It’s NOT All about Pounds and Oil
“We shall not rebuild civilization on a large scale. It is no accident that on the whole there was more beauty and decency to be found in the life of small peoples, and that among the large ones there was more happiness and content in proportion as they had avoided the deadly blight of centralization. Least of all shall we preserve democracy or foster its growth if all the power and most of the important decisions rest with an organization far too big for the common man to survey or comprehend. Nowhere has democracy ever worked well without a great measure of local self-government, providing a school of political training for the people at large as much as for their future leaders. It is only where responsibility can be learned and practiced in affairs with which most people are familiar, where it is the awareness of one’s neighbor rather than some theoretical knowledge of the needs of other people which guides action, that the ordinary man can take a real part in public affairs because they concern the world he knows. Where the scope of the political measures becomes so large that the necessary knowledge is almost exclusively possessed by the bureaucracy, the creative impulses of the private person must flag. I believe that here the experience of the small countries like Holland and Switzerland contains much from which even the most fortunate larger countries like Great Britain can learn. We shall all be the gainers if we can create a world fit for small states to live in.”
Friedrich Hayek, The Road to Serfdom (1944), Chapter 15 (emphasis added)
Austrian economist and political philosopher Friedrich A. Hayek
(Photo credit: unknown)
“Much of the reclaimed sovereignty would be purely notional, and some would be the sovereign power to mess things up”When we are asked why we support Scottish independence our immediate answer is that it is time to for Scots to take responsibility for their own affairs, quit moaning and break the notion of dependency with which generations have grown up. We never think purely in terms of an economic calculation – whether independence would make Scots in general better or worse off by a few pounds. That is to misunderstand the whole rationale for independence.
Bill Emmott (former editor of The Economist writing on Scottish independence), Financial Times Comment, 8 August 2014
We rarely try to explain to questioners that it is also in keeping with our whole philosophy of economics, politics and society. As we have noted in bold in the quote from Friedrich Hayek, one of the truly great observers of political economy and social philosophy, “it is the awareness of one’s neighbor rather than some theoretical knowledge of the needs of other people which guides action, that the ordinary man can take a real part in public affairs because they concern the world he knows.”
But equally – and this is the whole point – we agree with Bill Emmott: “…reclaimed sovereignty…would be the sovereign power to mess things up”. All countries have the right to make their own decisions even if that results in messing things up, at least in the first instance. In one of our country reports from 2013, Mongolia: Chaos In Action, we wrote that Mongolia, population of 2.9m, was a country in a hurry…
“…but, when combined with a traditional animosity towards foreigners, particularly Chinese and Russians, and the exuberance of Mongolian politics it is a backdrop which leads to lurches in policy positions as well as hasty decisions that produce more unintended consequences than results. In short, Mongolia’s economic immaturity is only matched by its political immaturity. It is a country in a hurry to go places but, like the traffic, it is stuck because of inadequate infrastructure, both physical and human. Not all resources are physical and, arguably, a country’s greatest resource is its people. That does not always go for its politicians and bureaucracy, as we are about to see.”We likened Mongolia’s young, vibrant and chaotic democracy to a process of trial and error where hasty decisions were taken, often without thinking through the consequences, and then reversed a few months later. Having a small, concentrated population where political and economic policy decisions fed through quickly to the general public meant that the pressure to rectify mistakes was fast and intense.
We are not comparing Scotland to Mongolia. But we know one thing for sure though, Mongolians would fiercely defend their right to make those mistakes of their own accord. In fact, we know of no countries that we visit, or nations around the globe, that do not rejoice in the ability to make their own decisions and take responsibility for their own actions.
For example, we doubt if an independent Scottish government would voluntarily take the decision, as is the case today, to have the largest concentration of nuclear weapons in Europe stationed just 25 miles away from Glasgow, the country’s biggest center of population. Scottish independence is not all about economics.
