Monthly Archives: August 2014

An independent Scotland would be a small government, free market utopia

Making a comeback

The Scottish independence referendum campaign is kicking into high gear and last night saw the first debate between Alex Salmond and Alistair Darling. The debate seems to have focused on the question of what currency an independent Scotland might use. It’s an important question, but one that Mr Salmond doesn’t yet have an answer for.

This is a question I’ve written about elsewhere previously. As I wrote then

“Imagine walking along Edinburgh’s Royal Mile in a newly independent Scotland. You want to buy a Bay City Rollers CD as a souvenir and you have a fiver issued by the Bank of England in your pocket. If you can find a vendor willing to take that English note and give you the CD in return, the English authorities would be no more able to prevent the transaction taking place than the U.S. Treasury is to stop rickshaw drivers in Nepal from taking dollar bills in exchange for rides.

There is also nothing necessarily to stop a Scottish government conducting its business in sterling, euros, or whatever else. But it would need to be able to get hold of the requisite sterling, euros, or whatever else. A government that issues its own legal tender has three ways of getting the money it needs to fund its activities: It can print it, it can borrow it, or it can tax it.

An independent Scottish government that chose to transact (pay its employees, transfer payments, etc) in sterling would have no ability to print the necessary currency. It would be in the same situation as a euro member-nation.

This might also act as a constraint on borrowing the necessary sterling. The increased risk of nominal default would push up borrowing costs. Independent Scotland would then be in the same position as a specific euro member-nation—Greece. Thus, Scotland would have to rely on its domestic tax base to provide the necessary sterling.

How would the taxpayers of an independent Scotland get the sterling needed to pay these taxes? They would need to export more to England (or anyone else who is willing to transact with them in sterling) than they import from them. In short, Scotland would have to run a fiscal and current-account surplus, a big ask.”

I’d like to elaborate on these last two points. First, an independent Scottish government is likely to find itself with an even bigger budget deficit than the United Kingdom has now. Mr Salmond’s apparent belief that he will be able to close this by ‘ending austerity‘ is curious to say the least. It makes it even less likely that a Scottish government would be able to borrow the sterling it needs to transact at anything like a plausible rate.

With money printing out a Scottish government would fall back for its funding needs entirely on its domestic tax base. For Scottish individuals and businesses to have the sterling to hand over to the government in payment of taxes they would need to sell more to England (or anyone else who will transact with them in sterling) than they buy – a current account surplus, in other words. To accomplish this the Scottish economy would need to be either super innovative (like Germany, producing things nobody else does) or super cheap (like China, producing stuff anyone can produce but cheaper than anyone else can). Which of these is more likely? Is either?

I find it very hard to believe that an independent Scottish government would, at least any time soon, be able to secure from its tax base the funding to maintain its present level of spending. Government spending in an independent Scotland would fall, fall quickly, and fall by quite a lot. It’s not clear how many of the pro-independence camp realise that.