Why the Left should beware Salmond-onomics

Following statements in both Westminster and Holyrood on the forthcoming referendum on separation, the debate on Scotland’s economic future has now been fully engaged. At stake in the referendum will be the nature of the new Scotland – either a low corporate tax, more oil and gas dependent economy on the SNP’s model, or a Scotland prepared to join the new agenda being advanced by the European left on reducing income inequality, and securing long-term investment in manufacturing and other growth industries through institutions such as a National Investment Bank, within the United Kingdom. For decades the SNP have used the rhetoric of national liberation to motivate their core support, and built support on the left by holding out the prospect of higher public expenditure in a separate Scotland and the ending of the influence of periods of Tory UK Government in Scotland. The nature of what would result if Scotland voted Yes is very different – fiscal rules negotiated between the Scottish and UK Governments, or membership of the Eurozone stability pact, binding the spending and borrowing policies of Scotland for years to come – not so much a social democratic nirvana, more a neoliberal nightmare.

The SNP’s preferred position is to seek to establish a currency union with the rest of the UK post-separation, while reserving its options on future membership of the Euro. Critical to this strategy is the SNP’s effort to secure the Bank of England as lender of last resort to a post-separation Scottish financial system. Some Nationalists have even claimed co-ownership of the Bank of England, but this is the politics of denial – in quitting the United Kingdom’s fiscal and monetary union, Scotland would also abandon the protections provided by the UK financial system to Scotland, including the Bank of England’s role in ensuring macro-economic stability. Over the period of the financial crisis, £1.2trillion in UK Government-backed support through re-capitalisations, loans and guarantees saved the banking industry in the UK, including RBS and HBOS, both headquartered at the time in Edinburgh. At the height of the crisis, the liabilities of RBS dwarfed the entire Scottish economy at around twenty-five times Scottish GDP. The SNP did not turn up to debate their policies on banking supervision at Westminster this week – a glaring admission of the weakness of their arguments affecting an industry employing 150,000 people, and thousands of savers and mortgage-holders, in Scotland.

While the Merkozy concentration on austerity economics is harming the generation of jobs and growth within the Eurozone as a whole, the German Chancellor was right to point out in a recent interview with The Guardian that the essential characteristics of successful currency and monetary unions are fiscal union, political union and a common treasury to deliver fiscal transfers from richer parts of the union to less affluent areas. The reason the UK has been the world’s most durable monetary union over the last three centuries has been the sharing of resources and risk alike. There are high levels of integration between Scotland and the rest of the UK, which is Scotland’s largest market for goods and services, with 67% of Scottish exports being purchased there. Figures from the Scotland Office from January 2010 point out that net fiscal transfers from the UK to Scotland over the two decades to 2007/8 were £75.8bn, and even factoring in every penny from oil and gas revenues, a net transfer of £30bn to Scotland occurred over the same period.

The Scottish Government has sent mixed messages on the scale of inter-governmental working between a separate Scotland and the UK. The First Minister has spoken of his preference for an economic union on the Benelux model, which has a common Committee of Ministers taking decisions by unanimity, an Interparliamentary Consultative Council, and even a common Court of Justice, but no responsibility over fiscal or monetary policy. His Finance Secretary John Swinney has claimed that a separate Scotland’s use of sterling as currency would involve merely a binary relationship with the Bank of England. But these arrangements would not involve fiscal transfers, nor acknowledgement of Scotland’s economic needs on the calibration of monetary policy, and the fiscal rules underpinning such a system would be politician-made, not banker-made. It also ignores the reality that the ultimate guarantor of the Bank of England’s lender of last resort status on separation would be the UK, not the Scottish, taxpayer, which ensures the fiscal rules negotiated by a UK Chancellor in any formal UK-Scottish currency union would be extremely onerous.

Choosing to leave the United Kingdom means Scotland would have to submit to a re-accession process to establish its EU membership on a stable footing. No matter the assertions from the SNP, this is an inescapable consequence of leaving the United Kingdom. Countries going through a similar process have no opt-out from the commitment to join the Eurozone and there is no reason to believe that a separate Scotland would be any different. If Scotland was committed to eventual Euro membership through its accession treaty, its fiscal path would require a deficit no higher than 3% of GDP, public debt no higher than 60% of GDP, and to demonstrate exchange rate stability for two years prior to adopting the Euro as currency. The new fiscal stability pact being designed by the Eurozone nations and being signed by all EU states with the exception of the UK and the Czech Republic, would entrench these rules into EU and Scottish fiscal policy, plus another on balanced budgets by preventing a structural deficit any higher than 0.5% of GDP in all circumstances but national emergencies.

Complying with these fiscal rules would mean personal tax rises for ordinary people, or major cuts in public spending and services in Scotland, or both, at a time when the SNP would be making its first priority to secure EU approval to halve the rate of corporation tax for banks and big businesses in Scotland. The Institute for Fiscal Studies, in their recent Green Budget, said increasing corporate tax competition between the nations of the UK would increase business compliance costs, and lead a race to the bottom on tax rates and revenues collected. On-shore corporate tax receipts from Scotland amount to 7% of the UK total, and figures produced by the Scotland Office last July put the cost in lost Scottish tax revenues by slashing corporation tax to Irish levels of 12.5% at around £2.6bn a year. It would seem absurd at a time when the public mood is in favour of a more responsible form of corporate governance and greater economic fairness, to encourage the worst excesses of rapacious capitalism through such policies, instead of re-shaping the economy in favour of longer-term investment in manufacturing as recommended by the TUC in its recent study on UK industrial policy, and a more sustainable growth model.