But even if it were all about economics, the evidence is good that small units, such as Scotland, rank high in global terms. Figure 1 shows the 11 countries AAA-rated for sovereign debt by Fitch Ratings and their respective populations.
Standard & Poor’s ratings exclude Austria, the Netherlands and the United States from the AAA list but include Hong Kong (population 7.2m), Lichtenstein (37,000), Sweden (9.6m), Switzerland (8.0m) and the UK (63.9m). Moody’s includes the Isle of Man (87,000) and New Zealand (4.4m). It is otherwise the same as Fitch although it also rates Lichtenstein AAA.
In summary, if there is one thing you want to be in order to get AAA rated it is small. That fits much more closely with Hayek’s optimistic vision of the world than Emmott’s downbeat pessimism.
Eilean Donan Castle, Scotland
(Photo credit: unknown, via imgur.com)
Having said that, a number of large companies have voiced open concerns about Scottish independence and their own future, or at least some of their assets and investment if not the future of the company as a whole, in an independent Scotland. This has frightened many people away from the independence camp. These companies include multinationals such as BP and Shell and finance giants such as Standard Life and the Royal Bank of Scotland (both of which are headquartered in Scotland).
The American-born CEO of BP is on record as warning that Scottish independence represented a “question mark” for the firm because of the “uncertainty” that it involves (he was speaking in a personal capacity but that was never reported by the anti-independence media i.e., almost every single newspaper and broadcaster, in Scotland. BP’s Chairman, subsequently, was at pains to reaffirm the company’s investment schedule even in the wake of a ‘Yes’ vote).
But just think about the CEO’s comments for a moment. The head of a multinational oil company which has investments in countries like Russia, Indonesia and Egypt is kept awake at night by the prospect of Scottish independence. It would appear that Alex Salmond, who runs a perfectly competent, business friendly devolved government already, is scarier than Vladimir Putin, retrospective taxes and contractual changes in Indonesia and revolution and political upheaval in Egypt. Could something else be at play here?
Financial service company executives have talked about relocating from Scotland before even seeing what the financial services regime would be like after independence. Not a single thought for shareholders as regards the massive costs of relocation or for staff well-being and quality of life (the lifestyle in Edinburgh, we can assure you, is quite superb for well-paid financial services staff).
Their objections do not stack up but perhaps there is a different agenda: large corporations like to deal with large states. It is in these states that they can exert most behind-the-scenes influence on technocrats, regulators and civil servants (admittedly, some large companies have committed to investing more in Scotland regardless of the referendum outcome). Let us return to Hayek:
“Where the scope of the political measures becomes so large that the necessary knowledge is almost exclusively possessed by the bureaucracy, the creative impulses of the private person must flag.”He could easily have added ‘and the interests and influence of the large corporation can be maximized’. In small countries the effort involved by large companies to buy relatively small influence is just too expensive. No wonder oil majors are wary of an independent Scotland and the prospect of a new North Sea tax regime; all the sunk lobbying costs from years of London activity would count for nothing. Likewise the influence the financial sector has on the Bank of England and other financial regulators. What these executives really mean is that Scottish independence would be inconvenient for them, regardless of the benefits (and costs) it might bring to everyone else.
But let us turn from the philosophical case for independence and concentrate on the economic issues which have become central to the referendum and outline our take on them.
To be continued tomorrow in Part 2: “The Currency – Sterling or Not?”
Dr. Jim Walker is the founder and chief economist of Asianomics Limited, an economic research and consultancy company formed in late 2007 and serving the fund management industry. He is also the owner of Forensic Asia, a bottom-up corporate research company which concentrates on financial stress and balance sheet health, and Chart Asia, a technical analysis unit which primarily focuses on trends in Asian stocks and markets. Prior to establishing Asianomics in December 2007 he was the chief economist at CLSA Asia-Pacific Markets. He joined CLSA in late 1991. Over the years Dr Jim achieved numerous ‘best economist’ rankings in the Asiamoney, Institutional Investor and Greenwich surveys of fund managers. Before coming to Asia, he worked in his native Scotland as a research fellow at the Fraser of Allander Institute for Research on the Scottish Economy, and then at The Royal Bank of Scotland’s Edinburgh headquarters. He holds a Bachelor of Arts Honours degree and a doctorate in economics from the University of Strathclyde, Glasgow.
