The Scottish Trades Union Congress (STUC) will publish its second ‘A Just Scotland Report’ on Thursday 20th February. In the context of the anticipated speech by George Osborne in which it is suggested he will rule out any prospect of a formal currency union with an independent Scotland, the STUC is releasing early excerpts from the report dealing with this issue.
STUC General Secretary Grahame Smith said:
“In the STUC’s view it would be unhelpful in the extreme for the Westminster Government and the UK’s other main political parties to declare that there are no conceivable circumstances in which they would agree to a formal currency union with an independent Scotland, and if they do choose to do so, they should lay out in very clear detail why this is the case. This is a duty they owe, not just to Scottish voters but to citizens across the UK.
“However, it is an unavoidable truth that, there are a number of disadvantages for the rUK in agreeing to a currency union and in its denial of these and its exaggeration of some of the presumed benefits, the Scottish Government is also guilty of bringing us towards what appears to be a looming impasse. The Scottish Government is currently far too optimistic over the degree of influence it would expect to exert under any formal currency union and takes for granted a number of future fiscal powers which would, at the very least, be a matter of difficult negotiation.
“There is no reason why a position cannot be reached in which the Westminster Government concedes that currency union is possible without it being concluded that it is inevitable. It should lay out in far more detail what its expected conditions might be. Equally, the Scottish Government must concede that the outcome of any negotiation might not be acceptable to both sides, in which case, it must identify which of the other options it should pursue. Given that the STUC and other commentators have identified significant potential difficulties in relation to all other options, the Scottish Government must provide a detailed picture of how it would proceed to create the fiscal conditions and institutional framework required to deliver on its preferred second option.”
For further information contact Kevin Buchanan 0141 337 8100
The STUC’s second ‘A Just Scotland’ report which will be published in full on Thursday 20th February will address the four main currency possibilities for an independent Scotland and will conclude:
While it might work for Ecuador (US Dollar) and Montenegro (the Euro), sterlingisation (or Dollarization) – or a unilateral decision to use a currency without any access to or influence over the institutions of monetary control – is not a viable option for a nation at Scotland’s stage of economic development particularly one with such a highly developed financial sector.
The Euro would at least provide one tangible benefit in the form of significantly reduced transaction costs with a major trading partner. However this would be more than offset by higher costs with rUK. Scotland would be required to establish its own central bank which would be able to exert only marginal influence on the European Central Bank and ECB’s decisions are likely to be even less well suited to Scotland’s circumstances than those of the Bank of England. There would also be significant constraints on fiscal policy as the Eurozone seeks to shield itself from a repeat of the recent (many would argue ongoing) crisis. In the circumstances in which Scotland would find itself in 2016 it is difficult to conclude anything other than the risks and costs of joining the Euro would significantly outweigh the opportunities and rewards.
A new Scottish currency
The STUC believes this option would in the long-term allow most discretion over fiscal and monetary policy but that the transition could be extremely fraught; requiring a period of potentially severe fiscal restraint.
Proponents of a new currency have yet to set out a detailed transition process and whether they support flexible, managed or fixed exchange rate policy. The STUC notes that most informed commentary accepts that a peg – probably against sterling but also possibly against the Euro or a basket of currencies – would be necessary at least in the medium term. With very limited foreign exchange reserves (estimates have put Scotland’s population based share of BoE reserves at less than £10bn) and a highly uncertain balance of payments position it would be very difficult for the Scottish Central Bank to maintain this peg without running budget surpluses which, on current forecasts and at least in the early stages of independence could only be achieved by spending cuts or tax rises. The transition costs (redenomination of contracts etc) will also be significant and borrowing costs higher.
The degree of policy flexibility that may seem to flow from a new currency may be more illusory than real under managed exchange rate policy. The risks associated with a floating exchange rate on day one of independence are real and significant. A currency board arrangement would lead to very restrictive monetary and fiscal policy.
A formal currency union with rUK
While formal currency union makes sense for the independent Scotland it is not at all obvious that it represents ‘common sense’ for rUK.
The benefits and drawbacks of formal currency union for an independent Scotland are now well-rehearsed. Continuing to use sterling avoids the large transition costs associated with other options and retains low transaction costs with rUK. Any dynamic economic effects achieved through the use of sterling UK wide (resources shifting from inefficient to efficient producers) will be maintained. The drawbacks include inevitable constraints on fiscal policy which many Scottish voters are likely to regard as inconsistent with their visions and expectations of independence. Sharing accountability for the Central Bank could be a sub-optimal arrangement for both nations.
The Scottish Government argues that a formal currency union is the best solution for both Scotland and rUK because:
• as noted above, it will keep the current benefits of the UK in terms of transaction costs;
• both states will continue to form an optimal currency area i.e. labour and product markets will remain highly integrated; there is a high level of labour mobility between both jurisdictions and, unlike the Eurozone, both partners have similar levels of productivity; and,
• rUK will need Scottish exports to the rest of the world to support the value of sterling.
The first point is well made. The second is highly contentious as the crisis in the Eurozone has forced a reappraisal of what constitutes an optimal currency zone. It is now very widely accepted that a durable formal arrangement should include (or work towards) banking union, common debt issue, agreement on limits of fiscal policy and a trajectory towards political union involving substantial transfers between different parts of the currency zone. This is not the model being proposed by the Scottish Government nor is it consistent with the common understanding of Scottish independence.
The STUC also doesn’t believe that the Scottish Government has made a convincing case that rUk requires Scottish exports to the rest of the world to support the value of sterling. Indeed, it is remarkable that while Ministers continue to use this issue as a debating point, it has not been developed in any of the substantial Scottish Government papers published over the past year.
If Scotland is to accept its share of UK debt then it must also receive a fair share of assets. The STUC expects a sensible formula to be agreed on bricks and mortar assets of which the Bank of England represents only a tiny part. More relevantly and as noted above, Scotland must also receive a fair portion of Bank of England assets such as foreign exchange reserves.
However, Scotland cannot automatically expect to continue to rely on the Bank of England to deliver liquidity support to Scottish based financial institutions in the event of further crises or act as lender of last resort (LoLR) to the same institutions or the Scottish sovereign. These are functions of the Central Bank, ultimately backstopped by rUK taxpayers, not ‘assets’ to be shared. In this respect it is unhelpful for currency to be conflated with functions of the central bank and to be described as an asset which can be divided.
For rUK the decision on whether to consent to a formal currency union is essentially a trade-off between:
• higher transaction costs between rUK and Scottish firms plus the loss of some dynamic benefits; and,
• the significant loss of economic sovereignty represented by having to share a Central Bank with another nation and the risk of rUK taxpayers ultimately backstopping a lender of last resort function to Scottish based financial firms and the Scottish sovereign. This is ultimately as much a democratic issue for rUK as it is an economic one.
Given the inescapable asymmetry in size between the only two members of this currency zone, the STUC finds it difficult to envisage any scenario in which Scotland would be able to exert genuine influence on monetary policy. As rUK is mindful of the problems that shared accountability will bring in times of crisis, it is very possible that Scotland may have to accept an entirely subordinate position. While this situation currently exists, it will become more problematic post-independence as the economies begin to diverge. In this context it is worth stressing that it is the Scottish Government’s position that the economies will diverge.
The STUC believes that the UK Government must clarify its position on currency union prior to the referendum. This should include the parameters of the fiscal constraints it would expect in the event of a shared currency negotiation.