Our final item of business is to take evidence on Scotland’s public finances post-2014 from Professor John Kay, Professor Gavin McCrone and Professor Peter McGregor.
Members have copies of the written submissions that our witnesses have provided, so we will go straight to questions from me, to be followed by questions from other members of the committee.
Last week, the equivalent session took some three and a quarter hours. In our discussions afterwards, I was chastised by one or two members of the committee for being a bit too liberal in allowing people to spend so much time on questions. I am not very keen on holding committee members back, but I ask everyone to apply a self-denying ordinance, which I will try to apply, too. I do not intend to hog the limelight for too long. That said, I might put questions to one individual initially—for example, the first question will be to Professor McCrone—but I would be quite happy for colleagues on the panel to comment, too, if they so wish. That will make for a much more interesting discussion.
Without further ado, we shall kick off. Professor McCrone, in the first paragraph of your submission, you say:
“The position I take is that Scotland could perfectly well manage as an independent country. It is even possible that it might eventually do better economically than remaining as a part of the UK; but this would depend on the wisdom or otherwise of the policies adopted by Government.”
You went on to give a number of caveats.
The last sentence of that paragraph says that, following independence,
“There could be a loss of some key industries.”
I take on board your point that it
“would depend on the wisdom or otherwise of the policies adopted by Government.”
Many countries have been able to have very strong economies through sound economic policies. Switzerland’s economy is bigger than that of the Ukraine, which has seven times the population of Switzerland. Singapore’s gross domestic product per capita is 15 times that of neighbouring Indonesia. Obviously, the policies that Governments adopt are key.
Will you elaborate on what you said in the Scottish context and touch on the issue of the
“loss of some key industries”?
I take the view that Scotland could function perfectly well as an independent country. There is no reason why it should not do as least as well as Ireland, which was much poorer when it became independent. However, a country cannot come out of a union that has lasted for 300 years without there being all sorts of implications and some potential damage.
The two industries that I would be most worried about are the finance industry, in which a number of institutions are wondering whether they should stay in Scotland or go south, and the defence industry. I did not deal with defence in my book or in the paper. It is a difficult subject, but it is plain that some of the major defence orders might be at risk, because Governments tend to place their defence orders in their own countries.
A lot depends on how independence would happen. If there is sweetness and light all around, the damage can be minimised, but if the break-up were to be acrimonious, things such as the tourism industry could also be affected.
Okay. Do Professor Kay and Professor McGregor wish to add to that?
I do not have anything to add on defence. On the financial services industry, my experience of talking to people in the industry is that when they express unease it is very hard to work out what the unease is about, when they are pressed. That may mean that it does not entirely matter, but it matters a bit in relation to those businesses’ customers. Having said in print a couple of weeks ago what I have just said, I now have an email inbox that is full of mail from people in England who have said that they have a policy with Standard Life and would be very worried if Scotland became independent. I have no idea what they would be worried about; nor do they, really, but the fact that they would be worried is genuinely a problem for Standard Life, whether either it or they have any basis for their worries.
I do not have anything to add, other than to say that the point about the policies that would be pursued by the Scottish Government post-independence is clearly crucial, because they will determine the success or otherwise of independence in the longer term. I agree that in the short term there are likely to be costs associated with independence.
I will follow up on Professor McCrone’s comments. The Scottish Government has pointed out that although Scotland contributes 9.9 per cent of the UK’s taxes, only about 5.6 per cent of defence expenditure is in Scotland. The Scottish Government would be looking for a policy of joint procurement whereby Scotland would buy equipment from south of the border and the UK Government would buy equipment from here, so that there would be a balance. It has been suggested that Scotland’s defence budget would reduce by £2.5 billion, which would free up resources to spend on other areas of Scottish life, such as schools, roads and hospitals. What is your comment on that, Professor McCrone?
That would be fine but, of course, joint procurement would have to be negotiated, and I am not sure how such negotiations would go. There is not much history of countries engaging in joint procurement with one another, although I suppose Britain has bought quite a lot of stuff from the Americans. However, joint procurement is a potential risk.
As for the other things that have been discussed, the only point that I would add is that a fair bit in the financial sector might depend on whether Scotland were to succeed in maintaining a currency union with the rest of the UK or had to adopt its own currency. You will see from my paper that I think that the latter is more likely in the end, even though there might be an attempt at the start to keep the same currency. That is not something that Governments can entirely decide for themselves. The break-up of the Czech and Slovak monetary union showed that the markets can force that quite easily.
Okay. The fiscal commission working group said that a shared currency would provide
“clear governance arrangements, a framework for financial stability and a consistent regulatory structure”.
The group also said that a shared currency would ensure no transaction costs and enhance trade, competition, efficiency and flexibility in the main interests of both Scotland and the UK; and that the risk of an asymmetric shock would be remote and therefore should not inhibit a currency union.
What do you think of that statement, Professor Kay?
From the point of view of Scotland, a currency union with England would be the best outcome, if it could be negotiated. I was sceptical, even before the various announcements from Westminster this year, about whether a currency union could be negotiated. I do not think that those announcements rule out the possibility of a currency union if Scotland did, indeed, vote for independence, but they clearly make it more difficult.
I think that the other options are, first, an independent currency, to which Professor McCrone referred. I have thought about the issue more and it seems to me that, secondly, the unilateral option might have more to commend it than seems to be the case at first sight: Scotland would simply go on using the pound anyway.
What would be the advantages of that scenario?
The advantages would be the stability and low transaction costs that are outlined in the fiscal commission report that the convener mentioned. The disadvantage would be the loss of some policy flexibility as a result of not being able to change the exchange rate vis-à-vis the English pound and not having any freedom in monetary policy. However, the practical reality is that an independent Scotland would not have any freedom in monetary policy anyway.
I basically agree with what has just been said about monetary union. Probably the best outcome for Scotland would be the maintenance of a monetary union with the rest of the UK.
11:00However, that is probably the best option but it is not costless because, within a monetary union, Scotland would give up the right to an independent monetary policy, which is significant. There would also almost certainly be severe constraints on the overall fiscal stance that Scotland could adopt. Experience in the eurozone suggests that that is more an issue now than it has been previously. In a monetary union, Scotland would give up those two significant powers—although I do not mean “give up” exactly, because Scotland has not had them for many years. There are costs associated with monetary union.
In terms of the limitation on the macroeconomic policy stance, however, there are also—as has been emphasised—major benefits to monetary union, particularly in terms of transaction costs. That is really important and it dominates the argument because of the extent of interdependence between Scotland and the rest of the UK, especially in trade flow, which is asymmetric because Scotland is more dependent on the rest of the UK as an export market. In my judgment, monetary union would be the best net outcome for Scotland, but it is not costless.
You mentioned the eurozone, but it is comprised of 17 countries with a range of productivity levels; for example, Greece’s productivity is 40 per cent of Germany’s. Given that Finland, the Netherlands and so on seem to be able to exert their own fiscal policies, why would it be difficult for Scotland, as part of a currency union of only two countries in which productivity is not too different, to exert its own fiscal policies in the way that the more successful countries in the eurozone do?
One problem is that the degree of integration between the rest of the UK and Scotland makes the situation more challenging; it means that the constraints will be more severe, if anything. You would have to ensure that the fiscal policy stance that an independent Scotland pursues would not threaten the permanently fixed exchange rate. Markets and market forces will have a major influence on that. I am not saying that it is not possible to have some independence in fiscal policy, but it will be much more constrained under a permanently fixed exchange rate—given that you are committed to maintaining the value of the exchange rate and the monetary union—than it would be in the absence of a monetary union.
The problem that I see is that I cannot imagine a Chancellor of the Exchequer for the remainder of the United Kingdom, with no electoral responsibility for Scotland, being prepared to put taxpayers at risk in the rest of the country for the sake of Scottish debt or bank debt in Scotland. I just do not think that they will do that, and it is probably the main reason why we have been hearing from George Osborne and the others that they will not contemplate currency union.
Of course, negotiations will take place and we will see what happens in the event of independence.
When I gave my first answer about Standard Life, one of the points behind it was that if people believe that something is true, that matters even if it is not true. We have a similar problem here in that it is now conventional wisdom within the eurozone that you can have currency union only if you are on a path towards fiscal and banking union. I do not think that that is true, but there is almost no point in our debating whether it is true, because people in markets and political circles believe that it is true. The result is that if Scotland votes for independence and we hold negotiations over monetary union, the rest of the UK’s Treasury will lay down conditions that will be difficult for a Scottish Government to accept because the rest of the UK will demand control over the banking system and fiscal policy in Scotland that it will not be willing to concede to a Scottish Government vis-à-vis the rest of the UK.
