What a week!

With the press release of our paper on 'Constitutional change and inequality in Scotland', last week was hectic. Apart from media appearances (e.g. GMS), which are a fairly new experience, the most stressful aspect was the concern that one side or other in the referendum campaign would claim the report as vindicating their position, and that we'd be seen as biased and partial in our analysis. For an example of how political our paper turned out to be, see the last 5 minutes of FMQs last week, which end with Baillie and Salmond arguing over who had read the report most closely!

I started to get worried when I saw the Scotsman article on the paper, which inserted the word "independent" every time our press release mentioned only "Scotland" which gave the impression that independence was somehow worse than the other constitutional options at tackling inequality. I then saw conversations on twitter accusing us of producing research to order for the No campaign. I joined one of these twitter conversations with a link to the press release accompanied by the words "needs a lot of spin to be anti-Indy". When this was repeatedly retweeted I thought maybe I'd gone too far the other way...

Anyway, what did our research say? And what comfort could it give to either campaign?

Our research quantified the impact on the level of inequality in Scotland of small changes in various tax and benefit levels. Our model included behavioural responses to policy changes, including a migration response. The conclusion of the research was that these small changes would have only a minute impact upon inequality levels - to achieve Scandinavian levels of inequality using on fiscal policy would require massive changes to current fiscal policy, which would likely be accompanied by adverse behavioural responses (read: decent proportion of tax base could flee the country).

If we assume that achieving Scandinavian levels of inequality is the aim, then the message of our research is that policy other than simply fiscal policy is likely required to achieve this aim. Changes in labour market policy, and in the levels of public service provision (such as improved childcare provision), that serve to bring down the level of wage inequality before the impact of taxes and benefits must be implemented - perhaps alongside small changes in fiscal policy. Over the course of a generation perhaps, the expectations of the population and the social norms that they operate under, will evolve to permit a more equal, Scandinavian style economy. All very consistent with the policy prospectus underlying the Common Weal project.

Conversely, Taxpayer Scotland also welcomed the report, especially its inclusion of behavioural responses, and they do have a certain logic: the report shows that reducing inequality to Scandinavian levels will be very difficult using only fiscal policy. If actually achieving Scandinavian levels of inequality will be slow and will require the commitment of the population over timescales of a generation or more, then Taxpayer Scotland suggest that the aim of reducing inequality should perhaps be reconsidered.

But what can the campaigns take from this? Well, The No side can claim that as an independent country, the UK already has all the levers that an independent Scotland would gain in order to tackle inequality. Indeed, the lower behavioural responses induced by the whole UK acting in concert, compared to a Scotland acting independently (with the rest of the UK functioning as an outside option for the fleeing Scottish tax base), means that, if the UK was serious about tackling inequality, then it would be easier to tackle as a 'whole of the UK' issue. The No side can also question the commitment of the Scottish population to actually implement policy over a generation to tackle inequality (especially given polling evidence like this).

The Yes side can point to the numbers in the report that show the UK being relatively unequal in OECD terms, markedly unequal in European terms, and extremely unequal when compared with the Nordics. They can point to the rationality of this situation from the point of view of what the UK has to lose in terms of the large contribution to this inequality from the City of London: the UK is not doing much to tackle inequality, and this may be its optimal policy; the UK is unlikely to ever do much to tackle inequality because it has to look after London. They can also point to the fact that fiscal policy is not nothing: power to do something here, even if relatively ineffectual, is perhaps better than the nothing that the UK is doing (in fact the UK may even be going backwards, given future planned welfare cuts). Finally, the Yes side can point to the potential of additional policy levers that do not come under the heading of fiscal policy, and which are unlikely to be included in any enhanced devolution settlement.

As one of the authors, I don’t think the report necessarily strengthens the case for or against independence, but it does highlight that there are real difficulties in using fiscal policy to tackle inequality in either case.

