Union Blues: Would an Independent Scotland Honor Her Debts?

There are still nearly five months to go until the referendum on Scottish independence but the debate is definitely hotting up. The polls are getting more interesting.

Buoyant is the default position of Alex Salmond, SNP leader and Scotland’s first minister, but he is unusually buoyed up at present. He, after all, has a history of winning in Scotland.

Were I a Scot living in England, I would be frustrated to the point of distraction by not having a vote in this, the most important decision for my country. For many Scots living in Scotland, I suspect, emotional arguments pull against the considerable economic risks of independence.

Recent evidence on the UK economy adds to those risks. Britain has turned into a formidable job creation machine, with nearly 700,000 new jobs created over the latest 12 months and an unemployment rate now below 7%, something the Bank of England said last summer it did not expect to happen until 2016.

Not only is the national labour market doing well, but Scotland is doing well within it. It has an unemployment rate of 6.5%, compared with 6.9% for the UK as a whole. Its employment rate, 73.3%, compares with a national rate of 72.6%.

10% of the new jobs created in the past 12 months have been in Scotland, bigger than its share in the UK economy. Would an independent Scotland do as well? Maybe, but there is a big risk it would not.

My last big piece on independence, ‘Separate Scotland will have to take the low road’, in September last year, described that and other risks. I will revisit it nearer the referendum but, without anticipating that entirely, the economic case has looked shakier even as support for independence in some polls has increased.

It was thought, for example, that Scotland’s budget deficit, assuming a geographical share of North Sea oil and gas, would initially be smaller than the rest of the UK, the big fiscal challenges coming later.

Now we know, from the Scottish government itself, it ran a budget deficit of 8.3% of gross domestic product in 2012-13, bigger than the 7.3% deficit for the whole of the UK.

Today I want to tackle a separate issue. When all three national parties (“Westminster parties” in SNP terminology) say they do not want Scotland to become independent, but if it did would not allow it to be in the currency union with the rest of the UK, there are three responses from the nationalists.

The first is that it is bullying of plucky little Scotland by the bigger boys in Westminster. I must say I’ve never seen Danny Alexander as school bully.

The second is that it is bluff, though it has to be said that it is a curious world in which the nationalists give greater weight to the off-the-record words of an unnamed minister than to the three parties’ economic spokesmen and the Treasury’s top official. If a future Westminster government opted for a currency union with an independent Scotland, it would do so against Treasury advice.

What about the third argument, which is that if the rest of the UK is so desperate to keep Scotland, this must show that Scotland is being exploited, either for her oil, or for other reasons?

Many English readers, I know, are entirely relaxed about Scottish independence. Some say the rest of the UK would be better off without Scotland. So why the keenness on the part of the Westminster political establishment to keep it?

One point can be dismissed. Salmond and his SNP colleagues insist that a post-independence rest of the UK would be desperate for a currency union for fear of losing the balance of payments support provided by North Sea oil.

This is a strange argument. Britain already runs a sizeable trade deficit in oil, and crude oil imports are between two and three times greater than exports. And, currency union or not, Scotland would have a separate balance of payments. That is what independence means. It would have a trade surplus in oil, partly offset by a deficit (including with the rest of the UK) on other goods and services.

The rest of the UK would have its own balance of payments and the level of sterling would be determined by that, not what was happening north of the border. There would be times when the right currency level for Scotland’s petro-dominated economy would be higher than that of the rest of the UK, and times when it would be lower. But the idea that an independent Scotland would provide balance of payments support for the rest of the UK does not wash.

There is, however, a genuine financial reason – among plenty of other reasons – why the rest of the UK wants to keep Scotland. This is the fact that an independent Scotland would almost certainly start life owing the rest of the UK a lot of money.

The latest paper from the National Institute of Economic and Social Research on independence, just published, suggests the negotiating range for Scotland’s share of UK debt will be between £102bn and £143bn, up to 86% of GDP.

The key point is that Scotland will not be able to pay off the rest of the UK immediately but is likely to be forced to issue an IOU.

This will have two implications. One is that until that IOU is honoured, gross public debt for the rest of the UK will be pushed up to more than 100% of GDP which, as the National Institute says, is likely to attract the attention of the ratings agencies.

The other is that the rest of the UK will be reliant on Scotland not reneging on her debts. Since some SNP politicians have warned that this is exactly what Scotland might to if not allowed to participate in a currency union, this would be a fiscal problem Britain could do without.

Sir Nicholas Macpherson, Treasury permanent secretary, has dismissed the nationalists’ warning that Scotland could renege on her debt as “not a credible threat”. The National Institute points out, though, that an independent Scotland would need to run tougher fiscal policy than the UK as a whole has had over the past four years to both take on her share of UK debt and bring it down to manageable levels.

This piece is cross-posted from EconomicsUK with permission.

There are many reasons why the rest of the UK wants to keep Scotland. But not being able to trust the Scots to take the tough fiscal decisions to honour her debts is one of them.