Alf Young: Fiscal discipline key to new Scotland

Inch by inch, day by day, we are getting to the nitty-gritty of that big decision we all have to make in the autumn of 2014. I had feared that fierce arguments about the means by which that choice would be made would dominate the next 30-odd months. But already we are into the meat of the issue. What independence might look like. What key ends it would pursue.

In his foreword to the Scottish Government’s consultation paper on the referendum, Alex Salmond makes it clear this is not a liberation struggle. In various interventions this week, John Swinney has repeatedly said the SNP’s core case for independence is having the power to deliver higher sustainable growth in our economy and greater material prosperity for Scotland’s people.

We currently measure such things in pounds and pence. Scotland’s finance secretary has now said that is how it will remain for as far ahead as any of us can see. Through both the short and the medium term. Well into the 2020s certainly. But, for me, the really striking thing in his Scotsman interview this week was the reasoning he offered for kicking the prospect of an independent Scotland joining the euro into the far yonder.

He and his party want nothing to do with the moves towards tighter fiscal integration within the existing eurozone. Mr Swinney doesn’t think fiscal union in Europe is either achievable or desirable. Countries, he tells us, should have the flexibility “to run themselves as they see fit”. Of course national economies should exercise “fiscal discipline”. But that is their individual responsibility. Collective pacts or treaties on fiscal conformity simply don’t work.

Given their current plight, were the 17 existing members of the eurozone to follow that advice, it is arguable there won’t even be a euro for Scotland to join in 2025 or whenever. However, if it’s to be sterling for the foreseeable future, the SNP’s stated position on fiscal discipline, as far as the euro is concerned, raises huge and as-yet unanswered questions about how it is going to negotiate an independent Scotland’s continued participation in a new sterling zone, including the Bank of England continuing its role as lender of last resort to an independent Scotland.

Mr Swinney says there will be “dialogue” with the Bank of England, but no negotiations with the government of the rest of the UK, over these plans. That view seems to be driven by a nationalist conviction that sterling and the Bank of England as a central bank are collective assets of the existing United Kingdom that both parties to the Treaty of 1707 will have a say over in any break-up.

There are other assets and liabilities of that union that the SNP wants nothing to do with. The Trident bases on the Clyde are an obvious example. But the First Minister has even suggested an independent Scotland would want nothing to do with the liabilities of the two big commercial banks, RBS and Lloyds, currently part-owned by the UK taxpayer, some of their exposure underwritten by that same Bank of England.

If Mr Salmond means what he says about their liabilities, one must presume he doesn’t want an independent Scotland to have a share of any return when they are finally returned to the private sector. As I pointed out in this space on 14 January, these two banks, incorporating Scotland’s 300-year-old twins, Royal and Bank of Scotland, could end up, post-independence, as rest-of-the-UK institutions with no more than branches here.

There are other assets, notably North Sea oil, where an independent Scotland would claim a geographic lion’s share. But, in the event of a yes vote, it is within this context of protracted horse-trading that the precise nature of Scotland’s continued participation in sterling and our access to the Bank of England would have to be thrashed out.

In Mr Swinney’s proposed dialogue with Threadneedle Street, the pitch would presumably be some solemn and binding gentleman’s agreement that an independent Scotland would pursue fiscal discipline while trying to use all the economic levers independence brings to achieve a consistently higher trend rate of growth than the rest of the UK. That’s the inexorable logic of his dismissive comments on tighter fiscal union within the eurozone.

But the last thing the Bank of England will want is the prospect of becoming the central bank for all of a fragmenting UK, where one of the constituent nation states wants to use its regained sovereignty to pursue a much more expansionist growth policy than its immediate neighbours, albeit one adorned with promises of continuing fiscal rectitude. Mervyn King must be having a quiet chuckle to himself. He won’t be around when this prospect crystalises, if it ever does.

Of course some argue there are clear precedents for what the SNP is proposing. On these pages yesterday George Kerevan cited the creation of the Irish Free State in 1922, when the Irish pound was pegged to sterling and Dublin banks kept their reserves in London. Of course that newly-independent Ireland remained for many years a pretty impoverished state with few natural resources. It was in no position to destablise sterling.

Scotland is already the most prosperous part of the UK, outwith the south-east of England, with reserves of oil on its doorstep. Its initial ambition is not to be poorer. But to be much richer still. And George’s sketch of the Irish parallel stops well short of the creation of the Central Bank of Ireland in 1943, the punt’s entry to the European Exchange Rate mechanism in the 1970s or, over the following two decades before the adoption of the euro, big swings of up to 25 per cent in the punt’s value against sterling.

He is much more forthcoming than John Swinney on the kind of serious fiscal conservatism that would be required of an independent Scotland without a central bank as lender of last resort if it were not to endure penal interest rates. But George’s prescription for how it could do that while going for growth at the same time is not convincing.

He offers as precedents on this Sweden and Finland in the 1990s. But both had their own currency and their own central bank. There was no euro then, only the ERM. And, of course, Sweden still hasn’t joined the euro. Their circumstances then are quite different from an independent Scotland attempting to stay with sterling, persuade the Bank of England to remain its lender of last resort, all on a promise of continuing fiscal discipline.

If and when the negotiations start for real, the least the rest of the UK will demand, I suspect, will be that the terms of Scotland’s continued participation in a sterling zone will be a binding treaty, with associated fiscal rules, on continued monetary union. And, as John Kay observed this week, that is certainly a possibility. But, as he also noted, “it might cause people to start wondering what the point of independence was in the first place”. One footnote. John is no longer a member of Alex Salmond’s Council of Economic Advisers.

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