The release of the yearly Government Expenditure and Revenue Scotland (GERS) report is the one of the most intensely debated topics of the constitutional question. The debate of the report exists in two parts. First on the methodology of the report itself and how accurate is represents the Scottish economy within the UK. Second, what the data suggests an independent Scotland’s fiscal balance could look like and what challenges this could entail.
These two debates lead to a healthy and largely informative discussion that introduce activists to new macroeconomic concepts. Yet sadly the debate also reinforces orthodox language and misleading claims that exist on both sides of the debate. This fundamentally comes from either a far too basic understanding of how the macroeconomic system works (i.e. only referring to “tax and spend”) or misguided knowledge regarding monetary operations that exist in the UK today. Responding to these issues will be the main purpose of this article, whilst leaving room to discuss methodology in the future.
From the unionist perspective, GERS is deemed as a positive advertisement for the UK as the data suggests that Scotland is subsidised by other regions within the union. The argument follows is that Scotland’s national deficit, which as part of the UK was £15.1 billion in 2020, could only have been achieved from the spending of the UK Treasury. The newly appointed leader of the Scottish Conservatives, Douglass Ross, responded to the GERS report, writing:
“That £15 billion deficit is larger than the entire health budget. Balancing the books would mean savings on the scale of throwing away Scotland’s entire NHS, every nurse and doctor, and every service that is so vital.”
Unionist commentator and chairman of the right-wing think tank These Islands, Kevin Hague, has also previously made comment on how this spending works within the UK. In his July article “Fiscal Transfers and Shifting Narratives” he makes a revealing comment with the following:
“It shows the journey from the oil boom of the 80s through to the situation today where Scotland benefits from a fiscal transfer of £2,000 per head or over £10bn annually. If you look carefully, you will see a pleasing symmetry: far from being a source of either grievance or shame, fiscal pooling & sharing within the UK has worked out remarkably equitably for Scotland over the last 40 years.”
From the independence perspective, others have argued that Scotland’s national deficit can be better managed if we had control of fiscal and monetary levers. Finance Secretary for the Scottish Government, Kate Forbes, was questioned by ITV on the size of Scotland’s government deficit compared to other countries and the rest of the UK. She said:
“We have just seen unprecedented borrowing from countries all around the world – small and large countries – including the UK government whose deficit is set to rise to £372 billion this year…the difference between them and Scotland is they have the powers and levers to manage a deficit. Those are powers we can use in order to invest in the economy and manage our public finances far more sustainably than they’re currently managed under this arrangement.”
Andrew Wilson, who is chair of the SNP’s Suitable Growth Commission paper, seemed to suggest himself that Scotland’s government deficit should be reduced. He argues:
“The whole point of independence is trying to make the economy and society more equal, better performing, more productive and better sustainable. It won’t happen overnight, it will take effort, but that effort will be worth it. I find it profoundly ironic that arguing for the United Kingdom are about saying things are so bad, we’re so unequal, the public finances are so dreadful, that things should stay the same. It doesn’t seem to me to be a sensible argument or one that’s winning.”
There are a few fundamental claims made by both sides of the argument, some with shared agreement and others with disagreement.
1) An independent Scotland would have to “balance the books” to control its finances (Indy+Union Argument)
2) Scotland is subsidised by taxpayers from the rest of the United Kingdom. (Unionist Argument)
3) Independence will allow Scotland to better manage a deficit compared to devolution. (Independence Argument)
The first claim is a dangerous route to austerity, the second claim is wrong from an operational analysis and the third claim is true from a macroeconomic perspective.
First – Must Scotland “Balance the Books?”
The first major problem from the discussion around GERS is the sole focus on one sector of the economy, that being the government sector. By focussing the narrative around the government as if its finances work as a household, political and economic commentators are ignoring two other vital sectors that must be included in any analysis of Scotland’s overall fiscal position. The best framework to look at any country’s overall macroeconomic position is to use the Sectoral Balance sheet, as shown below.
When using the sectoral balance framework, the net sum of all equity of the economy (i.e. all three sectors) is equal to zero. If the private sector (which includes households) is in a surplus, then that requires one of the other sectors to be in a deficit. In this case, it is revealed through GERS data that Scotland has a government deficit. But what does that mean for regular people?
When the government sector is in deficit to the private sector, the private sector is expanding which in-turn increases economic activity. A government deficit adds net-financial pound assets to other parts of the economy. It increases our income, which is then spent into private firms. Private firms then can afford to expand projects and production, in turn generating more jobs and growth. By increasing our productive output and further utilising our resources, we create a stable and functioning economy, which is down to economic boost from a government deficit. This is completely normal and necessary in order to run a healthy economy.
