Professor Ronald MacDonald, Adam Smith Professor of Political Economy, University of Glasgow
As the currency debate relating to a potentially independent Scotland rumbles on, it is perhaps a good time to take stock of some of the salient issues in this debate. The first, and perhaps most important, is the issue of the proposal that the Scottish government is currently running with, that a post independent Scotland would retain the pound sterling by remaining part of a sterling zone. But is this really a credible plan for a responsible government to be proposing? The answer for a number of reasons is a resounding NO!
Firstly, and as I have argued extensively elsewhere, it is important to note that an independent Scotland would become a net exporter of hydrocarbons and a monetary union, or indeed any system that would entail a rigidly fixed exchange rate, would not be a suitable option. But, say, the government of an independent Scotland were to press ahead with such a scheme what would happen?
In essence what would happen is that the other negotiating party, the rest of the UK (rUK), if indeed they are prepared to negotiate which in itself is a big if, would demand such severe constraints on the operation of fiscal policy – the ability to tax and spend – that it would emasculate any economic freedom that an independent Scotland is likely to have. Indeed, given this and given an independent Scotland would have given up the transfers that exist within today’s UK, would be straddled with its fair share of debt, would be relying on the volatility of oil prices to finance its deficit and would have no means of altering its external competitiveness all mean that the system would not be tenable. Such a system would inevitably be abandoned, creating huge disruption and uncertainty for an independent Scotland with clear implications for the provision of public services, employment and output.
In essence you simply cannot have a successful monetary union without a political union and we surely need look no further than the recent Euro zone experience to get a feel for the horrendous consequences of a monetary union without political union. But in the Scottish Government’s first Fiscal Commission report they give the example of the Belgium and Luxembourg economic Union as a successfully operating monetary union between a larger and smaller country working successfully and to the considerable benefit of the smaller country.
However, what is not mentioned in such arguments when the Belgium Luxembourg Economic Union (BLEU) is considered is that this was not what the majority of economists would classify as a monetary union at all. It was actually a dual exchange rate system in which one rate, essentially for personal transactions, was fixed and another rate was flexible, a bit like a black market rate, for certain financial transactions. This dual exchange rate system was at the heart of the success of the BLEU, but is clearly very different to what is being proposed in the current sterling zone proposal. And in any case such a system could only be sustained in a world of severe capital controls, which is very different to the world we live in today of free and unfettered capital markets.
In sum, the proposed sterling zone arrangement that the Scottish government is running with is nothing more than a sham and as Dr Angus Armstrong of the National Institute for Economic and Social Research has recently argued it is absolutely imperative that this issue is settled well before people go to the polls since the costs to both an independent Scotland, and indeed to rUK, of not doing so would in all likelihood be generational in its impact.
It seems the Scottish Government’s response to not being allowed to participate in a formal sterling zone, which as we have shown would actually be ruinous for an independent Scotland, is to say that it would not accept responsibility of its fair share of rUK liabilities and particularly its fair share of UK public debt. Presumably in that case it would not be given the share of assets relating to the sterling monetary union, such as, crucially, its share of the foreign exchange reserves held at the Bank of England. How then would they be able to operate a sensible foreign exchange rate policy absent foreign exchange reserves? Where would these come from? Perhaps the answer would be by borrowing from foreign countries.
But who is going to lend to a country where its political leader has already said that it is going to renege on a substantial and significant portion of its debt? Such a statement means that an independent Scotland would only be able to borrow on international capital markets at penal interest rates – if at all – with the consequences that that would have for an independent Scotland’s fiscal deficit, public spending and taxes. One wonders how the Icelandic public feel about the governments of both the UK and the Netherlands currently seeking reneged debt that amounts to about around two thirds of Iceland’s GDP. And of course Argentina is still being pursued in international courts for debt it reneged on many years ago and is highly restricted in what it can borrow in international capital markets. The unpleasant arithmetic of reneging on ones share of debt is it seems long lasting and profound in terms of its economic consequences.