The Currency – Sterling or Not?
For those of us living and working abroad, and especially in the world of finance, one of the most perplexing features of the debate on Scotland’s post-independence currency has been the misconception that somehow the successor state to the United Kingdom can stop Scotland using sterling as the medium of exchange. This has been the mantra repeated by leaders of all the major UK parties.Sterling is a freely-convertible, internationally-traded currency. It shares those features with a limited number of other currencies – the US dollar, the euro, the Australian dollar, the Canadian dollar and the yen (to name most). As such, sterling is available to any country in the world as a transactions and reference currency. So, unless the UK successor state intends to make sterling non-convertible (with dire consequences for the City of London) we can safely say that ‘sterlingization’ is not only a viable option but an attractive one given Scotland’s strong trading relationship with other parts of the UK, and vice versa. In this sense, Scotland would be making the same choice as the independent Irish government did post-1923 (Ireland operated a currency board arrangement with sterling between 1927 and 1979).
PT: A 50 pound note issued in Scotland. Currently, Scottish banks have to deposit an equivalent amount with the Bank of England if they want to issue notes – about £3.6bn pound sterling notes issued in Scotland are in circulation at present.
(Image source: The Royal Bank of Scotland)
The question of the availability of sterling for use as the transactional currency in an independent Scotland is therefore clearly established. It would be up to an independent Scottish government only to make that choice.
The deeper question is whether or not Scotland and the rest of the UK should form an official currency union, as proposed by the Scottish government in its White Paper (Scotland’s Future – Your Guide to an Independent Scotland,).
This would involve having Scottish representation on the Monetary Policy Committee (MPC) of the Bank of England and would mean Scotland revoking its right to set monetary policy on its own (more of that below).
Apart from formalising the partnership arrangement between Scotland and the rest of the UK – as long-standing trading ties would dictate – this relationship would achieve one thing that current arrangements do not. It would ensure that the views and conditions in a part of the currency area that are not dominated by London would be heard at all MPC meetings.
The current MPC is made up entirely of staffers and external members based in London and the southeast of England bar one – the US academic Professor Kristin Forbes, who is based in Massachusetts. Unlike the US Federal Reserve’s Open Market Committee and the European Central Bank’s governing council, the Bank of England’s decision makers do not reflect regional Federal Reserves’ or member countries’ inputs nor is there any necessary input from economists or decision makers with a non-London-centric view. Scotland’s inclusion in a currency union would add balance to the monetary policy decision process which currently does not exist.
The proposal regarding a post-independence currency union is a clear, mature recognition on the part of the Yes campaign of the reality of current trading relations. It would make sense for both successor states to continue this relationship in order to facilitate trading ties. Those that suggest that Scotland would ‘not be allowed to use the pound’, apart from being technically wrong, show scant regard for safeguarding jobs and relations on both sides of the border.
Alternative Options
However, the political reality – whether it would be maintained after a Yes vote or not is a different question – is that the Unionist parties oppose formal currency union. (The fact that denying Scotland the use of a shared asset would call into question the Scottish government’s current commitment to taking on its share of the UK debt, the corresponding liability, has not been broached by the leaders of these parties.) There are plenty of alternative courses of action open to an independent Scotland.The simplest alternative would be to adopt a sterling currency board – similar to the Hong Kong dollar’s relationship with the US dollar – at par. De facto the existing one-to-one currency relationship would continue although Scotland would have to establish its own monetary authority in Edinburgh and institutionalize rules around the functioning of the board. As to speed of implementation? Currency boards can be adopted overnight.
