Growth report lacks the detail required to settle currency issue

THE SNP’s Growth Commission finally reported on 25th May. The report has been long in gestation, and represents a substantial body of work – not to be commented on quickly, or lightly.

And there are points about it that ought to be welcomed. As regards the absolutely key question of currency, it attempts to repair the damage done in the SNP’s referendum white paper, where the ill-judged proposal that an independent Scotland should remain in a currency union with rUK was instantly blown out of the water when George Osborne said no – taking any chance of success in the referendum with it. The Growth Commission report is also much more realistic in tone than the White Paper – recognising the transitional difficulties in achieving a stable and prosperous independent Scotland.

And yet, despite these plus points, the Growth Commission report is still a severely flawed document – deserving of one and a half, rather than three, cheers. This note argues that there are two failings in particular in the document. One is the failure to be sufficiently radical, and to identify those areas where radical policy decisions will be absolutely essential if Scotland is to have any chance of managing the transition to a successful independent economy. And the other problem is the report’s curiously relaxed attitude to timing, which fails to recognise the adverse dynamics of the position Scotland is now in. Both problems, at root, relate to different aspects of the currency problem: so that is where this note starts.

The Growth Commission’s position is that a newly independent Scotland would, initially at least, use sterling as its currency – but not as a member of a currency union with rUK. To make this work, the economy has to earn enough sterling on its external balance to stop the economy deflating: and it has to reduce the deficit on the government’s account, (the difference between government expenditure and revenues), to a sustainable level – say 3% of GDP or less. The former requirement is assumed to be met by an aggressive export drive.

The latter, by relative fiscal stringency, accompanied by stable growth in the economy. More specifically, the Growth Commission assumes that the Scottish economy achieves what it sees as Scotland’s trend level of GDP growth of 1.5% in real terms, with inflation at 2%: then if public expenditure were to grow at 2.5%, (representing real growth of 0.5%), then the government’s deficit would shrink relative to GDP.

The Commission estimates that, after between five and 10 such years, the deficit would have reduced to a sustainable level of less than 3% of GDP.

At the same time, an independent Scotland would have put in place the necessary infrastructure of a central bank, and a financial regulatory system. And in due course, it might decide to go the further step of establishing its own currency.

This overall scenario looks challenging – but do-able. But where the Commission report is light is in the detail. For example, the critically important area of currency only occupies 31 pages out of the report’s 354 pages. And one of the areas which is not gone into in anything like adequate detail is how Scotland is going to obtain sufficient reserves, or other forms of backing, to enable it to support its use of sterling during the initial transition period.

In the last resort, since Scotland will initially have limited reserves, this support will have to be achieved by borrowing. And ultimately, the security for that borrowing must be the Scottish Government’s ability to persuade the markets that it can grow, and benefit from, the resources of the Scottish economy.

This is where fundamental changes are needed. In the UK, it would be easy to form the impression that the state exists primarily to serve the interests of specific privileged groups – particularly the owners of capital and land – at the expense of the revenues of the state, and the interests of common people. How else could one explain the generous taxation regime for North Sea oil companies; or the way landowners have been able to profit hugely from unearned rent on renewable energy; or the insanely generous, to the private investors, terms under which various forms of public private partnership have been set up; or the amount of tax, in relation to whisky and other industries, which is paid outside the UK – or not paid at all. And so on. It is these sorts of relations which an independent Scotland would have to demonstrate that it is able to modify, if we are to convince the markets that we are actually serious about securing our own resources, and the basis of our economy. This is where constructive radicalism is needed: and where the Growth Commission, which is too concerned with structures rather than policies, fails.

But the Growth Commission also fails to grasp the urgency of the position Scotland is now in – and this, in an odd way, also comes back to the question of currency. In one of its wilder asides, the Commission states that Scotland and the rest of the UK remain close to an optimal currency area.

This was never the case – as Scotland’s long history of relative population decline within the Union attests. But any pretence that the UK was a well-managed currency area disappeared for ever in 2016, with the agreement of the disastrous post-referendum fiscal settlement. The new system is unstable, and is likely to push Scotland into a cycle of economic decline.

This is because the abatement to Scotland’s block grant is indexed to the rate of growth of per capita tax receipts (most importantly, income tax receipts), in the rest of the UK. In effect, the new system pushes Scotland into an economic race with rUK – and if Scotland starts to lag behind, it will then be aggressively penalised, which could make the whole process self-perpetuating and unstoppable.

There are already hints of what might happen the latest report from the Scottish Fiscal Commission. This recorded a downgrade in Scotland’s projected income tax receipts for 2018/19 of £208 million. This was bad enough. But the Fiscal Commission report should really be read in conjunction with a subsequent blog by the Fraser of Allander Institute, which looked in addition at what was happening with the block grant adjustment, (BGA). And because the Office for Budget Responsibility in its last forecast revised up its forecast of rUK income tax receipts, the BGA has been increased, so further penalising Scotland.

As the Fraser blog states: “In fact, the outlook for the Scottish Budget has worsened in two ways since a few months ago. Not only has the forecast for income tax been revised down by £208m, but the BGA has been revised up by £181m. The net effect of these two revisions on their own is that the Budget is £389m worse off than a few months ago.”

Furthermore, as the Fraser blog notes, this pattern of revisions is effectively repeated in future years – e.g, the outlook for the Scottish Budget in 2019/20 is now around £400 million lower than it was in February.

The important point to note is that Scotland’s current position within the UK currency union is unstable, and likely to be unsustainable. Things need to change before irreparable damage is done to Scotland’s economy.

And this is where the Growth Commission’s laid-back attitude, taking the best part of two years to produce a report saying that we may get independence some-day, and failing to get stuck into the detailed planning, is inexplicable.