The proposed argument that this is somehow economically wrong does not make any real logical sense. In fact it’s when we attempt to “balance the budget” (i.e. government spending is equal to revenue) we face serious challenges. Before the global pandemic, the UK government had moved towards a government surplus, whilst the private sector has been moving to a deficit. With both the coalition and conservative governments imposing austerity on the population of the UK, there are now less pound assets in the economy, less spending and thus a fall in private incomes.
If the private sector wants to mitigate the damage to their lost income, they would need to cut into their savings, sell their assets or take out loans on credit (which they would have to pay interest). With less money in the private sector to be spent on goods and services this then strangles growth with increased private debt. That is exactly what has happened when governments have attempted to “balance the books” and is the correct recipe to lead the country to a recession.
This is a discussion that is largely ignored within the GERS debate, with commentators only focusing on the government sector and what that means for ordinary people. Therefore Scotland, as an independent country or within the UK, should embrace a government deficit to mitigate the current austerity measures that has been imposed over the last decade. As Professor of Economics Eric Tymoigne concludes in his paper “Debunking the Public Debt and Deficit Rhetoric”:
“If a growing public debt is so concerning to some, it is because it is supposed to raise interest rates, slow economic growth, raise inflation, and raise tax rates. Even a casual look at the evidence shows that these concerns are not warranted and that prior beliefs should be reversed. Deficits help to stabilize the economy, deficits do not raise interest rates, deficits are not necessarily inflationary, and a rising public debt does not lead to higher tax rates. The public debt and fiscal deficits provide several benefits to the rest of the economy.”
Second – Is Scotland Subsidised By The Rest Of The UK?
We’ve concluded that Scotland’s government deficit is, in current circumstances, necessary to reverse austerity. But the next debate is where Scotland would find the money to fund such a deficit. As we’ve seen from most discourse on the discussion, commentators more frequently use the (TAB)S framework – taxing and borrowing precedes spending. As the name suggests, this framework argues that there is only two options for the state to increase its spending; to tax the population more or to borrow our savings. This framework is to suggest that a government’s budget is like that of a normal household.
This is where “£2,000 Union Dividend” argument presents itself: if Scotland became an independent country then the sudden lose of income would require either massive tax hikes and/or fiscal austerity.
This is factually wrong.
The (TAB)S framework is a dated concept that does not reflect the realities of monetary operations for modern day economies with their own economies and central bank. Instead an updated framework is S(TAB) – spending precedes taxation and borrowing. This framework shows that modern day governments credit currency into the relevant accounts first, then followed by taxation and borrowing. This logic also applies to private banks when it comes to deposits. Private banks create brand new deposits by simply crediting the correct accounts, and do not use money from savers. Instead of taxation being used as a tool for spending, it is better used to control equity, social behaviour, demand and inflation. What we also call “borrowing” is also an accounting adjustment used to set over-night and long-term interest rate (a topic we recently touched on).
This is not a ground-breaking revelation. John Maynard Keynes in his two-volume masterpiece “A Treatise of Money” writes in page 30:
“There can be no doubt that, in the most convenient use of language, all deposits are ‘created’ by the bank holding them. It is certainly not the case that banks are limited to that kind of deposit, for the creation of which it is necessary that depositors should come on their own initiative to bring cash or cheques.”
From a modern day perspective, Professor of Economics Stephanie Kelton concludes in her paper “Can Taxes and Bonds Finance Government Spending”:
“An analysis of reserve accounting reveals that all government spending is financed by the direct creation of HPM; bond sales and taxation are merely alternative means by which to drain reserves/destroy HPM. The choice, then, is between alternative methods for draining reserves in order to prevent the overnight lending rate from falling to zero. In light of these findings, it is, perhaps, time to reconsider our definitions of monetary and fiscal policy as well as our treatment of taxation and bond sales as ‘financing’ operations.”
Even the Bank of England shares this same analysis, as they confirm in their working paper “Money Creation in the Modern Economy”:
“Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy. But they are far from the only ways. Deposit creation or destruction will also occur any time the banking sector (including the central bank) buys or sells existing assets from or to consumers, or, more often, from companies or the government.”
