Scotland: Treasury wants a pound for a pound

Royal Bank of Scotland £10 note Scottish pound notes are already visibly different to those in England

Both the Treasury and the Scottish government agree that it makes good economic sense for Scotland and the rest of the UK to share a currency right now. They disagree on how attractive, or workable, it would be if Scotland were to become an independent country.

Which side is right? Unless or until the Scottish people vote for independence, we'll never know. Each is certainly overstating their case.

What their true negotiating position would be after Scottish independence is another thing we cannot know unless or until it actually happens. But even their pre-referendum arguments each have a grain of truth.

If you're a country, how do you decide whether to have the same currency as your neighbour?

Eurozone lesson

Economists usually say the downsides to having a different currency are higher transaction costs and, potentially greater macroeconomic instability.

Companies have to worry about fluctuating exchange rates when they do deals across the border. And it costs everyone a little more to visit or do business with the other country.

As a government with its own independent currency, you also have to build your own credibility in world markets. If you share with another country, you have more chance of trading on their good name.

But there are also important upsides to currency independence - the largest being that when your central bank sets interest rates, it only has to worry about economic conditions here at home. It doesn't need to think about other countries that might be doing better or worse, or accept interest rates that have been set elsewhere.

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There is little mention of Greece or Austria in the Treasury paper. But the basic argument is the same: supporters of Scottish independence are suggesting you can have your cake and eat it too. ”

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Through history, countries have weighed up these two competing considerations: the greater stability and lower transaction costs that come with sharing your currency or fixing the exchange rate, versus the benefits of setting your own course (and interest rates).

The fact that currency arrangements have changed so much, and so dramatically, over the centuries, tells us the trade-off is tricky, and can change over time. If we didn't know that before, we have learned the lesson again, looking at what's happened with the eurozone.

When the euro was launched, at the turn of the century, most economists would probably have said the economic case for some of the 17 members signing was a lot stronger than others. In purely economic terms, it made a lot more sense for Austria to share a currency with Germany than it did for Greece.

Austria's economy was quite similar to Germany's in the late 1990s, in income terms and its levels of productivity. The two economies also tended to move together, over the course of the cycle. For good measure, they also spoke the same language and had a history of people moving back and forth across the border.

You could not say the same of Greece, which had much lower output and income per head, and an entirely different kind of economy to Germany. Currency union between Germany and Austria made quite a lot of economic sense - a union between Germany and Greece, rather less so, whatever the political arguments in favour.

I use the examples of Greece and Austria because each is only slightly larger, in economic terms, than Scotland would be, in the event of independence. Likewise, the difference in size between them and Germany is similar to the gap between Scotland and the rest of the UK.

Oil income

Within the union, the Treasury paper basically says the current set-up for Scotland makes sense, for the same reasons that a currency union between Austria and Germany makes sense - though I should say they never make the comparison. The two economies are structurally very similar. They move together. And there's a lot of back and forth - of trade and people - between the two. Same language, too (give or take).

Stephanie Flanders reports from Aberdeen on the North Sea oil industry's contribution to the UK economy

But if and when Scotland became independent, the paper suggests that a lot of those advantages would evaporate. Why? Primarily because without the financial transfers and political credibility that comes with being part of a single UK, Scotland's economy would be much more vulnerable to shocks, and less able to raise funds cheaply in world markets to even out the bumps.

Scotland's heavy reliance on North Sea oil and the financial sector for its revenues would, say the Treasury, make Scotland's economy much more volatile than the UK.

As I pointed out in a piece for BBC News at 10 on Monday, UK growth has been pushed down quite a lot recently by declining North Sea oil and gas output. Without it, the onshore economy would not even have had a double dip recession last year.

If it had been an independent country over the past decade, with a geographical share of oil and gas revenues, the impact of the recent fall in North Sea output on Scotland's tax revenues and overall economic growth would have been more dramatic.

