Tag Archives: Economics

The unfulfilled promises of independence

One of the most important things to realise about the referendum on independence is that no one really knows what would happen if Scotland chose to secede from the UK. Both unionists and nationalists speculate, each striving to gain some advantage from these speculations, but in the absence of a working crystal ball, everyone must finally accept that the future is unknown. The past, on the other hand, at least the recent past, is both known and well documented. History is an imperfect guide to the future, but however flawed, it is the only guide we have. It is worthwhile therefore looking at recent instances of independence in Europe and, as it were, ask ourselves how did secession work out for these countries.

 

The boundaries of European countries had changed hardly at all from the post-war settlement until 1990, but this all began to change with the fall of the Soviet Union in 1991. This was probably the most dangerous moment of the Cold War. It has always struck me as something of a miracle that the collapse of the USSR did not lead to World War 3, but it did lead to a number of quite serious conflicts and territorial disputes. Armenia and Azerbaijan fought each other over the enclave of Nagorno-Karabakh. This conflict is as yet unresolved. Georgia seceded from the USSR and then fought two wars when the regions of Abkhazia and South Ossetia chose to secede from Georgia. Moldova fought a war with separatists in Transnistria, who succeeded in setting up a tiny strip of a country, which is de facto independent even if unrecognised by the rest of the world. Russia, of course, fought two very bloody wars with separatists in Chechnya.

 

Even when there have not been wars there have been conflicts. Ukraine is a potential future flash point owing to the fact that there are Russian majorities in the eastern and southern parts of the country, some of whom would prefer to be part of Russia now. The Baltic states likewise have sizable Russian minorities, many of whom are denied the rights of citizenship owing to the various nationality tests administered in these states.

 

During the Olympics, I came across a nationalist MSP writing about how glad he was to see all the former Soviet Republics competing on their own. No doubt, he could plead ignorance as the reason for this remark, but he not only showed ignorance of history, he also showed ignorance of the present. How has independence in Europe worked out for all these newly formed states? According to the well respected Democracy Index 2011, not one former Soviet Republic is a full democracy. Some are categorized as flawed democracies, some as hybrid regimes and a number as authoritarian regimes.

 

http://www.sida.se/Global/About%20Sida/S%C3%A5%20arbetar%20vi/EIU_Democracy_I…

 

Prior to independence in each of these countries there were nationalists, who promised the people living there that all manner of good things would be theirs if only their country was independent. Such nationalists promised their supporters that they would gain freedom. But this promise turned out to be an illusion. No doubt, many people now who expected freedom wonder if these nationalists were lying.

 

Not only are these countries lacking in political freedom, they are also corrupt. According to the well respected Corruption index, each former Soviet Republic remains highly corrupt.

 

http://cpi.transparency.org/cpi2011/results/

 

What about wealth? Well, according to the following index, each of the former Soviet Republics remains by western standards poor. Sometimes extremely so.  

 

http://en.wikipedia.org/wiki/List_of_countries_by_GDP_%28PPP%29_per_capita

 

The reason for this is that each of these countries remains fundamentally uncompetitive.

 

http://www3.weforum.org/docs/WEF_GlobalCompetitivenessReport_2012-13.pdf

 

Separatists in all these countries promised the people living there, that if only they could achieve independence they would soon be living in a wealthy, honest and economically competitive society. But again this all turned out to be an illusion. So how is independence in Europe working out for these former Soviet states? They gained war, partition, lack of political rights and freedom, corruption, poverty and uncompetitiveness. They also gained independence.

 

Perhaps, this is all the fault of the Soviet Union. Perhaps, there are other examples of European independence movements, which have been more successful.

 

Take the example of Yugoslavia. The growth of Serbian Nationalism was answered by nationalisms in each of the republics which made up that country. The result was war, ethnic cleansing, crimes against humanity, partition and where once there had been one small country now there are eight tiny ones. Not one of these countries is a full democracy, each is highly corrupt and each by western standards is poor and uncompetitive. So how did independence in Europe work out for Serbs and Croats?

