Oh Scotland, don’t you dare! – Part 1

The 354-page report from the Scottish Growth Commission – Scotland – the new case for optimism: A strategy for inter-generational economic renaissance (released May 25, 2018) – could have been published by the IMF given its adherence to the flawed neoliberal macroeconomic framework that that institution imposes on everything. It is too generous to call the Growth Commission’s work ‘analysis’ – a series of unfounded assertions with logical extrapolation from that flawed basis is more accurate. If Scotland were to create an independent nation on the basis of the ‘blueprint’ outlined in the Growth Commission’s Report then it would soon be heading into a mediocre oblivion – a future where it would be unable to effectively counteract the fluctuations of non-government sector spending and a future where fiscal policy was forced to be pro-cyclical. Scotland would end up another failed austerity state. This is Part 1 of a two-part series where I examine the Report and its implications. In Part 2, I will examine the currency issues in more detail. I hope to be in Scotland in early October as part of my next speaking tour of Europe – more details later.

Background

I have written about the Scottish issue before, including:

1. Scotland should vote yes in 2014 but only if … (September 27, 2012).

2. Bonnie Scotland – ignorance or denial – either way it is fraught (October 30, 2013).

3. I would be voting NO in Scotland but with a lot of anger (August 18, 2014).

My position has not changed since I wrote those blog posts.

In 2014, at the time of the Referendum, I wrote that I favoured a Yes vote.

But that was conditional on the provisos that Scotland introducing their own unpegged, floating currency and avoiding any talk of joining the Eurozone.

I also indicated that any Yes vote should be conditional on the government committing itself to achieving full employment on the back of their newly created currency sovereignty.

Which meant that any pro-cyclical biased fiscal rules should be eschewed.

Under those conditions, I concluded that a Yes vote would improve economic welfare for the Scottish people.

And to underline that conclusion, I also noted that if Scotland continued to use the British pound – then nothing will be gained.

I also specifically noted that I was not qualified to speak of cultural aspects of any desire to become independent even though I have a fairly detailed understanding of Scottish history.

In that sense, one could still make a case for independence operating with a monetary system that was austerity-biased. But I doubt it.

The Growth Commission Report – May 2018

Here is the – Full Report (released May 25, 2018).

You can read a summary of the overall Report – HERE.

In September 2016, The Scottish First Minister Nicola Sturgeon established the Growth Commission to advise the Government on the economic implications of independence.

The Report was released in a blaze of publicity and the – a SNP Press Release – boasted of that “Scotland is a wealth country”, that it is “an energy powerhouse” with the aims to “build an innovative economy”, “a fairer society”, benefiting from its “natural resources” and able to “attract the best talent”.

It followed those assets and aspirations with a major heading “An independent economy” which desires to distance itself from the “Tory austerity” which has rendered “the UK is now amongst the most unequal countries in the developed world” and reduce “the legacy deficit it will inherit from the UK”.

All political spin taken from the Growth Commission’s Report. But, being fairer, a strong statement for a progressive government and society.

The only problem is that economic framework that the Growth Commission has recommended to guide this new found prosperity would likely achieve the opposite.

The Report recommends the retention of the British pound until “a series of tests for future currency decisions” are met. I analyse these tests in Part 2. They are as ridiculous as the convergence criteria that the European Commission set in place before Stage 3 of the EMU could be entered.

It also recommends encumbering the new independent government with a series of ad hoc fiscal rules identical to those that have made the Eurozone unworkable.

In fact, the Growth Commission’s Report wants the new independent Scottish government to replicate the dysfunctional Stability and Growth Pact constraints (3 per cent deficit/60 per cent debt ratio) rules that have rendered that Pact neither supportive of growth nor stability in the EMU.

Such rules if administered as part of a legal framework (which is recommended by the Growth Commission) would bias fiscal policy to operating in a procyclical fashion, which is the anathema of responsible and effective fiscal conduct.

We have seen that sort of folly in operation across the North Sea in the EMU during the GFC to the detriment of millions of European citizens who lost jobs and income support entitlements.

The Report immediately sets off alarm bells by its choice of some benchmark nations that it claims should guide Scotland independent future.

