Brexit, Growth and Crash Economics

A SCOTTISH CONUNDRUM: HOW TO GROW WHEN YOU HAVE FULL EMPLOYMENT?

THE latest Fraser of Allander Institute (FAI) report garnered a lot of media interest with its prediction that a “disorderly” Brexit would precipitate a full-blown recession in the Scottish economy.

The report reminds us that over 45 per cent of Scotland’s international exports are to the EU, supporting circa 144,000 jobs. Any interruption to market access would be catastrophic in the short term. A sudden hard Brexit would see output fall by between 2.5 per cent and a disastrous 7 per cent, unemployment jumping by around 100,000.

These are serious numbers from a think tank that is normally quite conservative in its analysis. However, a hard Brexit, while eminently possible in the current Westminster fog, is on balance unlikely – there is no majority in Parliament for a WTO exit. Unless a lot of centrist Brexiteers in the Conservative and Labour ranks panic and vote for May’s deal, we seem destined to remain in political limbo.

Even here, FAI are gloomy. On a “muddling through” scenario, the Institute still forecasts weaker than in their previous report. They predict growth of only 1.1 per cent of GDP this year, followed by an uptick to 1.4 per cent next year and 1.5 per cent in 2021. Note: that’s two years of below average growth followed by a return to just the bog standard 1.5 per cent Scotland normally achieves.

If borne out in practice, these growth numbers are significant. The Scottish economy is already operating at record full employment. In the three months to February, Scotland’s jobless total was only 3.3 per cent – well below the UK figure of 3.9 per cent. Of course, this is due in part to mature folk being forced into the labour market by having to wait longer for pensions.

But it also means the Scottish economy has no reserve of workers to call on – especially if the threat or actuality of Brexit reduces the size of the immigrant workforce.

A potential labour shortage impacts negatively on growth. If you don’t have the extra workers, you can’t increase economic growth without replacing labour by capital. In other words, higher growth becomes dependent on greater capital investment. But where is the cash coming from?

WHERE WILL INDY SCOTLAND GET CAPITAL INVESTMENT?

This brings us back to our old nemesis, the SNP Growth Commission. The Growth Commission targets an increase in growth from the Scottish average of 1.5 per cent to nearer the 3 per cent achieved by other small EU industrial economies. The question is: how do you double Scottish economic growth when you already have record full employment?

To date, Scotland has relied heavily on foreign inward investment. In 2017, Scotland was ranked 2nd in the whole UK in terms of foreign investment projects secured during the previous five years. There are some 1,000 enterprises in Scotland whose parent company is located in another EU country. The least one can conclude is that any sort of Brexit, or Brexit-related uncertainty, threatens this source of investment capital, never mind produce extra.

It is hard to see where we will find alternative sources of capital investment to double growth unless it is from inside Scotland and state-led. Which, of course, brings us back to the currency question.

Let’s start with a scenario in which an independent Scotland continues to use the pound Sterling for a while, though outside an agreed, official monetary union with rUK. This is the proposal outlined in the Growth Report and enshrined in the Mackay-Brown motion to SNP Spring Conference.

Of course, Scotland could go on using Sterling and no one could stop us. But the longer we did so, the more problems and dangers would accumulate. To begin with, the Scottish government could only borrow by issuing bonds denominated in Sterling (or the euro or dollar). Interest would be paid in that foreign currency. So the degree to which we could borrow abroad would be limited by Scotland’s ability to acquire foreign currency through exporting. We might also have to pledge collateral in the shape of public assets – as tiny Montenegro has done with Chinese loans.

This procedure would constrain our abilities too boost investment and growth. We would likely find ourselves in a negative feedback loop. Without access to significant foreign capital, Scottish economic growth would remain stuck around the historic 1.5 per cent. To go on borrowing abroad in a foreign currency, we would have to meet stringent fiscal requirements set by creditors – meaning strict limits on public spending and even slower growth.

There’s worse. Using Sterling in an independent Scotland means the Scottish monetary authorities would be unable to deal with a major banking crisis. If the banking system fails – as it did in 2008 – the monetary authorities must step in and create extra liquidity to pump into the financial sector to maintain confidence. In the UK and US, the central banks created that extra liquidity by increasing their own liabilities – essentially printed money.

A Scotland restricted to using Sterling (rather than create its own currency) would not have this option. It would not be able to withstand a systemic banking crash as it would have no mechanism for creating new financial assets to provide urgent liquidity. I predict this problem will become a front-page issue during any second independence referendum. Which is why I recommend we create our own independent currency during the first post-indy parliament.

Comments (9)

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  1. Mark Bevis says:

    Even a growth rate of a “mere” 1.5% is a doubling of the economy every 45 years, so in one generation you would have to double your energy sources and energy expenditure, double your total work hours, double your total monetary supply. Accompanied by increased population, increased resource depletion, increased urbanisation and transport resources. A growth rate of 3% is a doubling every 24 years.

