A Fate Worse than Debt

3517800489_4b5aaa6974_zIn the New Statesman today, George Eaton challenges the spin the SNP has put on the Treasury’s announcement that it will underwrite Scottish debt after a Yes vote.

The announcement is not, as the First Minister claims, an indication of the UK government’s willingness to ‘pre-negotiate’ the fiscal terms and conditions of Scottish independence.

Instead, George says, it is a reflection of the lack of confidence investors have in the Scottish economy to cope with the effects of independence. The Treasury’s pledge is an attempt to ward-off a rise in UK borrowing costs precipitated by a Scottish credit downgrading.

George bases his argument that independence will leave Scotland in a weakened fiscal position on a recent IFS report. Here is the key passage from George’s blog:

As the IFS (which has no stake in the race) noted, Scotland’s lower birth rate and lower immigration rate means it automatically incurs a larger “fiscal gap” (the difference between spending and revenue) of 1.9%, compared with 0.8% for the UK. Even in the most optimistic scenario, Scotland would need to raise taxes or cut spending by an additional £2bn (such as through a 8p rise in the basic rate of income tax or an increase in VAT to 27%, or a 6% reduction in public spending) to achieve a sustainable debt level. Should oil revenues prove less buoyant and borrowing less cheap than the SNP anticipates, this figure could rise to £9.4bn (the equivalent of an 18p rise in the basic rate or a VAT rate of 36%), a scale of austerity that makes George Osborne look like a Keynesian. This doesn’t mean that an independent Scotland wouldn’t be economically viable, but it does mean that most voters would be worse off.

Firstly (and I may be wrong about this), but I think the Scottish government’s oil revenue estimates are based on an aggregate of revenue projections. So they don’t, as George and the IFS suggest, offer “the most optimistic scenario” – they are in fact tempered by the highly conservative estimates of the OBR. More optimistic estimates can be found in the work of Alex Kemp, professor of petro-economics at Aberdeen University (and official historian of North Sea oil). In 2011, Kemp estimated that oil would generate between £50bn and £100bn in tax over the next 10 years alone. I trust his judgement on these things more than I do the OBR’s – in 2011/12, North Sea revenues were £11.3bn.

You might argue that Scottish borrowing costs could rise because Scottish expenditure is dependent on oil revenues and oil revenues fluctuate wildly. But the focus on annual revenue flows seems to me misleading: low revenues one year can be (and have been) compensated by high revenues the next. For instance, ‘08/9 revenues were £12.9bn, ‘09/10 revenues were £6.5bn, ‘10/11 revenues were £8.8bn and ‘11/12 revenues were £11.3bn. Over a four year period, that averaged out at a very healthy £9bn a year. Surely the creditworthiness of an independent Scotland would be based more on the overall or long-term value of its assets than it would the extent to which the value of those assets varies on an annual basis? (Perhaps not. Again, I’m happy to be corrected.)

Secondly, George doesn’t take any account of the (more or less) immediate savings to be made from independence. I and others have been over this countless times, but independence would give Scotland the freedom to radically reduce its defence expenditure. The SNP has set out plans to reduce Scottish defence spending from its current level of £3.3bn per year to £2.5bn – a saving of £800m. More radical defence strategies would free up more revenue. If we trimmed our defence spending to Irish levels we could save more than £2bn per year. That would cover, in an instant, the supposedly “optimistic” shortfall George identifies. Scotland also spends £700m a year on what the UK government calls “foreign office and other services”, £100m a year on the House of Lords and £10m a year on the Scotland Office. There are big savings to be made in each of these areas.

Thirdly, and this seems to me a key point, independence would enable Scotland to address its fiscal gap through a liberal immigration policy. In purely economic terms, the case for a separate Scottish immigration system is overwhelming. Scotland’s population is ageing faster than the UK’s but growing at just half the rate. Scotland needs more young workers. Perhaps credit ratings agencies would be less likely to downgrade Scotland if an independent Scottish government began opening Scottish borders. (Separately, am I the only person not remotely upset by the prospect of having to flash a passport at Carlisle or Newcastle?)