Even in the interim period before Eurozone membership, establishing a currency union with the United Kingdom with a common central bank would require compliance with fiscal rules negotiated after the referendum with George Osborne and the UK Government. To secure the Bank of England’s protection as lender of last resort, and to avoid moral hazard, the UK Chancellor is likely to drive a hard bargain over control of Scotland’s purse strings, and tough rules on borrowing, and spending for Scotland would be the result. Separation for Scotland, but not independence from Osbornomics.

The recent commentary on Scotland’s Currency and Fiscal Choices by the National Institute for Economic and Social Research raises further questions about the country’s fiscal direction under separation.

Firstly, the odds are that the implicit limitations on policy on taxation, borrowing and expenditure will be harsher in a separate Scotland than in nations which have their own central bank, or by remaining part of the United Kingdom. Even under the SNP’s own purported split of oil and gas revenues, with 90% being apportioned to a separate Scotland (not the universally accepted position under international law; and subject to hard cross-border negotiation if the referendum produced a Yes vote), the level of national debt inherited by a separate Scotland would be 70% of GDP. On a per capita split of oil and gas revenues, debt could rise to 80% of GDP in 2014. On the deficit, even using the SNP’s preferred measure including geographical split of oil and gas revenues, the average deficit would have been in the order of 4% over the last five years. Three leading credit agencies have indicated that Scotland would not inherit the UK’s credit rating on separation, which would further increase borrowing costs. The NIESR commentary concludes that Scotland would be an indebted nation on independence, with a substantial trade deficit, with no insurance from risk sharing or fiscal transfers, leaving us over-dependent on fluctuating oil and gas revenues, and placing greater strain on borrowing or tax hikes to fund current spending.

Secondly, from the time of Keynes to the current economic climate, a clear lesson to draw is that monetary and fiscal policy cannot be applied in isolation. That is the inherent error in George Osborne’s economic policy, which far from seeing quantitative easing as the last resort of desperate governments as was his position in opposition, views it as one of the few economic levers he is prepared to sanction today to dig the economy out of the slump he has created through too restrictive a fiscal policy since the four quarter of 2010. It is also the critical mistake of the twenty-one other right-wing Governments within the EU too, and the fundamental weakness at the heart of Salmond-onomics too. As Brian Ashcroft pointed out recently, the only tools available to a separate Scotland to manage aggregate demand would be of the self-limited fiscal variety remaining under the terms of a currency union treaty, so if inflation took off, taxes would have to rise, or public spending fall, or a combination of the two. Hardly a recipe for stability or social fairness.

Without a central bank to print money and control the money supply, a separate Scotland would find itself with higher long-term borrowing rates, and higher interest payments on government debt, whether inside the protection of a common central bank under a formalised UK-Scotland monetary and currency union, or even with a less structured relationship with sterling. These problems with rising costs of borrowing would manifestly worsen if oil and gas revenues continued to fluctuate as predicted. If the United Kingdom decided not to form a currency union with a separate Scotland, an informal sterlingisation mechanism would become the only available means for Scotland to use sterling as a currency, with no central bank as lender of last resort, and substantially weaker firepower to protect the financial system of Scotland in that event. Even higher capital buffers would be required in the banking system, as has been the case in Panama, which uses an informal arrangement to use the US dollar as its currency. Oil-producing Ecuador had to establish a stabilisation fund to insure against systemic failure in its financial system as the price for adopting the dollar as its currency without a formal currency union with the US.

The NIESR report is particularly damning on such informal arrangements to use another state’s currency:

“When a state uses the currency of another state and issues government debt denominated in that currency, it loses the ultimate response of printing money to repay creditors. This creates the possibility of default.”

Over the next few months, the Left in Scotland will put the arguments for Scotland’s future as a strong devolved nation within the United Kingdom with passion and commitment. This is not simply a debate about identity, it is about what is the best constitutional solution to ensure greater equality and fairness within Scotland. The Scottish left has not fought against austerity economics over the last two years just to see them become a permanent feature of Scotland’s future through separation. Embracing an SNP model of economics and attitudes to taxation resembling that of the Irish centre-right or US Republican-right from the 1980s would heighten inequalities and child poverty in Scotland, which have risen every year Alex Salmond has been in office. This referendum is battle of visions over what kind of Scotland we will become, a haven for the minimal state and ultra-low corporate taxes under the SNP, or a beacon for a more responsible form of capitalism under Labour. At a time when a powerful consensus is assembling from the OECD to White House economists that fairer societies generate stronger levels of long-term growth, we will fight for the social and economic justice that a strong, devolved Scottish Parliament within the United Kingdom can bring to Scotland for future generations.

William Bain is a Shadow Scotland Office Minister and Labour MP for Glasgow North East