Brexit makes the economics of Scottish independence much more attractive

There is a slightly later and extended version of this post, which may also be a little clearer, at the New Statesman here.

It is difficult to think clearly when you watch the utter hypocrisy of our Prime Minister, lecturing the SNP about politics not being a game, moments before she needlessly rejects a Lords amendment to secure the rights of EU citizens in the UK. Everyone knows those rights will be guaranteed during the negotiations, so it would be so easy to seize the moral high ground by doing that now. But I’m not sure our Prime Minister, and her MPs, would recognise the moral high ground if it was staring them in the face.

Nicola Sturgeon had no choice but to announce a second Scottish referendum. Brexit is a huge economic and political change, and she would be neglecting her duty to the citizens of Scotland not to explore ways she could avoid a hard Brexit fate for her people. She was given no choice by the decision to leave the Single Market, made not by UK voters but by the Prime Minister.

Yet it is also difficult to forgive the SNP for inventing the term Project Fear, which became the vehicle by which the Leave campaign was able to pretend that Brexit would not be the economic disaster it almost certainly will be. It is difficult to forgive them for trying to pretend that the short term costs for the Scottish people of leaving the UK would not be severe. I thought then that it was a huge risk to bear those short term costs when the long term benefits outlined by the SNP appeared to be little more than wishful thinking.

But Brexit changes everything. The economic cost to the UK of leaving the EU could be as high as a reduction of 10% in average incomes by 2030. If Scotland, by becoming independent, can avoid that fate then you have a clear long term economic gain right there. But it is more than that. If, Scotland can remain in the Single Market it could be the destination of the foreign investment that once came to the UK as a gateway into the EU. By accepting free movement, it could benefit from the immigration that has so benefited the UK public finances over the last decade. No, that is not what you read in the papers or see on the TV, but I’m talking about the real world, not the political fantasy that seems so dominant today.

There is an additional issue regarding the short term costs of independence. With little oil at a low price there is no doubt that the rUK is currently subsidising Scotland by a significant amount. Under Cameron it was reasonable to suppose that this subsidy would continue for some time, if only to prevent another referendum. I do not think we can make the same assumption about Theresa Brexit May. The prospects for the UK public finances under Brexit are dire, yet after the Budget there seems no way that the Conservatives will put up taxes to pay for the extra resources the NHS and other public services so desperately need. As the situation gets steadily worse, nothing - absolutely nothing - will be safe from continuing austerity. To be brutally honest, if the SNP loses another referendum, even the formidable Ruth Davidson will not be able to prevent Scotland being plundered by this government.

There are a huge number of issues that still need to be clarified regarding this second referendum. Will the SNP still go for, or at least appear to go for, staying in a monetary union with the rUK and keeping sterling just because it is the more popular option, even though having their own currency is much more sensible in economic and political terms? Will they be honest about the short term costs? Will the EU give them the chance of staying in the Single Market or EU, or will they insist they join the queue? But the bottom line is that the case for Scottish independence is now much stronger than it was in 2014. Then a brighter future outside the UK was patriotic wishful thinking. Now, if they can stay in the Single Market, it is almost a certainty. 

Should central bankers stick to talking about monetary policy?

Few disagree that the recent remarks on corporate governance and investment made by Andy Haldane (Chief Economist at the Bank of England) are interesting, and that if they start a debate on short-termism that would be a good thing. As Will Hutton notes, Hillary Clinton has been saying similar things in the US. The problem Tony Yates has (and which Duncan Weldon, the interviewer, alluded to in his follow-up question) is that this is not obviously part of the monetary policy remit.

Haldane gave an answer to that, which Tony correctly points out is somewhat strained. Perhaps I could illustrate the same issue by going down a better route that Haldane could have used. He could say that the causes of low UK productivity growth are clearly under his remit, and one factor in this that few dispute is low investment. If he was then asked by an interviewer what might be the fundamental cause of this low investment, Tony would argue that his reply should be that he couldn’t really comment, because some of those reasons might be too political.

I have in the past said very similar things to Tony when talking about the ECB, and their frequent advice to policymakers on fiscal rectitude and structural reforms. My main complaint is that the advice is wrong, and I puzzle over “how the ECB can continue to encourage governments to take fiscal or other actions that their own models tell them will reduce output and inflation at a time when the ECB is failing so miserably to control both.” But I have also said that in situations where fiscal actions have no impact on the ability of monetary policy to do its job (which is not the case at the moment), comments on fiscal policy are “crossing a line which it is very dangerous to cross”.