The almost intractable problem on which the negotiations would fail would be the demand for supervision of Scotland’s fiscal policy. Either Scotland would concede that, in which case you would be conceding most of the economic policy levers that you would hope to gain from independence, or Scotland would refuse, in which case monetary union could not go ahead in that form.
Professor McCrone also said that banking might leave Scotland. I had a private meeting with some senior bankers who said that the likelihood of, for example, the Royal Bank of Scotland moving its 3,000 staff to London—where they would all have to find houses, which would probably not be of the quality that they have in Edinburgh, and schools for their children, and would have to commute further and cope with a higher cost of living—and spending money on new premises for all those people to work in is probably zero. They said that, if a bank moved, it would be more to do with moving the place where it was registered rather than the place where it has its presence and employs staff. What is your view on that?
If that is so, that is good news. Of course living in London is much less agreeable than living in Edinburgh. I have been aware of that for a long time.
I am aware of it, too.
However, we must disentangle a number of points. One of Iceland’s banks had a branch in the UK and the other had a subsidiary company in the UK. When Iceland got into trouble, the British Government looked to the Icelandic Government to protect the depositors in the branch, but not in the subsidiary company, because that was separately regulated and, therefore, guaranteed by the UK deposit insurance scheme.
It would be terribly important for the banks in Scotland to ensure that whatever they were doing in England was separately regulated by the Westminster Government down there and protected by the bank deposit insurance scheme down there. Otherwise, if something were to go wrong, they could find themselves having to bail out depositors down south, which could, in effect, bankrupt Scotland. That is important.
It is not just a question of the depositors; it is also a question of the debt. What happened in Ireland was that the Government decided to honour the debt of banks—the bonds and all the rest of it—which nearly bankrupted the Irish economy.
There are a lot of difficulties in this area. If the banks were to move south, I presume that they would trade in Scotland through subsidiaries—the Bank of Scotland, in the case of Lloyd’s, and the Royal Bank of Scotland, in the case of RBS. Those subsidiary companies would be regulated in Scotland and might do a great deal of work for the whole group. That would be a safer situation than having major banks located in Scotland, with all the risks that would have to be borne if something were to go wrong with them.
We keep coming up against the problem of people believing that things are true even if they are not true or should not be true. In this discussion, we have yet another example. We have created the idea that if a bank erects a brass plate in some location and says, “This is our headquarters,” the taxpayers of the country where that brass plate is located become liable for all the debts of that bank. That is a strange idea; the Scottish Government should be in great haste to say that, as far as Scotland is concerned, that is not true.
As far as Ireland was concerned, as the result of a rather foolish commitment that was given overnight by the Irish finance ministers, it was true. Currently, it seems that the UK and American Governments believe that it is true, and the German Government certainly acts as if it is true. I think that they will find that that will cost them a lot of money, one day.
Dr McCrone is right to suggest that RBS would move its brass plate from Scotland to London. However, I do not think that that matters at all. For the reasons that were described, I do not think that RBS is going to move 3,000 staff, or any other number of staff, from Scotland to London. I cannot see why it should.
However, the subsidiarisation point is extremely important. With regard to insurance as well as banking, as long as the European Union rules stay as they are, a Scottish Government should ensure that, when Scottish insurance companies or banks operate outside Scotland, they do so through subsidiaries in those countries, rather than as branches. That will mean that Scottish depositors, policy holders and taxpayers would not be on the hook for activities that take place outside Scotland.
Thank you. I am keen to move on to ensure—as I mentioned earlier—that I stick to my own self-denying ordinance. We cannot cover every topic.
I will move on to the topic of quantitative easing, which Professor McCrone raised in his submission, before turning to an issue in Professor McGregor’s paper. We had an interesting debate last week—I do not know whether you saw any of it—on quantitative easing and whether it matters in terms of the overall debt because the Treasury does not charge itself interest.
Dr Jim Cuthbert made the point very persuasively—for some of us at least—that quantitative easing should not be included in Scotland’s debt figures, and that it currently impacts on the “Government Expenditure and Revenue Scotland” figures when it should not.
What is your view on the issue, Professor McCrone? You discuss it in some detail in your submission, in which you state:
“How this might affect Scotland’s inherited share of the debt is far from clear, but this needs to be taken into account in any negotiations.”
Why should it be taken into account?
It was Jim Cuthbert’s original paper that drew my attention to that very important issue. It is not one that many people understand, and certainly few people have ever talked about it, but roughly 30 per cent of the UK’s debt is now held by the Bank of England, and the interest that is paid on that debt is simply returned to the Treasury. In effect, George Osborne is borrowing all that money for no cost at all, so the burden of UK debt is nothing like as bad as it is often made out to be.
If Scotland was going to take a share of UK debt, the negotiators would need to be aware of that, because it is an issue for negotiation. It would be wrong if Scotland took a GDP or population share of UK debt and left the remainder of the UK with all the stuff that the Bank of England holds, on which it is paying nothing. That is an important issue.
I do not know what will happen to that debt in the end—nobody knows. The notion was originally that the Bank of England would simply sell it on the market. If it did so, the Government would have to start paying the interest on the debt, so it would not be very enthusiastic about such a move.
If, on the other hand, the debt just sits there for a long time, one can imagine a situation in which an incoming Government some years hence might say, “What the hell is all this debt doing sitting in the Bank of England? We are not paying any interest on it, so why don’t we just cancel it?” That would reduce the UK debt by 30 per cent overnight. It is an important issue, but I do not know how it would be resolved.
That point goes back to the issue of a monetary union. I think that, if there were a monetary union, the Bank of England would continue exactly as it is and there would be no issue of dividing up its assets and liabilities between the two independent countries.
If, on the other hand, the Bank of England was not to continue as the monetary authority for the entire British isles, the bank would have to be divided up in some sense. That raises the question of what would happen to the various assets and liabilities of the Bank of England, including that debt. That is a real wet towel issue; I could imagine months of discussion and negotiation taking place to resolve that particular question.
To determine the assets and liabilities of a central bank, which has the capacity to print money and has the kind of balance sheet that it does only because it has that power, is very complicated. The key point is right: the national debt is not quite what it seems, because the Bank of England owns almost 40 per cent of it. That must be taken into account as part of the total negotiations on the monetary arrangements for an independent Scotland.
I saw that Professor McGregor was nodding vigorously at times.
Yes. I have nothing to add, as I agree with the position that that needs to be taken into account in negotiations.
If quantitative easing goes ahead, would Scotland’s share of the debt as a monetary sum be less?
Yes, that is probably the implication.
11:15
I think that I am right in saying that—others will correct me if I am wrong—if Scotland were in the European Union and under its rules, it would have to have its own central bank, as is the case in all the European Union countries. However, it is the European Central Bank that has the money creation powers.
That is right, but a Scottish central bank could be just a man in an office in George Street.
I hope that he would be better remunerated than the members of the fiscal commission working group.
The committee is talking about not just the post-independence scenario, but the other side of the coin, which is if Scotland votes no. Professor McGregor, on the second page of your submission you say:
“Of all the independence and pro-union proposals for further fiscal powers (that are so far in the public domain) the common core is in fact the Labour Party’s plans, since these are the most modest to date: all other parties propose plans that are more radical in terms of control over the income tax system as a whole and the set of taxes that will be under Scotland’s control.”
You go on to discuss what would happen if that plan were implemented. For example, you say:
“our preliminary analysis of the long-run output and employment effects of setting the SRIT at 15% under conventional bargaining”—
if that happens, which it might not—would result in
“a 3% fall in GDP, with a slightly smaller fall in employment.”
Your paper includes a graph indicating that impact.
Given that the number of people employed in Scotland is around 2.575 million and its GDP is around £140 billion, you are talking about potential job losses of 75,000 and a GDP loss of £4.5 billion. However, you go on to say that if there was a
“willingness of workers to accept a lower take home wage”
the opposite might be true in that GDP could increase by 1.5 per cent and employment by around 2 per cent or around 50,000.
Will you talk us through your thinking on that particular issue? I found that quite fascinating. Were there to be a level of wage decline as a result of the policy, what would be the equilibrium decline that would provide the additional employment and GDP that is suggested in your figures?
First, when I said that the Labour Party plans were the “most modest”, it was of those in the public domain—
Yes, that is exactly what I mean.
I have tried to look at a common core of proposals that would be shared, such as tax powers that are common across a number of the different pro-union parties, as well as the independence party, and look at what the impact of using those powers might be. As far as I am aware, no party in Scotland has yet committed to any radical tax change; indeed, I am not aware of any commitment to do anything other than maintain parity with the UK tax rates. Nonetheless, given that all the proposed powers are quite significant—one may be modest relative to the others but they are all significant—it seems worth exploring what the exercise of those powers would be.
