11 Sep 2014

How we can measure the seven big #indyref risks

It’s clear after yesterday, that the main theme for the rest of the Scottish referendum campaign will be the economic risks.

But what are they? How do we measure them? And how do they stack up against each other? I’ve met a lot of people in this campaign who are very clued up about them — and others who tell me they can’t understand. So here’s my guide to the risks.


1. Scotland goes bust. Over time, the new country spends more than it can raise in taxes and oil money and the need for increased public spending — because of ageing and poor health — raises the deficit. Because Scotland is a new state, its borrowing costs are also high and the danger of the markets losing confidence in it are higher than for the UK. If it did go bust there would be only the EU (presuming it could join) and London to bail it out.

2. Scotland’s banks are too big compared to its economy. The presence of RBS and Lloyds/HBOS mean bank debts are 12 times GDP (see below) . If a bank went bust the country would go bust with it, even if the rest of its finances were healthy.

3. Scotland can’t use sterling without neutering the benefits of independence. So if it wants a currency union, says the Bank of England, it has to (a) surrender all its tax and spend powers to London and (b) raise a currency reserve of between 25 per cent and 100 per cent of GDP. To raise that reserve you would have to cut spending. So you would end up with no tax autonomy and lower public spending than the rest of the UK.

4. The transition will be painful. Banks will move south (see video, below)- hitting Scotland’s reputation as a banking centre; mortgages may become harder to get for a time; the Clyde shipbuilding work for the British MoD will go to yards in England. And it will all be chaotic until the currency question is resolved.

5. Scotland will end up outside the EU and outside NATO and have to re-apply. All the EU laws would have to be re-legislated locally to take effect, and without commitment to join the euro, Scotland might not be admitted at all. Outside the EU, trade would be hit, and general confidence.

Boring or Dangerous?

I’ve covered economics at a time when it moved from boring to catastrophically dangerous. I’ve seen grown men, highly qualified professionals, stare into space blankly as their careers, dreams, companies and even countries collapsed.

I’ve seen shaken prime ministers: yes really shaken — by the lapels by other more powerful politicians as they all faced doom together. And then I’ve seen the financial crisis spill over onto the streets, in the form of riots, far right racism and massive poverty.

In every case the problem was people’s inability or unwillingness to judge risk.

Right now there are a lot of London-based journalists running around Scotland proclaiming economic doom if it goes independence — and I have no wish to be one of them.

However, I’ve heard a lot of people tell me — as a 16 year old voter did last night on Channel 4 News — they are aware of the risks but they are outweighed by the opportunity for Scotland to control its future.

In this context there are two more risks, which nobody is really focusing on.

6. Scottish people (and English politicians) miscalibrate the risks, because the political emotions make them unable to properly understand them.

7. The wider risk, that is obsessing macro-economists, is ignored: that world growth stagnates, with near-zero interest rates and the need for trillions of dollars’ worth of money printing becoming permanent, and that as a result globalisation begins to fragment.

I think the biggest risk is #1. There are differing accounts of what Scotland’s public finances will look like, depending on oil money, defence cuts, the cost of interest on the debt. But even on the most optimistic there is a risk that Scotland’s books won’t balance. The heart of this risk lies in what you can’t control: you can’t control Scotland’s borrowing costs, you can’t control how much inward investment there is, or capital flight, and you can’t stop the oil running out. You can declare you want Scotland to be like Norway but you can’t control whether it does so.

Though it looks like a long-term risk, the moment the markets think Scotland’s long-term finances are unstable they will attack it. The risk is they will refuse to lend, or lend at only excruciating high rates, and that Scotland will need the EU and IMF to bail it out, imposing conditions that remove any possibility of economic sovereignty.

Looking the wrong way?

So risk #1 is the big one. But at the moment all the debate is focused on risks #2 and #3.

Actually risk #2 — the banks are too big compared to the economy — is more or less solved by RBS and Lloyds Group moving their registered offices to London. If Scotland goes independent, at that point the banks are the rump UK’s problem. Of course that means that, if they get sold, broken up, or go bust, London does not have the same moral commitment to save Scottish jobs — as English and Welsh taxpayers are supporting these banks. But on the whole I am less worried about risk #2.