New Year arguments for Yes

Whilst ranting/discussing on hogmanay about why a Yes vote isn't obviously a bad economic choice and quite possibly a good economic choice, I had the flow of my argument disrupted somewhat. It wasn't just the drink: my problem was that I was actually making two separate arguments, and the logic of one does not translate to the other.

The two arguments were:

1. Small countries do as well as large countries, if not better
2. The UK is run particularly badly as far as its peripheral regions are concerned

Obviously saying Germany's great and that the UK does badly and that this is because small countries function better is nonsensical. But I think the two points both stand - it's just that they stand independently (so to speak) of each other.

Consider those countries of Northern Europe which have never been part of the communist block, as the set of suitable comparators: Iceland, Norway, Sweden, Finland, Ireland, UK, Denmark, France, Belgium, Netherlands, Luxembourg, Germany, Switzerland and Austria. All data is 2010 GDP per capita at Purchasing Power Standard from Eurostat.

The trend (solid line) for income per capita against population size is decreasing, hence the first argument. The vertical dashed line shows Scotland's population and the horizontal dashed line shows average income per capita across these countries. The red data point is the UK - slightly below the average for this group of countries, but not by much.

This is not a very strong argument for independence: it is suggestive of small countries doing slightly better than large countries, but tells us nothing about the direction of causality. Small wealthy regions may choose independence rather than independence leading to wealth. It remains the case though that we have circumstantial evidence in favour of the first argument: the small countries of North West Europe appear to do a bit better than their larger neighbours, and this bodes well for the prospects of an independent Scotland.

The second argument is that the UK's regional policy is particularly poor and that the UK is a particularly bad place to choose to be a peripheral region. We have seen that per capita income in the UK is slightly below, but very close to, the average for this group of northern European countries - but how is this income distributed within the country? I rank the NUTS-2 Regions within this group of countries from lowest to highest. If the distribution within the UK was similar to that within the other countries of this group then we should see the regions of the UK (red columns) clustered around the middle of this ranking.

We see that rather than clustering around the middle, the red bars are disproportionately in the bottom half of the distribution, with very few in the upper half. But the UK is not a poor country: it's an average country within this group, so why are almost all its regions in the lower half of the income distribution? The answer is that it has the most skewed regional distribution and London is the richest NUTS-2 region in Europe. The following chart shows the same data as the previous but as deviation in income per capita from the NUTS-2 region with the national capital. The regions of the UK occupy ALL of the bottom spots.

So I think there is strong evidence in favour of argument 2: regional policy in the UK is terrible and if you are not the capital then independence is not a bad idea. Again this evidence is not overwhelming: it could be the case that the UK is fundamentally a very poor place compared with everywhere around it, and the wealth of London is pulling us all up. I don't believe that this is the case though. I think it is likely that policy is such that human and physical capital investment which in other countries is spread around, in the UK is instead directed towards London, and almost every single region of the UK is losing out as a result.

UPDATE: What I've done here repeats some reporting from last summer - http://www.scotsman.com/news/bill-jamieson-data-shows-why-uk-is-truly-divided-1-2944789
- http://www.neweconomics.org/blog/entry/Breaking-free-of-London-focused-growth
- http://www.heraldscotland.com/politics/referendum-news/london-calling-the-shots.21228380

End December Links

# New national infrastructure plan – old North/South divide including Garden bridges to nowhere

# In Two observations on the Autumn Statement, Simon Wren-Lewis points out that the OBR’s accompanying forecast notes that government plans imply that “government consumption of goods and services falls from 23.2 per cent of nominal GDP in 2009 to 16.1 per cent by the end of the forecast period, its lowest on record in data back to 1948.” Even if the electorate had expressed a preference for exceptionally low levels of public services (and I don't think, despite the Tory's being elected as the largest party in 2010, that this was the preference expressed), you would not choose a period in which we were flirting with depression to make this adjustment. Ridiculously pro-cyclical fiscal policy.