However I am beginning to have second thoughts about my own and Tony’s views on this. First, it all seems a bit British in tone. Tony worked at the Bank, and I have been involved with both the Bank and Treasury on and off, so we are both steeped in a British culture of secrecy. I do not think either of us are suggesting that senior Bank officials should never give advice to politicians, so what are the virtues of keeping this private? In trying to analyse how policy was made in 2010, it is useful to have a pretty good idea of what advice the Bank’s governor gave politicians because of what he said in public, rather than having to guess. (Of course private advice to politicians is never truly private, but this hardly helps, because with secrecy it allows politicians to hint that advice of a particular kind was given when it might not have been.)

The issues of MPC external member selection that Tony worries about are real enough, but perhaps that illustrates problems with the selection process. My guess is that the Treasury would be inhibited about choosing an MPC member who had previously been strongly critical of the government on other issues anyway. As I said my main complaint about the ECB is the nature and context of the advice they give, and at least by making it public we know about this problem.

It is often said that central bankers need to keep quiet about policy matters that are not within their remit as part of an implicit quid pro quo with politicians, so that politicians will refrain from making public their views about monetary policy. Putting aside the fact that the ECB never got this memo, I wonder whether this is just a fiction so that politicians can inhibit central bankers from saying things politicians might find awkward (like fiscal austerity is making our life difficult). In a country like the UK with a well established independent central bank, it is not that clear what the central bank is getting out of this quid pro quo. And if it stops someone with the wide ranging vision of Haldane from raising issues just because they could be deemed political, you have to wonder whether this mutual public inhibition serves the social good.

The non-independent ECB

Imagine that the Scottish National Party (SNP) had won the independence referendum. The SNP starts negotiating with the remaining UK (rUK) government over issues like how to split up national debt. On some issue the negotiations get bogged down. Rumours start circulating that this might mean that rUK will not form a monetary union with Scotland, and that Scotland might have to create its own currency. People in Scotland start withdrawing money from Scottish banks.

Now it is almost the definition of a private bank that if everyone who has an account at the bank wants to withdraw their money, the bank will run out of cash and go bust. That is why bank runs are so dangerous. It is also why one of the key roles of a central bank is to supply an otherwise solvent private bank with all the cash they need, so they will never deny depositors their money. (To be a lender of last resort.) If they did not do this, anyone could start a rumour that a bank was insolvent, and as people withdrew their cash just in case the rumour was true, the bank would run out of money and go bust anyway.

So in my hypothetical story, as people started withdrawing cash from Scottish banks, the Bank of England should supply these banks with all the cash they need. Except suppose it did not. Suppose it put a limit to the amount of cash it would supply. The Scottish banks would protest - you agreed we were solvent before independence, they would say, so why are you rationing our liquidity? The Bank of England replies that although they might have been solvent before independence, if there is no agreement solvency is less clear. The Bank of England says that the limit on cash will remain until the Scottish and rUK government come to an agreement.

This announcement of course leads everyone in Scotland to try and get their money out, and the Scottish Banks have to close. The Scottish economy begins to grind to a halt. The English media report that Scotland is running out of money because the Bank of England will not ‘lend’ any more to the Scottish banks. The Scottish government is forced to agree to the rUK’s terms. The English media say look what happens when you elect a radical government. In Scotland they call it blackmail. What would you call it?

If it sounds to you like the Bank of England is taking sides and putting impossible pressure on Scotland, then you will know what it feels like in Greece right now. When, on 28th June, the ECB stopped providing emergency funding to Greek banks, it took sides. Part of the ECB’s logic is that Greek banks may be insolvent if there is no agreement between the Troika and Greece (even though it is the Central Bank of Greece, and therefore the Greek people, which stands to suffer losses from defaults by commercial banks).

Why should the failure to reach an agreement influence the solvency of the Greek banks? Is it because without an agreement there would be a Greek exit? But Greece does not want to abandon the Euro, and the other Eurozone countries have no formal grounds to expel Greece. Greece will only leave the Eurozone if the ECB stops supplying Euros. We reach exactly the same self-fulfilling logic of a bank run. Is it because without an agreement the Greek government would default on some of its debts, and that might adversely influence the solvency of Greek banks? But the fact that the Greek government will not get money from the Troika to pay back the Troika seems to have no implications for the underlying solvency or either the Greek state or its banks. (Paul De Grauwe discusses this further.) If the Troika can make Greece insolvent by itself withholding money we have another self-fulfilling justification.   

