For success in politics or business, leaders need a coherent and effective “Plan A” to submit to the public and their key stakeholders. But they also need a viable “Plan B” – a contingency plan that can be rolled out in the event that Plan A cannot be delivered for reasons beyond their control.
The SNP’s plan a for a currency union and continued EU membership on the same terms as at present has increasingly been called into question. As an economist, I have no comment to make on the political case for Scottish independence. However, from an economic viewpoint, there is no reason why an independent Scotland could not survive, and indeed thrive – provided the Scottish Government puts in place an appropriate policy framework. This policy framework could involve rolling out a “Plan B” for both the currency and relations with Europe, as set out below.
Six steps on the path to Scottish economic independence.
1. Referendum Night: September 18th / 19th 2014.
In the headquarters of the “Yes” campaign, joy is unconfined, as news comes in of a decisive vote in favour of independence. The music is raucous and the water of life flows freely. Until, that is, at around 3 AM, when the plaintive voice of a junior adviser, who has imbibed slightly less copiously than others present, is heard above the hubbub, asking the killer question:
“What the (expletive deleted) do we do now?”
2. The Hangover: September 19th 2014.
As the revellers slowly come back into consciousness, sometime around midday on September 19th, the reality of the situation becomes apparent. Despite opinion polls showing gathering support for the Yes campaign in the months leading up to the referendum, the markets had genuinely failed to discount the result. The London Stock Market is in meltdown. The FTSE 100 records its worst one-day fall since the collapse of Lehman Brothers. Major companies, including RBS and Standard Life, announce that they are implementing plans to transfer their head offices from Edinburgh to London – and with them will go several million pounds of corporation tax and the income tax paid by their senior executives. Elsewhere in Scotland, major investment projects are put on hold as funders state that they are reviewing their commitments “pending clarification of the independence settlement.” The Scottish property market seizes up – there is a complete absence of buyers for both commercial and residential properties, and those who wish to buy are finding it increasingly difficult to raise money from the banks to complete their purchases.
3. The Emergency Budget: late September 2014.
Faced with the threat of a flight of human and financial capital from Scotland, Finance Secretary John Swinney gathers together his closest and most trusted advisers. Mr Swinney has proved himself to be a competent and prudent Finance Minister within the devolved administration, but nothing has prepared him for the panic that threatens to engulf Scotland even before the first date for detailed negotiations on the independence settlement is set. The Finance Ministry team devise a plan to combat the panic. An Emergency Budget is introduced, developing commitments given in the Independence White Paper to cut corporation tax to 12.5% and reduce Air Passenger Duty. More widely, the Finance Secretary gives an unequivocal commitment that income tax in an independent Scotland will be levied rates no higher than those that apply in England, and that the Scottish Government will manage its affairs to comply with the Maastricht criteria. This means that the Scottish Government will not at any time run a budget deficit that exceeds 3% of national GDP.
The message is clear. Companies are free to relocate from Scotland to England if they so wish. But if they do so, they will face a higher corporation tax bill on their profits, and their employees will have to pay higher taxes on their incomes.
Faced with this message, the threatened haemorrhage of Scottish companies south of the border slows to a trickle, as their Chairmen announce they are adopting a “wait and see” approach before taking any final decision.
4. The Medium Term Financial Strategy (MTFS): 2014-2015.
One implication of the Finance Secretary’s commitment to a competitive taxation regime is that public expenditure has to be kept under tight control. Over the succeeding months, the Finance team at Victoria Quay works well into the night and over weekends to develop a public spending strategy for post-independence Scotland. Out go previous expenditure plans that will no longer be affordable within the framework of the MTFS, such as the proposal to increase defence expenditure in an independent Scotland above the levels that applied within the UK (Why? Does an independent Scotland fear invasion from England – or perhaps from Russia?!). Little by little, as the resource constraints that an independent Scottish Government will face become clear, the Finance team is forced to look at more radical options, including a fundamental shake-up of the welfare system. The spending review concludes that minimum welfare standards must be guaranteed for all, but that real increases in benefits funded from general taxation are neither economically beneficial nor financially affordable. Instead, an independent Scotland will move towards an insurance-based system similar to those of Scandinavia or Germany, as Lord Beveridge himself envisaged in the 1940s.
Little by little, Scotland is weaning itself off the dependency culture of the UK, and moving towards a self-sustaining system of social insurance.
5. The End of the Currency Union: 2015-16.
While the Finance Secretary is creating a sustainable fiscal system for an independent Scotland, the Deputy First Minister is tasked with leading delicate negotiations with the rest of the UK on the thorny issue of the proposed currency union.