# Interfluidity is great. He makes another fantastic point in Standards of evidence: we don't know what the unconditional expectation is of the impact of tax rises or reductions in equality (or for that matter, of the imposition of borders); but that doesn't stop those whose main policy objective is low taxes arguing that taxes are bad for growth. Why then are those whose main objective is the reduction in inequality so coy about claiming that inequality is bad for growth? There are plenty of models in which the conditional (ie. all other things equal) impact of unequal income distribution is bad for growth...

# Big banks versus small banks: size doesn't matter: "interconnectedness, not size, [is] principle cause of systemic risk". This sounds right to me, but I think sharing a company so that you are one big bank is likely to be an 'interconnectedness enabling technology', so average size of banks and degree of overall interconnectedness in the sector is likely to be correlated.

# Interesting stats: Storify: Regional GVA stats & Mapping the recovery

# If negative interest rates are a tax then positive interest rates are a subsidy from the future

# Much is talked about Scotland taking a share of the UK debt, but much less is said about the asset side. Supposedly they are similar values: Independence will generate a £109,000,000,000 asset windfall for Scotland via Debt equals assets. I need to dig into this.

# Great column from the KrugTron, Bits and Barbarism: "Money, [Adam Smith] understood, was a way to facilitate commerce, not a source of national prosperity — and paper money, he argued, allowed commerce to proceed without tying up much of a nation’s wealth in a “dead stock” of silver and gold. So why are we tearing up the highlands of Papua New Guinea to add to our dead stock of gold and, even more bizarrely, running powerful computers 24/7 to add [bitcoins] to a dead stock of digits?" Charlie Stross on this too: Why I want Bitcoin to die in a fire

Is The IFS Report Inconsistent With The “Scotland’s Future” White Paper?

This is blatant self-promotion...

Based on last month's post, White Paper Reflections - Budget, last week I spoke at a Scottish TUC conference. The STUC's Stephen Boyd has written a very generous description of my talk in his write up of the event, and my slides are available.

End November Links

# The LSE blog had a great post, Britain’s spatially unbalanced economy is both wasteful and unstable. The solution requires much more than small-scale measures: "The fact that after nearly ninety years of regional policy Britain’s economy is still spatially divided between South and North suggests that the problem is a systemic one, requiring a systemic solution. It is often claimed that the success of London and the South East is merely testament to the ‘natural workings’ of the market. Some take this argument further and suggest that we should encourage economic activity and workers to abandon northern towns and cities and move to the South to maximize growth there. Such pronouncements fail to acknowledge the reality that the economies of London and the South East are not simply driven by market forces, but  also heavily underwritten by the State; that this part of the country enjoys preferential access to finance; that it is able to exert a disproportionate influence on government economic policy; and that in London it has a city which has a degree of political and economic autonomy not found in other UK cities." If systemic, the problem should be amenable to modelling. What's the mechanism? Does it imply that autonomy leads to growth?

# - Henrik Jensen: Willem and the Negative Nominal Interest Rate
   - Secular Stagnation, Coalmines, Bubbles, and Larry Summers
   - Why the future looks sluggish: "another possibility, ..., is to use today’s glut of savings to finance a surge in public investment. That might be partly linked to a shift to lower-carbon growth. Another possibility is to facilitate capital flows to emerging and developing countries, where the best investment opportunities must lie. It makes no sense for so much of the world’s savings to seek investment opportunities where they do not apparently exist and shy away from places where, one hopes, they do."
   - Secular stagnation, bubbles & inequality
   - Monetary and Fiscal Implications of Secular Stagnation [don't completely agree with:
"The point is that the case against austerity is as strong as it ever was. And maybe even stronger, once you think about debt dynamics. Right now the real interest rate on US government borrowing is about 0.5 percent on 10-year securities, negative 0.4 percent on 5-year. Meanwhile, even pessimistic estimates of US potential growth put it in the 1.5-2 percent range. So r is less than g — the real interest rate on debt is less than the normal growth rate. This in turn means that the usual worry about a rising debt level — that it will require that we eventually run big non-interest surpluses to pay down the debt — is all wrong."
Secular stagnation will lower g with r, so I'm not sure it helps public finances]
   - The (non) politics of stagnation.