The real explanation for the ECB’s actions is much simpler. Limiting funding on 28th June was the Greek government’s punishment for failing to agree to the Troika's terms and calling a referendum the day before. The ECB was not, and never has been, a neutral actor just following the rules of a good central bank. It has always been part of the Troika, and right now it is the Troika’s enforcer.

As Charles Wyplosz recounts, this is not the first time the ECB has chosen to bow to political pressure. There will be some on the left who will say of course - what else do you expect of a central bank? In response, let me go back to my hypothetical example involving Scotland and the Bank of England. I may be wrong, but I think in that case the Bank of England would have supplied unlimited cash to the Scottish banks. I may be naive, but I believe it would have realised that to do anything else was an overtly partisan political act, and recoiled from doing that. Just as I do not think it was inevitable that the Eurozone committed itself to austerity, I also think it was possible that the ECB could have been a more independent central bank. The really interesting question is why it has turned out not to be such a bank.  

Putting party before country

Philip Stephens in the FT says the idea that a Labour-SNP understanding would amount to Labour being held hostage by the SNP is nonsense. He is of course correct. In a vote on any particular issue, 50 odd SNP MPs could hardly impose their will on 600 MPs from other parties. More interesting is what this line tells us about the media, about the current Conservative Party, and about what the future might hold if they remain in power.

First the media. In my continuing series on mediamacro, I stress that myths are best based on half-truths. Half-truths are the grain of truth on which you can erect a huge lie. With the SNP and Labour, the half-truth is that SNP views on an issue could perhaps weigh a little more heavily on Labour than, say, the views of UKIP, because UKIP will always vote to bring down a minority Labour government, but the SNP will not. That fact will never make Labour go where it does not want to go, but at the margin it could nudge it a bit more in one direction. Conceivably, we might get a bit less austerity, we might treat welfare recipients a bit more humanely - that kind of thing. But would we get some policy that was against the interests of the rest of the union? Of course not. Colin Talbot makes it clear how limited the SNP’s power would in practice be here. [1]

With mediamacro, you generally need some expertise, or some knowledge of the data, to see that the half-truth is very far from the myth, knowledge political commentators may not have. In the case of ‘SNP blackmail’, political commentators have the required knowledge more than most. So for me the success of the scaremongering about a minority Labour government will be an interesting test: is lack of economic expertise or knowledge important in explaining mediamacro, or is control of the majority of the UK press sufficient. There are signs that the scaremongering is working.

As Lord Forsyth (former Scottish secretary in a Conservative government) said, his own party is putting electoral tactics above a historic commitment to the defence of the UK union. This can hardly come as a surprise. The Scottish independence referendum was a close run thing, so you might expect a party with the integrity of the nation at heart to tread carefully in the subsequent days and months to heal wounds. Instead, Cameron chose in the morning after the vote to attempt to wrong foot Labour on ‘English votes on English issues’, saying: "We have heard the voice of Scotland and now the millions of voices of England must be heard." It was a gift to the SNP.

What does all this tell us about the Conservative Party? Does it tell us that it secretly wants the SNP to get so strong that it could win a future referendum and break up the union? No, what it tells us is that this is a party that is prepared to take large long term risks for minor short term political advantage. As I have suggested on a number of occasions, that seems to be a common pattern in its macroeconomic policy (premature deficit reduction and Help to Buy being two obvious cases).

One of the clearest examples of this is our relationship with Europe. The decision to hold a referendum was taken to appease the right in his own party and potential UKIP voters, even though the uncertainty it creates will damage the economy and even though there is no chance that Cameron will be able to renegotiate to any significant extent. But large sections of what we might call the Establishment seem unperturbed as long as it helps return a Conservative led government. The assumption seems to be that Cameron will be able to sort things out when the time comes, and it will be business as usual. As Polly Toynbee puts it, the view is that “Cameron is “one of us” so he’ll somehow secure an “in” result for his 2017 referendum”

This ignores all the evidence about party before country. A Cameron recommendation to stay in the EU will split his party: after the election a majority of MPs may favour leaving, and a majority of party members already do. In two years time, all the senior figures in the party will be thinking about the elections for Cameron’s replacement. (This is why Cameron’s announcement that he would step down before 2020 was so significant.) In this situation, what are the chances that Cameron will either be equivocal or recommend exit (leaving his successor to negotiate what they can in the way of trade deals)? In that case, what are the chances of the electorate voting to stay in, when the right wing press that helped win the 2015 election for the Conservatives will be in full cry to leave? I would be foolish to say that exit was a probability, but I would be just as foolish to assume that the risk of leaving was small.