I emphasise in the paper that having and using a power are two quite different things. When using a power, presumably the Scottish Government would want to anticipate what the likely impact of those changes might be. We have explored a simple illustrative case to make a couple of points. When we have a tax rise and an equal increase in Government expenditure, two main countervailing effects are set in motion. On the one hand, there tends to be a stimulus to demand; Government expenditure increases and private consumption declines but, in net terms, demand is stimulated. On the other hand, there tends to be an adverse competitiveness effect because the usual view is that workers bargain for a net-of-tax real wage. If that is the case, as taxes rise, they will push for an increase in nominal wages to compensate them and move them back to a position in which the real wage is maintained.
In general, you cannot predict which of those forces will predominate, but the more open the economy, the more important the adverse competitiveness effects. Scotland is highly open so, in our default model, the net impact is negative and the adverse competitiveness effects outweigh the other effects when bargaining takes place over a net-of-tax real wage. However, if workers were persuaded that they ought to consider the notion of a social wage—that is to say, if unions, for example, valued the services provided by the enhanced Government expenditure—we would have a countervailing effect that could moderate the extent of the competitiveness effect.
The case that we have chosen to illustrate this, which makes the point emphatically, is to suppose that workers felt as well off after the change; that is to say, they valued the Government services as much as they valued their lost disposable income and reflected that in their wage bargains. That would mean that the adverse competitiveness impact would be negated. In fact, there would be no adverse competitiveness effect. In that case, we would get a conventional Keynesian response to a net stimulus to demand and the economy would expand. That would happen, and there would a greater proportion of stimulus to employment, because the real wage had declined. People would accept a reduction in their real take-home pay because they valued the quality of the public services that were provided in exchange for it. That is the mechanism.
It is difficult to tie down the strength of those forces. We have some evidence on attitudes that might suggest that people are a little sceptical about the traditional view that Scots prefer the high-tax, high-expenditure Scandinavian end of the spectrum to the low-tax, low-expenditure Baltic states end of it. However, it seems to matter a great deal in determining the net impact of the fiscal change.
What would be the percentage impact on people’s wages?
That is a very good point. I cannot remember the precise number. I think that it is in the order of 2 per cent, but I will check it and get back to you. I am sorry, I did not bring the full results of the simulations with me. However, it is a cut in the real take-home pay. The point is that, under the hypothesis, workers feel compensated for that through the quality of the public services that are provided as a consequence. That is why they do not push for a higher wage.
Does Professor McCrone or Professor Kay wish to comment on that?
I have not done the kind of study that Peter McGregor has done. Because Scotland has been so integrated with the rest of the United Kingdom, the scope for there to be differences in tax without some sort of adverse effect is reduced. The tax rates would constantly be compared across the border in a way that they probably are not between Scandinavian countries—at least, not to the same extent. That would mean that big differences in tax might result in some people shifting—including people that the country does not want to lose, such as entrepreneurs—but small differences would not be any more significant than differences in council tax or non-domestic rates.
I agree with the thrust of both those observations, because the UK is integrated whatever the constitutional arrangements. Scotland could not have tax rates that were 15 per cent different; it could perhaps have tax rates that were 3 or 5 per cent different, but there are clearly limits to that. If an independent Scotland had different tax rates and if we imagine, as I suspect we mostly do, that it would have a somewhat higher-tax, higher-expenditure base than Scotland does at the moment, a corollary of that—assuming that money does not grow on trees somewhere, which I do not think it does—is that Scots would have rather lower real take-home wages than they do now, whether they bargain for them or not. That is just an inescapable arithmetic outcome. It is the reality of the kind of world that we are describing.
It is worth saying that many of the people who comment on such matters in the newspapers argue for a less unequal society—a better provision of social services and all the rest of it. I favour that too, but those people never seem to say much about the tax implications. We cannot have more generous benefits, better social security and a better health service unless we have more tax. Scandinavian taxes are a lot higher than ours at the moment. The question is whether people would accept that. We do not know the answer to that.
Surely the issue is that even though Scandinavia has higher tax it also has significantly higher wages, so Scandinavians’ purchasing power is at least as high as that of UK citizens, with the additional services.
That is true, of course. The Norwegians will tell you that they do not mind paying higher taxes because they have very good public services—they have said that to me. However, we do not know what the Scottish electorate would think about that. That is the crucial issue.
Surely, because they have a higher disposable income, as I just said, as well as better services, the size of the economy and economic growth have to come into play as well.
Yes. Economic growth is key to all this. If we can make the Scottish economy grow faster, we can solve all sorts of problems. However, we do not quite know how we can do that at the moment—at least I do not.
I had better let committee members in—they are all champing at the bit.
Professor McCrone, your submission refers to the work by the Institute for Fiscal Studies suggesting that there could be challenges ahead for Scotland. It is an interesting point because, previously, an array of witnesses have suggested to the committee that the IFS paper that you referred to was misunderstood. Professor David Bell told us:
“I think that the IFS report was widely misunderstood in that it was a projection—in other words, it was based on things not changing, in policy terms.”
Angus Armstrong stated:
“It is almost inevitable that the projections will not be correct, as they predict the outcome on the basis of current policies”.—[Official Report, Finance Committee, 4 December 2013; c 3449, 3460.]
Indeed, Professor McGregor was at that meeting and suggested something similar in relation to the IFS’s population projections. Do you accept that, essentially, the work of the IFS is predicated on nothing changing?
The IFS said that its paper was just arithmetic. It was working out what would happen. There are two important points. The first is that North Sea oil revenues appear to be declining—we are certainly well past the peak of production. We do not really know what future revenues will be. It depends on a whole lot of things such as the price of oil, the cost of getting the oil out and so on. However, the general expectation is that North Sea oil revenues will decline. They have already declined quite a bit, which is why GERS shows that Scotland will be in bigger deficit this year than the UK as a whole. That is the first time for several years that that difference has appeared.
North Sea oil is one point. The other point is the ageing of the Scottish population, which is happening at a faster rate than for the UK as a whole, mainly because we have not had as much immigration as other parts of the UK have had.
We have to take account of those two issues. That is why I think that there would be a challenging situation for an independent Scotland after independence.
I am sorry, my question was more whether you accept that, in essence, the IFS work was based on nothing particularly changing.
The IFS was not making forecasts; it was just doing arithmetic—as it has said—so we cannot treat the IFS paper as a forecast. It does, however, illustrate that there are those two key issues. If we can somehow greatly improve Scotland’s economic growth, that could resolve those questions but we do not quite know how that will be done.
As for North Sea oil, there is a good bit of difference between the OBR estimates for North Sea oil in the next few years compared with the Scottish Government’s own estimates. The Scottish Government’s estimates are now fairly old, so we need new ones.
Do any of the other witnesses want to comment on that? I know that Professor McGregor said something previously about the IFS.
First, I think that the IFS deserves its excellent reputation, but it is the case that these are projections and they are mechanistic. They are comparatively mechanical. The projections make quite a number of assumptions and, if we change those assumptions, we get different results. One of those assumptions is that there will be an unchanged policy stance in some sense. That is potentially significant.
The ageing population issue is particularly difficult because of its dependence on migration. Typically, such population projections are based on very mechanical projections forward of the current population and they are very sensitive to what happens with migration, particularly with regard to the number of people of working age.
Of course, the IFS is aware of that, but the assumptions that we make about such issues are important and they can alter the conclusions of the analysis. None of that is to deny that North Sea oil revenue and ageing are real issues; it is just that the precise combination of those issues and of other things that might be done is difficult to predict.
11:30
Professor McCrone, you have provided us with a very useful submission. You were also the author of what is now a fairly well-known report for the United Kingdom Government from back in the 1970s, in which you said that Scotland would
“tend to be in chronic surplus to a quite embarrassing degree”.
Denis Healey, who was the chancellor when that report was circulating in Whitehall, told Holyrood magazine recently that the UK Government
“did underplay the value of the oil to the country”.
Just last week, Jim Cuthbert highlighted Cabinet minutes from 15 December 1977 in which an oil fund was discounted for those very reasons. Given that the value of the oil was underplayed in the past and that people were not told by the UK Government that an independent Scotland would
“tend to be in chronic surplus to a quite embarrassing degree”,
what might the people of Scotland not be getting told now?
I was being what I thought was honest in 1974. Various people have said that the paper was hushed up and should have been published. In that connection, it is quite interesting that Sir Nicholas Macpherson has recently been getting into trouble for publishing his paper. It is a fact that briefings for ministers are not normally published. If I had published the paper, I suspect that I would have been kicked out of the civil service pretty sharply, because civil servants do not publish their submissions to ministers. Ministers in the Scottish Government will find exactly the same thing. That is the first point.
