January 12, 2012 8:12 pm

Economics emerges as central to Scotland’s future

With his remarks questioning the currency arrangements of an independent Scotland, George Osborne has laid bare the central role of economics in deciding the country’s future. Scottish nationalists are equally keen to deploy the dismal science to justify their case for separation. But as politicians score points, the economic arguments remain far from straightforward.

As a starting point, Scotland’s living standards demonstrate little tartan exceptionalism. At £20,200, Scotland’s income a head last year was a touch lower than England’s, at £20,974, but better than all English regions bar London and the South East.

Scotland-charts

Scotland-charts

The Scottish and UK economies have followed a similar path over recent years. Although official figures show Scotland had a shallower recession, it has also had a more feeble recovery, leaving both economies producing almost exactly 4 per cent less than they did in the fourth quarter of 2007.

While Scotland’s economy is fairly representative of wider UK incomes, it is also very small, with an output accounting for only 8 per cent of the UK total. Scotland also has a much higher dependence on oil, which accounts for roughly 13 per cent of its output.

Small size and concentration in certain sectors can be problematic, says Anne Sibert, professor of economics at Birkbeck. “A big country has some insurance if one industry or one area of the country runs into problems, you can have transfers from the other areas. But if you mainly produce one thing, if you’re located in one small place, you don’t have so much insurance.”

Small size is one generic risk of independence – which is seen as an advantage by the Scottish Nationalist party because it could make the economy more nimble – but the real arguments would arise out of the financial and institutional arrangements separation would force between the rest of the UK and Scotland.

An independent Scotland would have to negotiate whether to stay with sterling in a formal currency union, maintain sterling independently of England, have its own currency or join the euro.

If Scotland were to remain in a currency union with the full protection of the Bank of England as lender of last resort, England would insist on fiscal controls to prevent it running unsustainable policies, in which case independence would be curtailed.

Alternatively, Scotland could adopt sterling while being a fully independent nation, just as Kosovo uses the euro and Panama uses US dollars.

The problem here is that Scotland would have no control over monetary policy and the Bank of England would cease to be the lender of last resort to Scottish banks. In these circumstances, English depositors in NatWest or the Royal Bank of Scotland would be warned that the Scottish state would not have the taxpayer resources to stand behind its largest bank, nor would it have a central bank to provide funds as a last resort. That would risk a run on the bank and other Scottish-based financial institutions.

If financial regulation under independence is vexed, public finances are just as bad. International law suggests Scotland would have a strong claim to the bulk of North Sea oil and gas revenues, but even so, the Scottish government’s official calculations show that even on this generous assumption, Scotland would have operated a 10.6% budget deficit in 2009-10, little different from the 11.1 per cent UK equivalent. Oil revenues are also projected to decline rapidly, leaving little windfall for the country.

Scotland has also made some generous fiscal promises to its population, which could become more difficult to keep as oil revenues decline.

Paul Johnson, the director of the Institute for Fiscal Studies, pointed out the Scottish population was ageing more quickly than the rest of the UK population, which would put increasing pressure on public finances. “Even if you have a happy year one, year 10 may look more difficult,” he said.

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