Perhaps Nicola Sturgeon will be proved right, and the Unionist Parties have been bluffing in ruling out a currency union in the run-up to the Independence Referendum. But I hope not. For if they were, she and her team face months if not years of arduous and difficult negotiations with a reluctant and probably sullen counterparty, who will quibble over every minor issue, and seek to squeeze every concession they can from the Scottish negotiators. The end result is likely to be an unstable and unsatisfactory compromise, which will probably collapse within a few years, as the First Minister appears to recognise.
A far better alternative would avoid going down this blind alley. Instead, an independent Scotland takes complete control of its own currency and monetary policy. The Government announces the creation of a new Scots pound, pegged at parity with the £ Sterling – in exactly the same way as the Irish pound used to be – to be managed by a newly created Reserve Bank of Scotland.
The powers and operations of the Reserve Bank are modelled on those of the successful Hong Kong Currency Board, established 30 years ago when the Hong Kong dollar was pegged to the US dollar, at a rate which has prevailed ever since, through years of radical constitutional change and financial turbulence.
John Greenwood OBE, one of the main architects of the Hong Kong currency board, has set out six conditions for such a board to operate successfully. On my analysis, an independent Scotland could fulfil all six.
Prime among them is the need to maintain high levels of gold and foreign exchange reserves. A couple of days ago, George Soros cautioned against the option of creating a new Scottish currency, warning that it would inevitably come under attack from currency speculators at some point (I wonder whom he could possibly have had in mind?). There is no doubt that Mr Soros is correct. It would therefore be imperative for the Reserve Bank to accumulate sufficient foreign currency to repel any speculative attack. It should also keep its own interventions in the foreign exchange markets a closely guarded secret, so that speculators would never know from day to day when the Bank might enter the market with heavy Buy orders for Scots Pounds, driving up its value and causing severe losses for any speculators naïve enough to believe that they could make easy profits by going short of the currency.
In order for the Reserve Bank of Scotland to command respect in international markets, it is important that it maintains reserves of foreign currency that are significant in relation to the value of Scottish GDP. This in turn implies that an independent Scotland would need to run a Balance of Payments surplus at least for the first few years after independence. So the fiscal framework put in place by the Scottish Government would need to encourage exports – electronics, IT, oil, renewable energy, financial services, whisky, and tourism. For example, the Republic of Ireland applies a 9% VAT rate to hotels and restaurants, recognising that a competitive VAT regime is essential if they are to compete in highly price-sensitive international tourism markets. As a result, Ireland has gained market share at the expense of the UK, where VAT is applied at 20%. An independent Scotland should follow the Irish model in this regard.
6. Relations with Europe: 2015-16.
Immediately after the Referendum result is announced, the First Minister makes contact with the European Union seeking to confirm the terms of Scotland’s continued membership.
There are two alternative scenarios of what happens next. Under the first scenario, EU leaders would enter into a constructive and positive dialogue. This is the scenario for which Alex Salmond – and indeed myself – would hope. In which case, Scotland’s continued membership of the European Union, on broadly the same terms as at present, is assured.
However, there is a second scenario, which has to be considered following recent ill-judged remarks by Mr Barroso and others in the EU hierarchy. These hint that Scotland’s continued membership of the EU in the event of independence is likely to be fraught with difficulty.
It would be demeaning for the leaders of an independent Scotland to go like a beggar to the banquet pleading for crumbs from the rich man’s table. There seems to be an attitude, exemplified by Mr Barosso and others, that wee Scotland should be grateful for any attention the panjandrums of Brussels deign to give us, and we should be duly humble if these great men so much as admit us into their august presence.
Nothing could be further from the truth. The reality is that the EU needs Scotland more than Scotland needs the EU. Whatever the merits of the European Union as originally conceived, in recent years it has increasingly corrupted into a self-regarding and self-serving bureaucracy whose incessant demands for the transfer of more power, wealth and influence to the centre has weakened the peripheral Member States – Portugal, Ireland, Italy, Greece and Spain – and, yes, Scotland.
The leaders of an independent Scotland should make it unequivocally clear from the outset of any post-independence negotiations that they are not prepared to join the EU club on any terms they care to dictate. If the terms are not acceptable, Scotland has a perfectly viable “Plan B” – namely, to remain outside the European Union but with a commitment to free trade and open frontiers with it – going the way of Norway, Switzerland, the Channel Islands, Monaco and others – none of whom seem to have suffered unduly as a consequence.
Following these six steps, within two years of a Yes Vote, despite current scaremongering and a reaction that is likely to be negative in the short term, Scotland could put in place three key pillars of stable growth and full employment – fiscal prudence, sound money and free trade. If it does so, the foundations of prosperity in a free society will have been laid.
MJN, March 2014