The second point is that there was, of course, an enormous expectation of huge oil revenues in the early 1980s. I wrote that paper in 1974 and had forgotten that I had written it until somebody unearthed it through the usual method of getting stuff out of secret information. When I read it again, I did not think that there was anything wrong with it. In fact, the oil revenues that I predicted were slightly lower than those that occurred. I said that I thought that the figure would be around £3 billion in 1980; it was £3.7 billion in 1980-81.
The output figures were the ones that everybody knew at the time. They had already been published by the Department of Trade and Industry. It was simply a matter to trying to calculate what the revenues ought to be, based on that output. That was quite difficult, because the Conservative Government had not put in place appropriate tax measures by the time that it left office, so it remained for the Labour Government to introduce petroleum revenue tax. It set up the British National Oil Corporation to do all the other things that it did in order to ensure that the country got a decent share of the revenue and that all the revenue did not just go to private shareholders sitting in America or wherever. Therefore, the calculation was fairly uncertain, but I am rather pleased that I managed to calculate the revenues as accurately as I did for 1980.
The situation now is completely different. At present-day prices, there was around £30 billion of oil revenues at that time. In the prices of the day, the figure was £12 billion, but in real terms it is around £30 billion. The revenues were therefore huge and, if Scotland had been independent, they would of course have had a profound effect on the whole situation here. In fact, one of the problems would have been what the hell to do with them, because they would have pushed up the exchange rate and put the rest of industry out of business if people had not been careful. That is why the Norwegians set up their oil fund and why their oil fund invests abroad—to try to help control the pressure on the exchange rate.
There are many issues, but my paper has become rather notorious because it was released under freedom of information. However, that was the situation then; it is not the situation now.
I accept that. I am not saying that anything was wrong with your report, and I am not suggesting that it was your responsibility as a civil servant at the time to release that information. The point that I am making is that it informed the UK Government of the actual position and the UK Government took the decision not to impart that information. That begets the question: is that happening now? To be fair, that might not be a question that you can answer with any certainty—in fact, it almost certainly is not. The only way that we will find out whether that is happening now is if that information is released 30 years hence. You have referred to an opportunity missed back then; there could be an opportunity missed now.
Obviously I do not know, but I do not believe that anything is being hushed up now. I do not think that things were actually hushed up then; it is just that that paper was not published.
I am not sure that I would entirely agree with that.
I might just add that I wrote a second paper, which has not been unearthed yet, in which I recommended an oil fund, among other things.
We will start looking for that one. Thanks for the heads-up. [Laughter.]
Professor McGregor, you start your submission by saying that
“the outcome of the referendum is, of course, uncertain”,
which is a matter of fact. You go on to say that
“it seems clear that future Scottish Governments will possess substantially enhanced tax powers relative to the current position”,
and you refer to the Scotland Act 2012. You also say:
“all of the pro-union bodies proposals for further devolution in the event of a ‘no’ vote that are in the public domain imply significant additional powers.”
We know that, if we get a yes vote on 18 September 2014, Scotland will go on to become an independent, sovereign state. If we vote no, there is no guarantee that additional powers will come to Scotland; indeed there is precedent to consider—for example, Alec Douglas-Home telling us to vote no in 1979 for enhanced devolution that did not happen. More recently, the Calman commission proposed more significant powers than were delivered by the Scotland Act 2012. Would you accept that there is no guarantee of additional powers if we vote no?
The only absolute guarantee is that there will be additional fiscal powers because of the Scotland Act 2012. That is the only decision that it is certain will be implemented, which is why I have considered that as illustrative of the common core. The Labour Party’s proposals go rather further than the act, but the act is the irreducible common core because it has already been decided. Everything else is uncertain.
What my analysis does is to give a flavour of the types of impacts that could arise if the powers are actually used. As far as I am aware, no one has committed yet to varying the Scottish rate of income tax from the rate in the rest of the UK.
I understand that point. The only thing that we know thus far is that the Scotland Act 2012 has been passed and the powers that are set out therein. However, we know that, if we vote yes in the referendum, we will become an independent state. If we vote no, we do not know whether those additional powers will come to Scotland. There is no guarantee.
There is no guarantee. That is correct.
You said in your submission:
“Under all of the pro-union plans that are in the public domain, the Scottish Parliament would have comparatively limited influence on the overall fiscal policy stance”.
What might be the consequences of that limited influence, from your perspective?
I believe that that is true—to different degrees, I should emphasise—of any of the proposals for constitutional change, including independence. Of course, it is less true of independence than of the other proposals.
We went through the arguments earlier about an independent Scotland that has monetary union with the rest of the UK, and Professor Kay reminded us of the importance of the Bank of England and its undoubted attempts to influence the fiscal policy stance in Scotland. I would say that all of the current proposals for constitutional change, including independence, imply a degree of restriction on the overall fiscal policy stance. However, I would accept that the extent of restriction will vary among the proposals and would be least in the case of independence. I am not sure by how much, though. That would depend.
What might be the restrictions in the case of the other proposals?
There are borrowing proposals in the Scotland Act 2012, which is important. Those proposals are focused on capital expenditure, which is important as well. However, I do not think that the pro-union proposals imply any great measure of control over the aggregate fiscal stance in terms of the difference between Government expenditure and taxation and the ability to run deficit-financed expansions, for example.
That is right. The big difference is that an independent Scotland would have to have regard to what its budget was and to keep the deficit under control. The general rule that the European Union has is that the deficit should be less than 3 per cent of GDP. There is no requirement in the case of regions in a country—which is what Scotland will be, economically anyhow, if the no vote prevails—to have any particular balance in their budget.
The idea is that expenditure should in some way be related to need and that taxation should be related to taxable capacity. For example, in Northern Ireland, there is a lower taxable capacity and a higher level of public expenditure. In Wales, there is a lower level of taxable capacity but a smaller level of public expenditure than in Scotland, although the overall deficit in Wales is probably larger than it is in Scotland because the taxable capacity is less. You can go round the various regions, although the figures are not very adequate now. The northern region is probably in much the same position as Wales. London has a higher level of public expenditure than any of the English regions and it is more similar to the level of public expenditure in Scotland, but it also has very high tax revenue.
I was very interested in Professor Kay’s comment that he does not think that there will be a monetary union because the very tight fiscal controls that would be required would not be acceptable to the Scottish Government. That reminded me of what I thought was a key point of Sir Nicholas Macpherson’s note when he said that the fiscal controls would be too tight. Assuming for the purposes of this question that there will not be a monetary union—although I assume it anyway—I am really interested in the possible consequences.
I am not sure whether Professor McCrone wants monetary union because it is the best scenario or whether he is saying that it will happen anyway because of the markets. For whatever reason, if it is going to happen, I am interested in the consequences, but they are not being spelt out to any great extent in the current debate. You mentioned the transaction costs, which are well known, but what would the effect be on interest rates and on any other economic and financial aspects?
Whether or not there is monetary union, there will be separate Scottish debt. That will probably be at a slightly higher rate of interest than UK debt, for the simple reason that the UK has a long record of not defaulting on its debt. Scotland has no such record—unless we go back to the Darien scheme, and that is something that we all want to forget. Scotland would therefore have to establish itself as a credible borrower because it would be a much smaller participant in the market. For all those reasons, I would expect the interest rate on Scottish debt to be a bit higher than it would be for the UK as a whole. That is particularly the case if there is independence.
With monetary union, that would still happen. It would probably be reflected in things like mortgage rates and various other rates across the economy. How big would that difference be? We do not know, but I think that the National Institute of Economic and Social Research has suggested a figure between 0.6 and 1.8 per cent of GDP. It would be quite significant, although we could cope with it. It does mean that, if you have to pay more interest on your accumulated debt, it affects your budgetary situation and your budget deficit is bigger than it would otherwise be.
What would be the additional interest rates if there was not a monetary union, assuming that there would be some? If there are no extra negatives, apart from transaction costs, to not having monetary union, it is not quite clear to me why the Scottish Government should be so adamant that there must be a monetary union.
If there is a monetary union, it makes all those things a bit easier. If there is no monetary union, there is more of a risk that the exchange rate might be altered either by force or by design at some stage. If the market thinks that there could be a change in the exchange rate, it tends to be reflected in interest rates, so you tend to get a bigger difference in interest rates.
On the whole, a separate currency that is pegged to sterling is probably the best answer in the long run. That is what the Irish did for a long time, and then they unpegged their currency when they went into the European exchange rate mechanism.