Over time, the Treasury says the two countries would be less and less well synchronised if Scotland were independent. A currency union between Scotland and the rest of the UK would start to look less like Germany and Austria - a bit more like Germany and Greece.

There is little mention of Greece or Austria in the Treasury paper. But the basic argument is the same: supporters of Scottish independence are suggesting you can have your cake and eat it too.

The paper asserts that Scotland cannot have all the extra autonomy over taxes and spending and regulation that comes with independence, while somehow also hanging on to all the benefits of sharing a currency with the rest of the UK, because currency union after independence would have to work differently than it does now.

There would not be the same automatic fiscal transfers, helping to keep the two economies in sync. There would need to be a fiscal pact, and a clear agreement about how - and when - the Bank of England would ever bail out Scottish banks.

The Scottish government accepts the last part of this, that there would need to be a deal on fiscal policy and the banks. It disagrees that it would be so onerous for Scotland - or unattractive to the rest of the UK.

Economists might have sympathy with that second point. What George Osborne said on the Today programme on Tuesday morning was actually stronger than the report itself. He said it was "unlikely that a eurozone-style currency union with Scotland could be made to work" after independence.

It is not obvious, given the practical and economic advantages of currency union highlighted in the report, why that would be the case, if Scotland were willing to sign up to a Treasury-style set of constraints.

As I said at the start, we don't really know what the negotiations would look like in the event that Scotland actually chooses independence, and what we've heard on Tuesday may not provide much of a clue.

It's not entirely plausible that Westminster would turn its nose up at a currency union with Scotland, in those circumstances. But nor is the idea that Scotland could win significant economic freedom as an independent country - without giving up anything significant in return.

Stephanie Flanders, Economics editor Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 98.

    In the 100:1 chance he gets independence, what happens when he goes?
    Good question

    Like Westminster, We need a new system

    We pray to God for someone who isn't stupid and corrupt

    We adopt direct democracy, like Switzerland, which has almost twice the population as Scotland

    (Personally speaking I reckon that the Scots are too chicken)

  • Comment number 97.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 96.

    Providing they can't vote on English matters or work in parliament I'm happy to leave a state profiting for a couple of decades on north sea oil.

    They will need a banking system that can print money like the BoE mind.

    Overall I think we are stronger together, but if they insist on going then English parliament should sever all umbilical cords.

    You pay your money and take your chance.

  • rate this

    Comment number 95.

    Thanks to Ipsos Mori's latest Scottish polling questions, David Lilley can rest easy that the SNP wouldn't be too lost without Salmond. As well as the usual q. on approval of Scottish party leaders, the last poll added Nicola Sturgeon and Alistair Darling to the pool. Ms Sturgeon actually had better approval ratings that Salmond (50% approval, net +17). Not so much of a solo act then.

  • rate this

    Comment number 94.

    There is bigger and insurmountable problem with the Scottish separatists, there is only one member, Alex Salmon. Without this epic politician, running rings round all his peers, the SNP would collapse tomorrow just as it did when he retired.

    In the 100:1 chance he gets independence, what happens when he goes?

  • rate this

    Comment number 93.

    Remember reading an article years ago about how Scotland's banks paid the BofE over £1bn a year to guarantee parity of Scottish notes against the English version in the international markets

    Maybe it's the loss of that revenue the money people and self-serving politicians are worried about

  • rate this

    Comment number 92.

    If Scotland gains independence, then keeping sterling makes sense for us all..
    There will obviously need to be agreements, but sensible voices will prevail.The rest of the UK trades with Scotland too, and doesn't want the hassle and expense of different currencies.

    Does anyone seriously think UK politicians will harm their own interests just out of spite, if the Scots vote to govern themselves?

  • rate this

    Comment number 91.

    Come on Stephanie.
    You write:

    "Scottish pound notes are already visibly different to those in England"

    You should also mention that for every Scottish Note issued those banks are required to hold the same amount of British Notes.