Voting for a political party that repeatedly puts itself before the national interest is not a good call in the best of times. When it could influence our position in Europe and even the Union itself, it becomes a huge mistake. Too many in the UK seem prepared to walk into that minefield, for the sake of avoiding what would be the mild inconvenience for them of a Labour led administration.

[1] I doubt very much that it will make any Labour government give additional preferential treatment to Scotland. The opposition will cry foul on this if that ever happened (and probably sometimes when it does not). As a result, Labour will go out of their way to avoid such an outcome. Would the SNP bring down a Labour government just because they failed to get some minor fiscal advantage? I think that is also highly unlikely. What the SNP will fear most is being seen as the party that brought down a Labour government and helped their opponents into power.

   

On the Stupidity of Demand Deficient Stagnation

In my last post I wrote about “why recessions caused by demand deficiency when inflation is below target are such a scandalous waste. It is a problem that can be easily solved, with lots of winners and no losers. The only reason that this is not obvious to more people is that we have created an institutional divorce between monetary and fiscal policy that obscures that truth.” I suspect I often write stuff that is meaningful to me as a write it but appears obtuse to readers. So this post spells out what I meant.

First a preliminary. If you do not understand why economies can suffer from deficient demand, and why this is a needless waste of resources, then to be honest your best bet is to read a few chapters of a popular book on macro, like Tim Harford’s latest. If you have done a macro course and do not believe prolonged demand deficiency is possible, just tell me how you get out of a liquidity trap in a world with inflation targets after reading this post (and maybe this).

Demand deficiency when inflation is persistently below target (the stagnation of the title) should not occur, because it is easy to solve technically. If I was a benevolent dictator in charge of both monetary and fiscal policy instruments, stagnation would never persist in my economy. The way I would ensure this most of the time is by varying interest rates, but if nominal interest rates hit zero (a liquidity trap) I have a whole range of alternative instruments, ranging from cutting various taxes to increasing transfers or raising public spending. I know of no macroeconomic theory on earth which tells me that everyone of these instruments will fail to raise demand.

Whatever instrument I use to raise demand in a liquidity trap, I need to finance it. I can do this by issuing bonds (increasing government debt) or creating money. A higher stock of government debt or money is the only legacy (apart from happier people) of my successful operation to remove demand deficiency. We generally prefer governments to use bond finance, for reasons I will come to. But supposing there is some constraint (real or imagined) on issuing bonds. As a benevolent dictator I can just create money, which we call money financed fiscal stimulus. Money financed fiscal stimulus is a sure way of ending demand deficiency in a liquidity trap.

If that higher stock of money proves too great later on when the economy has recovered, I can reduce it by various means. There will be no subsequent above target inflation. There are no technical problems that I as a benevolent dictator need to worry about here. Of course creating lots of money on a temporary basis is exactly what central banks in the UK, US and Japan have recently done (QE - Quantitative Easing). The problem is that they have not been accompanied by sufficient tax cuts, increased transfers or increased government spending. Creating money to buy financial assets is by comparison to money financed fiscal stimulus an unreliable way of raising demand.

So that is it. Demand deficient stagnation is easy to prevent technically. The huge waste of resources that we see in the long and incomplete US recovery, the even slower UK recovery and the absence of recovery in the Eurozone are all unnecessary, because we know how to fix them. [1]

What stops this happening in the real world is that we have become fixated by the labels ‘monetary’ and ‘fiscal’ policy, and created an independent institution to handle the former. Central banks do monetary policy (varying interest rates and creating money) but are not allowed to give money directly to the people (helicopter money, or John Muellbauer’s QE for the people). Governments run fiscal policy, so can do bond financed fiscal stimulus, but are not allowed to create money. So a self-imposed institutional setup prevents either central banks or governments doing money financed fiscal stimulus alone.

