By The Scottish Economic Planning Department. 1975.
At the meeting which you held last week on various aspects of North Sea oil and devolution I suggested that I might send in the attached paper in the hope that it would serve as a starting point for any assessment the Unit may wish to carry out on the economics of Scottish Independence.
The Paper was written over a year ago in the weeks immediately before the February 1974 Election. This will be particularly apparent of page 5 where, of course, the Ministerial pronouncements referred to relate to the Conservative Government.
I have not attempted to update any of the figures, since although there would be differences these do not seem to me to be such as to alter the argument. As you will realise, the debate on Scottish nationalism has been founded to a surprising extent on economic arguments ad the purpose of this paper was to examine how far this was affected by North Sea Oil. The first part goes through most of the usual arguments which have been used against the Nationalists in the past with fairly convincing effect; the second part sets out the sort of economic strategy which an SNP Government might try to follow indicating both the dangers and the possibilities.
As I said at the meeting, one can reach almost any conclusion depending upon the assumptions that are made about tariffs, a common currency, a Scottish Government’s spending priorities and its success in controlling inflation. My paper may give an SNP Government the benefit of too many doubts, but I was anxious to see whether a credible economic strategy could be put together which would appear to be more convincing in terms of solving Scotland’s traditional economic problems than the regional policies of the Unionist Governments have been up until now.
I think the conclusion is that the most convincing way of taking the wind out of the SNP’s sails is by demonstrating that we now have policies which can make major in-roads into these problems. When my paper was written it was classified “secret” and given only a most restricted circulation in the Scottish Office because of the extreme sensitivity of the subject.
I am copying it now to Leo Pliatzky, Dick Ross, Jim Hamilton, John Liverman and Stuart Scott Whyte. R G L McCrone
SECRET
THE ECONOMICS OF NATIONALISM RE-EXAMINED
It is commonplace that the discovery of North Sea oil and entry to the EEC are factors of major economic significance for Scotland. Already both issues, especially the former, feature widely in the SNP’s election material. The purpose of this paper is to reassess the economic arguments for an independent Scotland in the light of these developments, especially the discovery of oil.
It will be shown that the whole framework within which the economic implications of nationalism were argued has indeed been altered. The importance of this is probably greater than is recognised at present by the majority of the public and it may well be, therefore, that the discovery of North Sea oil will come to be seen as something of a watershed in Scotland’s economic and political life.
The case for Scottish nationalism is, of course, very much more than an economic issue. This paper makes no attempt to examine the wider questions. Suffice it to say that Scottish nationalism has been much more concerned with economic prosperity than nationalist movements in other countries.
Unlike Wales there is no great cultural movement attaching to the preservation of a language. The main cause of discontent is the country’s unsatisfactory economic performance over the last half century, especially the persistent unemployment and net emigration above all in the West of Scotland.
Poor social and environmental conditions, especially in and around the city of Glasgow, accompany this outdated economic framework and are as much a source discontent. Despite regional policy and the efforts of planners, these problems have not been overcome, nor do they look as if they will be in the foreseeable future.
The SNP have therefore based their campaign on the assertion that Scotland would be economically better off independent; and it is for this reason that budgetary estimates have always featured so large in the controversy. Yet in spite of Scotland’s undoubtedly poor economic performance the SNP case until recently lack credibility. Most people regarded both their statistics and arguments suspect, and they continued to believe that Scotland derived more economic advantage than disadvantage from the Union.
The importance of North Sea oil is that it raises just this issue in a more acute form than at any other time since the Act of Union was passed.
The Case Against Nationalism
The traditional economic case against nationalism has always been that a politically independent Scotland would be unable to gain sufficient economic sovereignty to solve her problems successfully. This is partly a question of the scale of the Scottish economy, but more of the extent to which it has become integrated with that of the rest of the UK over the last 270 years.
Scotland needs a faster rate of economic growth than wither she or the UK has had in recent years if she is to absorb her excess labour resources and thereby cut down both unemployment and migration, There are three principal way in which an independent Government might seek to bring this about. First it could seek to foster and protect Scottish industry by means of tariffs and import controls.
But such measures would risk retaliation from England which, given Scotland’s close trade ties with England, could cause damage far in excess of any benefit that may be hoped for. Such policies would also be incompatible with continued membership of the EEC and withdrawal, especially with England, Wales ad Ireland remaining members, would clearly have very damaging consequences.
Secondly, fiscal policies might be used to give especially large benefits to new industrial investment or tax relief and subsidies to existing industry. This might involve the imposition of a tax frontier at the border, as still exists between most EEC countries, but this need not to make it impractical. Such policies have been used with considerable success by the Irish Republic since the mid-1950s.
The main disadvantage is that England would probably feel obliged to match the Scottish measures with equivalent in grants or tax allowances for industry in English and Welsh Development Areas. Up to now England has always been in a position financially where, if she wished, she could have more than matched any measures which a Scottish Government would be able to afford.
