Category Archives: economics

Scotland and the Euro Convergence Criteria

Scottish euro coin
Scottish euro coin, a photo by viralbus on Flickr.
At the moment, most people seem to think that an independent Scotland should either stay in a monetary union with England, Wales and Northern Ireland or introduce its own currency.

However, very occasionally somebody suggests Scotland should adopt the euro (and of course, Better Together’s ubiquitous scaremongers love to pretend Scotland will be forced to join the Eurozone immediately).

It’s therefore perhaps worthwhile to examine briefly whether Scotland would actually be allowed to join. To introduce the euro, a country needs to fulfil the convergence criteria:

  • The inflation should be less than 2.5% (the exact figure varies from year to year — it’s based on the inflation figures of the EU member states). The figure for the UK is currently 2.6%, but there’s no reason to assume this would be the same for Scotland — it could be either higher or lower. I don’t think we can determine this at the moment; it’s possible Scotland will tick this box, but it’s quite likely it won’t.
  • The budget deficit should be less than 3% of GDP. The UK is currently running a deficit of 6.3%, and although Scotland’s finances are better than the UK’s, it would require exceptionally high oil prices to push the deficit under 3%. It’s probably safe to assume Scotland would need a few years to bring the deficit under control.
  • The debt-to-GDP ratio should be under 60% or falling. The UK’s ratio is 90% and rising, so if Scotland inherits its population share of the debt, this criterion will be very hard to fulfil. On the other hand, if the rest of the UK decide to keep all assets and liabilities, Scotland will have a ratio of 0%, so it’d pass this test with flying colours.
  • The country should have been a member of ERM-II (the exchange rate mechanism) for two years. This means that the country needs to have had its own currency for at least two years (using the Pound Sterling doesn’t count), and it needs to have been linked loosely to the euro. If we assume that an independent Scotland would continue to use the pound for at least five years after independence day before creating its own currency, the earliest this criterion can be fulfilled is 2023.
  • Finally, the interest rate should be no higher than 4.81%. The figure for the UK currently is 1.62%, so it’s likely Scotland’s would be much lower than the threshold, too.

To conclude, the main issues are likely to be the national debt (unless the rUK decide to keep all of it in order to safeguard their permanent membership of the UN’s Security Council) and the need to have been a member of ERM-II for at least two years. It seems unlikely Scotland would be able to introduce the euro before 2023, even if it became a political priority.

Of course, if Scotland decides not to introduce the euro, staying out of ERM-II is all it takes. This is what Sweden and many of the newer EU members are doing at the moment.

The great currency consensus

You're making decisions by consensus, but are you collaborating?
You’re making decisions by consensus, but are you collaborating?, a photo by opensourceway on Flickr.
The Better Together campaigners seem to claim the Yes side are conducting a civil war on the currency issue (whether to continue to use the UK pound, or whether to introduce a separate Scottish currency).

However, in reality the differences within the Yes camp are mainly about time scales.

Nobody (well, almost nobody) seems to suggest that a new Scottish currency should be introduced on day 1 (i.e., March 2016) — advocates of a separate currency tend to think it should be introduced a few years afterwards (e.g., in 2019) to give the new state a chance to set of the Central Bank of Scotland, print the banknotes and mint the coins, etc.

Those who advocate retaining the pound tend to argue their case based mainly on the short term. For instance, here’s what the Fiscal Commission Working Group wrote:

7.11 The economic area of Scotland is sufficiently large to support its own currency.

7.12 In the long run, the creation of a new Scottish currency would represent a significant increase in economic sovereignty, with interest rate and exchange rate policy being two new policy tools and adjustment mechanisms to support the Scottish economy.

7.13 In the short-run there would however, be a number of practical challenges associated with moving to a new currency, including the not insignificant steps required to re-denominate contracts and maintain intra-UK supply chains.

I don’t think they (or any other proponents of maintaining a currency union with the rUK) have tried to quantify the short and long runs, but I reckon they think the “sterling union” would last at least ten years or so (i.e., until at least 2026).

To sum up, almost everybody on the Yes side agrees the pound sterling will still be used shortly after independence (e.g., in 2018), but probably not in the long run (e.g., in 2030). The only difference is a question of time scales, and of how vigorously to pursue a proper currency union (as opposed to simply using the pound without representation on the Bank of England’s MPC).

The differences within the Better Together parties are probably larger. The LibDems are still in theory in favour of joining the euro (and when the Eurozone recovers, they will start saying this more loudly), and the Tories are wedded to the pound. This means they don’t just disagree about the time scales, but about the direction of economic policy.

Using the pound sterling after independence

Lloyds Banking Group Archives - 'Oldest Surviving Scottish Banknote'
Lloyds Banking Group Archives – ‘Oldest Surviving Scottish Banknote’, a photo by Scottish Archives on Flickr.

