In the Scottish independence debate, HM Treasury has asserted, in the first of its Scotland Analysis series of papers, that Scotland would become an entirely new state, with rUK inheriting the legal personality of the current UK. Needless to say, the Scottish Government did not agree with this statement and Nicola Sturgeon pointed out its status: it is legal opinion, this is perhaps very well informed opinion, but opinion nonetheless. This was much discussed at the time in terms of its implications on EU membership etc, but a new implication of this assumption is emerging.
At the International Conference on Economics of Constitutional Change held last week in Edinburgh, Dr Angus Armstrong of the National Institute of Economic and Social Research (NIESR) presented a paper on the currency options for an independent Scotland (Armstrong & Ebell), making the link that debt levels were an important consideration in making this currency choice. The analysis underlying this paper appears sound: it concludes that a small state with volatile tax revenues will pay a higher interest rate on its borrowings than a larger state with stable tax revenues (for a given average tax revenue per unit GDP, and debt stock level per unit GDP). The methodology looks solid and the conclusions are intuitive.
I do however question the assumption made in this paper about the splitting of debt. It suggests that rUK is "the continuing UK" and that newly independent "Scotland would also have to compensate the continuing UK for being relieved of its fair share of the existing UK public debt at the time of independence". Whilst both the UK and Scottish Governments have agreed that the assets and liabilities of the current UK should be split fairly, they may disagree on the method of this splitting, and what constitutes 'fair'. However there seems to be an emerging consensus that assets fixed in geography should accrue to the country in which they reside, and moveable or financial assets and liabilities should be split on a population basis. So let's consider splitting the UK debt by population and look at the consequences of assuming that "Scotland would also have to compensate the continuing UK for being relieved of its fair share of the existing UK public debt at the time of independence".
To simplify things massively let's assume that:
# the market value of UK debt, at the point at which it is to be split, is £1359B
# this is all 5 year zero coupon bonds
# which yield 2%p.a.
# Scotland is 10% of the UK by population
# The analysis in Armstrong & Ebell suggests that Scotland would pay 3.5% on its debt [this is not the real number from the paper, but just to keep things relatively simple].
The face value of the outstanding debt stock is £1500B. I think a reasonable way to split this is that Scotland becomes responsible for repaying 10% of this face value, £150B, as it becomes due. rUK would pay the other £1350B on the due date. The current market value of the debt will fall as existing creditors are not as happy with their new counter-parties as they were under the previous union. But this happens after every election: a prudent government issues debt for sensible reasons at low interest rates; then loses an election to an imprudent government and the interest rate rises; existing debt-holders get burnt. The Scottish independence referendum is another election, and not one that creditors can reasonably claim to have been ignorant about: most of the existing debt stock has been issued since 2007 when the SNP first came to power.
However, if the rUK was to be considered as "the continuing UK" then the scenario I've outlined in the previous paragraph may constitute a default by the UK - something that "the continuing UK" will never do. And if instead Scotland has to buy out the debt from rUK by raising new Scottish debt, it would need to pay rUK £136B to extinguish its liability, by issuing 5 year zero coupon bonds with face value of £161B - rather than £150B. This boils down to saying that in order for rUK to maintain the reputation of the current UK in international credit markets, Scotland should pay a premium. Is this 'fair'? In my view, any reputational assets currently "owned" by the UK should also be divided fairly.
Wednesday, 25 September 2013
Monday, 9 September 2013
Sans Frontières
Number 5 in the 'Scotland Analysis' series from the UK Government was published last week: "it discusses the macroeconomic performance of Scotland as part of the UK ... and the potential impact of a border between Scotland and the rest of the UK". Despite much ridicule from Yes supporting quarters, I think the HM Treasury estimate of the size of the potential "border effect" between Scotland and the rest of the UK is on the conservative side. The argument that, because economic forecasts are generally rubbish, it is impossible to make the case that a particular intervention is likely to be economically costly or beneficial, is a fatuous one.
I have written about the border effect before: it is the real phenomenon under which trade within a nation state is much higher than trade across a national boundary, even a national boundary within the EU. Why? Who knows, but we observe that this is the case. If trade is valuable then the reduction in trade associated with the creation of a border will be costly.
Though it is a real effect, its importance should not be overstated: HMT report a long run (actually steady state) value of 4% of Scotland's GDP, and a not unreasonable parameterisation could produce anything up to maybe 10% of Scotland's GDP. HMT further suppose that this long run steady state might be reached in 30 years. If this is a reasonable timeframe, then we are discussing a mechanism which may have an impact on GDP growth of between 0.1% and 0.3% per year. Given expected GDP growth of between 2% and 3%, an effect of this magnitude will be almost undetectable on a yearly basis, but cumulative over time.
