This week, we are highlighting the contributions of our fellows to Scotland's Decision: 16 Questions to think about for the referendum on 18 September. Today’s topic is the economy. The book is available as a free download.
Our experts look at three questions on the economy:
- David Bell - What would the outlook for Scotland’s economy be if the vote is Yes/if the vote is No?
- Angus Armstrong and Monique Ebell - Which currency arrangement would an independent Scotland use?
- David Phillips - What would the picture for the Scottish Government’s finances be if Scotland votes Yes? What if Scotland votes No?
David Bell sets out the difficulty of trying to predict Scotland’s future economic prospects - and questions the reliability of both the UK and the Scottish Government’s claims about how much better or worse off Scotland would be if it voted Yes:
“Trying to predict the economic consequences of constitutional change poses some difficulty, because nothing about Scotland’s economic future can be known with certainty. There may be a superficial appeal in predicting that you will be £1,400 better off within the union or £1,000 better off under Independence – as the two sides in the campaign have done – but both forecasts are almost certainly wrong.”
He discusses border effects, the public debt an independent Scotland might have, the impact of policies on inequality, but also the possibility that independence might set free what Keynes called ‘animal spirits’ of economic creativity and dynamism. He concludes:
“If there is a No vote the Scottish economy will continue to follow the fortunes of the UK economy. Whether this performance has been good or bad, and whether therefore its continuation is acceptable, is a judgement that people will likely make based on their personal circumstances. Under independence, animal spirits may prevail – or they may not. It is a difficult call. The evidence is much more difficult to gather and to interpret.”
David Phillips takes up these points, focused on public finances – and sees challenges whether Scotland says Yes or No:
“It looks likely that the Scottish Government’s finances will be squeezed in the years after 2016 whether the public vote Yes or No. If Scotland remains part of the UK, cuts to grants from Westminster are set to continue until 2018–19. If the vote is to leave the UK, an independent Scottish Government would likely have to make spending cuts or tax rises of its own just to balance the books. Delivering the promises in the White Paper would need further tax rises, spending cuts in lower-priority areas or higher borrowing.”
Focusing in on a Yes vote, he says: “Independence would give more freedom to pursue a different, and perhaps better, economic policy, to undertake the radical, politically challenging reforms that could generate additional growth.”
He then offers this advice for those weighing up the arguments:
“Whether you believe Scotland’s government finances would be in a better state if Scotland votes for independence, should depend on two things.
- First, do you think the Scottish Government could find new policies to deliver a sustained increase in economic growth; and
- second would that additional growth mean higher tax receipts that will more than outweigh the long run decline in oil revenues.
If so then an independent Scotland might be able to continue with its relatively high public spending without much in the way of additional tax increases. If not the Scottish Government’s finances would likely be weaker if the result is Yes.”
Angus Armstrong and Monique Ebell look at Scotland’s currency options in the event of a Yes vote. For them:
“The single most important economic question in the Scottish independence referendum is which currency arrangement would an independent Scotland use … The choice of currency arrangement matters far more than just the notes and coins in peoples’ pockets. It determines the menu of available economic policy options, the interest rates at which people borrow money and the capacity of the economy to deal with crises.”
They are sceptical about the durability of a formal currency union with the rest of the UK amid the challenges an independent Scotland would face in managing its public debt:
“Would a formal monetary union be stable? If there were any doubts that Scots, in these circumstances, would accept the austerity, investors would be less likely to lend to the Scottish Government. This is a slow form of capital flight (funds being withdrawn from the country) which, once it starts, is very difficult to stop without being rescued by another government or even the IMF.”
Another option is informal currency union in which Scotland would use the pound, but with no influence over rest of UK monetary policy (often known as ‘sterlingisation’ or, after similar examples in Latin America, dollarisation). They are sceptical about this too:
“The most likely outcome of dollarization is that Scottish banks would move to the rest of the UK where they would have the backstop of the Bank of England. UK banks would then provide banking into an independent Scotland through a branch network. Since the supply of loans into a foreign jurisdiction is generally a riskier proposition than at home, the cost of borrowing by private citizens is likely to be higher in Scotland under dollarization.”
Their conclusion is that a new Scottish currency is preferable to a formal or informal currency union:
“While introducing a new Scottish currency has serious transitional challenges, it may be the best option for a prosperous independent Scotland.”
“The currency option that an independent Scotland can unequivocally deliver is issuing its own currency. Having its own currency and controlling its own interest rates would provide the greatest amount of policy flexibility. The more flexibly Scotland can respond to shocks, the greater the stability of its economy. True, trade costs would rise as Scotland and the rest of the UK would no longer use the same currency, but these costs pale in comparison to the costs of financial instability. Many successful countries in Europe with similar wealth and population sizes (such as in Scandinavia) and dependent on neighbouring markets have their own currency.”