Gavin McCrone: Scots need answers to economic questions

Before Scots can make an informed decision on independence, they need answers to some serious economic questions, writes Gavin McCrone

When countries split to form independent states, this is most commonly because of differences in culture or serious grievances about the way they have been treated. In Scotland, however, the case is argued largely on economic grounds. The Scottish Government claims that it needs control of the levers of economic policy to improve economic performance and that the levers it already has, or those it would have with further devolution within the United Kingdom, are inadequate for this purpose. But what additional levers does it want? Until the Scottish Government can set out just how it would hope to improve Scotland’s economic performance and what powers it needs that it does not at present have, the case will seem to many people to be unconvincing.

The recently enacted Scotland Act confers substantial additional powers and many people probably do not yet realise the extent to which the Scottish Government’s responsibilities have been increased. The act will make the Scottish Government responsible for raising approximately half of income tax, for all of stamp duty, land tax and landfill tax. It is also free to introduce new taxes should it wish to do so. It is rumoured that the Treasury would be prepared to consider handing over the responsibility for all of income tax, if it is decided to increase further the devolved powers of the Scottish Parliament. As the Calman Report pointed out, however, that would leave Scotland heavily dependent on one tax. It would also be possible to assign the proceeds of VAT in Scotland, although under EU rules the rate could not be altered so long as Scotland remained part of the UK. These taxes, together with business rates and council tax, would cover some 66 per cent of the expenditure for which the Scottish Parliament is at present responsible.

With independence Scotland would, of course, have to raise all of its own tax revenue, just as it would be responsible for all of its public expenditure. But there would still be constraints. If personal taxation was different from the rest of the UK, there would be a risk that people would vote with their feet, though I suspect that the difference would have to be really significant, certainly larger than differences in council tax, for this to become an issue. Differences in VAT or in excise duties could encourage trading across the Border, as happens now with alcohol between Britain and continental countries.

What the Scottish Government has indicated it would like to do is to follow the Irish example, of very low corporation tax to encourage industrial investment. But that would raise problems both with the European Union and with the rest of the UK. Several other EU countries have taken issue with Ireland’s low rate of corporation tax, notably at the time of the Irish financial bail-out, arguing that it was unacceptably distorting. While Ireland has so far managed to resist this pressure, it is unlikely that a newly-independent Scotland seeking to establish itself within the EU would be able to do so. The rest of the UK might also feel compelled to retaliate, if Scotland’s low rate of corporation tax was designed to attract business that might otherwise go to English regions or to Wales, where economic conditions as measured by gross value added per head are a good deal worse than in Scotland.

The Scottish Government has said it would be its intention to keep sterling as the national currency following independence, so the monetary union would continue. But this leaves a host of important questions unanswered. Would the Scottish Government sell its own bonds on the market and if so, what interest rate might they have to pay? How much influence would the Scottish Government have on the Bank of England’s monetary policy? On what conditions would the Bank of England be prepared to continue as lender of last resort for Scotland or would there be a Scottish central bank to take that role? Would Scotland continue to use Bank of England notes or would there be a separate Scottish pound, exchangeable at par with Bank of England notes?

Here the experience of Ireland is interesting, although, of course, the circumstances of Scotland and the then Irish Free State in 1922 are very different. When it became independent, Ireland retained sterling as its currency and conditions were much as they are in Scotland now: Bank of England notes continued to circulate and the Irish banks issued notes of their own backed by deposits at the Bank of England. It introduced its own currency notes only in the late 1930s, but these were exchangeable at par with Bank of England notes. Ireland did not have a central bank until 1943 and, in the absence of a formal agreement with the Bank of England, was without a lender of last resort for some 21 years. Mercifully this need did not arise, as no Irish banks got into trouble during this time and successive governments operated extremely conservative fiscal policies. But, with much greater speculative activity now a feature of financial markets, it is hard to see an independent Scotland getting away with that. Nor, one imagines, would an independent Scotland trying to stimulate its economy and wanting to use fiscal levers for this purpose be content with an extremely conservative fiscal policy. But with a deficit of 7.4 per cent of GDP in 2010-11 (even including a geographical share of North Sea revenues) there would not be scope for an expansionary fiscal policy.

What is clear is that if an independent Scotland wished to continue to use sterling, there would have to be negotiations with the rest of the UK. If the Scottish Government wanted to borrow using common sterling bonds, like the eurobonds proposed but not yet implemented for the EU, that would imply that they were guaranteed by both the UK and Scottish governments. For this to be acceptable, the rest of the UK would have to be satisfied on the sustainability of Scottish fiscal policy, just as eurozone countries now see the need for fiscal union to support its monetary union. If on the other hand Scotland decided to issue its own bonds to cover any necessary borrowing, these might require a higher interest rate than for the rest of the UK until the market was satisfied, as a result of experience, that they were equally safe and fully backed by a lender of last resort.

If the Scottish Government wanted the Bank of England to continue as lender of last resort, it is most unlikely that this would be acceptable either to the Bank or to the government of the rest of the UK, unless it had oversight of Scottish fiscal policy and the right to withdraw from that role if it was not satisfied. If Scotland had its own central bank, as Ireland has since 1943, for it to be a credible lender of last resort to both the Scottish Government and financial institutions, it would have to be able issue currency, as the Bank of England has been doing in the present financial crisis. That implies a separate Scottish currency and, while that currency could be pegged to sterling, there would always be the possibility that its exchange rate could be altered either up or down.

So there is much that would need to be decided. If Scotland were to go down this route, my own view is that it would probably be best to have a separate central bank and a Scottish pound, which could be pegged to sterling or indeed the euro, depending on circumstances. But even so the Scottish Government still needs to explain how it would use the additional levers it would have to achieve a better performance from the economy.

• Gavin McCrone was formerly the chief economist at the Scottish Office.