Sir Ian Byatt: Debate is central to growth

SCOTLAND needs independent institutions where analytic thinking can flourish and and be throughly discussed to drive forward our economy, writes Sir Ian Byatt.

Economics has narrowed over the years, becoming an increasingly technical, and increasingly intrusive, subject. It was not like that in enlightened society in 18th century Scotland. Adam Smith attacked the whole commercial system of Great Britain, but humanly and pragmatically, in favour of the man of humanity: moderation, accommodation, “fellow feeling”, and respect for other individuals. David Hume emphasised sympathy and scepticism; he was no friend of specific systems and cautious about over-generalisation. The 18th century conversation operated within the classical form of the symposium , as used by Plato and Cicero: the “where” issues were debated rather than asserted in the form of serial monologues.

Recent developments in behavioural economics can help us to recreate necessary elements of this approach. Daniel Kahneman, in Thinking, fast and slow, has developed Hume’s approach to the association of ideas. Hume enunciated three principles of association: resemblance, contiguity in time and space, and causality. Nearly three centuries later, Kahneman has used these principles, backed by empirical research, to develop the notion that we have two systems of thinking, one instinctive and one analytic.

The first system comes out of our everyday experience through the association of ideas; we become very sensitive to what has passed over our desks, triggering learned connections. It is a rapid response system that has served humans well over millennia, perhaps built into our genes. The second system operates more slowly, requiring conceptual thinking and the conscious assembly and analysis of relevant information; this requires data, time, effort and reflection.

Both systems have their strengths and weaknesses. System one operates fast; we are short of time and decisions have to be made. System two requires information, not always available and analysis, often complex. But jumping to conclusions does not always produce the right answers and research has shown that system one is subject to systematic bias, such as over-valuation of losses over gains, reliance on inappropriate evidence and inadequate reflection on the consequences of action.

It is not so much that we need less instinctive thinking, based on experience; it is rather that we need more and better analytic thinking. Where is this to come from? Scotland needs institutions where this thinking can take place and where it can be properly discussed. There are already bodies, especially in Edinburgh, such as the David Hume Institute (DHI), where such debate takes place. But more analysis is needed, at the heart of the Scottish Government, in relation to the work of the Scottish Parliament, and by independent research bodies.

I have consistently argued for the development of a full Treasury function in Scotland, able to undertake both micro- and macro-economic analysis to replace the limited finance function concerned largely with allocating funds received from the UK. Such a body would need to establish its own credibility, in Scotland, in the UK and more widely. It would need to develop its own instincts and to respond quickly to events. It should be challenged, and supported, by Scottish-based bodies on the models of the London-based Institute of Fiscal Studies and the National Institute of Economic and Social Research.

They should be adequately funded to assemble, and sometimes collect, data and to analyse it and present the results in accessible ways. There is plenty to debate. If an independent Scotland stays within the sterling area, it will have little fiscal scope to pursue policies different from those in the rest of the UK. If Scotland is to apply to join the euro, how would it manage under the fiscal constraints likely to be imposed on new members?

If Scotland were to float its own currency and pursue its own fiscal and monetary policies, what new institutions, such as a central bank, would be required; how quickly could they achieve the credibility necessary to cope with the pressures of financial markets?

There are lessons to learn from the experience of Ireland – and these will be presented by the governor of the Irish Central Bank to a DHI seminar in November.

What should be the role of taxation policies in Scotland, both corporate and individual; and how would special Scottish taxes work while maintaining open borders with England? The openness of its labour market has been of great advantage to Scotland. What of social security, where major reforms are taking place in the UK, which may or may not chime in with the objectives of a Scottish Government? What of higher education, where Scotland has a comparative advantage over many countries, but where the current incentives risk reducing access by home-based students? The maintenance of excellence may require greater contributions from students.

What of the financing of infrastructure, where both user charges and investment have been cut and further burdens put on the public sector? Scotland is rightly proud of its thriving industries, whisky, tourism and education; government should provide the open and competitive structures that give them the opportunities for innovation and creativity, harnessing the “gale of creative destruction” that characterises an effective market economy.

Economics is helpful only if we choose the right tool and use it well. DIY economics, arising from people and organisations with axes to grind is dangerous. So are large computer models that are not always pointing in the right direction. The world is always revealing new experiences and providing new information.

Recent experience in Sweden shows that small economies can prosper and weather economic storms, including those in its banking sector, using crises to advantage. In Sweden, a deep fiscal crisis forged a broad consensus on the merits of budget discipline, on well-defined fiscal objectives, on fiscal transparency and on a well-defined process for evaluating the scope for active tax and expenditure decisions. Scotland has these challenges in no short order.

So, instinct or analysis? Both of course. Greater independence involves greater responsibility. Scotland should build on its 18th century history – more political economy analysis that is pragmatic and humane, and takes account of the interests of all the people who will be affected. A characteristic of the Scottish Enlightenment was its focus on the dialogue and the symposium, on scepticism and practicability; on reform where sensible, and on existing practice where working well: no utopias, no paradigms. We have learned that economic life is subject to constant change, to be regarded as a discovery process where analysis involves detective work, including the need constantly to scan the horizon for the emergence of “black swans” and “unknown unknowns”. Incentives are crucial; remembering that they are social and psychological, as well as financial.

So, both instinct and analysis, but, please, a shift to more analysis. This can lay the foundations for a conversation, where the issues are presented and ideas challenged in ways that calm emotions, welcoming new ideas while preserving our scepticism, leading to the emergence of productive and widely acceptable ways ahead for Scotland.

• Sir Ian Byatt is a former chairman of the trustees of the David Hume Institute. He was chairman of the Water Industry Commission for Scotland 2005-11. He is a former Deputy Chief Economic Adviser in the Treasury. This article is based on the David Hume annual lecture he delivered last night