Scotland currently has a very strange currency set-up — we’re technically speaking using the pound sterling, just as England, but three “Scottish” banks have got the right to issue their own banknotes in a currency board arrangement (I put Scottish in inverted commas because the Royal Bank of Scotland is owned by UK government, the Bank of Scotland is part of the Lloyds Banking Group, and Clydesdale Bank is part of the National Bank of Australia). I don’t know of any other modern countries where private banks issue bank notes in lieu of a devolved government.

After independence, there are several options available to Scotland.

As I’ve written before, my personal preference would be a currency board arrangement, where the National Bank of Scotland issues one Scottish crown (or pound or dollar or whatever) for each pound sterling in its vaults. In this way, it will still be very easy to do business with the rUK, but the coins and banknotes will all be issued by the NBS. The advantage of this system is that if the rUK economy collapses, the link could be broken and the Scottish crown could either be tied to the US dollar or the euro instead, or it could start to float freely, without the need to issue new notes or coins. During the independence negotiations, Scotland would of course be entitled to demand representation on the Bank of England’s monetary policy board in return for maintaining the currency board (which would be to the rUK’s advantage).

I think this policy would be more robust than trying to maintain the status quo exactly, where the Bank of England’s notes and coins are also circulating in Scotland, because it would be much harder to change the set-up if it becomes desirable to leave the sterling zone (who knows, the euro might be looking fantastically attractive again in ten years’ time).

What’s important to remember here is that changing a currency takes time. No matter what the outcome is, I’d expect the status quo to continue at least two or three years after independence day (until 1st January 2019 or so), which means that the actual way forward will be decided by the independent Scottish Parliament elected in May 2016, not by the current SNP government.

The fact that Scotland can decide to implement a currency board without the approval of the Bank of England shows that the unionists’ threat of the day (that there wouldn’t be Scottish banknotes after independence) is absurd. Even David Blanchflower said so today (“George Osborne would be better off revisiting his misguided and failing policies for growth rather than scaremongering to the people of Scotland”) and I don’t think anybody has ever accused him of being a Scottish nationalist.

PS: I’d recommend following Blanchflower on Twitter. For instance, he tweeted this today:

Focusing on London

233/365 Washed Up
233/365 Washed Up, a photo by thebarrowboy on Flickr.
There’s an interesting article by Larry Elliott in The Guardian today.

He neatly sums up why Margaret Thatcher was a disaster north of the Severn-Wash line but a huge success south of it:

In the 1930s, the centre of gravity of the British economy shifted to the south-east. […] Manufacturing jobs had peaked in the mid-1960s and the workforce had shrunk by a million. Britain’s industrial competitiveness had been impaired in the 1970s by high inflation, offset by a lower exchange rate. But the first two years of the Thatcher era were a veritable bloodbath. Industry faced a quadruple whammy: higher oil prices; an appreciating foreign exchange rate courtesy of sterling’s emerging status as a petro-currency; rising inflation caused by a doubling of VAT and high pay claims; and sky-high interest rates deemed necessary to reduce the growth in the money supply.

[Then there] was the big bang in the City. This accelerated the economy’s transformation away from manufacturing towards the service sector and the financial services sector in particular. The government’s thinking was that it made sense to exploit the size and international reputation of the City, because this was a sector in which the UK had a comparative advantage.

In other words, Mrs. Thatcher accelerated a process whereby economic activity was moving from north-west to south-east. A more sensible government might have tried to create more economic activity in the struggling parts of the country, but instead they decided to concentrate on the areas that were already doing well.

Larry Elliott continues:

The economy’s structure means that the growth sectors when it recovers are […] likely to be financial services, professional services and communications, digital and media. All three are concentrated in London.

So basically, because a large list of UK governments allowed the economy to shift gradually towards Greater London, this pattern has now been set in stone because all growth will by default happen there.

The future governments of an independent Scotland will certain not just give up and allow the economy to shift to London. It will do its utmost to create economic activity in Scotland.

I just feel sorry for the people of Northern England — they really could use independence from London, too!

The 2015 jobs boom in Scotland

Edinburgh, October 2005 by landhere
Edinburgh, October 2005, a photo by landhere on Flickr.

What will happen in 2015 if Scotland has just voted Yes to independence and if it’s looking increasingly likely that England will vote to pull the rUK out of the EU, and potentially even out of the Internal Market?

A large number of English companies are making their living trading with the EU, and it will be tempting for them to relocate to a country that will remain in the EU before it’s too late. Many countries are likely to benefit from this company exodus, e.g., Ireland and France, but surely the easiest option for many of these companies will be to relocate to Scotland (even if Scotland still hasn’t completed the negotiation of the EU membership terms and conditions at this point in time).