 

One last example of a recent European independence movement remains. It could be described as poster child of secession movements. Scottish nationalists frequently cite the breakup of Czechoslovakia as a favourable example for Scotland. Soon after the fall of communism in Czechoslovakia, known as the Velvet Revolution, nationalists in Slovakia began to seek independence and soon there followed the Velvet Divorce. One reason why Scottish Nationalists see this as such an ideal example an independence movement is that Czechs and Slovaks get on very well and the two states have excellent relations. Why couldn’t the same sort of Velvet Divorce occur in the UK?

 

But let’s look at how independence in Europe has worked out for Slovaks. While the Czech Republic is a full democracy, Slovakia is a flawed democracy. Both the Czech Republic and Slovakia are corrupt, but Slovakia is somewhat more corrupt. Both countries are poor by Western European standards, but Slovakia is poorer the Czech Republic, probably for the reason that it is much less competitive. Worst of all however, while the Czech Republic retained its own currency, Slovakia had the misfortune to join the Euro. This  means that it is liable for a share of  the debts of countries richer than it, such as Greece. No doubt, the separatists in Slovakia promised their people that if only they would vote for independence they would soon be rich and free. Nationalists tend to promise that independence will turn a country into something resembling the promised land. People who are foolish enough to believe these promises however, quickly find they did not get what was promised. A nationalist’s promise is at best a pipe dream, at worst a lie.

 

Scotland is very different from all these European countries, which recently gained independence. The point to take however, from these examples of independence movements, is that nationalism frequently promises much, but delivers little. As an ideology, which appeals to the selfish side of human nature, emphasising the differences between peoples, it frequently leads to unintended and unplanned consequences and conflicts. What really matters to most people is their standard of living and the fact that they live in a free, fair and honest society. Scotland already is a full democracy, because we are part of one one of the oldest and most democratic countries in the world. Neither Scotland nor England were especially democratic countries when we joined together to create the Union. Rather, through a gradual political process, we became the democracy that we are today. It is the UK which created our democratic traditions and which granted us the rights, which we now enjoy. Scotland is lucky enough  to be part of a very wealthy country. We are free and we don’t have to fear corruption in our daily lives. The UK is the 8th most competitive country in the world, which means that we have a much better chance than many countries to retain our living standards in the face of the present economic depression. We should rejoice that we live in such a country. The majority of the world’s population lack what we have. Nationalists everywhere promise the earth, but it is obvious from a glance at recent history, that such promises amount to very little. They don’t amount to what we in Scotland already have. If Scotland were part of an undemocratic, corrupt, poor and uncompetitive Great Britain, it might just be possible to argue that independence would bring vast improvements. Such promises, would probably turn out to be false, for these fundamentals change slowly if at all. But when a country is already close to the peak of democracy, freedom, wealth, lack of corruption and competitiveness, the idea that nationalists can suddenly massively change everything for the better by waving a magic wand called independence is scarcely credible. The UK has given us peace, freedom, wealth, honesty and competitiveness. Why would we exchange that for an uncertain future leading in who knows what direction?

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Scotland, debt and subsidy

The SNP have stated that they want to maintain a currency union with the rest of the UK (rUK) post independence. They also want the Bank of England to continue to operate as a lender of last resort. I believe that currency union without political union is inherently problematic. However,  let’s, for the sake of argument, grant the SNP all it desires on this matter, even down to having a seat on the Monetary Policy Committee.