There would also be the possibility of Scotland applying for membership of the euro area – although given that system’s problems at the moment yet another member would not likely be welcomed with open arms – or simply establishing an independent currency. Denmark, Norway, New Zealand and Sweden all have independent, successful currencies despite two of them being members of the EU and the other two being resource-dominated economies.
This option is attractive to many nationalists and has merit in many respects. It would not be difficult to conceive although inevitably the exchange rate between the rest of the UK and Scotland would diverge, thus increasing transactions costs and disruption. As to which currency would strengthen relative to the other; that would remain to be seen – although with Scotland running a current account surplus and the rUK running a deficit, the odds would have to be on the Scots pound.
But it is important to admit that any ‘independent’ currency would be independent in name only. For a country that wishes to manage a fully-convertible currency, which Scotland would, it would mean coping with international capital flows and the domestic monetary consequences that these produce. New Zealand and the others we have mentioned do that very successfully but it is also true that the openness of the international economy reduces the flexibility of national exchange rate independence and monetary management around the globe. That reduces the flexibility of national exchange rate independence and monetary management around the globe. That is not an excuse or a rationale for the Scottish government’s currency union proposal; it is simply a fact.
As we have just mentioned, one thing that even an independent currency would not do is give Scotland control over its monetary policy. Sad to say, in today’s world, that is an option that no longer fully exists for anyone – not even for supposedly capital-controlled China.
Monetary Policy – Recognizing Reality
Figure 2 shows the range of one year Treasury bill yields for ten of the eleven countries rated AAA by Fitch Ratings. Austria, Finland, Germany, Luxembourg and the Netherlands are all members of the euro zone. Yields in these countries are all close to zero. The only country in the group where interest rates are not depressed to extraordinary levels is Australia.
The thought that Scotland could set its own interest rates in its own currency in isolation from the rest of the world is naïve. China, one of the few countries that have attempted to run an independent monetary policy behind closed capital account doors, has ended up with a disastrously distorted industrial structure. That will become clear over the next few years as it undergoes its own version of an emerging market crisis.
The fact is that fully convertible currencies and indeed almost all currencies with an open capital account, are forced to adopt interest rates close to global norms. If they do not, the opportunity for disruptive and speculative capital flows is set in motion.
We have seen criticism from some quarters of the No campaign that the currency union arrangement would mean that mortgage rates in Scotland would be set by monetary policy made in London. These critics of Scottish independence seem unaware (or unwilling to admit) of the fact that monetary policy is not made in London anyway.
Mortgage rates, along with most official interest rates, are set internationally. UK monetary policy is almost exactly the same as that prevailing in the US, the euro zone and Japan. That is not an accident. There is no such thing as monetary independence, even for the Bank of England.
But back to mortgage rates. Yes, the majority of mortgages on offer would probably be linked to interest rates set by the Bank of England. But that is where Scottish independence and the increased financial sophistication that will accompany it would be able to provide more choice for Scottish citizens.
In Hong Kong it is possible to buy property with a traditional mortgage, a mortgage linked to Hong Kong interbank rate or a mortgage linked to a variety of currencies. All that matters in these various products is that banks appropriately price risk and customers are aware of the pros and cons of borrowing different products and in different currencies. Just because Scots at the moment have little or no access to products such as multi-currency accounts, foreign currency mortgages and interest rate swaps doesn’t mean that that will be the case in the future, especially in a vibrant, internationally-oriented independent environment.
The critics of Scottish mortgage rates being set in England needn’t worry. They will be set as they are today but, in an independent Scotland, what is on offer will be determined by the ingenuity of financial institutions and the appetite for new and varied mortgage products by the Scottish people.