Small countries often do that. The Danes have kept their own currency but it is pegged to the euro, and that means that they can alter it if they really have to. The pressures on Scotland’s balance of payments would be rather different from that of the UK as a whole because of the oil. If the oil price went up, the pressure would be to lift the Scottish exchange rate. If the oil price dropped dramatically, the tendency would be to push the balance of payments into deficit and that would tend to be reflected in the exchange rate. Although the two economies are similar in many respects, the oil means that there is one big difference between them.
Do the other two professors agree with the comments on interest rates?
11:45
No, I do not altogether. I think that all of this is rather complicated.
We need to talk first about what scenarios we are looking at. Professor McCrone talked about pegs, and he mentioned Ireland and Denmark, but they are different. In the case of Denmark, there has always been the Danish krone, which is now fixed or pegged at, I think, 7.5 kroner to the euro. In the Irish case, back in 1921 or 1922 when Ireland became independent it did not peg the Irish pound to the pound sterling; it did nothing at all. Things continued just as if political independence in Ireland had never happened. Private commercial Irish banks issued notes that circulated in Ireland and Northern Ireland, but not in the UK, that were like current Scottish banknotes, which are backed by the English pound. There was not even an Irish currency board until the late 1920s, at which time the Irish Government started issuing Irish banknotes. However, they were backed at that time by Bank of England notes. It was not until 1941 or 1942 that Ireland set up its own central bank.
We do not have quite the leisurely pace today that characterised Ireland and the global financial markets then. However, there are a lot of variants on the possible options. That does not answer your question, but I think that it gives a relevant background for it.
That is helpful. Thank you.
Jamie Hepburn referred to the Institute for Fiscal Studies looking far into the future. That clearly has its difficulties, but I want to concentrate on the immediate post-independence period if there is a yes vote. What is your assessment of what the fiscal situation would be for an independent Scotland? Our witnesses last week tended to say that it would be more fiscally challenging than the situation that the rest of the UK would face. Professor McCrone, what is your assessment of the fiscal situation facing an independent Scotland in 2016?
I think that it would be more challenging because the figures already show that the deficit in Scotland is slightly larger than that for the rest of UK as a whole: 8.3 per cent compared with 7.3 per cent of GDP. If oil revenues go on declining, that is a pressure that will make the situation worse.
I think that there would be a fiscally challenging situation for an independent Scotland because a lot of promises have been made and some of them will be quite expensive. I do not see that the revenue would be there to match all those promises, so I think that there would be quite a tough situation.
Do you have any comment, Professor McGregor?
I broadly agree with that answer: it looks likely that the post-independence situation would be more challenging. However, public sector deficits are notoriously difficult to predict accurately because of the difference between two very big numbers, and they depend on what is happening with a whole load of other things in the economy.
It is difficult to predict, but present evidence indicates that the post-independence situation is likely to be more challenging. That is not to say that policies pursued by an independent Scottish Government that were successful would not generate more economic growth. There is a puzzle as to how exactly growth would be generated, but if Scotland was successful in doing that, it could grow its way out of a fiscal problem.
I accept that in principle, but obviously that would take a year or two. I want to concentrate on the immediate post-independence period.
My final question is to Professor McCrone. In both your book and your paper you talk about options for further fiscal devolution. I am particularly interested in why, although you are a supporter of further devolution of control over income tax, you are not in favour of that control being completely devolved to the Scottish Parliament. I am interested in your thinking about that.
That is what my primary question is about, although another proposal of yours is also of interest. My secondary question concerns why you are keen on the assignment of VAT revenues, but my main interest is in the income tax question.
I have thought quite a lot about the income tax issue. A number of people have suggested that the whole of income tax should be devolved. The trouble with that is that it would leave the UK Government with taxes that are mainly regressive. If the UK Government then had to raise more money all of a sudden—because of some disaster or a war, for example—it could raise VAT but it would be unable to put up income tax.
I think that there ought to be some tax available to the UK Government that is progressive, not regressive. In this recession, I would not have put up VAT; I would have put something extra on income tax, because that would have hit the poorer people less hard. That is the main reason why I shied away from advocating the devolution of the whole of income tax.
Various people have told me that assigning the revenue from VAT is pointless. For various reasons, I do not think that that is true. Obviously, you cannot alter the rate of VAT within one country, as that is against EU rules, but in a situation in which VAT is assigned, if the Scottish Government is successful in generating more economic growth, it will get more taxation revenue. A lot of the people who have argued in favour of giving Scotland more tax powers have said that the Government needs to have the ability to get additional tax revenues if it is successful in promoting growth. We would get that if we assigned VAT. That seems to me quite important.
The other point is that, in England, there is a fair amount of pressure with regard to the view that Scotland gets more public expenditure than it deserves and the Barnett formula is too generous—all of that kind of thing. Although nobody has made a commitment in that regard, someone will eventually have to examine the situation again—I do not know when, but sometime in the future.
The pressure in that regard would be a bit reduced if Scotland were seen to be raising more of its own money from taxation, so that the block grant would be considerably smaller. Those are the two main reasons I recommended those things.
That is helpful. Thank you.
I have had many questions in my head since we started this discussion, but I would like to ask you about the current economy of the United Kingdom. There seems to be an implication that everything is okay as it is, and that we should not upset the apple cart. However, many economists and others feel that everything is not okay and that, actually, Scotland could make a much better stab at things.
Earlier today, we were looking at the OBR’s forecast. On house prices in Scotland, it says that
“although property transactions have picked up recently, they remain well below their long-run trend”.
All of that suggests a scenario in which things will get back to normal after we have paid off a debt. To a lot of people, that approach seems likely to lead us headlong straight back into the extraordinary economic mess that we are currently struggling to get out of. My question to you is, how do we effect change, from a Scottish perspective, without actually changing something?
You will probably get different answers from all three of us on that question.
I rather agree with what you have said. Many people misunderstand the situation that we got into with the financial crash. The main problem was not with Government debt. Levels of Government debt perhaps should have been a bit lower than they were, and the Chancellors of the Exchequer in the Labour Government should not have been budgeting for a surplus when they had a deficit of 3 or 4 per cent, but the deficit was not the problem. The problem was with private debt, which escalated more and more until, eventually, it could escalate no further and the thing collapsed. That turns into Government debt, because the Government finds that its tax revenue is reduced and its expenditure on things such as unemployment benefit has gone up, which means that Government debt goes up. However, that was a consequence of what happened, rather than a result of any adverse planning by the Government itself.
Are we heading for the same situation again? I am worried about what is happening in the housing market. House prices in Britain are probably too high anyway. Countries such as Germany, where there is a much smaller owner-occupied sector and a much better and bigger social rented sector, are at an advantage, because they do not get themselves into that pickle.
There is a danger that we will fall into the same trap again. Usually, the best way out of such a recession is for the exchange rates to go down and exports to improve, as they did in the early 1990s, but it would be difficult to get exports to improve even if the exchange rate were to go down at the moment, because the markets to which we export are also depressed. That is the main difficulty. The eurozone is in quite as much trouble as we are. I am a bit worried that we have not learned the lessons and that we will get back into the same pickle that we were in before. It is difficult to say how a Scottish Government would deal with that, but I would like a considerable change to be made to housing policy.
We have a global financial sector and system that is set up to generate endemic financial crises. What we saw in 2008 was simply one of a series that I expect to continue. The UK Government’s capacity to do much about that unilaterally is limited; the capacity of a Scottish Government to do something about it is a good deal smaller. The best that a UK or a Scottish Government can do is determine what small steps it can take to insulate the UK or the Scottish economy from the consequences, but the capacity to do that is also quite limited.
We need to accept that in any society—even the richest—the distribution of income is such that the poor people in that society cannot afford the full economic cost of their housing and that encouraging people to buy housing when they cannot really afford it is one of the problems that has arisen. That is why I like the situation in Scandinavia and Germany, where there is a decent provision of social rented housing and less emphasis on encouraging people to buy houses when they cannot really afford it.
The implication of that is that it would be a good idea for Scotland to govern itself.
A Scottish Government could certainly do something about that if Scotland were independent. It could also move in that direction if it were simply given more devolved powers.
More should be spent on social housing. We can take the constitutional implications of that any way we like.
It clearly depends on the extent to which you judge the set of problems that the UK is currently experiencing to be a function of UK policy or a function of events in the rest of the world, Ms Urquhart. It is absolutely right that rest-of-the-world events are crucial and are basically exogenous to the UK, as they are to Scotland. Scotland can do its best to insulate itself against them, but I agree that there is not a fantastic amount that it can do.
If you judge that, in addition to the world forces, the UK Government has behaved in a manner that has made things worse, you might use that to make an argument for Scotland having greater fiscal powers and, ultimately, independence, but it is rather difficult to do that, although I can see that the policies that the chancellor pursued are controversial. The UK economy is in recovery, but it is a modest one and some would argue that the counterfactual is that it might have recovered rather more rapidly had a different set of macroeconomic policies been implemented. It depends critically on the point on that spectrum that you judge to be appropriate.
