Getting wise to ways of money

Whatever economic and financial arrangements emerge for an increasingly devolved, or independent, Scotland, the Scottish Government needs radically to enhance its capability to manage policy and practice on revenue-raising and borrowing as well as on expenditure, setting them within a well-articulated and defined economic and financial framework. The task is urgent; despite starting before the 2007 election, progress has been painfully slow; it is now needed to support the greater responsibility that is a precondition of greater independence. It may be some time before Scotland has greater powers; but it takes time to build the right institutions.

The passage of the Scotland Bill through the UK Parliament increases this urgency by providing for increased devolution of taxation and borrowing powers. UK funding of public expenditure in Scotland would be reduced in order to transfer more responsibility for financial management to Scotland, for making decisions involving taxation as well as expenditure. An enhanced capability is also urgently required for analysis of Scottish proposals, such as the current one on Corporation Tax.

There have always been, and always will be, Scottish decisions on revenue as well as expenditure, including decisions to forgo potential sources of revenue. Council tax has been frozen for several years: tolls over the Forth have been abolished: university fees have been abolished except for students from other parts of the UK and outside the EU. Such changes should not be made in isolation; all proper budgets have two sides, revenue and expenditure; all balance sheets have assets and liabilities.

Expenditure, revenue and borrowing decisions must all be framed in the wider context of the Scottish economic situation – how much to raise and spend overall, how to allocate funds, and how to make choices relating to taxation. Early action is also needed to deal properly with the fiscal crunch facing Scotland, albeit postponed for one year by the decision to defer spending cuts because of Scotland’s special circumstances. So far the main actions have been to freeze public sector pay and cut off lending to Scottish Water. Neither is sustainable beyond the short term; aspirations for greater efficiency in public services remain to be delivered.

To look widely and deeply across the whole board, Scotland needs an effective treasury (or ministry of finance & economics) function, designed to identify what the country can afford and how it can manage its affairs over the coming years – looking at its economics and at its consolidated public finances. Scotland cannot continue to rely on the UK Treasury and on non-governmental bodies in Scotland – valuable though they are.

Building a treasury function involves political judgements and economic analysis– involving micro as well as macro-economic analysis. These issues are not straightforward.

Achieving evidence-based policies involves an interaction between political aspirations and economic realities. At the technical level this involves: the right mix between macro-economic and public finance issues: identification of the context of the analyses, i.e. of wider considerations such as confidence in governments and markets: the relationship between economics and accountancy; the collection and analysis of data: recognition of sudden extreme events: and understanding of interactions between economics and political events. Handling all these variables requires sound judgement as well as analytic skills. The necessary skills cannot just be learned from a cook-book; they require practical experience. Getting them right creates confidence; getting them wrong destroys it.

Micro-economic issues are often critical. Spending money is not all that matters – digging holes and filling them in again is of little value; think of the Edinburgh tram project. Wasteful projects, especially big capital ones, are a wicked waste of valuable resources – requiring financing without yielding benefits. Ensuring good project appraisal has always been a key Treasury function. In Scotland that should include a central group of micro-economists looking sceptically at specific proposals emerging from spending departments.

Looking hard at all the options, not just the ones favoured by individual cabinet secretaries, before making decisions is crucial to good policy. For example, decisions should not be taken on the regulation of public enterprises, such as Scottish Water, without looking at the wider aspects of all the options (as I argued in The Scotsman last month). An important development in Whitehall in recent years has been the requirement to undertake a regulatory impact analysis for all new policies – before they are adopted. This has been a valuable discipline; experience also shows that publication of such analyses is a necessary spur to sufficiently wide and tough analysis.

This work should not be pursued behind closed doors; accountability requires transparency. Parliament should have a role in this. It already has the benefit of the excellent work of Audit Scotland. Audit Scotland concentrates on results; parliament also needs to look at prospects, so that it can integrate forward planning and achieved results. The Treasury select committee in the UK Parliament has shown how this can be approached.

This should not require massive resources; it’s the people that matter. Frameworks for looking at receipts (including potential receipts) alongside expenditure and borrowing can be adopted from elsewhere and peopled with Scottish data. Economic forecasts can be provided by the UK Office of Budget responsibility; the skill lies in knowing how to use them. Household and business data sets can be taken from existing material. Their use can show the consequences of expenditure and taxation on businesses of different sizes and sectors of the Scottish economy and on families and individuals in different circumstances with different incomes. Some of this work has been done; much remains to be done. For example, good use of increased borrowing powers for Scotland, albeit within the UK total – or within any other currency block, such as the Eurozone – requires good analysis of how the money would be used as well as how it could be raised, and at what price.

Proper account must be taken of the prospects for inflation. The Bank of England and the Monetary Policy Committee have responsibilities to devolved parts of the UK. Competition policy has an EU as well as a UK dimension. Where key economic and fiscal decisions are taken in London, Scotland needs the capability to influence them in an effective practical way. As the Scottish and UK economies interact and, indeed, overlap, Scotland can use many of the formats used in the UK. Increasingly thought will need to be given to how policies in the EU impinge on Scotland and providing Scotland with the capability to influence such policies. There is also an important role here for the Scottish Parliament.

Much of the running so far has been made by non-governmental groups, such as Calman, the Independent Budget Review (Crawford Beveridge) and the David Hume Institute essays on Scottish public finance and on higher education. Non-governmental bodies enrich the knowledge base for evidence-based policy. They keep government on its toes but cannot substitute for a capability at the heart of government. Without such a capability, the political arm of executive government and the power of the parliament cannot be fully realised.

There is no resting point in this quest. We need to think of adapting to and managing a dynamic process within the EU as well as within the UK – taking account of wider developments in the world economy. Scotland needs a way forward that can be adapted as circumstances and challenges change. More independence must mean more responsibility backed by greater ability to use independence in a positive and practical way.

l Sir Ian Byatt is chairman of trustees of the David Hume Institute. He was deputy chief economic adviser at HM Treasury from 1978 to 1989 and head of the Treasury’s Public Sector Economic Unit from 1972 to 1978.