A major reason why this institutional arrangement exists is to discourage non-benevolent governments creating inflation through fiscal profligacy, or more recently in order to increase policy credibility. Of course during a period of stagnation there is no danger of rampant inflation. Unfortunately this institutional arrangement creates a problem when governments – in my view for largely imaginary reasons - put a priority on reducing deficits. Money financed fiscal stimulus is not available to get you out of a liquidity trap. So we get this huge waste of resources.

Within the existing institutional framework, there is plenty to be done to convince fiscal policy makers that reducing deficits should not be a priority in the short term, or in trying to improve the monetary policy framework so liquidity traps happen less often. Yet it would be better still if we had an institutional framework which was a little more robust to failures on either front. We need to regain the possibility of money financed fiscal stimulus in a liquidity trap.

[1] What I say here has a lot in common with the advocates of Modern Monetary Theory. However, it also appears to be perfectly standard macroeconomics to me, so here I will simply commend them for highlighting these aspects of mainstream thought. 

Fighting the last war

It is often said that generals fight the last war that they have won, even when those tactics are no longer appropriate to the war they are fighting today. The same point has been made about macroeconomic policy: policymakers cannot avoid thinking about the dangers of rising inflation, and in doing so they handicap efforts to fully recover from the Great Recession.

Another military idea is the benefit of using overwhelming force. In the case of inflation we have two legacies of the last war that are designed to prevent inflation reaching the heights of the late 1970s: inflation targets and in many countries independent central banks. Do we need both, or is just one sufficient? I think this question is relevant to the debate over helicopter money (financing deficits by printing money rather than selling debt).

Why are helicopter drops taboo in policy circles? Why is it illegal in the Eurozone? The answer is a fear that if you allow governments access to the printing presses, high inflation will surely follow at some point. Many of those who worry about helicopter money are fairly relaxed about Quantitative Easing (QE), which involves much more money creation than would be involved in a helicopter drop. (Of course some are not relaxed, and (still) think that QE is about to produce rapid inflation - I will ignore that group here.) The key reason they are more relaxed is that central banks are in control of QE, whereas governments would initiate money financing of deficits. [1]

Take the recent interchange between Tony Yates and myself on helicopter money (TY, SWL, TY), and consider the following hypothetical. The economy needs a fiscal stimulus, but for some irrational reason the government will not allow debt to rise. It therefore instructs the central bank to create money to fund a fiscal stimulus (i.e. a helicopter drop). However it also tells the central bank that this action should not compromise its inflation target (which is currently being undershot), and the central bank agrees that the helicopter drop will not compromise its ability to stop inflation exceeding the target, but instead it will help inflation rise to meet that target.

Tony’s problem with this is in the instruction. In these particular circumstances the actions are not a problem, and will do some good (given the government’s irrational fear of debt). However we have crossed a barrier - the government is telling the central bank what to so. The fact that in my hypothetical example the inflation target remains is not enough: he writes “the inflation target in the UK is a very fragile thing”. He goes on: “So I don’t view the inflation target as a cast iron protection against helicopter drops undermining monetary and fiscal policy.  There’s a good reason why monetary financing is outlawed by the Treaty of Rome.  Allowing yourself tightly regulated helicopter drops is not time-consistent.  Once government gets a taste for it, how could it resist not helping itself to more?”

I think it is possible to take two quite different views to Tony on this. The first is that, in most OECD economies today where macroeconomic understanding is better and information more available, inflation targets are more than sufficient to prevent us experiencing the inflation rates of the 1970s again. The hypothetical to think about here is a government that has direct control over the inflation target, but asks the central bank to vary interest rates to achieve that target. Of course we do need to imagine this - it is the UK set-up. Would such a government happily raise the inflation target in order to finance a bit more spending? Such a move would be highly unpopular, because most people think higher inflation means lower real wages. In the UK no political party has even hinted that raising the inflation target might be a good idea, despite obvious fiscal incentives to do so. Suppose a government pretended repeated money creation would not breach the inflation target, even when the central bank advised otherwise. Would that government survive when inflation took off?

A second view is that we have the story of the 1960s and 1970s all wrong. We did not get high inflation in advanced economies because governments wanted to monetise their own profligacy. There were, after all, independent central banks in the US and Germany. Inflation occurred because of the combination of a number of specific factors: trade union pressure in the face of shocks that tended to reduce real wages, underestimation of the natural rate (and a poor understanding of how monetary policy should work), and placing too great a priority on achieving full employment. The latter might have been a legacy of the 1930s: policymakers were also fighting the last war, except in the 1970s the last war was about unemployment, not inflation.