I have a question on Standard Life, which has had much publicity, and other incorporated companies that are supposedly threatening to leave Scotland in the event of independence. It seems to me that the annual report of every incorporated company has to highlight its risks.
The risk that is highlighted in, for example, Standard Life’s annual report seems very nominal compared with the publicity that is generated about that risk. I know that the issue has already come up, but I presume that no company would be in a rush to leave Scotland until it better understood what was meant by independence, all of which would be down to the negotiated settlement and the nation’s political philosophy.
12:00
Yes, I think that that is right. What companies do will depend on what their clients want them to do. If Standard Life felt that, given that the majority of its clients are not in Scotland, it would do better, get more clients and satisfy the ones that it has by moving part of its operation to England, that is what it would do. It would determine its position on that basis.
I am less sure whether any action would need to be taken by the fund managers—the people who run the investment trusts and suchlike—but clients in England might ask why they should put their money in a company that was in a foreign country rather than in one in their own country. That is the issue.
Are you seriously suggesting that everyone who is a Standard Life customer thinks in those terms?
It is possible that such thinking could affect Standard Life’s ability to get new customers. People who place an insurance policy with a company just want to consider what the risks are. If they think that a degree of risk exists because they would be placing their insurance policy with a company in a foreign country, such as Germany or France, they would not do that. Most of those people invest in their own country for that reason. The question is whether independence would have a significant effect in that regard. That will depend very much on what happens and we cannot predict that in advance.
A critical factor would be the judgment about the likelihood of maintaining the monetary union. Were there to be a lack of confidence around that, the risk would increase and the incentive to move might be higher.
This argument is very strange, because people do not know the specifics of what they are talking about. Everyone in this room has a bank account. Those accounts will be with various banks—some of them will be UK banks, but one of them is, ultimately, a Spanish bank and another is, ultimately, an Australian bank. If you went into any branch of those banks and asked the people behind the desk the questions, “What is the regulated entity with which I am trading?”, “Under what law am I making a contract with the bank when I place a deposit?” and “What provisions could the Scottish Government or the UK Government make to change the terms of my contract?”, they would not have the slightest idea how to answer. Indeed, you could go to a top Scottish Queen’s counsel and he would struggle to give you answers to those questions and the answers that he would give would be very long.
Those are the questions that are relevant to the risks that people are taking and how those risks would change were there to be independence. Those risks depend on what the regulated entity is and where the contract is made. The answers to all those questions are rather obscure. If Scotland became independent, those matters would be sorted out in ways that were sensible for all parties. Everyone who thinks about it knows that that is the answer to the question. Such fears are, essentially, imaginary. To investigate what they are is almost impractical, but that does not mean that people may not genuinely hold such vague, ill-formulated concerns; it is plain in talking to people that they do. It is simply the case that any threatened change creates unease and uncertainty. I cannot see that there is any specific material basis for that.
My final question is very short. The economic scenario that is painted in various reports is based on the status quo across the UK. The percentages for expenditure on defence and so on are based roughly on what is being done, but that is only one side of the balance sheet; we have to look at the other side.
Is it not the case that, in an independent Scotland, which would have its own set of priorities, some of those budgets would change quite dramatically?
Are you suggesting that, because of independence, the rate of economic growth would be different—higher, for example?
It could be. I am looking at the expenditure. We are talking mostly about the collection of tax and the ability of the country to pay its tax and so on, but there are British Government expenditures—aside from the expenditure on public services such as health and education that everybody expects—that Scotland might choose not to make. Expenditure on defence is the obvious example, but there are many other sections of the balance sheet for UK plc that Scotland plc might choose to change.
The Treasury produces its identifiable expenditure figures, which leave out of account things such as foreign embassies, defence and interest on the national debt, as those are not capable, at present, of being allocated to particular parts of the United Kingdom. Those elements make up much the smaller part of the budget, but it would be possible for Scotland to take different decisions on them. That is most obviously the case on defence.
On foreign embassies, I would expect that the cost might go up rather than down, because Scotland would want foreign embassies all over the place. Although it might not want as many as the UK has, it might want to have a number comparable to the number that Ireland has.
The other area that is not very much devolved is social security and welfare. In my submission, I suggested that there would be scope for devolving quite a lot of what the Department for Work and Pensions does. We would probably not want to devolve all of it, because I think that we would want to retain the same level of old-age pension—which is the main element, being nearly half of the DWP’s expenditure—throughout the UK, but a lot of other benefits could perfectly well be devolved. If Scotland were independent, it might take a different view on all those things, its rate of old-age pension might be higher or lower and the way in which it dealt with benefits might be quite different.
I would expect that, over time, the tax system and the expenditure side would both change dramatically. There is a need to reform the tax system, as it is pretty anomalous at the moment. Sir James Mirrlees, who is a Scot and a Nobel prize winner in economics, has produced an enormous report that makes recommendations on the future of the tax system—a report that, incidentally, I have not read, because it is so long.
It is clear that an independent Scotland would want to look at that sort of thing with a view to coming up with a more practical and less anomalous system. All that would take time, but it might result in quite a lot of differences in the long run.
One of the big arguments in favour of fiscal devolution or decentralisation is the idea that we bring decisions closer to the people who are affected by them. There are undoubted benefits in doing that but, traditionally, there are acknowledged to be areas in which the cost of doing so might be rather more significant. We just heard an example: defence and foreign affairs are areas that are typically emphasised in that regard. There might be some loss of efficiency as a consequence but, nonetheless, such a change would undoubtedly bring decisions closer to the people who are directly affected by them.
Going back to our earlier discussion about the capacity to grow the economy and how we would do so, I do not think that any of you have suggested how that would be possible. The Scottish Government’s white paper, which I am reliably informed has the answers to everything, suggests that a 3 per cent cut in corporation tax would grow the economy. Some people have analysed that, and Professor Stiglitz is among a number of people who have said that the suggestion is not quite as straightforward as it would appear in the white paper. Do you have any comments on that?
We have also had Professor Hughes Hallett and Crawford Beveridge in front of us suggesting that the margin of difference would have to be much more radical than 3 per cent to make any difference. Do you agree with that analysis?
It is rather difficult to say. As far as I can see, the two measures in the white paper on how an independent Scotland would grow the economy are, first, a lower rate of corporation tax and, secondly, the use of childcare to free up more of the labour market to take jobs. Of course, the latter depends on the jobs actually being there. If Scotland was able to generate more jobs, people would, as happened in Ireland, automatically come in from outside.
What happened in Ireland has given people the idea that a lower rate of corporation tax is the answer to all of this, but I think that there are various problems with that. When Ireland joined the European Union it was by quite a long way the poorest member state, and nobody raised much objection to the fact that its rate of corporation tax was very low. As far as I can recall, at the time Ireland did not have corporation tax for businesses that dealt only in exports, and the tax was only on businesses that dealt in the home territory. It was obliged to change that, but, when it did so, it brought in a corporation tax of 12.5 per cent, which was about half of that in most other countries. That resulted in a lot of companies looking at Ireland that would not otherwise have done so—and, incidentally, also resulted in a lot of businesses declaring their tax in Ireland without actually employing many people there. We have had the same problem throughout the world with companies such as Google and Starbucks trying to declare their profits in areas where the taxes are lowest, which has adversely affected the UK and various other countries.
If an independent Scotland reduced the level of corporation tax, it would probably generate more economic activity and would also result in businesses wanting to declare their taxes in Scotland rather than in the rest of the UK. That would mean that, if there were a negotiation on monetary union, the rest of the UK would insist that there was no discriminatory tax that could attract business to Scotland that might otherwise go to, for instance, the north of England, which I think would be up in arms otherwise. I therefore think that it would be very difficult for an independent Scotland in a currency union with the rest of the UK to have a different rate of corporation tax. I might be wrong about that, but that is what I think.
There is also the question of the European Union. It has been trying like anything to get the Irish to raise their corporation tax, but they have so far managed to resist. However, as the eurozone develops, it is possible that taxes will be much more harmonised across the countries in it, so the Irish might eventually have to give up their lower rate of corporation tax.
Corporation tax is a difficult issue, but it seems to me to be fraught with all sorts of problems if Scotland wanted to remain in a monetary union with the rest of the UK or wanted to join the European Union.
I completely agree with Professor McCrone. The strategy of having a much lower rate of corporation tax—we are talking not about a 3 per cent difference, but about a much bigger one—was successful for Ireland in attracting economic activity and tax revenue, both of which came almost entirely at the expense of European countries. The very success of that policy for Ireland means that other countries are not going to be allowed to do it—that would be the practical reality of any negotiation. Scotland would have to have extended negotiations with both the rest of the UK and the EU over independence. I therefore think that believing that Scotland would get economic growth from lowering corporation tax is chimerical.
