Tuesday, 21 May 2013

Will Scotland Be Independent In a Currency Union?

Chamber's Dictionary definition of independence is, "not subordinate, completely self-governing". Sovereignty is defined as, "pre-eminence, supreme and independent power". Political philosophers have debated sovereignty for centuries, from Bodin to Rousseau but the UK Constitution has determined that sovereignty rests with parliament, while Scots consider it rests with the people, although we seem to have great difficulty deciding whether or not it is divisible, never mind actually exercising it. The SNP and many of its supporters would appear to believe that sovereignty can be "shared" but at the same time retained, "given away", and retained, without explaining how that can be achieved. That argument will be examined to some extent below, as I take the opposite view.

I was given the link to the blog written by Gordon McIntyre-Kemp of Business For Scotland, entitled, "Economic Policy in an Independent Scotland", which is sub-titled, "Exploding the Scotland will not be fully independent myth". My opponents in this debate about currency, claim it is "brilliant" and effectively demolishes arguments to the contrary. We shall see.

Mr McIntyre-Kemp makes his first mistake when he includes Denmark in the euro-zone. It is not, but has "pegged" its currency to the euro, which gives the Danish government a great deal more freedom than if they had actually joined the euro, but gives it absolutely no input to monetary policy in the euro-zone. Mr McIntyre-Kemp's article does no more than list the twenty-six revenue streams currently controlled by Westminster, then the five others, which will be transferred to the control of the Scottish Parliament by 2015, under the Scotland Act of 2012. He calls them all economic levers, a total of thirty one, twenty six plus five, when in actual fact, there are just two - those associated with tax (fiscal levers) and those associated with money supply (monetary levers). Finally he gives a list of seven items of expenditure which are controlled by Westminster, including trade, which is actually controlled by the EU.

Those three lists allow Mr McIntyre-Kemp to conclude that an independent Scotland would have control over its economic and fiscal policy. He goes on to say, "Scotland by voting "Yes" and staying within the EU would be gaining at least twenty eight new financial and economic levers and have control over some of our major expenditures, while trading the ability to set an interest rate in order to maintain a free common market and currency zone with the rest of the UK." Of course Scotland would be gaining nothing of the sort, as it is the intention of the Scottish Government to have a formal currency union with the rUK, which means it will have no control over monetary policy and limited control over fiscal policy. Therefore, instead of the twenty eight mysterious economic levers Mr McIntyre-Kemp claims, Scotland will have part control of ONE - fiscal policy.

Before reaching his rather self-satisfied conclusion, Mr McIntyre-Kemp indulges in some extraordinary flights of fancy. He states, "The Bank of England operates independently of the Government and does not control economic or fiscal policy in the UK but it has a key role of maintaining inflation at a low level, using interest rates. It does this independently from the Westminster Government but the inflation target is set by the Chancellor" I will have more to say below, about the relationship between the Government and the Bank of England, but here again, we have the assertion the Bank is "independent" although its sole function of controlling inflation is determined by Government, to whom it is answerable. On sovereignty, he has this to say, "All independent countries in common markets or currency zones, have to agree to integrate some of the policies and market conditions that they operate under, in order to make the market/zone work as an optimum solution. It does not mean they give up sovereignty as they can always change their mind - unlike Scotland today where we have given up 100% sovereignty to Westminster on these issues."

Let us look at the sovereignty argument as it applies to the EU. If Scotland was independent and decided to join the EU, it would agree to give up all control of agriculture or fishing, as well as a host of other functions of government (for a fuller list see my Blog "Independence Don't Make Me Laugh"). Mr McIntyre-Kemp and his supporters all argue that sovereignty is retained because "we could change our mind". The CAP is not a one-off agreement about a single agricultural arrangement, it is an agreement that the EU will act for Scotland and determine ALL agricultural policies from then on in. As Qualified Majority Voting (QMV) applies, whether or not a policy is in the interests of Scottish farmers, they have no option but to agree (ear marking of sheep is a recent example). This applies on EVERY agricultural issue and CAP has not been to the overall advantage of Scottish farmers. On agriculture therefore, Scots have no sovereignty. If they leave the CAP, they leave the EU therefore the only two occasions on which sovereignty can be exercised is once, when they give it away when they join the EU and second, when they leave the EU and take it back. They cannot exercise sovereignty at any other time, and retain membership of the EU. Any arrangement will be as a consequence of a deal between the member states, not some ad hoc agreement and Scotland can be regularly outvoted, just as it is in Westminster. Fishing has been a disaster for Scotland's fishing communities and over 100,000 jobs have been lost in the industry. Scottish sovereignty obviously played little part in protecting our fisher communities. Of course Westminster carries the blame for this but would the situation have been any different if Scotland had been in a position to make its own deals, as the prize was our fishing grounds?

