by the National Institute for Economic and Social Research and John Kay, a former member of the Scottish Government’s Council of Economic Advisers, has produced, in my view, several clear conclusions.
First, on monetary matters, the view attributed to the Scottish Government that the Bank of England (BoE) would become the central bank for the sterling monetary union as a whole is difficult to defend. A simple but critical point is that, after independence, there would be two jurisdictions but only one currency, if Scotland adopted sterling.
The rest-of-UK (rUK) government would not want rUK to have the current status of France to the European Central Bank because this would effectively mean that both Scotland and rUK would be borrowing in a “foreign” currency while the BoE, as now the central bank for the new Scotland-rUK union, not the rUK, would be issuing the currency. In such circumstances – one central bank but more than one government – the risk of default on borrowing is perceived by the financial markets to be greater and hence the premium on rUK Treasuries would be higher than at present.
Currently, the ultimate guarantor of the BoE is the UK taxpayer. In the event of Scottish independence, it will become the rUK taxpayer alone. So, in monetary matters, Scotland would not be equal to rUK. The BoE would essentially be the rUK’s central bank, one jurisdiction, one bank, but potentially performing some necessary financial and monetary stability functions for the wider sterling union. There would be a common interest rate across the sterling union.
The BoE would, I believe, be likely to act as “lender of last resort” to all banks in the monetary union, including Scottish banks, but would do so at “penal” or above market rates. The Scottish Government would be issuing its own bonds but in sterling. It would effectively be borrowing in a foreign currency and would have no ability to print money. Accordingly, markets are likely to demand a higher yield premium on Scottish bonds than rUK Treasuries and present UK Treasuries.
And then there is Alex Salmond’s view that a British chancellor would be “biting our hands off” for an independent Scotland to keep the pound. Is that fair comment? It is true that the contribution of oil and whisky exports is favourable to the UK balance of payments and to UK tax revenues. Sterling probably trades at a higher rate because of this. However, if, after independence, the UK government was not receiving the tax revenue from the income earned by these exports it might baulk at the penalty paid by UK exports through the loss of competitiveness due to the higher exchange rate. Accordingly, while the UK government might reasonably wish to hang on to the tax revenues, and keep Scotland within the UK political union, without the tax receipts why would it want an overvalued pound?
Turning to fiscal policy, if Scotland was to keep the pound, the BoE and the rUK government would require the Scottish Government to observe an agreed set of fiscal rules which would probably limit the scale of borrowing, the size of the primary budget deficit in relation to Scottish GDP and the level of Scottish Government debt to GDP. The requirement that Scotland adopt certain fiscal rules is the “price” that Scotland would have to pay for the BoE continuing to be lender of last resort to Scottish banks and enjoying the benefits of a stable currency. The BoE and the rUK government would desire Scotland to adhere to the fiscal restrictions. All of that could de-stabilise sterling.
Of course there would be the risk that the Scottish Government might not observe these rules. The risk for an independent Scotland inside sterling is that it would be able to issue its own bonds, like eurozone members, but it would be unable to print or change the exchange value of its currency. Again the result for Scotland would be that its sterling denominated bonds would trade at a premium to present UK Treasuries.
Third, the volatility of oil revenues, given their size in relation to the total budget, would make it difficult for expenditure planning by a post-independence Scottish Government. Kerevan’s imaginative covered bond and oil fund solution (Scotsman, 27 January) would not adequately deal with the revenue volatility issue.
On the positive side, Scotland would be able to run a more independent fiscal policy. Indeed, in an independent Scotland within a sterling union, it would only have fiscal policy. Within the UK’s monetary union, there would be no exchange rate adjustment to mitigate real effects on the economy. Scotland would have to conduct its fiscal policy within the broad fiscal framework set by the BoE and the rUK government.
In the event of domestically generated inflation and deteriorating competitiveness, the Scottish economy, currently, has to rely on ex post policy responses such as Scottish industrial policy and UK regional policy. The Scottish economy also benefits significantly from the risk-pooling arrangement with rest of the UK, which has facilitated bank bail-outs and ensures social security payments flow to the disadvantage and unemployed. There is no separate Scottish fiscal policy to prevent Scottish inflation from taking off, or cyclical unemployment from emerging, although this would become possible in a devo-plus world.
In an independent Scotland, we do not know whether productivity growth and competitiveness would be worse or better than under present arrangements. What we can say is that UK regional policy and risk pooling would not be available to help the Scottish economy adjust and grow. Under independence, Scotland’s ability to adopt radical fiscal policies is likely to be restricted and, in any event, most of the options might be available under devo-plus. The key question is whether such benefits more than outweigh the costs.
In conclusion, the “policy mix” post-independence will require clarity on both monetary arrangements as well as possible fiscal options. There is a need for further debate.
• Brian Ashcroft is Emeritus Professor of Economics at the University of Strathclyde
Join the debate. A Question of Independence: How will the referendum work?, 9th March Edinburgh.