Comment: Currency question key to referendum

'So with next year's referendum it is already clear that the debate will focus on financial issues'. Picture: PA

The focus was on the short-term: stabilising the Scottish currency which had suffered as a result of the ill-fated Darien Scheme; exemption from taxes on paper, windows, coal, and salt which the Scots did not think they could pay. None of the participants could have known where the Union would take Scotland and England, for better or worse, over the next three centuries.

So with next year’s referendum it is already clear that the debate will focus on financial issues. Some are strikingly similar to 1707, though the language is different. We no longer have a Scots pound or charge taxes on windows, but the consequences of the financial crisis on public sector debt has profoundly altered the context of this monumental decision.

It is also unavoidable that opinion will be influenced by the world beyond these shores. Events in the Eurozone remind us that fiscal and currency instability and depression-like conditions are not peculiarities. Greece, Spain and Ireland are perhaps the most extreme cases, but economic malaise has spread more generally across Europe. Farther afield, Japan – which has its own currency – is still struggling to escape stagnation two decades after its financial crisis.

Statements from both the Westminster and Holyrood governments in the past two weeks signal that the phoney war is over. The Treasury’s analysis of financial services and banking in Scotland implying that the risks in an independent Scotland would be greater than in Ireland or Iceland may be an exaggeration. However, it is also an admission that the new UK framework for prudential policy cannot rule out the fiscal consequences of future crises.

The heart of the problem is the same as three centuries ago. How is it possible to ensure the stability of a currency union between two sovereign states? Experience shows that one country in a currency union does not have the power to force another to change its budget, even though the costs of budgetary irresponsibility may fall across borders. Europe is littered with examples of how treaties designed to deliver fiscal responsibility have been wilfully ignored by national governments. Without being able to post collateral in advance to the other country, there is simply no credible enforcement mechanism.

There is no better example than the tensions between northern Europe, especially Germany, and some countries in southern Europe. From the perspective of a German taxpayer, they are potentially on the hook for the consequences of the fiscal irresponsibility of Greece, Spain and Italy, as imbalances between countries pile up on the books of central banks. Of course, from the latter’s perspective, these imbalances are simply the counterpart of Germany’s determination to run large current account surpluses. Whatever the rights and wrongs, the currency union has proved unstable and led to enormous indirect fiscal and financial exposures that the system was supposed to prevent.

To the Scots, the Act of Union provided access to the English pound. The price extracted was full political and, therefore, fiscal union – Scotland lost its tax powers. The current Chancellor’s doubts that a currency union with an independent Scotland would be in the interests of the rest of the UK must be rooted in the perceived difficulties of cross-border enforcement. Certainly, the suggestion that an independent Scotland may not accept a fair share of UK public debt is not credible. Too many contracts in sterling require the co-operation of the Westminster government.

As a consequence, commentators and politicians are looking again at the possibility of a new or old Scottish currency. Although favourable comparisons can be drawn with successful European own-currency economies with similar populations, conditions are not the same. An independent Scotland is likely to start with more public debt and liabilities as a consequence of this financial crisis and the malaise which followed. Small countries with hard currencies generally have low debt and a record of fiscal prudence. Scotland would have to establish such a record, which may not be quick or easy.

At the referendum, Scottish voters may be more or less willing to take risks. But such are the vagaries of history and it remains to be seen whether it indeed repeats – or reverses – itself. «

• Prof David Bell, University of Stirling, and Dr Angus Armstrong, National Institute of Economic and Social Research, speak at The Economics of Independence on Tuesday 4 June: www.scotsmanconferences.com