Any basic economic text book will have a chapter headed along the lines of "The interaction between Fiscal (tax) and Monetary (money supply) Policy". The SNP leadership and its supporters are determined to defy the laws of economics and deny that such an interaction takes place, arguing that as long as we control fiscal policy, it doesn't matter who controls monetary policy. Alex Salmond is on record as saying, "I believe the essence of economic independence is control of taxation and spending because it allows you to revive your economy." This totally ignores the fact that fiscal policy will have a direct impact on monetary policy (witness the problems in the euro zone) and vice versa. Using the examples in Mr McIntyre-Kemp's lists, if a Scottish government decided to "go for growth" and implemented a benign fiscal policy by lowering corporation tax and VAT, the first would encourage investment by business (Ireland has been under pressure from the EU to increase their corporation tax and the SNP has said it intends to radically reduce the tax) while the second would encourage consumers to spend more. The overall impact could be inflationary pressure caused by an excess of demand. Government could increase income tax, which would run counter to its benign fiscal policy, but would more likely raise interest rates (monetary policy). If, as has happened recently, the inflationary pressure was as a consequence of increased costs of raw materials, increasing interest rates would be a waste of time because inflation was of the cost/push variety, therefore increased personal taxation would be more in order. But what effect would that have on economic growth?

That is a very simple example of how fiscal and monetary policy can interact and why, as Mr McIntyre-Kemp pointed out, "all independent countries in common markets or currency zones have to agree to integrate some of the policies..." although he did not seem to appreciate why such integration took place. He finished his blog with, "It could even be described as xenophobic to suggest countries that enter into integrated common markets and or shared currency agreements, are not truly independent".  Others can judge how "brilliant" it was.

On a more serious note, the following is taken from the recent paper I prepared for the Options For Scotland think tank, and which caused such a flurry of support for a Scottish currency in the media. The preferred option for the SNP is a formal currency union with the rUK and, particularly in the past fortnight, they have made an increasingly strong argument in favour of this union. The No Campaign and the Treasury have made an equally strong argument opposing such a union and the strident tone of their opposition is such, that one has to wonder why Scots would find anything attractive in a continuing union with the rUK The Chancellor in particular, has taken every opportunity to threaten Scots with the most dire consequences if they vote Yes next year. The SNP argues that it would be in the interests of both an independent Scotland and the rUK, to have a formal currency union, pointing out that the balance of payments of the rUK would benefit by over £40 billion per annum, that cross-border trade between both sides would continue uninterrupted and costs would be minimised. The most important aspect of this option for the SNP, is that they claim that Scotland would have control of fiscal policy, thereby allowing a Scottish government the freedom to initiate the kind of economic policies which would create economic growth and employment. A currency union based on sterling, is made to sound so attractive for both sides by the SNP, that it is worth asking why either side would choose to change the relationship at some time in the future. Their commitment to a sterling zone does not suggest they would want to move towards ever having complete control of the Scottish economy. The problem for the SNP is that not even the Working Party of the Fiscal Commission totally agrees with them. The Working Party Report suggests that a sterling zone would be in the interest of an independent Scotland "in the immediate aftermath of independence" but that a Scottish currency would be the best option to give maximum control of the Scottish economy. In order to create a successful sterling zone, the Fiscal Commission sets out the following conditions:-

  • the Scottish Government has a formal input to the Monetary Policy Committee (MPC) of the Bank of England. In other words a member on the MPC
  • Interest rates are set to promote price stability across the sterling zone
  • Financial stability is ensured across the sterling zone on a consistent basis
  • A joint fiscal sustainability agreement is established to govern the level of borrowing and debt within the sterling zone
John Swinney, on behalf of the SNP, welcomed those conditions but claims that a Scottish government would still be free to follow economic policies, including taxation, to create growth and prosperity , in the Scottish economy thereby "creating the fairer society we all seek". It is difficult to see how an agreement between two parties, as laid out by the Fiscal Commission, can allow one of those parties the freedom to follow its own economic policies, at one and the same time.