I think both views are probably correct. As a result, I’m much more relaxed about money financing of deficits in the current situation. However in one crucial respect I do agree with those who say we have no need for helicopter money today, because there is no reason for governments to have a fear of rising debt if their central bank can undertake QE. However irrational fear of rising debt in a recession has similar characteristics to fighting the last war: deficit bias is a problem, but a recession is not the time to worry about it. I think this is why I am not persuaded by this article by Ken Rogoff: yes, in the grand scheme of things we should worry about inflation and debt, but right now we are worrying about them too much and therefore failing to deal with more pressing concerns.

[1] Some people imagine the central bank could itself initiate a helicopter drop, independently of government. That is simply not possible given current institutional arrangements, but as I noted in my earlier post (point 7) I think it is interesting to explore institutional changes that give the central bank some role in countercyclical fiscal policy. A simpler confusion is that helicopter money involves giving money to everyone, while tax cuts just go to taxpayers. Helicopter money is really about financing a fiscal stimulus of any kind using money: the form of that fiscal stimulus is a separate matter.

Wishful thinking and economics

Economics is often called the dismal science, and the Scottish referendum showed why this description has stuck. The Yes side appeared full of hope and optimism about what could happen once the constraints of Westminster rule had been cast off, while the No campaign kept on going on about one problem or other, which usually involved economics.

The general meme is that this negativity was a tactical mistake by the No side, but it was a quite understandable mistake, because the economic problems were large and self evident. It is no surprise that the vast majority of economists thought Scotland would be worse off under independence (see here, or here, or here). They had looked at the numbers and issues, or looked at institutions they respected that had done so, and thought this does not look good. Even for some of those economists who are in favour of independence, like Joe Stiglitz for example, it is clear that the attraction is despite, rather than because, of the basic macro and fiscal numbers. (See also Adam Posen’s response.)

This is of course not new. Politicians on the right like to believe that tax cuts will pay for themselves, and it is boring economists who (mostly) point out this is not true. Politicians of all shades thought that austerity would not have much impact on output and growth, while the vast majority of economists knew better. One of the reasons for deficit bias is that politicians believe that their policies will galvanize the economy and raise the tax base, and most of the time the macroeconomy stubbornly refuses to be impressed.

Now it is tempting to say, given this evidence, that politicians will believe anything that suits them. But what the independence referendum showed us is that voters have similar problems. As the campaign progressed the stronger the Yes vote became, and there is some evidence that this reflected additional information they received. As I suggested here, the problem is that this information was superficially credible sounding stuff from either side, but often with no indication from those who might have known better of the quality of the analysis.

For me this has always been the major argument for establishing fiscal councils - independent institutions who are charged with, at a minimum, scrutinising fiscal projections. Although the OBR (the UK’s fiscal council) has a remit that is quite narrow, we also have the highly respected IFS. In Sweden the fiscal council itself has a much wider economic remit.

Whenever I make this point, someone puts forward the argument that this is anti-democratic, or that I want economists to dictate decisions. This is wrong on at least two levels. First, my general argument is not specific to economics, but involves any area that involves technical expertise. Indeed, the case I make here is partly to avoid politicians using the views of a small minority of economists as cover. Second, the problem with democratic accountability as normally defined is that it is very weak: voters make one decision every five years that involves a whole basket of issues. I would suggest that charging an institution with a small set of tasks, where there is effective democratic oversight over the performance of that institution, can make that institution more accountable to the electorate than any politician doing the same.

In the case of Scottish independence, although we did not have a direct assessment of fiscal prospects from the OBR, that organisation’s oil revenue forecasts were used by the equally respected and independent IFS to point out the problematic outlook that an independent Scotland would face. Although the Yes side attempted to suggest that the OBR was part of the very Westminster elite that it wanted a divorce from, I suspect many voters saw this as independent analysis and were concerned by it. In a world where politicians can always find some experts to back their view, I suspect it is only through singular institutions like the OBR and IFS that the views of the majority of economists get to have some influence, and the economics of wishful thinking gets exposed.

Scotland and the SNP: Fooling yourselves and deceiving others

There are many laudable reasons to campaign for Scottish independence. But how far should those who passionately want independence be prepared to go to achieve that goal? Should they, for example, deceive the Scottish people about the basic economics involved? That seems to be what is happening right now. The more I look at the numbers, the clearer it becomes that over the next five or ten years there would more, not less, fiscal austerity under independence.