# The intergalactic trade frontier: "Trade moralists are fundamentally illogical and dangerously plausible. The idea of exporting your way to recovery is seductive. But it simply is not possible for all countries to export their way to recovery. Someone, somewhere has to have a trade deficit."

# Scottish Economy Watch's "Independence Facts" series:
   - 1: Trade flows, migration flows and capital flows are significantly lower across international borders than within a country
   - 2: Small states have higher per capita GDP (are richer) than other states
   - 3: Growth in small countries is neither more or less fast than in other countries but is more volatile
   - 4: Scotland's exports to rest of UK account for 70% of its exports. Rest of UK exports to Scotland account for 11% of its exports

# I love maps like this: The UK as a cartogram

# International interest in the referendum, especially on currency, and all concluding that a currency union is not such a great idea:
   - Scotland, Sterling, and the debt
   - A history lesson for Scotland
   - Scotland must be braver "Scotland must bite the bullet and fearlessly seek to establish its own currency. ... Edinburgh ought to declare its intention to create a Scottish Central Bank and a temporary currency board that will peg the new currency to sterling before, once cross-border capital movements have been stabilised, the Scottish pound is allowed to float freely and Edinburgh’s monetary authorities set Scottish interest rates with a Scottish inflation target in mind."

The White Paper vs the IFS

Many of the questions, both actually asked in the press conference, and hypothetically asked in the Q&A in Part 5 of the White Paper, drew a comparison between the optimistic assessment of Scotland’s economy from the Scottish Government against last week’s negative assessment from the Institute for Fiscal Studies.

Firstly it is important to note what the IFS actually did: they compared projected UK finances with projected Scottish finances, both under what can be labelled as “best estimate, given current policy”. What these projections show is that, under union, Scotland would either start to see large subsidies from rUK, or it would see its budget cut. Prof Brian Ashcroft has shown that Scottish funding has actually tracked Scotland’s net fiscal position reasonably closely (Has Scotland already spent its oil fund?) – there is no reason to expect this relationship to change going forward (especially when England and Wales are agitating about the Barnett Formula). The IFS report really said nothing about the finances of Yes vs No: it described the finances of Yes under the policies of No, and said nothing about either the finances of No under the policies of No or the finances of Yes under the policies of Yes.

What the Scottish Government’s White Paper seeks to do is outline some of the policies of Yes and to speculate on the finances. In the short run, p75 of the White Paper presents a budget for a newly independent Scotland that is more optimistic than the IFS. This is explained almost entirely by a more optimistic short run assessment of oil revenues:

In the long run, to avoid the tax rises or spending cuts needed under the IFS projection, the Scottish Government has to counter the demographic decline that is ‘baked-in’ given the current age profile of the Scottish population. There are two ways to do this and the White Paper describes policies in both areas.

The first way is to increase the labour market participation rates of, and hence tax take from, the current population. The policy of enhanced childcare provision is explicitly justified in these terms: enhanced childcare would allow greater labour market participation by parents who would otherwise have childcare responsibilities. Whilst the policy would have a spending cost it would also have revenue benefits from the expanded tax base. To the extent that such a policy also reduces the cost to parents of having children, it may improve Scotland’s long term demographic outlook if people respond to this incentive.