It is now more than 20 years since I left the Scottish Office. I was there for 22 years, and I spent most of my time trying to encourage economic growth in Scotland—that was my main objective. I was one of the architects of the regional policy that was introduced in the 1980s, and I greatly regretted the fact that, during the years of the Conservative Government, many of the regional policy measures were removed, which greatly weakened the policy.
By setting up the Scottish Development Agency—or what is now Scottish Enterprise—we managed to preserve that approach during the 1980s, but only just. I think that the problem now throughout the United Kingdom is an increasing imbalance between the economy in the south-east of England and the economy in the rest of the UK, and that badly needs to be addressed with some measure. I do not know whether that would mean bringing back a stronger regional policy but that is the kind of measure that needs to be pursued.
12:15For a variety of reasons, partly to do with North Sea oil and partly to do with the financial sector, Scotland has done much better than other parts of the UK. In terms of GDP per head, we have more or less caught up with the rest of the UK, and we are now about 2 per cent below the UK average. Places such as Wales, the north of England and other parts of England have done much less well. The priority, therefore, is not quite as great in Scotland as it is elsewhere. Nevertheless, whether Scotland remains part of the UK or becomes independent, we badly need to think about how we deal with the balance of the economy in these islands. The south-east of England, and London in particular, will go on being a magnet unless something is done about it.
I agree with the point about regional policy and regional policy activism.
That aside, though, I should say that when colleagues in the Fraser of Allander Institute and I explored the impact of a 3 per cent cut in corporation tax, our work reaffirmed Professor McCrone’s intuition, because we found that, eventually, such a move would have a small stimulating effect on the Scottish economy. However, there were perhaps two qualifications. First, we assumed that there would be no reaction whatever with regard to corporation tax rates elsewhere in the UK. It was around the time of the negotiations with Northern Ireland on an agreed and negotiated reduction in corporation tax, and we looked at the implications of that kind of scenario. There was no gaming around the setting of taxes, which, in practice, made the analysis a great deal simpler. However, as has already been said, that would be a major issue.
Although in this particular case we did not explicitly analyse the impact on the rest of the UK, it is correct to say that there would almost certainly be negative spillover effects for the rest of the UK. However, under those restricted circumstances, it looked as if corporation tax cuts could eventually be effective in stimulating activity.
Professor McCrone also mentioned the childcare initiative. We have discovered that the Scottish Government has not modelled any projections in that respect and that its figures in the white paper are, at best, speculative. Have you done any gaming with or modelling of the figures in the white paper?
No. The childcare proposals are an area to which we would like to turn our attention but we have not been able to do so yet. Although such supply-side policies are known to be able to generate significant effects, you need to be very careful about the specification, the transmission mechanisms and the link to the wider economy. That is a challenge in itself. However, we are certainly interested in looking at the proposals in more detail.
I have one more question on how we analyse the figures. A report in yesterday’s newspapers suggested that a German bank, Commerzbank, had looked at the figures being used to illustrate Scotland’s economic performance and had identified that, too often, we are comparing apples and oranges. For example, the Scottish Government has used tax receipts as a per capita figure but when it looks at public expenditure, it has used the figures as a share of GDP. However, when we carry out a proper comparison of the figures on a per capita basis, we find that the figures used in the Scottish Government’s analysis indicate that spending is 10 per cent higher in Scotland than is shown by the figures produced by the Scottish Government. Are you familiar with that type of statistical manipulation?
Not directly. It is undeniable that spending per capita in Scotland is significantly higher. However, I cannot comment on the report that you have highlighted because I did not read that particular analysis and do not have the data at my fingertips.
All that I would say is that this kind of debate—if that is what this is—and concern about the accuracy of data that is provided by the Government are precisely why there is a good case for establishing a fiscal commission and having independent analysis of statements made by any party or Government of the day. I cannot comment on the specifics of this particular case, but I think that the issue itself indicates the need for that kind of independent analysis.
I agree with you on that point.
It is well known that Scottish public expenditure per head is higher than the UK average by about 10 per cent. We also know that onshore tax revenue, excluding North Sea oil, is about equal to the UK average. That creates a gap that North Sea oil revenues would be required to fill; they would not fill it completely, but they would go a long way towards doing so.
That is the essence of the budgetary problem. Somebody asked earlier whether things would be more challenging if Scotland was independent, and the fact is that this issue would have to be dealt with. If Scotland’s public expenditure was similar to the UK average, North Sea oil would be a kind of bonus, which would be all right. However, Scotland’s public expenditure is about 10 per cent higher than the UK average.
Nobody really knows whether that level of public expenditure is justified. It has been like that for absolutely ages; the Macmillan Government deliberately raised it in Scotland and the north of England in the 1960s to try to deal with the then higher levels of unemployment, and since then we have tended to have a higher level of public expenditure per head. Is that justified? No needs assessment has been done, other than a rather scrappy one by the Treasury in the 1970s, and no one will be able to decide whether that higher level of public expenditure is justified until that analysis is carried out.
You might have caught the tail end of the earlier part of this morning’s meeting, in which we had a discussion about the Scottish rate of income tax and the estimated £35 million in transition costs. Have our panellists looked at the transition costs for Scotland if Scotland were to vote yes to independence in September? What transition costs would we be talking about? Are you aware of any analysis of that?
I have not looked at that, but it is pretty obvious that there would be substantial costs in setting up an entirely new tax system and a lot of institutions that are currently UK based. There will certainly be transition costs, but I cannot put a figure on them and I do not know whether any of my colleagues can.
I cannot either. There are some relevant pieces of analysis, such as attempts to measure the scale of the risk premium that would be associated with Scottish Government debt, and other individual pieces of analysis. However, I am not aware of analysis that covers the whole issue, so I really have no idea of what the figure would be.
I, too, do not think that any work has been done on that; I am certainly not aware of any. An implicit theme that has emerged at various times during this morning’s meeting is that the number of complicated details that have to be sorted out is extremely large and that, at the moment, almost nobody knows how many of them there are. They are problems that arise only when you start to think about the issue.
We have touched on the overall fiscal situation a couple of times during questions. At one end of the scale, the Institute for Fiscal Studies published 50-year projections and, at the other, the white paper has projections for one year—2016-17. Do panellists have a view on the level of detail and for how many years forecasts should be published, either by Governments or independently, so that people who are looking at the issue sensibly can get a reasonable sense of what the situation would be, were Scotland to become independent? I know that there are many unknowns.
One of the things that you must know about economic statistics is that forecasts are always wrong. They are a bit better than the weather forecasts, but not much, and the further out they go, the more wrong they usually are.
I would like to see five-year forecasts, but they have to be treated with a lot of caution because all kinds of things can happen. Nobody—or very few people—saw the financial crisis arising. It hit us in 2008 and knocked everything skew-whiff. The UK Government forecasts proved to be completely wrong. It is nearly always the case that economic forecasts, whatever they are, are not quite right.
Such exercises, however, are done not because people believe that the forecasts in them will come true, but because the forecasts provide information that illuminates policy decisions. For example, the IFS work brings home the fact that Scotland has two particular issues—declining North Sea oil revenues and a relatively unfavourable demographic situation. In looking at those issues over 50 years, one is not saying, “This is what is going to happen over the next 50 years.” It is simply an arithmetical way of identifying issues in order to illuminate the debate and the policy decisions that we make.
I completely agree with that. In terms of forecasts, we should think at least in terms of the lifetime of a Government; a five-year period seems to be perfectly reasonable.
People should understand that of course forecasts may be wrong because we cannot foresee the future, but that is not the point. Forecasts are conditional and are understood to be conditional, but they inform us about a likely future and they provide us with a modelling framework that allows us to explore the potential impact of policies. It seems to me that that should be an essential part of the policy formation process.
The projections that the IFS has produced for the longer term are understood in a rather different way and are for a different purpose. They are valuable, provided that they are interpreted with caution, in that they are very useful in drawing our attention to potential problem areas. There is a challenge for policy to respond to, in solving problems.
The panoply of shorter-term forecasts and longer-term projections are useful inputs to the information set that the public and the Government can use to assess the quality of the policy decisions that are being made.
Just in passing, Professor McCrone said that nobody saw that the banking crisis was going to happen but—
About two people saw it coming.
The number of people who now say that they saw the crisis coming is amazing. The numbers do not quite match up. That is just a detail.
Professor McCrone talked about the rate of interest on borrowing that a Scottish Government would have to pay. Can you expand on what you think the difference in the rate of interest might be between what the Scottish Government would pay and what the UK Government currently pays?