    How much land do you intend to sequester from the sea to put all the grains, sheep and cows on that this increase will demand in feed, in an era of rising sea levels?

    With the current decline in Scottish population, Scotland has a unique opportunity to present a managed Degrowth to the world during the sixth mass extinction. Who knows, Scotland may well harbour some of the last surviving enclaves of the species. By all means, I fully support the adoption of a unique currency, it will give Scotland more flexibility in dealing with the predicaments en route.

    1. Tim Rideout says:

      Mark, you are mixing up inputs and outputs. GDP is simply the money value of the goods and services produced domestically in the economy. It does not say anything about the physical quantity of anything. If I stay in a 5 * hotel rather than a B&B it will more than double my contribution to GDP although it is still one room and one breakfast. Making things more efficient allows GDP to rise without any increase in inputs. So for example LED lights mean we can either have the same amount of lighting for a quarter the energy input or four times as much light for the current energy. Thus although there has been substantial money increase in UK GDP since 1990, the energy input has not increased. In the UK we actually use less land for active farming now than we did a hundred years ago, but with substantially higher agricultural output. GDP is not a very good proxy for human wellbeing, so we should develop other measures. But I would also say that in almost all natural systems if they are not growing or moving forward in some sense, then they are dying. I think personally that if you go by the Gaia theory then the Earth is approaching the point at which it flowers and seeds. By that I mean humanity (and everything else as our baggage) have to expand to somewhere else, i.e. initially into the Solar System and ultimately beyond. If we mess that up and fail to achieve it then humanity will have turned out to be a dead end and Nature will try another approach (without us!).

  2. Wul says:

    Mark beat me to, it but I wanted to question the assumption that we need to grow our economy every year. Is it no longer possible to run a modern country on 0% growth? Serious question. Perhaps it isn’t?

    My small business feeds my family and runs my household. I have no intention of “growing” it or “expanding” or “increasing my “market share”. I get by, I’m safe & healthy. Isn’t that enough? Why would I want to work harder & longer hours?

    Unless we can find a planet that grows it’s natural resources at 3% per annum, any continuous growth strategy will kill us all.

    George Monbiot once pointed out that, had the ancient Egyptians grown their civilisation at 3% per annum, we would now need a planet size of several million solar systems in diameter to contain it. Probably not possible.

    1. Me Bungo Pony says:

      Monbiot’s claim makes for a dramatic figure, but economic growth does not need a concomitant growth in population or, obviously, area. In 1970, Scotland’s GDP was only £3.6bn compared to around £152bn in 2017. In this time, Scotland’s population remained broadly static and, of course, the area did not increase at all.

      I’m not saying “hooray for capitalism” here. I’d say social democracy and increased productivity due to science and innovation has had a far bigger impact than the heedless pursuit of wealth at all costs. Capitalism is a useful economic tool to incentivise people to get involved in business and encourage investment, but it is not the only economic methodology and it is not the sole ideology to build a country around. Britain between 1800 and 1945 is proof of that.

      However, whatever economic model the World comes up with within the boundaries of the globe, including anything Extinction Rebellion can suggest, will ultimately fail as resources are finite but we will constantly require new sources …. forever. Population control and extra-terrestrial sources are human-kinds only hope, and that will take A LOT of science, innovation, investment and education to achieve.

      As an example of a “possible” future economic model from “the arts”, has anyone watched “The Expanse” on Amazon? It’s brilliant 🙂

      1. Me Bungo Pony says:

        As a correction, and a bit of a side-swipe at the Labour Party, Scotland’s “area” actually shrank in the time between 1970 and 2017. Labour’s imposing of the Scottish Adjacent Waters Boundaries Order 1999 saw around 6000 square miles of Scottish waters go to England. Thanks Labour; always looking out for Scotland’s interests …. aye right!

  3. tartanfever says:

    I have serious doubts that the unemployment figures suggested in the UK are accurate.

    If our employment rate was really that high, wouldn’t we expect to see wage inflation and quite a dramatic rise in tax receipts ?

    Even the ONS have admitted in recent years (2017) that these official figures do not include part-time workers who want full-time jobs, “inactive” workers alienated from the workforce, people who retire, students, or those who work in the home.

    1. Today you are classed as ‘employed’ if you work one hour a week. The unemployment figures mask thousands of people on precarious, part-time, low-paid, zero-hours, gig-economy work

      1. tartanfever says:

        Blimey, how did I forget to mention that. That just makes a bigger mockery of official figures.

        1. Wul says:

          Apparently the great Mrs Thatcher re-defined the meaning of “unemployed” thirteen times during her term in office.

          It seems to be a peculiarly Tory problem, not knowing what ’employment” really means. But, then again, perhaps many Old Etonians think that one hour of work per week actually does qualify as a job.

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