This enhanced childcare policy can be criticised as something that can be implemented under the current devolved settlement. But the current settlement essentially provides the Scottish Government with funds to implement its equivalent of policy implemented in England (the Barnett Consequentials). If England is not implementing this policy, then the funds are not necessarily there for its implementation in Scotland. Further, to the extent that the costs are borne now and the benefits seen in the future, the balanced budget constraint embedded in the block grant is not a good funding mechanism. Finally, the costs will be borne by the Scottish budget, so if this policy is to be self-funding, the increased tax revenues must also go into the Scottish revenue. This is not true under the current settlement (and it will not hold even under the enhanced devolution of the Scotland Act 2012).

The other way, and this is a policy lever not available under the current settlement, is to implement policy to attract more immigration. The White Paper expresses the desire for a more liberal immigration policy than that pertaining to the rest of the UK. Specifically this would involve a points based immigration system, and a reintroduction of the student visas removed by Westminster.

The Scottish Government’s task in outlining how the future will be more favourable under independence is difficult: if these policies are so good then why doesn’t the UK Government implement them? But on immigration especially there is a clear dividing line: The IFS report assumed that the ONS low migration scenario was most consistent with current UK Government policy. In this White Paper, the Scottish Government are clearly expressing their desire that immigration be higher than this.

End October Links

# What does the long term price guarantee for electricity given by the UK Government (UK nuclear power plant gets go-ahead) say about Prof Gordon Hughes's contention (at last month's International Conference on Economics of Constitutional Change [slides and paper here]) that given current high prices, we should expect energy prices to fall, and that English consumers are unlikely to want to buy low carbon electricity from a renewables-powered Scotland?

# Of academic interest:
   - The Fractal Market Hypothesis and its implications for the stability of financial markets (related to Mandelbrot's 'The Variation of Certain Speculative Prices')

# Wayhey!? Nuclear fusion milestone passed at US lab: "during an experiment in late September, the amount of energy released through the fusion reaction exceeded the amount of energy being absorbed by the fuel - the first time this had been achieved at any fusion facility in the world"

# Borrowing from the Future — Except that We Aren't: "At an individual level, borrowing is truly borrowing from the future.  At a population level, borrowing is the creation of assets and liabilities across different people.  People like King are committing a fallacy of composition. Incidentally, we are borrowing from the future.  We are shirking the investments we need to make so that our children and grandchildren can live in a habitable world with a well-educated population that enjoys a productive infrastructure.  No fallacy of composition there."

# Interfluidity say that Mobility is no answer to dispersion: "If we augment standard utility functions with plausible notions of habit formation and social reference group comparison, the case against mobility grows even stronger. The cost and shame of downward mobility dramatically outmatches the potential benefit of upward mobility...A functional polity values rising fortunes across the wealth spectrum, but it fears and resists falling fortunes much more strenuously. I would go so far as to claim this is a universal social fact, a characteristic of all polities that endure. Capitalism is always crony capitalism — and socialism tends towards crony socialism! — not because of corrupt bad actors but because human lifestyles are sticky-downward. Large social divergences can in practice be remedied smoothly only by convergence upward from the bottom. The wise course is to prevent extreme divergence from emerging in the first place. Once it has, the only way out is to hope for growth, and to direct the fruits of growth towards the bottom of the distribution."

# Great idea from Chris Dillow: Shares in people

# From the ESRC's Future of the UK and Scotland project blog: How the SNP can still win the vote for an independent Scotland "Poor rates of economic growth, high levels of emigration and appalling social and health conditions of Scotland should be difficult to defend. If independence is to be judged over the long haul, so too should the union. Yet supporters of the union have been under little pressure to defend Scotland's miserable record within it. Historians will look back on this campaign and ask why unionists were not on the defensive given this poor track record."

# George Rosie Losing the Heid - this has to describe the losses that come from being a peripheral region of a large country (as well as a peculiarly British attitude to corporate ownership). Such losses might well be simply reallocative (and may even represent aggregate efficiency gains) but they are certainly losses to those of us who live in Scotland (and north England, Northern Ireland, and Wales). I suspect once imperfect information and agency problems are included in the analysis that they likely also do not represent aggregate efficiency gains.