So the border effect will likely have only a small effect on annual GDP growth rates, but on whose GDP growth rates will it impact? The mechanism by which borders have an economic cost is that it prevents productive firms expanding and shelters unproductive firms from competition. If firms were geographically fixed then the cost of the border would fall predominantly on Scotland as the smaller party. However, the following scenario outlines a case consistent with a costly border effect, but under which the cost falls on rUK:
As the Treasury say, the border effect also applies to migration flows as well as trade flows. I have also written about migration and population: migration over the Scottish-English border is currently roughly balanced, but that this is an atypical situation by comparison with the 20th century. Even with balanced migration it is possible that Scotland loses out and could benefit from a reduction in these gross flows: this would be the case if these flows represented a net export of human capital from Scotland. Perhaps we export the brightest and best of our young people to the head offices of London, and import middle managers to run branch offices and pensioners to enjoy the views? Demographics also demand that Scotland cannot do with only balanced flows anyway: it needs “net imports” of young people. This may be increasingly unlikely within the UK if the political centre is dragged UKIP’s way.
To summarise, the critique of the border effect is fatuous and confuses a discussion of mechanisms with economic forecasts. The border effect is real and, all other things equal, it is a cost of independence which should not be rubbished. However, all other things are never equal, and if low barriers to trade mean that Scotland is exporting its productive capacity south, then the possibility exists that the border effect could be part of the reasons for independence.
And remember, HMT are currently working for political masters who want an In/Out referendum of the EU. The border effect applies there too.
I have written about the border effect before: it is the real phenomenon under which trade within a nation state is much higher than trade across a national boundary, even a national boundary within the EU. Why? Who knows, but we observe that this is the case. If trade is valuable then the reduction in trade associated with the creation of a border will be costly.
Though it is a real effect, its importance should not be overstated: HMT report a long run (actually steady state) value of 4% of Scotland's GDP, and a not unreasonable parameterisation could produce anything up to maybe 10% of Scotland's GDP. HMT further suppose that this long run steady state might be reached in 30 years. If this is a reasonable timeframe, then we are discussing a mechanism which may have an impact on GDP growth of between 0.1% and 0.3% per year. Given expected GDP growth of between 2% and 3%, an effect of this magnitude will be almost undetectable on a yearly basis, but cumulative over time.
So the border effect will likely have only a small effect on annual GDP growth rates, but on whose GDP growth rates will it impact? The mechanism by which borders have an economic cost is that it prevents productive firms expanding and shelters unproductive firms from competition. If firms were geographically fixed then the cost of the border would fall predominantly on Scotland as the smaller party. However, the following scenario outlines a case consistent with a costly border effect, but under which the cost falls on rUK:
- suppose under union there are low barriers to trade and large markets; a productive new Scottish firm takes advantage of this situation to expand; as part of this expansion it makes use of London’s comparative advantage in supplying head office services and moves it’s management and R&D divisions to London, keeping its call centre in Scotland
- under independence barriers to trade are higher; the productive new Scottish firm cannot expand as much; so the overall output of the Scottish & rUK economies is lower; but this is London’s loss as the (smaller) firm stays in Scotland with its high quality management and R&D divisions providing high status employment;
As the Treasury say, the border effect also applies to migration flows as well as trade flows. I have also written about migration and population: migration over the Scottish-English border is currently roughly balanced, but that this is an atypical situation by comparison with the 20th century. Even with balanced migration it is possible that Scotland loses out and could benefit from a reduction in these gross flows: this would be the case if these flows represented a net export of human capital from Scotland. Perhaps we export the brightest and best of our young people to the head offices of London, and import middle managers to run branch offices and pensioners to enjoy the views? Demographics also demand that Scotland cannot do with only balanced flows anyway: it needs “net imports” of young people. This may be increasingly unlikely within the UK if the political centre is dragged UKIP’s way.
To summarise, the critique of the border effect is fatuous and confuses a discussion of mechanisms with economic forecasts. The border effect is real and, all other things equal, it is a cost of independence which should not be rubbished. However, all other things are never equal, and if low barriers to trade mean that Scotland is exporting its productive capacity south, then the possibility exists that the border effect could be part of the reasons for independence.
And remember, HMT are currently working for political masters who want an In/Out referendum of the EU. The border effect applies there too.
Sunday, 1 September 2013
End August Links
# Simon Wren-Lewis and Paul Krugman describe the objectivity of analysis produced by the civil service in assessing Gordon Brown's 5 tests for joining the Euro. I think it's fair to say that the positions taken by civil servants in producing the Scotland Analysis series for the UK Government and the various Scottish Government papers have been much less impartial.