Fiscal Policy – The Real Difference
That leaves fiscal policy as the real difference between an independent Scotland and the rest of the UK. But what a huge difference that can mean. This is where choice, responsibility and independence of mind and spirit enter the equation. As Austrians, we would probably make very different choices from those set out in Scotland’s Future but, there again, we would make very different choices from those made in the UK, the US, Europe and elsewhere. (At the same time, we believe that we would have more opportunity to influence these decisions in a smaller administrative unit than we do today.)We have a philosophical problem with the Scottish government’s commitment to policies such as “free medical prescriptions”, “free university education” and the retention of public ownership of the Health Service. But our issue is with terminology and blind faith, not with the choices. In fact, these are good examples of the priorities that Scots in general espouse relative to the rest of the UK. Provision of medical treatment for all people in society, a commitment to education for the young and a functioning medical care system. These are all strongly supported public services in Scotland. As Hayek would put it, an awareness of what our neighbors want – who are we to argue?
Government provision of services is never “free”, however. Provision of these services means public expenditure cuts elsewhere – defense spending being one of the prime candidates for cutbacks (there is no reason for Scotland to have nuclear weapons or to maintain nuclear weapons bases). This probably goes a long way to explain the rather strange intervention of President Obama in the Scottish referendum debate when he declared his preference for the status quo. What he was really saying was, “we are happy with a nuclear submarine base near Glasgow because it suits us just fine.” (There is nothing which can explain the bizarre utterings of the Australian prime minister, Tony Abbott, when he urged a ‘No’ vote.)
Fiscal spending choices are a major attraction of an independent Scottish government and so too are fiscal revenue choices. Despite the popular (mis)conception of Scotland as a left-wing society the current Scottish government proposals include lowering the rate of corporation tax, rates relief for small businesses and halving of the air passenger duty (which would mean a reduction in costs for every passenger flying into Scotland of between GBP13-87). Currently air passenger duty is imposed centrally by the UK authorities in an effort to choke off demand for slots at London’s Heathrow Airport. Neither regional airports nor the Scottish Executive are allowed to vary the charge i.e., to compete.
In the area of oil and gas, much has been made of the drop-off in production which has taken place in the UK sector of the North Sea continental shelf. In the independence debate the UK Treasury and associated budget offices have used production declines – as well as questionable price assumptions – to show that Scotland would not be better off as an independent oil and gas-rich country (although the absurdity of that argument is simply beyond us). Suffice for us to say here that Professor Donald MacKay, an expert on the North Sea oil industry, has debunked the UK government’s case elsewhere.
But it is not just in official circles that information is distorted or suppressed. The existence of oil and gas deposits in the Clyde estuary has only recently come to light despite being known to the UK government for decades. Failure to exploit these important resources is entirely down to the existence of the nuclear submarine bases on the Clyde. Moreover, BP has had a major exploration success in the Clair field near Shetland. The company has shut down its exploration well and refuses to make an announcement – quite contrary to the norm in the industry – as to how many additional barrels this discovery is likely to produce in future years. However, even for a company extremely worried about the “uncertainty” of Scottish independence it has said that, “We intend to invest billions in the area in coming years.”
North Sea oil rigs off the coast of Scotland
(Photo via theguardian.com / Author unknown)
And what does the US Energy Information Administration (EIA) have to say about declining production in the UK sector?
“Since 2011, there have been a number of tax changes that affected production (or investment) in the United Kingdom Continental Shelf (UKCS), including the change in the rate of supplementary charge (an addition to the corporate tax) and the capping of relief for decommissioning costs at 20% of the supplementary charge. In addition, the tax rate for fields that are subject to petroleum revenue tax (PRT) increased to 81% of their profits (from the previous 75-percent rate), and fields that are not subject to PRT now pay a 62-percent tax (compared with the 50-percent rate in the past).
“As a result of the significant increases in taxes, the UKCS projects have become even less competitive. Increases in operating costs coupled with higher taxes have resulted in decreased investment in both brownfields and new exploration. Even without the increased taxes, operating costs in the UKCS were prohibitively high, exacerbated by the high decommissioning costs of old facilities, which also discourage investors.