Risk #3 concerns sterling. The Bank of England governor has made two separate interventions this week — saying (a) Scotland can’t have any control over tax and spend if it forms a currency union with the UK and (b) it would need to build up a reserve of cash so large that it would suppress public spending and economic growth considerably. Meanwhile the Westminster party leaders have said there will be no currency union.

To me this risk looks entirely political. If a currency union was formed, it would be in nobody’s interest in London to impose punitive tax and spend limits on Scotland — above all because that would tank its economy. Likewise it would be in nobody’s interest to undermine confidence in Scotland.

It would be, in this case, sensible for Scotland to build up a bigger currency reserve than the minimum needed. But one way of doing so would be for the UK to assume some of Scotland’s share of the debt.

With goodwill in London you could easily have currency union, fiscal autonomy but within limits agreed between London and Edinburgh, and you could mitigate — thought not entirely solve — the need for a bigger currency reserve. If this goodwill were demonstrated to the markets, then it would also lower Scotland’s borrowing costs.

So the main issues being thrown around the airwaves and the streets right now are, essentially, solvable through political agreement.

So the big risk is, there will be no agreement. But compared to the current dire warnings from the newspapers in London there are two things to bear in mind.

a) The governor of the Bank of England’s job is to boost stability and confidence in the UK’s financial system, not cause panic about it; at some point he will have to switch from dire warnings to explaining how he will calm things down, and how the situation is manageable.

b) Governments change. If there’s a Yes vote in September 2014, then it will be hard for Labour to fight the election in 2015, in Scotland, on the platform of “get lost you ungrateful people, we will block your attempt to use sterling”.

Risk #4 is real. The transition will beĀ painful, even maybe at times chaotic. That’s what you’re voting for if you split up a 300 year old major country.

Risk #5 — with NATO and the EU — is also real but solvable. Scotland is NATO’s frontline when it comes to the Arctic and northern Scandinavia. It’s unthinkable that anybody would want Scotland outside — particularly because parts of the London political class believe independence is being boosted by Russia to destabilise the UK.

With the EU, the reason it is warning about having to re-apply is to stop the Yes vote happening. So again this is political. The EU is breaking its own rules on many other things, so the rules can be got around. I would expect in the “London goodwill” scenario for the UK government to promote Scotland’s membership. Meanwhile there is also a chance that in 2017 the UK votes to leave the EU.

Finally there are risks #6 and #7. There is nothing to do about #6 other than recognise it and remember the adage: if Lehman Brothers had been Lehman Sisters it might still be alive. You want to avoid hubris and testosterone when assessing risk.

Risk #7 — global stagnation — is important. The world that a new country comes into is a hostile world. The global order is breaking up and Scotland would have to be nifty in deciding where to fit in it. The Eurozone could collapse; politics is getting mixed up with economics — with sanctions on Russia etc. People who fantasise that Russian money would save an independent Scotland — or Chinese — have to understand they would then be a pawn in geopolitics.

However, if we do face global stagnation, then the ability to control your own destiny is important, as long as you don’t mess it up.

So that’s my rundown of the risks.

If the UK government stymies currency union, and Scotland has to use sterling without permission, then the risks are higher: it will need more reserves, it will need to do more to prove its public finances stack up, it will lose some of the advantages of independence. I can’t see “sterlingisation” lasting long: if the euro stabilises that would be attractive; if not, Scotland may end up with a situation like the Irish punt.

To summarise: for me the biggest risk is that Scotland’s long-term public finances don’t work. The transition risk is real but survivable. The currency risk is a product of politics and can be solved, though it would need massive goodwill and sensible negotiating between London and Edinburgh. None of these risks are unsolvable.

Maybe my assessment of these risks is wrong. I’m keen to hear yours. And of course there are other risks — political and economic — from merely doing nothing.

What’s driving many of the people I meet to vote — either way – is a vision of the kind of country they want to live in, or a cultural identity, or even a dream.

But one of the facts about economics is: it is real. The market is a relentless machine — tougher than any politician or journalist. It does not respect national anthems, borders, flags, poets or cultural icons. It can destroy your dreams.