This article first appeared in The Herald on 18/08/2021- see here.
This year’s dramatic GERS fiscal deficit figure of 22.4% of GDP again underscores the importance of the fiscal risk pooling and sharing that occurs in political and monetary unions, such as the UK. Such fiscal insurance becomes most evident, in the form of automatic stabilisers and extra discretionary government spending, when large macroeconomic shocks occur, such as the financial crisis in 2008, the oil price shock of 2015 and now with the macroeconomic shocks induced by the pandemic.
In the current crisis the fiscal insurance provided as part of the UK has clearly been absolutely crucial in supporting businesses, workers and the health service. Additionally, the firepower that the Bank of England has brought to bear during the pandemic with its QE policies has proved crucial in providing orderly markets for government borrowing.
Given the size of this year’s deficit it seems unlikely it will generate the traditional bunfight between those who accept the veracity of the underlying numbers and those who contest the manner in which they are generated. Rather the debate has already shifted to those who argue that an independent Scotland would be able to borrow at the kind of historically low interest rates that the UK and other countries have borrowed at during the pandemic and those who argue that the borrowing costs will be significantly higher in an independent Scotland because of the currency regime favoured by proponents of independence.
Even with an appropriate currency regime in place, a newly minted independent Scotland without the long history of credibility that the Bank of England and Treasury have, would have to pay a premium on its borrowing over UK rates due, for liquidity and credibility reasons, of up to 1.65%. But the borrowing rates an independent Scotland would face would be dramatically higher than this because of the SNP’s stated policy of using sterling informally post-independence.
Alongside Scotland’s structural fiscal deficit is an historically high balance of payments deficit of around 10% of GDP. Unfortunately, this deficit, which is quite distinct from the fiscal deficit, does not get the same publicity as the GERS figures despite its significance for the economics of independence. With such a large external deficit, financial markets will from day one of independence, if not before, be expecting an abandonment of sterlingisation and a move to a sharply devalued Scottish currency at around 20-30%. Such a large expected devaluation would have to be reflected in borrowing costs along with a default premium. Additionally, sterlingisation implies that an independent Scotland would not be able create extra liquidity in a crisis to ensure orderly borrowing conditions. For example, the Croatian central bank effectively monetised 74% of its fiscal deficit in 2020.
There can be little doubt that the current GERS figures again highlight the sheer folly of the SNP’s independence plans and the huge costs and disruption that they will impose on the Scottish economy in any transition to an independent country. The current fiscal and monetary union that exists within the UK clearly works smoothly and to Scotland’s considerable advantage compared to the alternative proposed by the SNP.
By Professor Ronald MacDonald
Professor of Macroeconomics and International Finance at the University of Glasgow