The National:

This is the latest edition of the free newsletter from Scotonomics. To receive it direct to your inbox every week, please click here.

One of the founding concepts of Modern Monetary Theory is sectoral balances. And its power lies in its simplicity. Every economy can be broken down into three sectors: The government sector, the private sector (which includes me and you) and the foreign sector. Assuming a balanced budget, then government spending increases our net-wealth. A government deficit is our surplus.

The Australian Modern Money Lab maintains sectoral balances for most nations. Visit the website and choose any nation. You have more than a 95% chance of seeing an economy with the government consistently running a deficit. Here is the UK’s sectoral balance from 1990 to (projected) 2028.

The National:

Notice that what appears above 0 is a mirror image of what lies beneath. By definition, one sector's deficit is another's surplus. This is the simplicity. It is an accounting identity. Overall income must equal expenditure. Any surplus of income over expenditure by one sector of the economy – private, public or foreign – must be balanced by deficits elsewhere.

You will notice that the UK Government balance is historically in deficit (in red) below zero, as is the case for all but a handful of oil-rich economies like Saudi Arabia and Norway.

Also, notice that the UK has a trade deficit (above zero in blue) again, as is the case for all but a handful of oil-producing nations and a few export giants like China.

READ MORE: How to hamstring Scottish economy after independence

What the sectoral balance tell us about the UK economy

Every year, the foreign sector runs a surplus in our economy: The value of imports is higher than the value of exports. As we import so much, we have two choices. Either the private sector (me and you again) finances that foreign surplus or the government does. On most occasions, thankfully, the government does the deficit spending instead of us. But this isn’t always the case.

Zoom in on 2015 to 2019, and you can see the grey boxes below zero. For five years, it was the private sector that did part of the deficit spending. Over that period, we started to draw down our net financial wealth. The government took most of the slack, but we went into more debt to create a surplus for the foreign sector. UK private debt reached £3 trillion for the first time in 2015. By 2019, it was £3.4tr.

It is no coincidence that there was a private sector deficit in 2006 and 2007 preceding the great financial crash. Private sector debt is much more dangerous for financial stability than public sector debt. As a currency issuer, the government can always pay off debts in its own currency. That is not the case for me and you. Debt can lead to insolvency.

READ MORE: Scotonomics: Moving past straw-man version of Modern Monetary Theory

Where would we have been without massive government spending during Covid?

In 2020 and 2021, private sector net financial wealth increased and was mirrored by government deficit: Of course it was. As the foreign sector has a surplus, the deficit spending could only come from the government. If the government didn’t spend, collectively, we would have all eaten into our financial wealth as we emptied or cashed in all of our savings. The government deficit was our surplus.

Very importantly, sectoral balances tell us nothing about who in the private sector is taking all of this government spending. But there are other tools for that. As well as showing that government deficits are normal, needed and good for us, sectoral balances are useful for one more thing.

Sectoral balances show the madness of fiscal deficit targets

The underlying assumptions behind fiscal targets are neoliberal ones, principally that government spending is bad and that without rules, governments will "spend too much money". Or, as we have outlined above, "create too much financial wealth for their citizens".

The EU’s fiscal rules are among the most well-known. They were abandoned during Covid-19 but will be back in 2024. They stipulate that deficit spending can be no more than 3% of GDP each year. So, if the foreign sector runs more than a 3% surplus in your economy, it is the private sector that must take the hit. In other words, more grey beneath the zero. These rules ensure that the EU is a tough place for small nations that run a balance of payments deficit. The rules limit the fiscal space. However, it is the price that the small nations are willing to pay for the benefits of being a member of the EU. They take the pain along with much of the relief.

Scotland’s economy is similar to most of those small EU members, with a significant balance of payments deficit. But get this: Once we are independent, we don’t need to wait to take the pain delivered by those fiscal rules, and we don’t want any of the relief. According to the Scottish Government’s "A Stronger Economy with Independence", we will volunteer to mirror the EU’s fiscal rules before we join.

It says: “We would propose, for the period before Scotland re-joins the EU, fiscal rules that were, as far as possible, aligned with the principles and the approach of any future EU Stability and Growth Pact. Meeting existing Stability and Growth Pact criteria is not a precondition for joining the EU."

The current plan for an independent Scotland is to sign up to rules (that no one is asking us to sign up to) that will almost certainly ensure that the Scottish public must reduce their net financial wealth to cover the foreign sector surplus in our economy.

All the pain without any of the relief.

We would call the current plan madness. But we are volunteering for this. We simply don’t know what to call that! We are open to suggestions.