Later this week, I will be in Britain to participate in a series of events. You can see the details from my – Events Page – and I urge interested readers to support the events that are run by activists. Two of these events will be in Scotland where we (Warren Mosler and I) will discuss, as outsiders, issues pertaining to the monetary arrangements that might accompany a move to Scottish independence. I have noted in the past that this is a controversial issue in itself that is also made more divise because it has become intertwined with the vexed issue of EU membership. I certainly don’t intend to use these presentations to lecture the Scots on what they should do. What I hope to achieve is to set out a framework based on Modern Monetary Theory (MMT) principles to allow the protagonists to make their own decisions, free of the neoliberal sort of monetary myths that I think have dominated the independence debate to date. I am always cautious discussing the pro and con of situations where I have no direct material stake and a less than full understanding of specific cultural and historical influences that are at work. But the Scottish question is interesting and demonstrates many of points that nations should be cogniscant of when discussing monetary sovereignty.
My previous blog posts on Scotland are:
1. Ridiculous MMT critiques distorting Scottish independence debate (April 23, 2019).
2. Oh Scotland, don’t you dare! – Part 2 (June 5, 2018).
3. Oh Scotland, don’t you dare! – Part 1 (June 4, 2018).
4. I would be voting NO in Scotland but with a lot of anger (August 18, 2014).
5. Bonnie Scotland – ignorance or denial – either way it is fraught (October 30, 2013).
6. Scotland should vote yes in 2014 but only if … (September 27, 2012).
While I do not claim to be an expert on Scottish affairs, I have been following the Scottish debate for some years and have read a lot of literature and studied a lot of data.
The Scottish Growth Commission and the currency choice
The Growth Commision – Report – released on May 25, 2018 after the SNP had sought advice on the economic implications of independence, recommended the retention of the British pound until “a series of tests for future currency decisions” are met.
I have dealt with the Report in detail in the blog posts cited above – (1) and (2).
The so-called ‘six tests’ are nonsensical from an Modern Monetary Theory (MMT) perspective and if adopted would lock Scotland into using the British pound indefinitely.
In other words, the newly independent Scotland would become a client state of Britain – with no real independence at all.
The so-called ‘sterlingisation’ option is thus inconsistent with MMT principles.
The Growth Commission also recommended encumbering the new independent government with a series of ad hoc fiscal rules identical to those that have made the Eurozone unworkable.
They want the new nation to replicate the dysfunctional Stability and Growth Pact constraints (3 per cent deficit/60 per cent debt ratio) which have rendered that Pact neither supportive of growth nor stability in the EMU.
However, nowhere in the very long Growth Commission Report is there recognition of the principle that fiscal policy should not function to achieve some given ‘numbers’ but rather should be designed and implemented to achieve functional outcomes that bear on the well-being of the Scottish people.
And further, following that reasoning, it is impossible for the government to really achieve rigid fiscal financial targets because the spending and saving decisions of the non-government sector are major influences on the fiscal outcomes.
In other words, we can only talk about fiscal policy in the context of what is happening elsewhere in the economy.
An MMT analysis of the Scottish position
The new Scotland will continue to run an external deficit, which means that income generated within the economy is leaking out in net terms from the economy to the rest of the world – and to the rUK in particular.
There is a lot of misinformation about this issue.
For example, Business for Scotland, which is a pro-independence/pro-EU lobby group representing the produce a regular Scotland the Brief articles in the form of “Fact rich graphics” to summarise different aspects of the Scottish economy.
The ‘Fact rich’ element is, however, questionable.
On the matter of the balance of trade, they produced this graphic covering the year 2017 based on the Regional Trade Statistics published by H.M. Revenue and Customs:
If we consult the most recent H.M. Revenue and Customs – Regional Trade Statistics – Fourth Quarter 2018 (issued on March 7, 2019), we find that for the 12 months to December 2018, Scotland exported more than it imported.
Here is the latest graph:
There are two issues that make this misleading:
1. The Regional Trade Statistics only cover goods and Scottish service exports to the EU constitute 33.6 per cent of total exports to the EU, 39.9 per cent of total exports to Non-EU nations, and 57.7 per cent of exports to the rUK (in 2017).
2. The Regional Trade Statistics only cover trade with outside of the UK – in the December-quarter 2018, exports to the rUK comprised 61.4 per cent of Scotland’s total exports.
In 2017, exports to the rUK were 60.1 per cent of total Scottish exports. 18.3 per cent went to the EU (other than the UK) and 21.6 per cent to Non-EU nations (US being the largest).
In value terms, Scotland’s exports of goods and services to the rUK are worth four times that of exports to the EU.
The latest – GDP Quarterly National Accounts, Scotland – (released January 30, 2019) for the December-quarter 2018 show that, in fact, once we include services, the net trade for Scotland is consistently negative.
The following graph shows the evolution of Net Trade as a percentage of GDP from the March-quarter 1998 to the December-quarter 2018 (the latest data).
