Brexit, Growth and Crash Economics
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.