Scotland’s Future: Power to control the future

THE key question on the economy is whether Scotland’s interests are best served within the UK, or would it perform better as an independent country, write Peter McGregor and Kim Swales

Over the past ten years the growth performance of Scotland closely mirrors that of the UK as a whole. Also, Scotland has performed slightly better than a set of comparator small countries used by the present Scottish Government as a benchmark.

Over a longer time period, Scotland’s growth against the UK is somewhat slower. However, its present GDP per head is very close to the UK average. The major fundamental spatial economic problem for the UK is the polarised regional economic performance that has been sustained over many decades.

For Scotland, the key economic issue might be framed in the following way. Are Scotland’s economic interests well served within the spatially polarised UK economy, whose general growth performance it typically tracks? Or would it perform better as an independent country? Of course, rejecting independence does not imply accepting the status quo. Greater degrees of devolution are possible, and will be delivered once the Scotland Act (2012) comes into force.

If Scotland were independent, it would be able to administer, control and plan its own economic policies. At present, Scottish Governments have control over a block grant, a fixed budget, from Westminster. Under full independence, a Scottish Government would also control other elements of public expenditure at present reserved to Westminster – in particular, the welfare budget, which makes up about a third of public expenditure in Scotland.

However, most of the expenditure relevant for economic development is already devolved to the Scottish Government. Moreover, there is no ring-fencing. The Scottish Government can impose its own preferences or criteria in spending this budget. It can choose the priority it wishes to give to growth and the most appropriate ways of using the expenditure to increase growth. The budget is not excessively restricted: public expenditure per head is significantly above that in the UK as a whole. Further, as a result of the 1997 referendum vote, the Scottish Government has additional tax-raising powers and these have been extended in the Scotland Act (2012).

Many of the areas of responsibility that are important for growth have been devolved to the Scottish Government: that is to say, policy on human capital formation, such as education, skills and health. Policies on transport and industrial development are similarly devolved. Further, the Scottish Government has a co-ordinated decision-making process, aided by its own set of civil servants. Such co-ordination has been an aspect of policy making in Scotland even before devolution, with government activity planned through the Scottish Office and industrial development stimulated through the Scottish Development Agency and the Highlands and Islands Development Board. Devolution has strengthened this.

There are areas, at present controlled by Westminster, where the Scottish Government would have control over policies which could affect growth. The most straightforward is the welfare budget. Successive UK governments have attempted to change the administration of the welfare budget to encourage participation in the labour force and therefore increase GDP. It is not clear that Scotland’s population has specific characteristics in this regard which would benefit from different rules. Further, the Scottish participation rate – those who work – is above the UK average at the moment. Of course, having the welfare budget funded from Scottish taxation potentially reduces the power of automatic stabilisers in the Scottish economy which would have detrimental growth implications.

One major difference if Scotland were to become an independent nation, rather than simply a devolved region of the UK, is that a more substantial administrative border would be introduced between Scotland and the rest of the UK (rUK). What was previously a transaction between two parts of the same country would now be a transaction between different countries. At present, exports from Scotland to rUK make up 17 per cent of all output in Scotland. Using the conventional approach of tracking the expenditure impact of the purchases of intermediate inputs and labour needed in production, exports to rUK are estimated to support just under 30 per cent of production in Scotland.

It is difficult to know what role the introduction of a more substantial border between Scotland and rUK would imply for trade. It seems inconceivable that any government of an independent Scotland would not wish to encourage trade with rUK. However, the possible impact of reduced trade with rUK is a source of concern and uncertainty that would accompany full independence.

An example would be in the electricity supply industry. At present Scotland exports electricity to rUK. However, it is likely that, while rUK will want to trade electricity with Scotland, for security of supply reasons it is likely to wish to be less reliant on Scottish imports than where Scotland is part of the UK.

Similarly, much inter-regional trade is between branches owned by the same firm. In so far as an independent Scotland develops a set of formal and informal institutional arrangements that differ from rUK, the degree of cross-border branch operations are likely to fall. With this, Scottish exports will fall.

One policy which is central to the growth debate in Scotland is migration. Immigration does not seem to be the toxic issue in Scotland that it appears to be in England and a benefit of independence would be the ability to operate a more liberal immigration policy. However, the implementation of a different policy to that operated by rUK would require the strengthening of the Border.

Economic growth is dependent on a set of stable macro-economic conditions and the implementation of a set of appropriate supply side policies. There appears to be a consensus at present that an independent Scotland would be tied closely to the monetary and fiscal policies of rUK.

On the supply side it could be that there is some psychological “independence” stimulus. Independence might influence the behaviour of politicians and the perceptions of voters and workers in ways that do encourage growth. However, within the devolved framework that already exists, and will be strengthened after the full introduction of the Scotland Act (2012), many of the policy levers are already in the hands of the Scottish Government. It is important to stress that Scotland has much greater supply-side powers than English regions and that Scotland can already undertake a co-ordinated growth strategy with appropriately targeted public expenditures and administrative structures.

From a growth perspective, an important potential advantage of independence is that this would give the Scottish Government a greater ability to use tax rates to act as signals and incentives to greater efficiency. This is only an important power if the appropriate rates required to stimulate growth in Scotland differ from those set by the UK government. One reason why these optimal rates might differ, and where the UK government will resist spatial variation in tax rates within a devolved setting, is where there is likely to be tax competition.

Corporation tax is one such tax. Again, from the point of view of stimulating growth, a significant risk is the impact of a national border on trade between Scotland and rUK. At present, Scottish exports to rUK make up a large share of the total sales of Scottish goods and services. There is a risk that introducing a border will reduce this trade, and this would impact much more seriously on the Scottish economy than on the economy of the rest of the UK. There are issues here simply of the demand-side effects, but, perhaps more seriously in the longer term, the impact of reduced competition and variety in the Scottish economy.

• Professor Peter McGregor is head of the Economics Department, University of Strathclyde. Professor Kim Swales is director of the Fraser of Allander Institute, Department of Economics, University of Strathclyde. This article is an extract from Scotland’s Future: the economics of constitutional change, a new economic commentary on constitutional options facing Scotland, edited by Profession Andrew Goudie, of the University of Strathclyde. Readers of The Scotsman can buy Scotland’s Futures for the special discount price of £13 at www.dundee.ac.uk/dup. The code is SCOT1.