# Noah Smith thinking in thought experiments: Does private sector net saving necessitate government net borrowing? A trivial example, but this is the way thinking should be done.
# Why savers can't have nice things: it's all about time travel; Why @saveoursavers are doomed, & Depressions are bad for debtors and creditors, and workers and bosses
# Another North/South divide in the UK
# John Kay's speech at Glasgow University transcript: "Here we come up against one of the most serious problems of Scottish business, the drain of Scottish business and Scottish headquarters out of Scotland over 20, 30, 40 years. How much of that is due to Scotland’s membership of the United Kingdom and how much would have happened anyway in a world in which London is a major financial and business centre is an open question. But certainly, Scotland has not been able to adopt policies of retaining corporate headquarters within its boundaries in ways that it might have been able to do as an independent country." An important question about how constitutional set-up can influence economic outcomes.
# Great comment from Simon Wren-Lewis on Tory macroeconomic policy: The wrong sort of recovery
# This needs to be expanded upon: I have sympathy with the view that this might be true, but I need a theory for why it's true; simply stating it is not enough. "Scotland is a surprisingly elitist society where a relatively small number of people own land, run businesses, own wealth, stand for election and run government. The result is a deep-seated belief that ordinary Scots cannot own and run things, don’t want to own and run things and indeed that it hardly matters who does. It matters. It matters so much that talented folk still leave Scotland instead of pushing for fundamental change. Well-intentioned public servants scour the universe for an explanation of the Scottish Effect (where Scots health is consistently worse than English counterparts in areas with similar levels of deprivation). Perhaps the answer is simple. Perhaps the sheer stultifying burden of disempowerment has finally caught up with us all." This is important not just for Scottish Independence and the referendum, it also has strong message for the economics of inequality: inequality is usually deemed to be bad because the poor have a higher marginal utility of consumption (this reason has also been augmented with newer theories with utility over status or rank). But the quote also hints at negative impacts upon human capital development i.e. supply side impacts of inequality; and how inequality impacts upon self-identity which has knock-on impacts on supply ("we cannae dae it", where "we" means Scots).
# Krugman's 'Banks and the monetary base' made sense to me; but then so did Interfluidity's 'Banks and macroeconomic models'; and even Steve Keen's 'The reductionism stops here'. And they can't all be right...
# Self publicity!
# For future reference: Final version of Tyler Cowan's International Trade class reading list
# Noah Smith thinking in thought experiments: Does private sector net saving necessitate government net borrowing? A trivial example, but this is the way thinking should be done.
# Why savers can't have nice things: it's all about time travel; Why @saveoursavers are doomed, & Depressions are bad for debtors and creditors, and workers and bosses
# Another North/South divide in the UK
# John Kay's speech at Glasgow University transcript: "Here we come up against one of the most serious problems of Scottish business, the drain of Scottish business and Scottish headquarters out of Scotland over 20, 30, 40 years. How much of that is due to Scotland’s membership of the United Kingdom and how much would have happened anyway in a world in which London is a major financial and business centre is an open question. But certainly, Scotland has not been able to adopt policies of retaining corporate headquarters within its boundaries in ways that it might have been able to do as an independent country." An important question about how constitutional set-up can influence economic outcomes.
# Great comment from Simon Wren-Lewis on Tory macroeconomic policy: The wrong sort of recovery
# This needs to be expanded upon: I have sympathy with the view that this might be true, but I need a theory for why it's true; simply stating it is not enough. "Scotland is a surprisingly elitist society where a relatively small number of people own land, run businesses, own wealth, stand for election and run government. The result is a deep-seated belief that ordinary Scots cannot own and run things, don’t want to own and run things and indeed that it hardly matters who does. It matters. It matters so much that talented folk still leave Scotland instead of pushing for fundamental change. Well-intentioned public servants scour the universe for an explanation of the Scottish Effect (where Scots health is consistently worse than English counterparts in areas with similar levels of deprivation). Perhaps the answer is simple. Perhaps the sheer stultifying burden of disempowerment has finally caught up with us all." This is important not just for Scottish Independence and the referendum, it also has strong message for the economics of inequality: inequality is usually deemed to be bad because the poor have a higher marginal utility of consumption (this reason has also been augmented with newer theories with utility over status or rank). But the quote also hints at negative impacts upon human capital development i.e. supply side impacts of inequality; and how inequality impacts upon self-identity which has knock-on impacts on supply ("we cannae dae it", where "we" means Scots).
# Krugman's 'Banks and the monetary base' made sense to me; but then so did Interfluidity's 'Banks and macroeconomic models'; and even Steve Keen's 'The reductionism stops here'. And they can't all be right...
# Self publicity!
# For future reference: Final version of Tyler Cowan's International Trade class reading list
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