Several of the nations are not themselves independent!

So Denmark, Ireland and Finland are held out as exemplars in different ways without any apparent recognition that Finland and Ireland do not issue its own currency and belongs to a monetary system which has no functional federal fiscal capacity, or that, Denmark must obey the harsh Stability and Growth Pact rules and peg its currency to the euro, effectively eliminating any independent monetary policy.

But it gets worse.

The Growth Commission appears to be oblivious to economic context when it sets out different time paths whereby the ‘new’ nation would ‘balance its fiscal situation’.

This exercise ignores what might be happening in the external and private domestic sectors (summing to non-government), and, as a result, the implications of the ambition to ‘balance the budget’ are lost to the reader.

Let me tell you what the situation would be and why it would be irresponsible for the new government to adopt the neoliberal ‘balanced budget’ obsession that has stifled governments all around the world and entrenched their nations in low growth and elevated levels of labour underutilisation.

Consider its commentary on the UK economy.

The Report makes the assessment:

A dependence on consumer debt fuelled spending for growth has been a consistent feature of the UK economy, is not sustainable and carries very significant risks …

The UK’s export performance has been poor and with a falling share of the global market. The UK has – by far – the highest trade deficit in the EU.

I agree with conclusion that the current trajectory of the UK – where the British government is relying on increasing household debt to maintain consumption spending in the context of flat wages growth, on-going fiscal austerity, and an external deficit – is unsustainable.

But think about those statements in the context of the fiscal rules that the Growth Commission advocates, which I consider in the next section.

Fiscal framework and policy – aka ‘the wheels fall off’

For background reading the following introductory suite of blog posts – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3 – are relevant for an understanding of the concept of fiscal sustainability.

The Growth Commission could have saved themselves a lot of time and effort by just copying and pasting the standard IMF mantra about fiscal balances and public debt into their Report.

Their rendition is indistinguishable from the typical neoliberal treatment common in IMF publications.

The standard proposition of the neoliberal Groupthink are repeated.

First, the Growth Commission recommends that newly independent Scottish government “Target a deficit value of below 3 per cent within 5 to 10 years”.

This is the Eurozone’s Stability and Growth Pact fiscal rule.

I wonder if the Growth Commission knows the history of the 3 per cent rule, which I covered in my book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015).

There is no economic rationale for a 3 per cent rule. It was a quick and dirty ‘back of the envelope’ construction conceived in the French Ministry of Finance in 1981 after the newly-elected French President, François Mitterrand (elected May 21, 1981) instructed the “Budget Department” to come up with a simple, practical deficit rule which carried the semblance of authority by being endorsed by economists and would provide an image of fiscal discipline so that he could resist the demands for more funds from his government ministers.

The officer who came up with the rule, one Guy Abeille, later wrote (in 2010) that the rules was politically motivated rather than driven by economic concerns. He wrote that it T”no other foundation than the circumstances of the day”.

Please read my blog post – Options for Europe – Part 40 (March 6, 2014) – for more discussion on this point.

So where is the justification from the Growth Commission for this rule?

Especially, when it has proven unworkable in the face of the GFC when applied in the EMU.

And especially when the recent Scottish fiscal deficit was of the order of 8.3 per cent of GDP (in 2016-17) and will not likely come down to 6-7 per cent in the next 4-5 years, and that is assuming growth continues unabated.

Of the current situation, the Growth Commission asserts that “A 6-7% fiscal deficit is not sustainable and action will be required to reduce it to more sustainable levels. The economic and political reality is that will require to be addressed whatever Scotland’s constitutional position is.”

And the next sentence it notes that “it has been at 6% or more for 6 of the last 10 years”. And the sky hasn’t fallen in!

The important point is that there is no analysis presented to justify the conclusion that this scale of deficit is unsustainable.

Pure assertion is offered as if it is an eternal verity.

And, importantly, there is no integration of the ‘fiscal’ discussion with other statements about the unsustainable private debt and trade positions.

Here we encounter the usual myopia in all these ‘IMF-type discussions’. The fiscal situation is analysed according to its own logic and the logic imposed is that deficits are bad, large deficits are worse, surpluses are good etc.

