May 1, 2013
By Graham Bishop, economic analyst and founder of www.grahambishop.com
The authors of the HMG paper ‘Scotland analysis: Currency and monetary policy’ (23 April 2013) faced a fundamental difficulty from the outset: If they were wholly non-partisan, then any merits in the case for Scotland joining the euro could be turned round and applied correspondingly to the UK. Clearly, Mr Cameron would not welcome such an analysis. So they hit on the safe solution of recycling some of the tired old arguments from a decade ago about Gordon Brown’s infamous “Five Economic Tests” for joining the euro. Even with a dash of re-heating they are no more convincing than they were originally.
Yet joining the euro is the only route for a Scotland that wishes to be genuinely independent.
The paper lays out the four obvious currency options for an independent Scottish state:
1. “continue to use sterling with a formal agreement with the continuing UK (a sterling currency union);
2. use sterling unilaterally, with no formal agreement with the continuing UK (“sterlingisation”);
3. join the euro; or
4. introduce a new Scottish currency.”
Taking the currency union option first, the authors have certainly absorbed the current progress of the euro area towards a genuine monetary union to deal with the economic crisis. So they argue that “In practice this [currency union] would be likely to require rigorous oversight of Scotland’s economic and fiscal plans by both the new Scottish and the continuing UK authorities.” As the remaining UK would be about 10 times the size of Scotland’s GDP, it is not clear what arrangements could be made that would prevent England simply dictating to Scotland. By contrast, in the euro area the European Commission acts as an independent arbiter and the final decisions must be accepted as fair by all the other 16 states. Scotland would be at number 10 – larger than Portugal or Ireland. In a Scotland versus UK situation, there would not be any such system of protection against unfairness.
The second option of “Sterlingisation” might appear to have some attractions as a number of small countries have used that approach with both the euro and the US dollar – either directly or via a `currency board’. The HMG paper highlights the need for a “credible” anchor currency and then helpfully provides a chart (5A) of the euro/sterling exchange rate since 1999. It opens at €/£1.4, swings up to €/£1.7 and then declines to a low of €/£1.1. The period since 2007 includes the third largest sterling devaluation in the last 100 years so some might question the credibility of this particular anchor.
However, Scotland has a very substantial financial sector – especially if Royal Bank of Scotland (RBS) and Bank of Scotland (BoS) used it as their `home state’ for regulatory purposes. Memories of the events that forced the Act of Union in 1707, combined with the similar lessons of the last decade, might suggest that the price of independence with this currency option would be a drastic reduction in the size of a key economic sector.
Turning to the fourth option, the idea of a new Scottish currency seems to run in the opposite direction of recent developments around Europe where smaller countries have joined the EU and committed to using the euro. So this brings the discussion back to the third option as the only realistic choice that avoids some form of dependency on the UK: joining the euro.
The HMG paper points out that “all countries that have joined the EU since 1993 have committed to adopt the euro in due course.” This author believes this is now a standard EU requirement. Given the current difficulties that flow from insufficient co-ordination in the euro area, it is difficult to imagine that the EU would suddenly change policy and make an exception for Scotland. Moreover, the logic of `banking union’ is to draw closer together the regulatory control of the financial system under the ECB. If RBS and BoS were domiciled in Scotland, they would both fall under the ECB’s supervision if Scotland were in the euro. Given their recent history, it is difficult to think that Europe would agree to a new pair of `loose cannons’ within its financial system but outside its control.
So the only real game in town for an independent Scotland is the euro. HMG makes a great play about high transition costs. But this is based on work done a decade ago for the `Gordon Brown tests’. Many states have joined the euro since and this author is unaware of any countries (or companies) that have even bothered to footnote the transition costs in their accounts.
The HMG paper descends into pompous assumptions about the great ship `UK economy’ sailing majestically and imperviously through the euro area storms. If Scotland joins the euro, it would have to move to euro area fiscal rectitude. The HMG paper notes that “None of the options are likely to provide the same scope to use fiscal policy to support the economy or the same effectiveness for the resolution of financial crises as is currently available as part of the UK.” The clear implication is that if Scotland remains part of the UK, it can avoid the nasty parts of reverting to a sensible fiscal policy in the not-too-distant future.
But the paper neglects to point out that this year’s UK budget deficit (as forecast by the European Commission in its recent Winter Forecast) at 7.4% of GDP is expected to exceed Spain’s 6.7% or Greece’s 4.6% deficit. The UK’s deficit is likely to be more than three times that of Italy and be twice that of the euro area as a whole! So Scotland is in for a rough passage as part of the UK. The paper provides no guidance on the current fiscal position of an independent Scotland.
The HMG paper also provides no comment on the central conundrum in this debate. If Scotland voted in late 2014 for independence and thus EU and euro membership once negotiations were complete in say 2017, what would happen if the “continuing UK” voted to leave the EU in a 2017 referendum? How far would the EU bend over backwards to assist Scotland to join just as England left? At the very least, the risk of an English veto would be removed!
(Note by the author: These observations do not seek to make any comment about the merits of Scottish independence, but instead simply review the HMG analysis from a European perspective.)
Author : European Movement UK