“Almost immediately after the new tax rates were implemented, development on several start-ups was suspended, including Statoil's Mariner and Chevron's Bressay fields. In addition, Centrica launched a review of all of its exploration activities, as many projects were deemed uneconomical under the new rates. Given a nearly 16-percent decline in production following the implementation of the new tax rates, the UK government has introduced new incentives for producers to counter some of the increase in taxes.”
USEIA United Kingdom country analysis, Jul 14
A more imaginative tax regime with built-in production and exploration incentives – similar to that of Norway – would not be difficult to concoct. Maybe then BP and Shell – their lobbying investment notwithstanding – would be happy to stay in Scotland and invest much more. And with Trident cleared from the Clyde they could start making money and creating jobs in the west of Scotland too.
The Case Against
Too wee. Too poor. Too stupid. Too risky. In the run up to the referendum, these four charges are daily leveled against Scots who support independence. (Mr. Abbott has added the commentary that they are the enemies of freedom and justice – go figure.) Westminster politicians, their appointees who lead the Unionist parties in Scotland, the media (led by the BBC and the national press) and business people who should know better all trot out these banalities for why Scots should say ‘No’ on 18 September.It would come as a great shock to our many friends in Denmark, New Zealand, Singapore and Austria that they are too small to be able to run themselves. It would be an even bigger surprise to Filipinos, Indonesians and Thais that they would be deemed far too poor to be able to run their own affairs.
And as for ‘too stupid’, just what have Scots been doing for the last 500 years? Lying in their beds or making a sprinkling of contributions to things like Economics (Adam Smith); Philosophy (David Hume); United States Navy (John Paul Jones); Penicillin (Alexander Fleming); Telephone (Alexander Graham Bell); Television (John Logie Baird); Steam engine (James Watt); Logarithms (John Napier); Electromagnetism (James Clerk Maxwell); Oil Refining (James Young); Ultrasound scanner (Ian Donald); Waterproof Macintosh – we needed that one (Charles Macintosh); Kirin Brewing Company (Thomas Blake Glover); Buick Motor Company (David Dunbar Buick); and many, many more.
A nation so rich in people, ideas and innovation can never be too wee, too poor and, least of all, too stupid to run its own affairs. Quite the contrary.
David Hume and Adam Smith – two famous Scottish thinkers of the Enlightenment
But the debate gets even worse. In many people’s eyes, it all comes down to a marginal decision about whether Scots would be better or worse off by a few hundred pounds a year were independence to be chosen. In other words, it is “too risky”. What we have tried to show above is that it is about much more than pounds and pence – especially since no-one can possibly tell what the actual outcome in pure economic terms will be. Moreover, for Scots who wish to retain the National Health Service in the public sector, a ‘No’ vote is the greatest risk given the current government’s privatization plans.
Worse still is the question of EU membership. The Scottish government fully supports Scotland’s continuing membership of the EU. The recently-elected president of the European Commission, Jean-Claude Juncker, has explicitly stated that a moratorium on new EU member states does not apply to Scotland. Maybe that is why David Cameron, the UK prime minister, was so opposed to his appointment. The biggest risk of all to the Scottish people is that they are forced to exit the European Union because of a vote to do so delivered by the rest of the UK in the next parliament, assuming Mr. Cameron wins again.
Independence economics will all be down to the decisions of an independent Scottish government and the Scottish people. The world is a risky place, economic policies and political decisions are there to be debated and who is to say, a priori, what is right or wrong, what is beneficial or costly? Every people sets its own priorities – for better or for worse. Ask the Mongolians. The debate on Scotland’s future is about taking responsibility, making decisions and contributing to the international community as best Scotland can. The list of names we set out a few paragraphs above certainly suggest that that is task Scots are fit to undertake.
In our view, it is about getting the balance right and making decisions that suit Scotland’s neighbors as well as Scotland itself. As Hayek argued in The Road to Serfdom, “We shall all be the gainers if we can create a world fit for small states to live in.”
Scots can meaningfully contribute to the creation of that world by voting ‘Yes’ next month.
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