Based on current monetary operations, taxpayers from the rest of the UK do not subsidise Scotland. It is the Bank of England marking up relevant accounts on behalf of the UK Treasury with credit creation that results in higher spending in Scotland. If Scotland were to become an independent country, it would require its own currency and central bank in order to carry out similar operations to credit relevant accounts. If this can be set up during the transition period towards independence, then the question is not if Scotland can finance its public services, but if it has the domestic resources (labour, skills, physical capital, technology and natural resources) to carry out public services and programmes. However, what an independent Scotland’s spending priorities would be entirely down to political decision making.
Third – Can an Independent Scotland Better Manage A Deficit Compared To The Current Model?
This last argument is largely a political one and will depend on how we define “manage”. In this case, under the current devolution settlement the Scottish Government is limited in its abilities to reshape the economy in a manner that matches that of regular monetary sovereign countries of its size. Without monetary control and limited tax/borrowing powers, the current devolution model forces Holyrood to use the (TAB)S framework, which could indirectly influence how commentators discuss the economic opportunities and challenges an independent Scotland could face.
However, these opportunities come down to having the levers to invest into government programmes and utilise our resources. If Scotland were to adopt an economic model of Sterlingisation then we would still be bound by the (TAB)S framework. This means the monetary operations discussed above would not apply to us, and instead an independent Scotland would be more likely to raise taxes and/or cut public services. We could also borrow, but as we discuss in our bonds article this leaves us open to bond vigilantes and a real default risk.
An independent Scotland does have the capabilities to better manage its current government deficit compared to the model of devolution. But if the model Scotland picks is self-harming, then the short term economic opportunities are far more limited.
Further Comment – Tax and Regional Inequality
There has been an interesting discussion on the issue of Scottish taxation between economist George Kerevan and chartered accountant Richard Murphy. Kerevan presents the argument that Scotland’s taxation levels, as a percentage of GDP, are relatively low compared to international standards. He cites a few interesting examples, including Norway which has almost a 20% taxation gap compared to Scotland. Kerevan also acknowledges the potential risk of capital flight, but argues that a mix of capital controls and monetary sovereignty could mitigate any potential damage. Finally, he also discusses opening new revenues for taxation, citing the failed 28,000 new Green jobs target by the Scottish Government (only achieving 6% of the target).
Murhpy responds to George by arguing that, whilst raising taxation has clear benefits, the real case to be made is in spending. Murphy rightfully uses the S(TAB) framework and points out spending comes before taxation, and that as the aggregate tax rate rises so does GDP. Richard concludes that higher taxation should occur later down the line.
So who is right? Seeing as both men come from similar economic positions, both hold a large element of truth. As stated above, Murphy’s use of the S(TAB) framework is accurate, though for the short to medium term there could be the case to raise certain taxes. Tax liabilities creates demand for any currency, and when launching a new Scottish currency post-independence it would not be unreasonable to offer a tax rise in certain areas. Which areas this could be will depend on your politics and economic school of thought. But a reasonable position would be a gradual tax rise in line with growing GDP.
Finally, the discussion of regional inequality within the UK also raised its head, this time between Kevin Hague, Sam Taylor (also part of Hague’s think tank) and former Liberal Democrat candidate John Ferry. Together they have two arguments, which summarised are 1) No, the UK does not have some of the worst regional inequality in Europe 2) Even so, the fact this wealth is redistributed shows the UK is working.
The source used by Taylor in this argument is the Financial Times, though this is not exactly a strong citation to use. Better insights can be offered by Philip McCann, chair of Economic Geography at the University of Groningen. In his paper “Perceptions of regional inequality and the geography of discontent: insights from the UK” he concludes:
“the UK is one of the most interregionally unequal countries in the industrialized world. Wide-ranging evidence suggest that on many levels the UK economy is internally decoupling, dislocating and disconnecting, a reality which the UK’s highly centralized, top-down, largely space-blind and sectorally dominated governance system is almost uniquely ill-equipped to address.”
The extremist attitude to deny or disguise regional inequality in the UK is concerning. Commentators need to start discussing how to evenly spread resources across the UK, instead of viewing the South East as some sort of economic protector for other regions. This is a structural issue, not simply a problem that can be tweaked. Further discussion on the issue can also be found by Dr Craig Dalzell, where you can his analysis on GERS by clicking here.
Conclusion – Update The Debate
The debate on GERS is a welcome and healthy discussion for Scotland’s democracy, even if it is largely contained within a social media bubble. But discussing macroeconomics with one eye shut only leaves voters and political commentators misinformed. Activists on both sides of the debate must go beyond the headline numbers and ask themselves what this means for our economy, but more importantly for ordinary people.