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.
Sunday, 15 December 2013
Sunday, 1 December 2013
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."
# - 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."
Tuesday, 26 November 2013
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.
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.
Tuesday, 5 November 2013
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.
# 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.
Monday, 7 October 2013
End September Links
# Interesting academic research:
- Recasting international income differences: The next-generation Penn World Table, Robert C Feenstra, Robert Inklaar, Marcel Timmer
- Immigration, diversity, and economic prosperity, Alberto Alesina, Johann Harnoss, Hillel Rapoport
- Creativity, cities and innovation, Neil Lee, Andrés Rodríguez-Pose
- The economic future of British cities, Henry Overman
# Savings, investments, and a dose of realism - Frances Coppola is nicer than me about greetin' faced savers organisations...
# Typically interesting posts from Chris Dillow, On wage-led growth; & Interfluidity, Not a monetary phenomenon & Terminal demographics
# Chris Dillow gives a pointer towards some literature on diseconomies of scale: The Management Question
# How relevant is this for any proposed Sterling Union? Why asymmetrical monetary unions are bound to fail
# A useful resource: Migration in Scotland
# Interesting column in the Guardian: UK Growth? Make London independent to mend the North-South divide. I'm not sure about conclusion though: "Were the government to publish regional trade figures, they would show that London runs a current account surplus with the rest of the UK, offset by capital transfers from the rich south to the poorer north. As an independent city state, London would have a higher exchange rate and higher borrowing costs. The rest of the country would, by contrast, get a competitive boost." A London GOVERNMENT would be in surplus vis-a-vis the rest of the UK, but that's not the same as London running a current account surplus (selling to more than it buys from) and paying capital transfers north. I suspect that the private savings made by the rest of the UK, on net, go TO London. And it definitely does not seem obvious to me that total capital flows (private savings plus fiscal transfers) are from London to the rest of the UK. Of course I might be wrong...
# From same column, I'm also interested in the point about "the strength of persistence over time in patterns of relative unemployment at local level" (which comes from a Paul Ormerod article in Applied Economics Letters): are markets not flexible enough, or is policy not good enough? If it's the second point then the North-South divide would argue for the existence of policy that was good for the South but not so good for the North. And the relevance of this to the Scottish independence debate is...
- Recasting international income differences: The next-generation Penn World Table, Robert C Feenstra, Robert Inklaar, Marcel Timmer
- Immigration, diversity, and economic prosperity, Alberto Alesina, Johann Harnoss, Hillel Rapoport
- Creativity, cities and innovation, Neil Lee, Andrés Rodríguez-Pose
- The economic future of British cities, Henry Overman
# Savings, investments, and a dose of realism - Frances Coppola is nicer than me about greetin' faced savers organisations...
# Typically interesting posts from Chris Dillow, On wage-led growth; & Interfluidity, Not a monetary phenomenon & Terminal demographics
# Chris Dillow gives a pointer towards some literature on diseconomies of scale: The Management Question
# How relevant is this for any proposed Sterling Union? Why asymmetrical monetary unions are bound to fail
# A useful resource: Migration in Scotland
# Interesting column in the Guardian: UK Growth? Make London independent to mend the North-South divide. I'm not sure about conclusion though: "Were the government to publish regional trade figures, they would show that London runs a current account surplus with the rest of the UK, offset by capital transfers from the rich south to the poorer north. As an independent city state, London would have a higher exchange rate and higher borrowing costs. The rest of the country would, by contrast, get a competitive boost." A London GOVERNMENT would be in surplus vis-a-vis the rest of the UK, but that's not the same as London running a current account surplus (selling to more than it buys from) and paying capital transfers north. I suspect that the private savings made by the rest of the UK, on net, go TO London. And it definitely does not seem obvious to me that total capital flows (private savings plus fiscal transfers) are from London to the rest of the UK. Of course I might be wrong...
# From same column, I'm also interested in the point about "the strength of persistence over time in patterns of relative unemployment at local level" (which comes from a Paul Ormerod article in Applied Economics Letters): are markets not flexible enough, or is policy not good enough? If it's the second point then the North-South divide would argue for the existence of policy that was good for the South but not so good for the North. And the relevance of this to the Scottish independence debate is...
Wednesday, 25 September 2013
A fair division of reputational assets
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.
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.
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.
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