The Institute for Fiscal Studies is widely respected as an independent and impartial source of expertise on everything to do with government spending, borrowing and taxation in the UK. It has produced a detailed analysis (recently updated) of the fiscal (tax and spending) outlook for an independent Scotland, compared to what would happen if Scotland stayed in the UK. It has no axe to grind on this issue, and a considerable reputation to maintain.

Their analysis is unequivocal. Scotland’s fiscal position would be worse as a result of leaving the UK for two main reasons. First, demographic trends are less favourable. Second, revenues from the North Sea are expected to decline. This tells us that under current policies Scotland would be getting an increasingly good deal out of being part of the UK. To put it another way, the rest of the UK would be transferring resources to Scotland at an increasing rate, giving Scotland time to adjust to these trends and cushioning their impact. Paying back, if you like, for all the earlier years when North Sea oil production was at its peak.

The SNP do not agree with this analysis. The main reason in the near term is that they have more optimistic projections for North Sea Oil. The IFS analysis uses OBR projections which have in the recent past not been biased in any one direction. So how do the Scottish government get more optimistic numbers? John McDermott examines the detail here, but perhaps I can paraphrase his findings: whenever there is room for doubt, assume whatever gives you a higher number. In my youth I did a lot of forecasting, and I learnt how to be very suspicious of a series of individual judgements all of which tended to move something important in the same direction. It is basically fiddling the analysis to get the answer you want. Either wishful thinking or deception.

I personally would criticise the IFS analysis in one respect. It assumes that Scotland would have to pay the same rate of interest on its debt as the rUK. This has to be wrong. Even under the most favourable assumption of a new Scottish currency, Scotland could easily have to pay around 1% more to borrow than rUK. In their original analysis the IFS look at the implications of that (p35), and the numbers are large.

So what would this mean? Could Scotland just borrow more? I am all for borrowing to cover temporary reductions in income, due to recessions for example, which is why I have been so critical of current austerity. However, as the IFS show, North Sea oil income is falling long term, so this is not a temporary problem. Now it could be that the gap will be covered in the longer term by the kind of increases in productivity and labour supply that the Scottish government assume. Governments that try to borrow today in the hope of a more optimistic future are not behaving very responsibly. However it seems unlikely that Scotland would be able to behave irresponsibly, whatever the currency regime. They would either be stopped by fiscal rules imposed by the remaining UK, or markets that did not share the SNP’s optimism about longer term growth. So this means, over the next five or ten years, either additional spending cuts (to those already planned by the UK government), or (I hope more realistically) tax increases.

Is this a knock down argument in favour of voting No. Of course not: there is nothing wrong in making a short term economic sacrifice for the hope of longer term benefits or for political goals. But that is not the SNP’s case, and it is not what they are telling the Scottish people. Is this deception deliberate? I suspect it is more the delusions of people who want something so much they cast aside all doubts and problems.

This is certainly the impression I get from reading a lot of literature as I researched this post. The arguments in the Wee Blue Book are exactly that: no sustained economic argument, but just a collection of random quotes and debating points to make a problem go away. When the future fiscal position is raised, we are so often told about the past. I too think past North Sea oil was squandered, but grievance does not put money into a future Scottish government’s coffers. I read that forecasting the future is too uncertain, from people who I am sure think about their future income when planning their personal spending. I read about how economists are always disagreeing, when in this case they are pretty united. (Of course you can always find a few who think otherwise, just as you can find one or two who think austerity is expansionary.)

When I was reading this literature, I kept thinking I had seen this kind of thing before: being in denial about macroeconomic fundamentals because they interfered with a major institutional change that was driven by politics. Then I realised what it was: the formation of the Euro in 2000. Once again economists were clear and pretty united about what the key macroeconomic problem was (‘asymmetric shocks’), and just like now this was met with wishful thinking that somehow it just wouldn’t happen. It did, and the Eurozone is still living with the consequences.

So maybe that also explains why I feel so strongly this time around. I have no political skin in this game: a certain affection for the concept of the union, but nothing strong enough to make me even tempted to distort my macroeconomics in its favour. If Scotland wants to make a short term economic sacrifice in the hope of longer term gains and political freedom that is their choice. But they should make that choice knowing what it is, and not be deceived into believing that these costs do not exist.