John Kay, an economist who at one time served on Alex Salmond's committee of advisers, has been moved to ask, "It makes one wonder what independence means." Tod Murray, in their recent paper on the currency said, "If an independent Scotland keeps the pound, there needs to be an appreciation that at best, Scotland will have limited control over monetary policy. The Bank of England could impose checks and balances on Scottish fiscal policy, debt, deficit, taxation and public spending which would amount to a loss of fiscal autonomy." Jim Cuthbert, a well-respected economist whose work has often been quoted by the SNP, in his  latest paper "The Mismanagement of Britain", calls on the Scottish Government to reverse its policy on sterling in light of the current dangers faced by the pound and avoid Scotland being exposed to the "high likelihood of a potentially catastrophic crisis in the not-too-distant future." He goes on to say, "meaningful independence is not attainable within the UK monetary union" and "Independence could potentially insulate Scotland from the worst effects of the impending economic crisis."

If a sterling union was to be set up, great faith is being placed on two things; the first, a Scottish member of the MPC and the belief that a Scottish Government would adopt and follow sensible fiscal policies in any case. It is claimed that one Scottish member on the MPC will be able to influence policy decisions to the extent that the most potentially adverse effects for Scotland, will be avoided. In other words, it is hoped to reverse the attitude towards Scotland of the past thirty years. What appears to be forgotten is the relationship the MPC has with the UK Government and the Chancellor of the Exchequer, who must write to the Governor of the Bank of England at least once every 12 months, laying down the government's inflation target for the coming year and reminding the MPC of its remit under the Act. The letter is couched in the following terms:-

"The MPC is accountable to the government for the remit set out in this letter. Any changes to the remit will be set out in the Budget."

That does not leave much room for interpretation and one Scottish representative is hardly going to make any impact on a committee which is a creature of the Government of the UK and whose remit is to achieve the Government's target on inflation. What also requires some explanation is the faith being placed in an organisation whose record of setting interest rates over the past thirty years, leaves much to be desired in terms of the effects it has had on the economic growth in Scotland. Between 1995 and 2002, Scottish economic growth was 1.9% per annum as opposed to the 2.7% achieved by the rest of the UK over the same period. Any objective analysis would be hard pushed to find any period during the past thirty years, where the economic policies and interest rates set out by successive UK Governments, favoured Scotland. In every year over the past thirty years, economic growth in Scotland has been 0.5% lower than the growth rate in the rest of the UK.

In light of all of the above, the most sensible currency option for an independent Scotland would be a Scottish currency. In the past, any mention of a Scottish currency has been derided, with the usual sneering references being made by the usual suspects. It has been asserted Scotland is too small, it would be too difficult, it would cost too much and it would be either a petro currency floating on a sea of oil or, the oil price would make the value so unpredictable it would be unmanageable. More sensible and realistic assessments now recognize that small countries can mange their currencies just as well as the larger countries. The opening lines in the report from the Fiscal Commission states, "By international standards, Scotland is a wealthy and productive country. Even excluding North Sea oil output, GVA per head of the population in Scotland is estimated to be 99% of the UK average and the highest in the UK outside London and the South East. However, over the past 30 years, Scotland's economic growth rate has lagged behind that of many of its peers."

A nation's currency is much more than a store of value, it is a measure of the status of a nation state and can even be viewed as an object of pride. The German, Swiss and Dutch currencies have all been used as reserve currencies in the past and many German and Dutch now bitterly regret having lost their own currencies for the sake of the euro. The success of Norway and Switzerland in managing their currencies is a measure of just how small countries can manage their own financial affairs for the benefit of their own societies. As those countries which were once part of the Soviet Union or were part of the Eastern Bloc such as Poland, became more successful, they become less and less inclined to give away their new found independence by joining the euro. Why does New Zealand, with a population of 3.5 million insist on having its own currency, when there are economic arguments for having a monetary union with Australia? Canada, with a population of 33.5 million, exports over 82% of its goods and services to the USA and over 54% of its imports come from the USA, ratios which are far in excess of those that Scotland has with the rUK and the EU, but she guards her independence jealously, including her currency. The population of the USA is ten times that of Canada and all the arguments about being in bed with an elephant apply just as much as they do for the relationship between Scotland and the rUK. There are 221 currencies in the world with just over 60 in some form of currency union, either formal or informal but only 11 countries have the much vaunted AAA status. These include the following, Austria, Australia, Canada, Denmark, Finland, Germany, Netherlands, Norway, Singapore, Sweden and Switzerland. How many large countries are on that list?

An independent Scottish currency is the only option which will allow a Scottish government the degree of economic control necessary to diverge from the history of mismanagement of the Scottish economy since the end of World War II. If sovereignty means anything at all to the Scottish people, control of their own currency is a prerequisite.

Those in favour of a currency union now have a responsibility to EXPLAIN why such a union is to Scotland's benefit, why it is so much better than our own currency and, how it can possibly mean independence, by any reasonable and acceptable definition of the term.

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