It is here that the budgetary position of a Scottish Government becomes important. Various studies, notably the Treasury’s Scottish Budget of 1967/68 and the work of the Kilbrandon Commission have shown that public expenditure per head in Scotland is generally above the UK average, whereas public revenue is Scotland is slightly lower, largely because Scottish incomes are below the UK average. The result is that budgetary estimates for Scotland show a proportionately larger borrowing requirement than for the UK as a whole.
His position is confirmed in the most recent estimate of Scotland’s budgetary position carried out by the Economic and Statistics Unit of SEPD for 1971/72. This shows a Scottish current account surplus of £24m. but a net borrowing requirement of £447m. overall.
There are, of course, various ways in which this could be tackled. In the first place it is not necessary to balance the budget. To finance loans and various items of capital investment, particularly those which yield a return by borrowing is quite reasonable; other items too may be covered by borrowing form time to time particularly if an expansionary budget is necessary to generate a higher level of economic activity in the economy.
For these various reasons the United Kingdom budget normally involves a net borrowing requirement and whilst this will normally be fairly small this is not always so; in the present year, for example, the borrowing requirement reached the record figure of £4,000m.
If allowance is made for the capital items that it would normally be reasonable to finance by loan, this would still lave a Scottish deficit of over £200m., a very similar figure in 1971/72 to what it was in 1967/68.
Whilst such a figure could be covered if it arose only exceptionally, it could not be tolerated as a regular feature of the budget. It would involve a steadily increasing Scottish debt and it would have serious implications both for interest rates and monetary policy, unless a substantial part of it could be financed from abroad.
A Scottish Government would therefore have to take steps to reduce the deficit either by raising taxes or cutting expenditure. Such measures are perfectly possible, and on the scale necessary, need not provoke a intolerable situation, especially if defence was one of the items cut; but they would create a background of acute budgetary stringency against which it is hard to see it being possible to provide a major fiscal stimulus to encourage economic expansion.
The third possible course of action would be to devalue the Scottish currency. This would stimulate economic activity by increasing the demand for exports and making Scottish goods more competitive against imports in their home market. In many respects devaluation would be the obvious measure for an economy in Scotland’s condition with persistent unemployment, a budgetary deficit and probably a serious adverse balance on the balance of payments.
Indeed, if the later was persistent, it might be that devaluation would be inescapable. Exchange rate adjustment is, of course, the ultimate and most effective weapon by which an economically sovereign state maintains approximately full employment while at the same time avoiding balance of payments disequilibrium.
Indeed, if Scotland could have devalued by a good thumping 2 percent and made the adjustment effective in terms of costs, this would be by far the best way of solving Scotland’s economic problems of the last two decades. It has been argued that the‘regional problem’ only arises because exchange rate adjustment, the normal way of dealing with disequilibria between countries, is not possible between regions.
However, the economic case against Scottish nationalism has always at bottom come down to the proposition that an independent Scotland would not find it possible to carry out an effective devaluation. To be effective, devaluation involves a country in making a cut in its real living standards at least until such time as production is able to catch up. But the Scottish labour market is so closely linked with that of the rest of the UK that it is hard to see how real earnings could be adjusted downwards without giving rise to the most serious difficulties. For such a small country heavily dependent of international trade, devaluation would, of course, have serious inflationary consequences, since all imports would rise in price.
Trade Unions are to a large extent on a Great Britain basis and it is hard to see them accepting a deliberate attempt to cut real wages in Scotland compared with England whatever the reason for it may be. Furthermore, even with independence, freedom of labour movement between England and Scotland would be likely to continue, a common language and two and a half centuries of free movement make this easy.
Changes in real wage levels would therefore be likely to be reflected in migration figures and could lead to a shortage of certain types of skilled labour in Scotland even while a surplus among the less mobile unskilled persisted.
It is for these reasons that many economists have in the past concluded that Scotland, if she were independent, would probably be unable to devalue effectively against the rest of the United Kingdom.
Lacking this ultimate weapon of economic sovereignty and limited by the budgetary situation in the use she could make of fiscal policy, it did not seem that political independence would give Scotland sufficient economic sovereignty to enable her to tackle her economic problems successfully, At the same time, whatever the constitutional set-up, the Scottish economy would remain closely integrated with that of the rest of the UK and would be greatly affected by policy decisions taken in London, though as an independent state her ability to influence those decisions would be greatly reduced.
The Implications of North Sea Oil
The analysis in the last section is based on the situation as it appeared before the discovery of North Sea oil. Even after its discovery the full significance of North Sea oil was not immediately apparent and it still remains in large measure disguised from the Scottish public by the DTI’s failure to make provision for a proper Government return when the fourth round of licences was issued.
So far all that Minister have said is that they expect North Sea oil to be yielding 70-100m. tons of oil per annum by 1980 and that on that basis the Government revenue from rent and royalties from the whole of the Continental Shelf including the gas fields in the southern sector may be of the order of £100m. per annum at that time.
It has been explained that this estimate does not include the yield from ordinary taxation on the oil companies and it has been stated that licensing policy is currently under review but the significance of this has probably not been fully appreciated by the public.
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