Then, finally, there is the question of “sustainable debt”. Unfortunately, George is quietly echoing Tory austerity rhetoric here. Compounded by a lavish welfare settlement and unstable public finances, an independent Scotland would face a debt crisis. Market pressure would force cuts to Scottish expenditure. The need for fiscal discipline would kill Scottish social democracy stone dead.

However, both the Scottish government’s Fiscal Commission report and GERS show that Scottish debt and deficit levels are currently lower than those of the UK as a whole – and on the basis of Kemp’s oil estimates, they are likely to remain so for the foreseeable future.

More importantly, though, I simply don’t accept that Scotland’s debt, which is expected to reach upward of 70 per cent of GDP by 2017, is, in the short-to-medium-term at least, “unsustainable”. In fact, I’d argue that any responsible independent Scottish government should borrow more in order to finance new capital expenditure programmes. If this results in increased borrowing costs then so be it. The long-term effects will be beneficial, and we will have avoided the social vandalism wrought by Osborne’s cuts.

George is right, of course, to say that Scotland faces significant financial pressures. They are the same or similar pressures faced by the UK and the most of the world’s developed economies. But Scottish debt should be reduced over a period of 10 or 15 years, not two or five, with tax increases for the wealthiest ten per cent, higher corporation taxes and new levies on the financial sector. To argue that independence will result in cuts to Scottish expenditure so severe as to be terminal for the Scottish welfare state is to accept the narrative of the tartan libertarians – and of libertarians south of the border, too.

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  1. HMG’s announcement has nothing to do with Scotland’s mythic sovereign debt and everything to do with stating the obvious to assuage the fears of creditors – that the external debts of the continuing state belong exclusively to the continuing state.

    Per their publication of their legal opinion last year which became the foundation of Number 10’s policy with respect to matters constitutional and Scottish, HMG’s asserts (in Part IV of that document) that Scotland ceased to be in 1707 when it was absorbed into England, that the titles “United Kingdom” & “England” are synonymous, referring to a continuing indivisible unitary English state.

    In shorthand, England IS the UK and the UK is England. There is no such country as Scotland (so much for “states within a state”), and by extension no Scotsmen – we are all English men and woman. After all, we were all born in England according to HMG.

    Therefore in the event of secession of a portion of England AKA UK territory, England will be the continuing state, whilst that part of its territory that will secede will be an entirely new nation.

    The continuing state is deemed to be the original state obligated under treaties and agreements, AND responsible for ALL sovereign debt (since it is its name on the IOUs they sold to bond holders).

    The new state to be (Scotland) has no liability for any sovereign debt owed by the continuing state. There are no instruments of external sovereign debt with Scotland’s name on them. Scotland not only would NOT be liable for any portion England’s sovereign debt, it COULD not be liable for any portion of that debt.

    How could it? Scotland as a new state will have signed no promise to pay and has no contract with bond holders of that sovereign debt. Scotland is born free and clear.

    Now were Scotland to be deemed a SUCCESSOR state along with England (as it obviously is) then it WOULD be liable for its portion of UK sovereign debt.

    It would also inherit the rights and obligations of treaties and agreements entered into on its and England’s behalf by the (by then) defunct United Kingdom.

    However as noted HMG insists there is no basis for the reemergence of two successor states since Scotland was “extinguished” (HMG’s term) in 1707.

    HMG until ysterday nevertheless INSISTED that Scotland, even as a new state, WOULD be liable for a portion of UK external debt, leading incredulous creditors to fear that HMG may pull a fast one and not honour its entire obligation.

    Creditors did not fear Scotland would not honour its sovereign debt, but that ENGLAND/uk would renege on part of ITS sovereign debt by claiming Scotland owes bond holders ~ 100 billion of it. Creditor response was “sod that for a game of soldiers” and threatened to discount Treasury paper.

    Confidence was thereby undermined in the promises of HMG to live up to its pledges to repay its debts. Thus the degree of perceived RISK associated with underwriting UK sovereign debt increased, causing upward pressure on interest rates.