    Of course Notes are small beer now. Ceremonial.

    Mortgages are the real McCoy.
    And debt.
    Ones and noughts in memory.

    Currency Notes mean nothing.

    Except to voters...

  • rate this

    Comment number 90.

    8. AMJHAJ

    Your remark should have been very obvious. Stephanie tends to think in a stereotyped way about Scotland. The UK may not be a nice place to live in by the time of the referendum.

    If Scotland isn't allowed a currency union with England, it will have its own currency (which is seen as such bliss by Europhobes!) or, oyez, oyez, it might even join the euro.

  • rate this

    Comment number 89.

    The £ is a UK currency and if Scotland chooses to leave the UK it should leave the pound. Scotland won't be independent if it expects a UK of England Wales and Northern Ireland to pay for it's central bank, it's defence, it's embassies etc.

  • rate this

    Comment number 88.

    The oil companies had a bonanza in the 70s. The tax regime was such that they romped off with whatever they liked.

    Come the 80s Thatcher sold off what was left of BP and BNOC was simply assimilated.

    All so that Thatcher could sell off utilities and industry.
    For her experiment. The City.
    Well guess what: - It failed.

    We are now left with nothing. Thank you Thatcher, Blair etc.
    A hollow shell..

  • rate this

    Comment number 87.

    Calling all Scots. Please don't let this rigmarole about the silly old pound put you off. Listen to Alex. If it was really important he would have thought about it long ago. Clearly he didn't, so it can't be worth worrying about.
    Bit like his plan to give away newly-won independence by subjugating Scots to the EU & EZ?

  • rate this

    Comment number 86.

    Calling all Scots. Please don't let this rigmarole about the silly old pound put you off. Listen to Alex. If it was really important he would have thought about it long ago. Clearly he didn't, so it can't be worth worrying about. And just think how nice it will be to have Salmond's head on your coins and stamps, and his face on your banknotes. Put Connery and Gibson on there too. Pure class.

  • rate this

    Comment number 85.

    83. ExpatKS
    I spend a lot of time in Scotland & that’s my impression as well.
    Several of my friends vote for the SNP because they think they do a good job supporting Scottish interests, but they have no intention of voting for independence.
    Salmond would be foolish to think that every SNP voter will support independence out of patriotic duty.

  • rate this

    Comment number 84.

    One of the reasons why Oil & Gas production fell was a response to Bertie’s cash grab on North Sea production.
    Thankfully he realised the error of his ways & balanced things with a package of tax allowances to develop brown field projects.
    Stephanie makes it sound like the Oil & Gas industry in Aberdeen is going into decline, but those of us in the Biz are quietly confident.

  • rate this

    Comment number 83.

    Our long time (40yrs) Scottish friend was staying with us last week. She loves Scotland but says that the referendum will give a resounding NO to independence. She says the majority of Scots realise that it's all about legacy for Salmond & less about the peoples' interests. She sees hundreds of patients a week & they nearly all agree with her, she said.

  • rate this

    Comment number 82.

    Never tie your colours to the mast of a sinking ship.

  • rate this

    Comment number 81.

    Typical. The Scots offer something malleable to both parties and the secessionists throw a tantrum, removing nose from spited face ;-)

    Scotland have plenty of options, keeping the pound would have been the least disruptive and costly for both parties.

    The comparison with Greece is just another spurious comparison with no merit. And I'm sure there will be plenty of takers for Scottish power.

  • rate this

    Comment number 80.

    I am led to believe that China will not let the Scottish people suffer at the hands of the Bullingdon louts.

  • rate this

    Comment number 79.

    Its easy enough they can go join the Euro.

    If they want to be independent then we've enough problems of our own without having to get involved with complex monetary arrangements.

    Independence isn't about we'll have that bit from there and this bit from here its Independent or Not Independent

    Can't wait to get rid of all those Scottish MP's :0)


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