Saturday, September 12, 2015
The Great Escape: How Scotland dodged a bullet
Posted by David Smith at 09:00 AM
Category: David Smith's other articles

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My regular column is available to subscribers on www.thesundaytimes.co.uk This is an excerpt.

A year ago this Friday the Scottish people voted on whether to remain part of the UK. It was a big moment, more important because of its irreversibility than this year’s general election. Maybe more important than the coming referendum on European Union membership.

The Scots, of course, voted no, by 55.3% to 44.7%, to my considerable relief and I hope theirs. In doing so, they gave us a Scottish version of The Great Escape. They dodged a bullet. Had Scotland voted for independence, its economy would be in deep trouble. Nicola Sturgeon, its first minister, would not be attacking George Osborne’s austerity but announcing more of it in an effort to prop up Scotland’s chronically weak public finances.

But, and this is not purely a backward-looking exercise, these issues have not gone away. After rejecting independence in September last year, Scottish voters flocked to the Scottish National Party in the May general election, its 50% vote share being enough to give it an astonishing 56 out of 59 Scottish Westminster seats.

Buoyed up by this, some in the SNP have been talking up the prospect of a second referendum, with its former leader Alex Salmond saying it is “inevitable”. A vote to leave the EU would be seen by the SNP as one reason to hold a second referendum but there could be others.

Even if another referendum is avoided, Scotland is getting more fiscal powers under the enhanced devolution promised in the run-up to the referendum. Though the SNP has gone a bit quiet on full fiscal autonomy, the economic stepping stone to independence, it remains a possibility.

Why was it such a lucky escape for Scotland? The main reason, and the biggest change since the independence vote, has been for North Sea oil. The Scots were promised a future of high oil prices and rising production. The reality has been plunging prices and a crisis in the North Sea. The Scots were told that Westminster was keeping secret from them the true picture of future North Sea riches. If anything was being kept secret, it was how bad it would be.

A few numbers illustrate the point. In June the Office for Budget Responsibility (OBR) issued its latest long-term “fiscal sustainability” projections. As far as North Sea tax revenues are concerned, their conclusion was that it would be wise to plan for nothing from 2020 onwards. Total North Sea revenues will be just £2.1bn in the 20 years from 2020, it said, equivalent to a single year’s revenue in a bad year now.

Ahead of the referendum, the OBR’s projections were frequently criticised by nationalists as too pessimistic. In fact, by comparison with its current revenue forecasts, the OBR was looking at the North Sea through rose-tinted spectacles. In 2014 it though revenues in the 20 years from 2020 would be more than £36bn. In 2011 it thought they would be more than £130bn.

Forecasts, like oil prices, go up and down. What about if we saw a big recovery in oil prices closer to home? The OBR had an answer to that. As it put it: “Even an assumption of higher production and oil prices reaching around $210 a barrel leaves revenues as a share of GDP (gross domestic product) at a fraction of the levels seen in the past 10 years.”

As for keeping the good news back, the Scottish government’s own revenue projections from North Sea oil and gas have come down dramatically. In May 2014, a few months before the referendum it said that revenues for the next five years would range between £15.8bn and £38.7bn. In June, updating those projections, it said they would be between £2.4bn and £10.8bn. Taking the mid-point of those ranges, and the mid-point of the latest range looks generous given the oil price, the post-referendum projection is less than a quarter of what it was.

Nor is there any sign of things getting better. Oil & Gas UK, in a report a few days ago, said that 65,000 jobs have been lost in the North Sea since 2014. Exploration is at its lowest since the 1970s and investment is plunging. Even last year, when the plunge in prices was not complete, “more was spent on UK offshore oil and gas operations than was earned on production”.

The response of the Scottish government to this has followed a well-worn path. The North Sea was only ever a “bonus” for Scotland, not the lifeline. The trouble is, at least as far as the public finances are concerned, it is not true. The latest official figures, Government Revenue and Expenditure Scotland (GERS) show that without North Sea revenue, Scotland had a Greek-style budget deficit of 12.2% of GDP in 2013-14. With that revenue, the deficit came down to 8.1% of GDP, still higher than the overall UK deficit of 5.6% of GDP.

Since then, according to the Institute for Fiscal Studies, Scotland’s public finances have gone backwards. After the March budget, the IFS’s David Phillips used OBR figures to calculate a budget deficit for Scotland of 8.6% of GDP this year, 2015-16, the same as in 2014-15. This year’s forecast is more than double that of the UK as a whole (4% of GDP). According to Phillips, events since March will have tended to widen Scotland’s deficit, both in absolute terms and relative to the UK as a whole.

Oil and the deficit were not the only factors a year ago. The SNP went into the referendum on a wing and a prayer, hoping against all the denials that Westminster would allow it to be part of a sterling currency union and threatening to renege on its share of UK debt. An independent Scotland, I wrote then, would be “poorer, unstable and fiscal weak” and, if it carried out its debt threat, a pariah in international markets. There would have been an exodus of big employers.

As I say, these things have not gone away. Angus Armstrong of the National Institute of Economic and Social Research points out that greater fiscal autonomy for Scotland poses huge challenges. The Smith Commission’s proposals for greater devolution will give Scotland control over 60% of spending and 40% of revenues, which he says will make it “one of the most powerful sub-central governments in the OECD”.

Such is the weakness of Scotland’s public finances that it is a very long way from the balanced budget Armstrong says it would be required to follow. Allowing Scotland to borrow on the markets to give it more flexibility would, because of its fiscal weakness “and clear intention to borrow and spend more” attract the attention of the ratings agencies and possibly affect the UK’s credit rating as Scotland’s ultimate backstop.

Scotland may have dodged the bullet on independence. The challenges of its weak fiscal position remain.