But, there is nothing intrinsically good or bad about any particular fiscal position.

If the Growth Commission is really concerned about the unsustainable private debt situation then it should understand that it is intrinsically linked to the external and fiscal sectors.

When one digs into the data, it is clear that Scotland (if we calculated it as an independent nation) would be running a trade deficit despite claims to the contrary (Source).

Its investment ratio as a per cent of GDP has been falling over the last 20 years as has the household saving ratio.

The business investment ratio as a per cent of GDP has fallen from 10.9 per cent in 1998 to 6.9 per cent in 2016, while the public investment ratio has risen from 2.5 to 3.9 per cent, providing some offset.

Economic growth is languid.

In other words, trying to achieve substantial fiscal contraction in that sort of context would be extremely damaging to the prosperity of Scotland.

Just as enforcing context-free fiscal rules in the EMU have ravaged prosperity.

The Growth Commission conjures up an argument that cutting the fiscal deficit of the scale recommended will not harm economic growth if there is a “a strong contribution from a key growth engine, which for small economies is almost certainly the export sector”.

Enter the IMF fictional ‘every nation can export their way to prosperity’ strategy!

Growth Commission cites the example of “New Zealand which experienced relatively strong export growth (from currency depreciation coupled with cost restraints)”.

Not to ignore the fact that one-third of New Zealand children live in poverty (Source), the depreciation route (even if it works) would be denied to the newly independent Scotland as a result of retaining sterling as the currency.

So they would be left with the Eurozone-style ‘internal devaluation’ – wage and pension cuts. Hardly the basis for a progressive society. What the internal devaluation experience has taught us is that net exports decline but mostly because of falling imports as a result of the domestic austerity.

Further, it is not feasible that Scottish exports can grow from their current base to outstrip imports and create a sufficient net export surplus that would offset the decline in public contribution to growth coming from their desired fiscal cuts.

Second, the Growth Commission recommends that “National debt should not increase beyond 50% of GDP and should stabilise at that level”.

What is the basis for this rule?

The Report essentially misleads with statements such as when the public sector runs a deficit:

… it is necessary for the Government to borrow to cover the deficit. This is the ‘flow’ that adds to (or in a period of surplus subtracts) from the stock of historic debt.

They reinforce this with throwaways such as “when a Government regularly runs deficits and must borrow”

These statements are not true. They are just assertions that fit their neoliberal bias.

Whether a government issues debt to match its deficit is a matter of political choice in a fiat monetary system rather than a financial necessity.

In fact, a progressive government would stop issuing public debt at all, given that in a fiat monetary system, it only serves as corporate welfare.

The Growth Commission, however, makes the link because they assume that the Scottish government should maintain the charade of issuing debt to feed the corporate welfare recipients as if, somehow, the Scottish government would need the private sector to give it its own currency before it can spend it.

That link can only be made as long as Scotland used a foreign currency – the pound. Should it introduce its own currency, then the need to issue debt to the non-government sector disappears.

The Growth Commission also claims that private bond markets will discipline any government that breaches acceptable fiscal limits.

However, the reality is that no such limit is binding on a currency-issuing government which can set whatever yield it wants.

For a currency-issuing government the bond markets are the subjugated ones.

Please read my blog post – Who is in charge? (February 8, 2010) – for more discussion on this point.

The reality is that government debt-issuance supports the long-term domestic debt market not the other way around.

Further, there is never a solvency issue for a currency-issuing government no matter how fancy you want to define the condition.

Even if the private bond markets are negative towards a government.

A currency-issuing government can always meet its liabilities as long as they are in its own currency.

Its central bank can continuously run with negative capital (in accounting terms) and what we think about the capacity of that type of government to pay up is irrelevant.

If 60 per cent was some defining threshold how do we account for Japan?

A sovereign government can sustain deficits indefinitely without destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose.

So debt is only an issue if Scotland chooses to use sterling. We will consider that debate in Part 2.

Third, the Growth Commission also adopts the standard neoliberal IMF line that fiscal sustainability can be determined with reference to “both deficit and debt figures” with no mention of the available real resources in the economy.