    THIS is why HMG made this statement assuring the markets that it is responsible for ALL UK sovereign debt. It was stating the obvious that the continuing state, England/uk, will be liable for ALL England/uk debts.

    The bond holders are well aware they have no contract with Scotland, that Scotland owes them nothing, and that they could not pursue Scotland in ANY court ANYWHERE to pay the debts of another country.

    1. If that’s correct about Scotland having been written off with the Union it’s remarkable. I’d always thought the idea was to have NB and SB, but that lapsed when SB never played the game, though I just remember letters addressed to NB.

  2. FlimFlamMan says:

    As ever the first question isn’t being asked: what currency would an independent Scotland use? It has to be the first question because the nature of the constraints that Scotland would face are vastly different depending on the answer. SNP policy is that Scotland would continue using sterling, but what would actually happen has yet to be decided.

    If Scotland does continue with sterling then it will lack control over the currency it uses, and government debt servicing, along with all other economic activity, will depend on the acquisition of that now foreign currency.

    This need to acquire currency will require constant current account surpluses, which in Scotland’s case will mean continued large scale oil exports. Any hopes or plans to move Scotland to a renewable energy based economy will be lost, since those plans cannot guarantee the export surpluses needed to acquire sterling.

    In this situation Scotland would indeed be subject to the dangers of credit ratings and interest rates set by markets, both for whatever obligations are negotiated with the UK government regarding existing debt, and, if oil exports aren’t enough to guarantee a current account surplus, for new debt issuance.

    If Scotland issues its own currency then the need for constant CA surpluses goes away, opening the door for a concerted and rapid drive to renewables and away from oil. Worries about credit rating and new debt issuance go away too.

    What might get slightly more complicated is the negotiation over existing debt, since now two currencies are involved. As I’ve said before though, bond traders – including bond desks at major banks – are usually not idiots. The prospect of a newly independent Scotland investing in its people in general, and the build-up of significant renewables based energy generation and engineering in particular, will not scare them.

    There would likely be a significant number of holders perfectly willing to trade their sterling bonds for bonds denominated in the Scottish Pound – or whatever the new currency is called. This effectively cuts the UK government out of the negotiations, or at the very least weakens any advantage they may otherwise imagine they have.

    1. “As ever the first question isn’t being asked: what currency would an independent Scotland use?”

      That question IS being asked each and every day, ad nauseam, and the answer is it will continue to use its own currency – the British pound.

      “What might get slightly more complicated is the negotiation over existing debt ,,,”

      Scotland, if it is as HMG asserts, a new state, will have no existing sovereign debt – how could if its just come into existence?

      All IOUs issued to the holders of UK Treasury are the exclusive responsibility of the United Kingdom as the continuing state. It was the UK that issued the gilts and it is the UK that is the debtor state.

      The fact that a part of England-UK territory has seceded to form a brand new never-in-300-years-existing nation, is irrelevant. We know that because in the UK legal opinion published last year HMG told us so.

      HMG insisted and continues to insist that Scotland will not be a successor state (because that would make England a successor state too) which by definition would be heir to the assets and liabilities of the UK. The UK will continue on its merry way as the CONTINUING state we’re told. As such, Scotland has zero liability for UK debt.

      Now if on the other hand, Scotland is to be a successor state, it along with England will be members of the EU and both will have to negotiate an adjustment of status WRT the size of their contributions, representation, et al. Scotland will also be liable for a portion of UK external debt.

      However, until Scotland is acknowledged as an equal in this divorce, that the Union is dissolved yielding two successor states, I see no reason it should entertain the absurd suggestion that it is heir to the UK’s debt but has no clam to its assets INCLUDING the rights and privileges of UK INTER-state treaties and agreements entered into on its behalf by the former UK.

      1. FlimFlamMan says:

        “That question IS being asked each and every day, ad nauseam, and the answer is it will continue to use its own currency – the British pound.”

        It doesn’t get asked when questions of debt come up, despite the fact that it changes the answers to those questions. After independence the British pound – if that is what is used – won’t be Scotland’s *own* currency, merely the currency it uses.