 

What does being a lender of last resort mean? It means that if Scottish banks, or the Scottish government went bust, the Bank of England would be there to bail them out. But as we have found out recently, when the UK central bank bails out banks, ultimately it is the UK taxpayer who is responsible for the debt. But what if an independent Scotland’s banks were too big to be bailed out by the Scottish government, or if the Scottish government itself was insolvent? Who then would be responsible for the debt? Well, initially the Scottish government and people would be responsible for the debt, but ultimately, if they could not pay back the debt, the burden would fall on the rUK taxpayer. In the same way it is looking ever more likely that if Spain or Italy have debts that they cannot pay back, the burden falls first on the European Central Bank, but in the end on those countries in the Eurozone which are still solvent, i.e. the taxpayers of Germany, Finland, Austria etc. But just as the Germans are not very happy about this, it is easy to see why the rUK taxpayers would not be very happy about bailing out an independent Scotland.

 

But let’s not be so pessimistic about an independent Scotland’s economic future. What if the SNP are right and Scotland would be rolling in oil wealth, its banks full of cash, its streets paved with gold. Well, what would happen if rUK having lost its Scottish cash cow found that it just couldn’t cope anymore economically and that it had to be bailed out. The Bank of England would act as the lender of last resort, but under this circumstance the reverse situation would obtain as that, which occurred previously. Just as solvent rUK taxpayers would be liable if a bust  independent  Scotland had to go to the Bank of England as a lender of last resort, so solvent Scottish taxpayers would be liable if a bust  rUK had to go to the Bank of England as a lender of last resort. The Bank of England would be playing the role of the European Central Bank in the Sterlingzone. If rUK could not ultimately pay back its debt, the money would have to come from that part of the Sterlingzone, which was solvent, i.e. independent Scotland. The trouble with monetary union is that it looks as if each part ultimately remains responsible for each other’s debt and if a bankrupt partner in the end cannot pay its debt, it’s hard to see where else the money would come from other than from the richer partner. Scotland wants the rights which go along with having the Bank of England as a lender of last resort, but it can hardly wave the responsibilities which go alongside those rights.

 

Looking further at how monetary unions work, it is becoming clearer that one of the fundamental problems of the Eurozone is that imbalances of competitiveness and wealth exist between the rich north and the poor south. The EU already has a system of transfers from the richer countries to the poorer countries, but it is becoming clearer that this is not enough to maintain a stable monetary union. Many commentators are stating that ultimately the Eurozone will have to become a transfer union, with Germany and the rich northern countries permanently transferring large amounts of money to subsidise the poorer southern countries. Germany accepted this logic when it created monetary union with the former East Germany, transferring huge amounts from the rich west to the poor east.

 

In order for a monetary union to work in the long term, it is necessary that there do not exist excessively large imbalances between one region and another. What this entails at present, in a UK context, is that if one region is much poorer than its neighbour, then money is transferred so that something approaching an equilibrium is obtained.

 

What this means is that if Scotland were to become independent, while maintaining a monetary union with rUK,  this monetary union would have to remain a transfer union, with money transferred from the richer parts of the Sterlingzone to the poorer parts. Many people in England might expect therefore, that post-independence it would be necessary for rUK to continue transferring money to Scotland. They already complain about England subsidising Scotland, about the Barnett formula giving more money per capita to Scots than to the English. But let’s take the SNP at their word and accept that an independent Scotland would be as rich as they claim and indeed even richer than rUK. What would be the result of this? The answer is simple. Scotland would have to transfer a proportion of that wealth to rUK, otherwise the imbalances in the monetary union of the Sterlingzone could lead to strains which might lead to it breaking up.

 

Are SNP supporters really aware that according to SNP policy an independent Scotland would be liable for England’s debts and might have to permanently subsidise their former southern countrymen?

Why monetary union may not survive independence

The SNP have said that they wish to maintain monetary union with the Rest of the UK (rUK) post independence. But although it might have been possible to maintain such a monetary union in the past, when a number of countries, albeit most often with a colonial relationship to the UK used the pound as their currency, it is looking less and less likely that this model of monetary union is possible given modern economic conditions.

The experience of the breakup of Czechoslovakia is especially illustrative of why a currency union between rUK and Scotland would not necessarily last, even if there were good will on both sides. The Slovak Parliament declared independence on 17th July 1992 and after negotiations with the Czech side of the union it was agreed that Czechoslovakia would be dissolved on 31st December 1992.

