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Is the opposition of the three main political parties at Westminster to a post-independence currency union with Scotland a bluff? North of the border, many believe it is. I have no window into men’s souls: these Scots may be right.
But I hope it is no bluff. A currency union does not have to be ruled out on any terms. But a union that could make sense for the remaining UK would be highly unequal. Why would a newly independent nation accept it?
Experience with the euro has clarified many issues relating to currency unions. Some are only partially relevant to a currency union between Scotland and the UK. While the oil-dependent Scottish economy would be different from that of the UK, it is fair to argue that, after more than three centuries, integration of the economies and, in particular, the labour markets, is sufficient to make currency union workable.
That is part of the reason why it is hard to understand the zeal for independence. Is it, as Oxford university economist Paul Collier has argued, really no more elevated than a resource grab?
Accept that the currency union could work from a narrowly economic point of view. Is that the end of the story? Definitely not. The point about a currency union – evident from the experience of the eurozone – is that it is not just about the economies. Sharing a fiat (or government-made) money entails a high degree of institutional and political integration. This is why currency unions between notionally independent states are so fraught.
Risking that might have made sense for countries proposing to move towards a deeper union, as was the case for the euro (however ill-advised). But how can it make sense for a country that has decided to dissolve a union? It is weird to tell the English you are desperate to be rid of them and, in the same breath, say you trust them so much that you wish to share a core activity of the state you are leaving.
How then should the rest of the UK respond the day after a Yes vote? By saying that Scotland can be in the sterling area, provided the institutions of that union are established under the law of the UK and are accountable to its government. Among other things, these institutions would carry out financial regulation. Scotland’s fiscal deficit would be controlled by binding agreements, as would government borrowing. Scotland would also have specified fiscal obligations in the event of a bailout. These arrangements between Scotland and the UK would be established by treaty.
The logic of the one-sided fiscal rules is that within a currency union, the cost of fiscal profligacy by a smaller member may be shifted on to the larger one. But the much larger member cannot shift the cost of its profligacy on to the smaller one. Thus Scotland would have an incentive towards profligacy that the UK would not. A one-sided risk demands one-sided control.
A similar logic applies to financial regulation. Scotland might gain from a financial boom headquartered in Edinburgh whose costs ultimately fell on the UK. For this reason, regulation would need to be centralised. But Scotland would have to take on some fiscal obligations in the event of a disaster. They could not fall solely on the UK.
The need for clear lines of accountability and authority is fundamental. One country, one government, one central bank – that is the right principle. This, we have learnt, is particularly important in emergencies. Then the closest possible co-operation between the government, the central bank and the regulators is essential. In the next crisis the government may even require the central bank to finance the government outright. It has to be clear that, in this situation, the bank would be answerable to one government – the UK government.
Some argue that insisting on these conditions is impossible. A letter to the Financial Times even stated that: “The UK after a Scottish secession will not be the UK but a different state.” It will not. It will be the UK without Scotland. As happened when the Irish Republic left in the 1920s, the Westminster parliament, the bulk of the laws of that parliament and a government accountable to that parliament will all continue to exist. Scotland will merely have terminated its temporary participation. Evidently the Act of Union would be repealed. But this does not mean the existence of the Bank of England or the laws that govern it will be in doubt. Scotland may leave the UK. It cannot take core institutions with it.
A currency union on the lines I have outlined would be perfectly satisfactory. But it would be one in which Scotland and the Scots would have still less weight than now. They would retain access to a lender of last resort within the sterling area, but at a heavy price.
If that is what the Scots really prefer, that would be fine by me. But if they want sovereign equality, they should reject the idea. Alternatives to the currency union exist. Some might work well. An independent Scotland should choose one of them.
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