The underlying claim is that:

… the willingness of capital markets to finance a fiscal deficit is a primary consideration.

So, the Growth Commission is just rehearsing the standard line – which for a currency-issuing government is largely irrelevant.

The lack of context is a major problem that discredits the Growth Commission Report.

For example, we read (topic: fiscal institutions):

There is good evidence that these institutions helped to stop the increase in debt accumulation in many countries from the early 1990s.

Yes, but the mirror-image, which the Growth Commission ignores, is that the fiscal austerity which reduced the growth of public debt, created an environment where private debt accumulation was the only source of growth and that proved to be unsustainable.

A nation that insists on matching public debt increases to deficits cannot simultaneously reduce non-government debt levels and public debt levels.

A government deficit (surplus) is pound-for-pound a non-government surplus (deficit).

The Growth Commission claims that:

… high levels of debt impose economic costs (e.g. a higher risk premiums, which are damaging to investment), expose the economy to additional risks, and compromise growth and the ability to respond to cyclical or structural shocks.

None of that is universally true.

A sovereign government can set yields at whatever level it chooses and allow the central bank to purchase any debt at those yields that the private bond markets do not wish to take up.

A sovereign government doesn’t even have to issue any debt.

Further, the current public debt level, has no bearing on the capacity of the government “to cyclical or structural shocks”.

A currency-issuing government can always purchase whatever is for sale in its own currency irrespective of its past fiscal position.

Depoliticisation

The Growth Commission also advocates the standard neoliberal line that key policy decisions should be taken out of the political process and the responsibility vested in so-called “independent fiscal institutions”.

All the related neoliberal institutions are then recommended – Debt Management Office, Fiscal Commission etc – to oversee the “deficit reduction policy”.

In my recent book with Thomas Fazi – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, 2017) – we provide a detailed discussion of what we refer to as depoliticisation.

The proponents of neoliberalism have pursued a process of depoliticisation, as an essential aspect of their desire to gain greater control for global capital.

This has led to policies that have constrained existing national sovereignty and curtailed popular-democratic mechanisms.

Depoliticisation is the process whereby governments absolve themselves of political responsibility for policies that harm the citizens by appealing to ‘independent’ external authorities (such as the IMF, or central banks, or independent fiscal institutions).

The shifting the responsibility for policy and its manifestations away from the elected polity to unelected and largely unaccountable technocrats – is antithetical for a progressive state.

Brexit

The Growth Commission Report uncritically buys the HM Treasury line that “Brexit will make the UK ‘permanently poorer'”. Why?:

There is a widespread consensus among economists, with few exceptions, that leaving the EU will damage UK economic growth, productivity and job creation.

The same economists also believed that the period before the Global Financial Crisis was one they called “The Great Moderation” and were so adamant that the ‘business cycle was dead’ that they didn’t even include banks or a financial sector in the standard New Keynesian models that dominant policy analysis.

The same economists didn’t see the GFC coming despite it being obvious that the period of fiscal conservativism backed by financial market deregulation and massive increases in private debt were unsustainable and it was only a matter of time.

The same economists predicted that Britain would suffer an immediate recession if the June Referendum voted to Leave.

We consider that failure in the Jacobin article (April 29, 2018) – Why the Left Should Embrace Brexit.

And further, in these blog posts:

1. The Europhile Left use Jacobin response to strengthen our Brexit case (May 22, 2018).

2. The Europhile Left loses the plot (May 1, 2018).

I am more comfortable with ideas that the mainstream economists do not accept.

The Report thus concludes that:

In this respect leaving the EU and Single Market would obviously act as a growth restraint for Scotland.

This is despite the evidence being that the Single Market has had no significant positive effect on Britain as we explained in the Jacobin article.

Please also read my blog post – The facts suggest Britain is not as reliant on EU as the Remain camp claim (April 16, 2018) – for more discussion on this point.

Conclusion

In Part 2, tomorrow, I will examine the currency question in detail.

The arguments that the Growth Commission use to justify the retention of the pound are flawed and deceptive.

That is enough for today!

(c) Copyright 2018 William Mitchell. All Rights Reserved.