David Simpson: The Currency Case for Yes

Despite the bluster of Westminster, businesses on both sides of the Border will be better served by sharing the pound, writes Professor David Simpson

Businesses would be better of sharing the pound post-independence, David Simpson says. Picture: Phil Wilkinson

Currency and debt have featured heavily in the independence debate and more often than not as though they are difficult issues for the Yes campaign when in many respects the opposite is true. There is no legal obligation on the government of an independent Scotland to accept any liability for UK Government debt. But the current Scottish Government has expressed its willingness to accept voluntarily an equitable share of it on the basis Scotland’s people also receive an equitable share of the assets to which they have contributed. How big should that share be?

The final outcome is negotiable, but I believe that Scottish negotiators should take a hard line. The huge size of the present debt is the result of mismanagement of the public finances by successive UK governments.

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By April 2015 public sector net debt is expected to be some £1,355 billion. It is forecast to reach £1,548bn by 2019. This liability amounts to about £50,000 for every family in the country.

The annual cost of servicing this debt exceeds £50bn. This is the amount that the government has to find every year just to pay the interest, never mind the principal. It is more than the entire annual defence budget.

If Scotland remains within the Union we will share of this burden for decades to come. If we vote for independence there is no reason why the UK Government should get a permanent subsidy from us to help them clear up a mess of its own making.

How did this huge increase in debt come about? The politicians responsible are quick to shift the blame. They say that in 2007 the British economy was hit by an “external shock”, a “global financial crisis”.The financial crisis was not global; it was confined to Europe and the US. Nor was it external. Unlike a meteorite strike, a financial crisis is wholly man-made. It was made by governments, as well as by bankers in the City and on Wall Street. Bank of England officials, financial regulators, Treasury ministers and civil servants and their political masters all share some of the responsibility for having led the UK economy into the financial crisis of 2007-08, and then allowing it to languish in recession for four more years.

In the run-up to the financial crisis, monetary policy was kept too loose for too long. The mortgage market was barely regulated, while wholesale financial markets were not regulated at all. No legislative provision was made for dealing with insolvent banks.

In 2000 the UK ran an estimated “structural” budget surplus equivalent to 2.4 per cent of GDP. By 2007 that had turned into a structural deficit of 5.2 per cent. This was the result of unsustainable spending commitments, as well as persistently over-optimistic forecasts by the Treasury. Because of the Treasury’s pipe-dream of “no return to boom and bust”, it made no provision for the risk of a recession. The UK was therefore poorly placed to deal with the consequences of the recession that began in 2008.

Despite tax increases and cuts in planned spending, debt has continued to grow under the present UK Government. Messrs Osborne and Alexander are going to add an estimated £530bn to the national debt in the five years of this Parliament. This is more than Brown and Darling added in 11 years.

No politician or civil servant has accepted responsibility for these mistakes. Instead, ordinary people have been punished. Under the Union, average real wages in Scotland have fallen in each of the past five years. Thanks to the mismanagement of the public finances by the British political class, we have become poorer together.

Despite oil tax revenues from the Scottish waters of the North Sea having contributed some £160bn to the UK Exchequer since 1980, the economic policies of successive UK governments have meant that every family in Scotland has ended up with a debt of some £50,000. In Norway, on the other hand, the Government’s management of that country’s oil tax revenues has resulted in the accumulation of a national wealth fund worth some £450bn, or about £200,000 for each Norwegian family.

It is clear in my mind that following independence there will be a sterling currency union with the rest of the UK. A continuation of existing monetary arrangements will be in the best interests of both countries. Scotland will be the second-largest export market for England after the US, and English small and medium-sized business exporters will not want to have thrust upon them the transactions costs and exchange rate risks associated with a separate currency.

A formal currency union between two sovereign countries usually requires consistent financial regulations together with agreed limits on government budget deficits. Having a binding budget agreement provides cover for politicians who would otherwise be tempted to abandon restraint in the hope of winning votes. We should and will have these kind of prudent limits whether or not we are in a currency union.

If the currency union proposed by the Scottish Government is in the rest of the UK’s interests, what is all the fuss about? As the Nobel Prize winner Professor Christopher Pissarides of the LSE observed, it is about trying to influence the outcome of the referendum. By pretending Westminster won’t agree, the No campaign hopes to create the very currency uncertainty about which it complains.

In the most unlikely event that the rest of the UK refused to enter into a formal currency union, it would be quite possible for Scotland to carry on using the pound. This was what Ireland chose to do when it left the UK in 1922, and continued doing so until 1979. In Ireland’s experience, as in so many other historical episodes, including Scotland’s from 1716 to 1844, the absence of a central bank proved no handicap. On the contrary, a major factor in the reckless behaviour of many US and UK banks in the run-up to the 2007-08 financial crisis was their belief that they were too big to be allowed to fail. As a result, policy throughout the Western world has changed, and “bail-out” by the taxpayer is being replaced by “bail-in” by shareholders and creditors. I mention this only because it will be a factor in the negotiations, not because I believe there will be any other outcome than the continuation of a currency union. Once the politics of the referendum campaign subside, the economic interests of both parties with so much in common will prevail.

• Professor David Simpson is a former economic adviser to Standard Life and founder of the Fraser of Allander Institute.