The red line is the difference between total exports to and total imports from the Rest of the World the (expressed as a percentage of GDP). That is, it excludes trade with rUK, and is a relatively meaningless figure.
The blue line shows the actual trading position of Scotland against the rUK and the Rest of the World (which is what it would be if Scotland became an independent nation.
It presents quite a different picture.
So there is a significant income leakage from Scotland to the rUK via trade.
The latest – Government Expenditure and Revenues Scotland (GERS) – data (2017-18), which is produced by Scottish government statisticians:
… estimates the level of public revenue raised in Scotland and the level of public spending for the residents of Scotland, under the current constitutional arrangements.
The data shows that the fiscal deficit in 2017-18 was around 8 to 9 per cent of GDP depending on whether North Sea tax revenue is included or not.
The overall UK fiscal balance was in deficit of 1.9 per cent in 2017-18 (too low but that is what it was).
Other relevant pieces of information include the Household saving ratio and the Business Investment ratio.
The first graph shows that Business sector capital formation in Scotland is a lowly 7 per cent of GDP (in 2018) and over the last decade or more has fallen significantly.
The second graph shows that the Household Saving Ratio (per cent of disposable income) has also fallen substantially since the turn of the century.
The Scottish government has recently started publishing much more detailed national accounts and trade data which helps us assess the situation it is in as a standalone nation.
On December 19, 2018, the latest – Primary Income Account and Gross National Income for Scotland – data was published and allows us to examine the difference between GNI and GDP, which means we can now estimate the net flows of income out of Scotland.
Remember that GNI estimates the nation’s total income accruing to its residents (including business) from all sources – domestic or external.
GDP, by contrast, measures the income that is generated in a particular year by the nation, irrespective of whether the income flows to residents or foreigners.
The Scottish publication accompanying the data release – Development of a Primary Income Account and Gross National Income (GNI) for Scotland – notes that:
Gross National Income (GNI) is an adjustment to the conventional GDP measure of economic activity to take account of financial flows into and out of the country due to ownership. For example, where profits made by Scottish companies outside Scotland are repatriated, this would be included in an estimate of Scottish GNI but is not included in Scottish GDP. Likewise, when non-Scottish companies repatriate profits made in Scotland, this is included in Scottish GDP but would be omitted from estimates of Scottish GNI.
The key summary results are:
1. “In 2017 Scottish GNI (including a geographic share of UK extra-regio) was estimated to equal 94.5% of Scottish GDP” – which means that there was a net outflow of income to the rUK and the Rest of the World.
2. “Scottish GNI has remained below GDP throughout the period from 1998 to 2017 … This reflects in part a large insurance and pension sector with policy holders outside Scotland, a predominance of company headquarters in London and the South East and the high level of foreign ownership among North Sea operators.”
3. “In 2017, an estimated £17.2bn came into Scotland from the rest of the UK whilst an estimated £18.5bn went in the other direction. This resulted in a net outflow from Scotland to the rest of the UK of around £1.3bn.”
4. “Scotland has also had a net outflow of income to the non-UK rest of the world throughout the entire period covered by these statistics.”
5. “In 2017, an estimated £7.6bn came into Scotland from the non-UK rest of the world whilst an estimated £15.5bn went in the other direction. This resulted in a net outflow from Scotland to the non-UK rest of the world of around £7.9bn.”
So taken together, we would expect that should Scotland become independent, the net income flows on the current account would be negative and of the order of £9.2 billion (the 2017 outcome).
The external position for Scotland is thus the sum of its net trade position and the net income flows.
The data is still experimental and so I am reluctant to use it for calculations etc in relation to assembling the sectoral balances.
But what it tells me in qualitative terms is this:
1. The external sector would drain income from the Scottish economy both view the trade and income accounts – that is, the current account for the new nation would be negative and fairly sizeable in relation to GDP.
2. The household sector clearly has expressed a desire to save but has been squeezed in recent years.
3. The investment ratio is low – meaning that it is likely that the private domestic sector is only running a fairly small overall deficit.
4. That means that the fiscal net spending injection is supporting growth and may be too low given the declining household saving ratio.
Think about that in relation to what the Growth Commission would have the Scottish government do in relation to fiscal policy.
Ignoring considerations about the debt ratio, any attempts to impose a EMU-type Stability and Growth Pact fiscal rule of 3 per cent deficits or less on Scotland once it become independent would be highly damaging to its growth outlook.
Any attempt to reduce the fiscal deficit which last year was around 7.9 per cent (including the revenue from the North Sea resources) would push Scotland into recession almost immediately.
If anything, the fiscal position will have to provide more support for household saving – via income growth – and also ensure that there is sufficient public spending during the transition from being part of the UK to being independent nation to avoid any hint of recession.
That means increased deficits. Which then raises a number of related issues which I will deal with in Part 2.
In Part 2, tomorrow, I will consider other aspects of the independence decision such as debt sharing, foreign reserves, and the option to enter the EU or not.
That is enough for today!
(c) Copyright 2019 William Mitchell. All Rights Reserved.