Peter Jones: A hard Spanish lesson for Scotland

FINANCIAL crisis can push devolution into reverse gear, and even lead to a return to centralised control, writes Peter Jones

Spain’s troubles just keep on multiplying. Bankia, its third largest bank, has just been effectively nationalised, and the cost of new government debt, for benchmark 10-year bonds, yesterday nudged up to 6.8 per cent, a record high for Spain. While it is, all too obviously, yet another drama in the apparently unending Eurozone crisis, there are serious lessons for Scotland and the Scottish constitutional debate, including the fact that financial crises can push devolution into reverse gear.

The roots of Spain’s problems are quite different from those of Greece. Like Ireland, Spain took advantage of the low interest rates available inside the euro to splurge heavily on property construction. Once the world-wide recession hit, Spain’s government had to cut spending and raise taxes more sharply than other countries because tax revenues from property dried up.

Now, even though the Spanish are generally pretty zealous about meeting their mortgage payments, the default rates on property loans are rising, hitting bank balance sheets. Banks are also being damaged by depositors taking their money out, fearing that this is the start of a slide which will lead to Spain being not far behind Greece in the queue to exit the euro.

For us in Scotland, the interesting thing about Spain is that much of its governing structure has echoes of European political architecture while also offering models of devolved financial mechanisms that Scots may or may not want to emulate. This has been noticed by backers of devo plus – that the Scottish Government should control enough taxes, including corporation and income tax, to raise pretty much all that it spends.

Experience in Spain just now bolsters the argument for devolved structures having a reasonable degree of financial autonomy. Spain has three layers of government – the central state, then 17 regions or autonomous communities, and finally 57 provinces or municipalities. The central government controls about 30 per cent of public spending, the regions about 50 per cent, and the municipalities about 20 per cent.

Regional tax powers vary widely. Most regions have very little, getting most of their revenue from assigned shares of income tax, VAT and some other taxes. There is also an equalisation fund designed to ensure that public services are equally provided throughout Spain; rich regions pay in and poor ones get money out.

Two regions have high fiscal autonomy. The Basque Country and Navarre collect nearly all taxes raised in their territories, have the power to vary some of them, including corporation tax, and send a sum of money to Madrid to pay for some centrally provided services such as defence.

The financial crisis, then recession, and now the sovereign debt crisis have put a huge amount of strain on this system, and particularly on the regional governments. The Valencia region, home to about five million people, is one of the worst hit. I recall visiting it during the good times, as Valencia city was staging the Americas Cup, and thinking it had come a long way in a very fast time. The city had built an impressive underground rail system, connected directly to the airport. It had diverted the main river through the city, creating a vast area of central green space in one part of which it had built an extraordinary opera house looking like an egg on stilts.

Much was built using borrowed money, and now the debt is a millstone around Valencian necks. It amounts to about €20 billion (£16bn). It also owes about €4 billion to street cleaning companies and health care providers. And its credit rating has sunk to junk status, meaning it cannot afford to borrow any more.

The borrowing was done on the explicit assumption that the investment made would boost tax revenues through Valencia’s assigned shares of central taxes and on the implicit assumptions that the good times would carry on rolling and the central state was the ultimate guarantor of Valencian debt. This last assumption (which echoes the wider eurozone problem) seems to be valid, but it carries a price now being exacted by Madrid. Since the central government cannot afford to let Valencia go bust, it is threatening to take it over.

In January, the conservative Spanish prime minister Mariano Rajoy, extended credit to the most hard-pressed regions so they could pay suppliers, but legislated to produce mandatory deficit reduction targets for the regional governments. Failure to meet these targets will mean Madrid taking control of regional budgets and imposing penalties.

Not surprisingly, this move, reversing several decades of advancing devolution, is greatly resented in some regions, particularly Catalonia and the Basque Country where there are nationalist parties in regional power. But in other regions, including Valencia (where conservatives are in power), they seem to be welcomed as a curb on the excesses of regional elites viewed as corrupt.

The Catalan president, Arturo Mas, a nationalist, has been railing against Madrid’s moves. He points out that his government, since taking power 18 months ago, has cut spending by 10 per cent and aims to reduce its deficit from 4.2 per cent of spending in 2010 to 1.3 per cent in 2012, within the Madrid targets.

Yet the markets are unimpressed. They side with Mr Rajoy’s assault on regional autonomy. Here is a sample view, issued recently by our very own Alliance Trust, an investment firm based in Dundee. It said: “One of the main problems facing the Spanish government is the over-spending by the autonomous regions, which control a large share of overall spending, in particular that related to both health and education.

“It will be almost impossible to bring spending fully under control, to the extent required by the latest [Spanish government] austerity package, without the support of the regional governments.”

How this plays out will have a profound effect on Spanish politics and perhaps a knock-on effect on Scotland’s debate. One conclusion, from the Basque and Navarre examples, which will be the subject of a later column, is that devolution of power to borrow money must be accompanied by devolution to raise taxes.

The other conclusion is that those people who think that devolution is a slippery slope leading inevitably to independence (who range from the former Labour MP Tam Dalyell to, more recently, Tory peer Lord Fraser of Carmyllie) are wrong. Devolution, if the structures and powers are badly designed, can go into reverse, especially in a crisis, and be replaced by centralisation.