        “Scotland, if it is as HMG asserts, a new state, will have no existing sovereign debt – how could if its just come into existence?… As such, Scotland has zero liability for UK debt.” etc.

        HMG’s insistence that Scotland will be a new state, if accepted, determines who will held to be the issuer of current UK debt. The treasury announcement makes clear their policy that it will all remain UK – rUK or whatever – debt.

        That does not remove Scotland’s obligation to service at least some of that debt, it simply means that the Scottish government’s obligation will be to the rUK government, not to the bondholders. The exact nature of that obligation will also be subject to negotiation. This is not disputed in Holyrood: current Scottish government policy is to accept “Scotland’s fair share” of UK government debt, provided Scotland also gets its fair share of assets.

        “… I see no reason it should entertain the absurd suggestion that it is heir to the UK’s debt but has no clam to its assets…”

        I agree; I’m not disputing that at all. I’m pointing out the dangers and advantages of being a currency user or a currency issuer.

      2. @FlimFlamMan – ” I’m pointing out the dangers and advantages of being a currency user or a currency issuer.”

        Understood.

  3. CW says:

    ‘(Separately, am I the only person not remotely upset by the prospect of having to flash a passport at Carlisle or Newcastle?)’

    No, I would not be upset by this either, and I am mystified by its apparent potency as an argument.

  4. Alistair McIntosh: “If that’s correct about Scotland having been written off with the Union it’s remarkable. ”

    Oh yes, it’s true alright.

    The whole purpose of this convoluted and (in my view, entertaining) legal opinion is to set England up as the continuing state. That is a requirement if England is to keep its current EU waivers and exemptions. It is also likely the only way it gets to keep the UK seat on the Security Council. That’s what motivates them.

    The truth is that with the dissolution of the Union, its associated acts of parliaments and any INTRA-state treaties and agreements contingent upon it, its principals should reemerge as two SUCCESSOR states, the Kingdom of Scotland and the Kingdom of England, each heir to the rights and responsibilities pursuant to any INTER-state treaties and agreements made on their behalf by the (by then) defunct United Kingdom.

    This would mean that as successor states, both Scotland and England would be members of the European Union but would require to submit to technical adjustments of status and renegotiation FROM WITHIN the EU.

    The same would apply to the countries relations with the UN, and here England’s hubris and delusions of grandeur meets the nettle of the defuct UK’s seat on the Security Council as a permanent member with veto power. As one of two successor states rather than THE continuing state, does she, a middle-ranked nation of 55 million souls, inherit the UK’s chair?

    Below is a link to the document and below that is a cite to a couple of actual bulleted statements in Part IV containing the offending language about Scotland’s demise in 1707 and how :

    1) UK-shmoo-K (they do a lot of hand-waving) it’s England by any other name.

    2) How the Treaty of Union, even though it was the internationally recognised bilateral agreement that joined the two countries and created the political and legal entity called the United Kingdom of Great Britain, doesn’t have ANY relevance whatsoever when considering the terms of the divorce.

    I urge folks interested to read the entire insulting document. That’s necessary to appreciate the Pythonesque quality of it – it’s pretty lightweight since IT’S FULL OF HOLES!!! 😉

    Enjoy.

    https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/79408/Annex_A.pdf

    part iv 37 – how Scotland
    part iv 95

  5. bellacaledonia says:

    Passports at Carlisle? No problem. It’s an old cliche that is just meant to scare people. Who cares?

  6. Michael says:

    I holiday frequently in Switzerland which of course is not in the EU. It’s possible to travel to Italy(in the EU) without ever showing one’s passport or undergoing any border formalities. On the main motorway from Italy to Switzerland all vehicles are stopped but this is to ensure that drivers have purchased the permit that allows them to drive in Switzerland, the function of the permit is to compensate Switzerland for the use of its roads by millions of foreign drivers who use the country as a route over the Alps. When it’s possible to travel into and out of the EU without showing one’s passport it is clear that there is no real possibility that passport controls would be erected at the Scotto-English border within the EU especially in view of the fact that they don’t exist at the UK’s existing land border with the RoI. Just more scaremongering nonsense.

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