Because England is about ten times bigger than Scotland, this will have immense consequences for the Scottish economy, even if only a small percentage of English companies relocate north of the border. In conjunction with the other jobs created by independence, it’s likely that the years immediately after the independence referendum will be remembered as the great jobs boom.

PS: This blog posting was inspired by a chat with my mum in Denmark, who had been watching a programme with Uffe Ellemann and Mogens Lykketoft (both former foreign ministers of Denmark), in which they apparently touched upon this topic; however, I haven’t been able to find either a version of the programme that I can watch or a transcript. If you know more, please let me know!

Will Scotland be richer than Norway after independence?

Scottish Thistle Coin 1602 by Tropic~7
Scottish Thistle Coin 1602, a photo by Tropic~7 on Flickr.

There was an extremely interesting blog posting on Wings over Scotland about the size of Scotland’s exports.

This made me think about the consequences for the finances of an independent Scotland.

First of all, the figure provided by WoS is $20,886 per capita, but that’s excluding oil. According to STV, Scotland’s oil and gas exports are worth about £7.6bn, which is about half the amount produced. If we assume that half of this is actually exported to England, we get a rough figure of £11.4bn, which is $18bn. Per capita this is $3400, so a very rough estimate of an independent Scotland’s exports including oil would be slightly more than $24,000 per person, which would make us number six in the World rankings, between Norway and Ireland.

There also tends to be some kind of correlation between exports and GDP. Looking for similar countries in this table, one finds Denmark and Sweden around 50%, Norway at around 40% and the UK at 30%. In other words, it would be really strange if Scotland’s GDP was very low, and one would probably expect a GDP figure per capita between $50,000 and $60,000, which would definitely place Scotland in the World’s top-10, way ahead of the UK (which has a GDP per capita of slightly less than $40,000).

My calculations are very rough, so it’s hard to say exactly how rich an independent Scotland would be, but it looks likely it would be much richer than the UK, and potentially even richer than Norway.

My only remaining question is why previous calculations of how much better off Scotland would be after independence have been so cautious. It seems to me that we’re likely to be talking about every single person in Scotland being better off to the tune of about £10,000 per year (between $10,000 and $20,000). Where has Westminster been hiding all that wealth?

Will Scotland have to join the euro?

Scottish euro coin
Originally uploaded by viralbus

The unionists seem to be in a tizzy about the prospect that Scotland will be forced to join the euro, so let’s have a rational look at the most likely scenarios.

To start with, it’s entirely possible (perhaps even likely) that Scotland will be allowed to inherit the UK’s opt-out. In that case, Scotland will have a formal right to remain outwith the euro indefinitely.

However, what happens if Scotland has to let go of the opt-out as part of the renegotiation of the membership terms? It’s not like Scotland would have to introduce the euro at once. Before any member state can introduce the euro, the convergence criteria have to be fulfilled:

  1. Inflation rates: No more than 1.5 percentage points higher than the average of the three best performing member states of the EU.
  2. Government finance:
    1. Annual government deficit: The ratio of the annual government deficit to gross domestic product (GDP) must not exceed 3% at the end of the preceding fiscal year. If not it is at least required to reach a level close to 3%. Only exceptional and temporary excesses would be granted for exceptional cases.
    2. Government debt:The ratio of gross government debt to GDP must not exceed 60% at the end of the preceding fiscal year. Even if the target cannot be achieved due to the specific conditions, the ratio must have sufficiently diminished and must be approaching the reference value at a satisfactory pace.
  3. Exchange rate: Applicant countries should have joined the exchange-rate mechanism (ERM II) under the European Monetary System (EMS) for two consecutive years and should not have devalued its currency during the period.
  4. Long-term interest rates: The nominal long-term interest rate must not be more than 2 percentage points higher than in the three lowest inflation member states.

Currently the UK doesn’t pass any of the tests apart from the last one, and as far as I can tell, the same would apply to Scotland at the moment. Therefore, Scotland wouldn’t be allowed to join the euro at first, even if the people of Scotland so desired.

It is of course possible (and probably also desirable) that Scotland will fulfil (1) and (2) in the longer term, but criterion (3) requires a deliberate step that Scotland can decide not to take.

This is how the Swedes have managed not to join the euro — they’re technically obliged to join the euro, but they have chosen not to join ERM II, which means that they cannot join. Scotland can do the same, even if it’s against the spirit of the treaties.

Finally, by the time the Scottish economy qualifies to join the euro, the European Union and the euro might have changed beyond recognition, and it is entirely possible that there will be a strong desire to join the euro by then.

It’s definitely not anything to worry about at this stage.