The intention of both sides was to mitigate against the economic consequences of break-up by maintaining the currency union of the Koruna for at least six months with the possibility of extending this union if both governments agreed. However, this currency union lasted just six weeks.

What were the causes of the failure of monetary union in the newly independent Czech Republic and Slovakia? The answer is capital flight. From the moment independence was announced, money began flowing out of the Slovak half of Czechoslovakia into the Czech half and this flow became a torrent once Slovakia actually became independent.

The Slovak half of Czechoslovakia had developed somewhat differently from the Czech half during communism. It was dominated by heavy industry that had become obsolete. The Czech half of the union was up to 20 % richer per capita and was perceived to dominate the union of the two peoples. With the introduction of democracy in 1989, the Slovaks began to voice their resentment and started to vote for nationalist parties. Mutual resentment continued until the June 1992 elections, when Czechs voted for Czech parties and Slovaks voted for Slovak parties. At this point divorce became inevitable.

What caused the capital flight? The same thing that is causing capital flight in the Eurozone. If a person has 100,000 euros in his Greek bank account and Greece were to leave the Euro and these Greek Euros were  then to be converted into new Drachmas, which were then to depreciate against the Euro by 50 percent,  the 100,000 Euros, which were in the Greek bank account, would now only buy 50,000 Euros. It is therefore rational for a Greek fearing that Greece will leave the Euro to send his money either into a German bank account, or perhaps better still into a US dollar, Swiss, or Sterling bank account. This can now be done almost at the touch of a button.

Slovaks thus fearing that their money would soon be denominated in a new Slovak Koruna, chose to move their money into Czech banks, supposing that a new Czech currency would be stronger than a new Slovak currency.

In the end, it was the Czech authorities which broke up the currency union between the two countries. The capital flight from Slovakia, was such that it was unnerving the Czech authorities, who then imposed capital controls. The run on the Slovak banks, of course, unnerved and destabilised  the fledgling Slovakia too and they agreed to the breakup of the currency union, on February 2nd 1993, just over a month into independence. The border was briefly closed. The physical  notes of each country were stamped so as to mark them as Czech or Slovak. And as predicted the Slovak Koruna depreciated against the Czech Koruna.

The lessons for Scotland are obvious. Even if both Scotland and rUK  wished to maintain the present currency union, it might not be possible to do so. Capital flight from Scotland could be such that  the Bank of England would be forced to introduce capital controls and overnight all banknotes in Scotland could be stamped as new Scottish pounds which could either appreciate or depreciate against rUK pounds. Would this happen? Who knows. Could it happen? Absolutely. It is happening in the Eurozone at present and it happened a few years ago in Czechoslovakia.

Ask yourself if independence was announced today what would you do with your money? Personally, I would instantly move all my money into an English bank account or if I was sufficiently worried I would move it into a dollar account or a Swiss account. Why would I do this? Because I would be worried that the currency union with rUK would not last and if a new Scottish pound were created, that it would fall relative to the rUK pound. This would mean the value of my savings would fall and I would lose money. This does not, of course, mean that the currency union would fail. But my knowledge of economics and the recent experience of the Eurozone tells me that modern currency unions require fiscal and political union. They require one government. Without these things, which is the inevitable consequence of Scottish independence, currency break up is always a possibility, always a risk. It is this risk which caused capital flight in Slovakia, which created a self fulfilling prophecy. It is the same risk, which could create a self-fulfilling prophecy in Scotland post independence. The mere fact that the pound zone could break up might make it inevitable that it would break up leaving all Scots poorer.

We have enough economic troubles at the moment without the question of independence adding to them. Canny Scots would be well to look at their pocket books when they contemplate breaking up the union. How would you like to see your savings, your house, your salary paid in devalued new Scottish pounds?