John McLaren: Do the figures add up for Scottish independence?

WHETHER Scots will be better off with independence or by staying in the UK comes down to fiscal balancing act, writes John

After this week’s launch of the referendum campaign, the electorate are entitled to feel somewhat confused as to the potential impact of independence on economic concerns.

The claims that were made on Monday ranged from Scotland’s citizens each being £1,200 a year better off than the UK as a whole, within the Union, to each Scot being £500 better off under independence. In both cases, these advantages are not in terms of individuals’ incomes being higher or lower, but in terms of what is spent on them through public services: schools, hospitals etc.

The first of the figures, the £1,200 Union advantage, refers to 2009-10 and is in relation to the public expenditure side of the fiscal balance only (where the fiscal balance is the difference between government revenues and spending). As such, it ignores whether or not this extra spending on public services could be funded by equally high Scottish revenues. It is not talking about the relative fiscal balance position, but rather it indicates Scotland’s relative public spending position versus the UK as a whole.

The second figure, the £500 independence advantage, relates to the latest relative fiscal balance figure for 2010-11, as shown in the Scottish Government’s publication Government Expenditure and Revenues in Scotland (GERS). This shows Scotland (including its geographic share of North Sea oil revenues) to have a smaller deficit than the UK by the equivalent of £2.7 billion, due to relatively buoyant North Sea oil revenues.

This is equivalent to an extra £500 per person, which could be spent on additional Scottish public services or, more likely, on reducing the inherited level of borrowing (ie, the relatively higher level of taxation receipts in Scotland would be used to bring expenditure and revenues more into line, rather than to fund extra services).

Analysing the competing claims, it is fair to say that the £1,200-per-head Scottish public spending advantage is true, but this is only a problem, post-independence, if revenues cannot be found to pay for it. At present, as with the UK, these funds are not available, hence the deficit, but the £500 per head fiscal balance advantage suggests that Scotland would be nearer to balance than is the case in the UK. However, this £500 per head advantage is just a one-year snapshot, and as North Sea oil revenues vary substantially, so, too, will any such fiscal-balance advantage or disadvantage.

Looking forward from the latest GERS figures, estimates by the Centre for Public Policy for Regions, using projections made by the independent Office of Budget Responsibility, show that Scottish North Sea oil revenues will be more than £10 billion in 2011-12, but will then fall to £5.5bn by 2015-16. This means that the Scottish relative fiscal position advantage should increase in 2011-12 over 2010-11, but by 2015-16 the UK will be in a relatively better position (see table above).

For simplicity’s sake, these issues have been discussed above largely in relative terms, and as if the UK was in fiscal balance. However, it is important to remember that both countries have large fiscal deficits at present and, over time, need to move government revenues and expenditure more into balance.

The bottom line is that Scotland has a relatively higher spend per head on public services than for the UK and that, post-independence, this could be afforded – but only so long as North Sea oil revenues remain strong.

Unfortunately, the future level of North Sea oil revenues is – and will remain – unclear, as they depend on world demand, Middle East politics, environmental factors, the future price of alternatives (shale and renewables, for example), taxation levels and a variety of other factors.

Uncertainty over annual North Sea oil revenues brings into play another important issue that is worthy of greater discussion and clarity; that is, whether an oil fund should be established. Such a fund would spread the benefits of North Sea oil over time, and also temper the likely fluctuations in such revenues, thereby acting as a statement of intent, both in terms of intergenerational equity and in terms of fiscal prudence.

An oil fund has advantages and disadvantages associated with it. In the short-to-medium term, it has the drawback that there would be a loss of some revenues and so a difficult transition phase in order to accommodate this loss of revenue. In the longer term, the fiscal position should improve as the interest earned from the growing fund becomes available to spend; however, it would take a very long time, if ever, for any such interest benefit to equal the size of the money being annually saved. Rather, the main benefit is that this money could be spread over a longer time period.

Monday’s launch also saw further discussion of the claim that, under independence, Scotland would become the sixth most prosperous country in the world, in terms of gross domestic product per person. This implies a considerable increase in the average Scottish household income, as opposed to the relative shifts in spending on public services discussed above.

Such an out-turn, if true, would be a significant factor in the referendum debate. However, no-one who makes the claim has so far explained how such a transformation in Scottish household incomes would come about. What is the mechanism that would make Scots so much richer post-independence? The answer is that there isn’t one, as the figure is an irrelevance brought about by confusion over how much of Scotland’s gross domestic product actually stays in Scotland.

The big post-independence GDP per head boost is brought about by the inheritance of most North Sea activity, but the profits from a substantial chunk of these North Sea operations end up overseas, due to their being, in large part, non-Scottish owned. This significantly reduces their imputed contribution to Scottish prosperity.

The fact that this red herring is still being used as evidence of something important highlights how the debate needs to travel in order to reach more fertile ground.

However, a measure of Scotland’s true prosperity would be useful to have. Gross national product, which adjusts for the international flow of profits, would provide such a measure. Currently there is no GNP estimate available for Scottish, although its development would be a welcome move.

Overall, an important lesson to learn from this analysis is that – as the referendum is a decision on the long-term future of Scotland – it is not very insightful to dwell a single year’s figures. Furthermore, some of the options available, under both independence and some evolution of the status quo, will involve trade-offs rather than pure wins or losses, and this complexity needs to be acknowledged. Interviews with the public suggest that there is a desire for a more informed and nuanced debate than the one we are currently getting.

• John McLaren is an economist with the Centre for Public Policy for Regions