Earlier this month, the newly established survey of UK macroeconomists considered the economic costs that might be faced by Scotland should voters choose to break away from the rest of the UK in the referendum in September. In a second question, respondents to the Centre for Macroeconomics Survey were asked whether the continuing UK should form a monetary union with an independent Scotland, writes Jagjit Chadha.
Unusually for macroeconomists, whose responses tend to be conditional on many possible scenarios, the outcome was a clear and unconditional view. Of those who answered, nearly all felt that Scotland would not be better off in the event of a break-up of the Union. A smaller majority felt that it was in the interests of the continuing UK to rule out the formation of a monetary union with Scotland.
It is tempting to interpret this result as policy advice: that the case for the economic benefits arising from a break-up has not been made in a manner that convinces the UK economics profession; and that the experience of Europe’s monetary union has made economists wary of setting up a new monetary union.
Let me first me deal with the background to the second question. A generation ago, the UK wrestled with the problem of whether to join a monetary union that was not predicated on a political union. Even though there was reasonable agreement that there were probably microeconomic benefits from the abolition of many currencies within a single free trade area, the likely risks arising from the loss of macroeconomic stabilisation at the national level were considered too great. Given the subsequent problems in the euro area, as it suffers from chronic internal payments problems, the UK’s decision to remain at arm’s length has proved wise.
The prospect of Scottish independence leaves the continuing UK with a not dissimilar problem. Should the continuing UK join or, rather more accurately, form a monetary union that is no longer predicated on a political union?
A new Scottish nation would have the same issues to consider as any small nation-state: how to manage the value of their currency so that it helps rather than hinders the attainment of internal and external balance. If its newly established leaders were to focus on an alternate horizon for their nation’s political and economic institutions, the moment of independence may well be an appropriate moment to design Scottish monetary instruments, including a currency, the management of national debt and wholesale money markets. Yet there seems to be a reluctance to develop these other tangible aspects of nationhood, which were key parts of East European moves to economic and political independence in the 1990s.
When we consider the economic costs of independence, it seems that it would be risky. Of course, all change involves risk and sometimes no change involves risk. Small open economies such as Scotland with excellent stocks of human capital and natural resources clearly have the potential to be run successfully in the global economy. But underpinning success in most advanced economies requires a programme of structural reform, the development of key infrastructure hubs and the maintenance of sound fiscal and monetary policies.
In the longer run, if such a programme can be developed, Scotland may be in a position to benefit from independence. But in the short run, while the ability of a new Scottish government to carry out these reforms is uncertain and as long as any reforms may carry short-run costs as resources are (sometimes) painfully re-allocated, the Scottish Entitlement to a better life under independence is perhaps not vouchsafed.
Jagjit Chadha is Professor of Economics at the University of Kent. He writes in a personal capacity and not on behalf of the Centre for Macroeconomics.