You also said that that difference would transfer in some way to mortgages in Scotland. Can you expand on how it would transfer and what the effect might be?
It is now fairly widely accepted that if Scotland becomes independent, the rate of interest on its debt would likely be a bit higher than the rate of interest on UK debt because Scotland would be a new borrower. It does not have a track record of no defaults since the reign of Charles II, which is what the UK has. For that reason, and also because Scotland will be a fairly small borrower, the rate of interest would likely be a bit higher. The IFS has put a range of figures on this. I cannot remember the figures exactly—the figures are between 0.6 per cent higher and 1.8 per cent higher, or something of that kind. I do not know what the rate would be, but we have to assume that the rate of interest on Scottish debt would probably be about 1 per cent higher, which would have quite a big effect on the cost of the debt.
Why would that affect mortgages and so on? If the rate at which the Government is borrowing is higher, it tends to be reflected right through the financial system, so there would probably be higher interest rates on mortgages as well. Of course, there is a bit of a problem with mortgages. If Scotland had a separate currency, or was at all likely to have a separate currency, it would be rather foolish for people to have mortgages from companies that were based elsewhere in the rest of the UK, rather than in Scotland, because if the Scottish currency were to depreciate, people might find it very difficult to repay their mortgages—even more difficult than it is at the moment for many people. A higher rate of interest could likewise affect pensions and all sorts of other things. It just tends to feed through the market.
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We have to be careful on this question. First, we have to ask what the currency would be in Scotland and, secondly, we have to ask the different question of what would be the currency in which people borrowed. Even if there were an independent Scottish currency, the Scottish Government could, and probably would, borrow in pounds rather than its Scottish currency, and that would also be true for private firms in Scotland and for people who take out mortgages here.
For people borrowing in sterling, I cannot see why it should make a difference to a Scottish company or a Scottish home buyer whether the lender is Scottish or not. For example, the Weir Group report on independence discusses why it would raise borrowing costs, but I cannot see why it would raise them any more than Novo’s borrowing costs on global capital markets are raised by the fact that Novo is located in the small country of Denmark.
Equally, if Scots chose to borrow in sterling, I anticipate that they would be able to borrow on terms similar to those on which a similar person in England would be able to borrow in sterling. If Scots chose to borrow in a Scots currency—if there was one—the interest rate would clearly be determined by the interest rates in the Scots currency, which would in turn be determined by whatever the monetary policy of a Scottish central bank turned out to be.
Again, we have to be careful in talking about the actual legal position, the contractual position, the regulatory position and the nature of the contracts that people make.
The issue depends a lot on whether there is any exchange risk. I remember that when I was in the Scottish Office, a company more or less went bankrupt because it had borrowed in Deutschmarks and the pound had depreciated substantially over the period of the loan, so it simply could not repay the loan in Deutschmarks. If there is a currency risk, there is that danger.
If there is no currency risk because there is a currency union that everybody is happy with, and if there is no chance that it will be disrupted, there will not be much difference in interest rates. It is because there might be a different currency that I think, on the whole, that it would be sensible for people to have their mortgages from Scottish mortgage providers.
I agree with that. Monetary union makes things easier in that sense. Provided that people have confidence in the monetary union, it will eliminate the exchange rate risk part of the equation. However, for an independent Scottish Government within that monetary union, we would still expect a premium on the debt. That would certainly be reflected in Government debt, but depending on from where people had borrowed, it might not have a widespread impact throughout the Scottish economy.
The one near certainty is that a Scottish Government would pay a bit more for borrowing in sterling than the UK Government pays for borrowing in sterling because Scotland would be a new borrower and Scottish debt would be illiquid relative to UK debt. Everything else would be pretty much up for grabs.
One or two members asked about economic growth. Putting corporation tax and the childcare idea to one side because you have given answers on those, are there in the white paper other ideas that would lead to significantly improved economic growth, relative to that in the UK?
I am not aware of any such ideas, but I may have missed them. The corporation tax and childcare proposals are the two concrete ones. I would very much like faster economic growth in Scotland; we have been trying for ages to bring that about. That is why I regretted so much the downgrading of regional policy in the 1980s. However, on where we should go from here, and how we might increase the rate of economic growth, we are all still waiting to hear. I have no solution to that problem.
The largest issue is whether there would be a more vibrant entrepreneurial business community in an independent Scotland. That could go in one direction or another, depending on the nature of the society that was established after independence. However, that is the key issue that we ought to be talking about when considering economic growth and, indeed, economic issues generally.
The bit of the Scottish economy that has been disappointing over the years is the growth of the small business sector. We have done very well in attracting business from abroad, particularly during the 1980s. The Scottish Development Agency and, following it, Scottish Enterprise have done quite a lot to try to promote the small business sector. However, it remains the bit on which we need to do rather more. I have a number of suggestions in my book about that. I think that there is some advantage in trying to study what the Germans do with their mittelstand, which is a very important part of their economy. The banking sector in Germany operates in a much more supportive way for business there than the banking sector here does for Scottish business. To my mind, too much of the bank lending in this country goes into housing and not enough goes into other things.
Although I would echo many of those comments, I think that corporation tax and childcare seem to be the two main ideas for economic growth. However, that is not to say that the Scottish Government does not have control of other levers that might have an impact on growth. It is a very difficult area, but the Scottish Government has control over a large part of the spend, so there might be opportunities. I know that some people would claim that the opportunities are already being taken, but there might be other opportunities there for directing expenditure in a way that might stimulate economic growth, innovation and so on. If there is independence and greater fiscal autonomy, there might be the opportunity to revisit the kind of policies that Gavin McCrone has raised, and to undertake them on a self-funding basis. That might be worth exploring.
One of the areas that need to be looked at is vocational training. There has been a lot of emphasis on increasing the number of people who go through universities, but there has not been the same emphasis on trying to equip people with vocational skills to go into business, which is a weak spot. Again, the position in that regard is much better in Germany than it is here, and it is another aspect of the success of the German economy. The position here needs to be looked at.
I would also like to see the UK Government look more critically at the whole business of takeovers. There are occasions on which a takeover is necessary and, indeed, helpful—for example, when a company is in difficulty and will collapse if it is not taken over.
However, there are many cases in which a company is taken over just for aggrandisement of the management or because the shareholders will get a short-term gain, and so on. The Cadbury case is a well-known example in the UK, and the Scottish & Newcastle case in Scotland seems to me to be a similar example. I would like to see a bit more grit in the system, so that takeovers are not easily done unless it can be shown very clearly that the takeover will be to the advantage of the company and the country in which it operates. The present hullabaloo about Pfizer and AstraZeneca is an example of the same thing.
Those are examples of how people have not got the significance of takeovers. The drain of corporate headquarters out of Scotland as a result of acquisitions over the past 20 or 30 years is one of the most serious issues in the whole debate.
I am sure that the witnesses are glad that I am the last committee member who will ask questions. I want to go back to interest rates. A couple of people have said that if and when Scotland becomes independent we would, because we would not have a credit history, pay a bit more of a premium, at least to start with. I presume that that would not last. We have heard evidence that some smaller countries actually pay lower interest rates than some bigger countries. I presume that Scotland would have that potential—if not on day 1, then at least later on.
That would depend to a large extent on how we run the country. If there is any anxiety about the exchange rate, interest rates will be higher. I have not looked at the issue in detail, but it is usually the case that small countries pay rather more in interest than large countries do. John Kay perhaps knows more about this than I do.
Small countries tend to pay higher interest rates in the same currency, as it were—the global currency—so nobody pays better dollar interest rates than the US Government, although the German Government pays a similar rate. Denmark pays low interest rates, but that is because there is a one-sided exchange rate risk, because the Danish krone might rise against the euro but is very unlikely to fall. Hong Kong is in a similar position vis-à-vis the dollar. If Scotland were to borrow in sterling, which we should presume it primarily would, we should and could expect it to pay a small premium to the rest of the UK Government for that, probably on a permanent basis, because—
Would that be the case even if we were run more carefully than the UK?
Yes it would, because the default risk in both cases is extremely small. It is really a familiarity and liquidity risk that is at issue.
One of the difficulties is that interest rates are the outcome of a number of complex influences, one of which is country size. The work that was referred to, which was conducted by my colleague Angus Armstrong and his colleagues at the National Institute of Economic and Social Research, attempts to control for all other factors. They do models in which they attempt to control for everything else, including the size of the country, debt to GDP ratios and other things that might influence perceived country risk. The estimates that they have come up with therefore take account, at least in principle, of the other factors. The 1 per cent premium that has been referred to on a number of occasions is the part of the interest rate level that they attribute to the small-country effect, so I clarify that that premium is the impact of the size of the country, trying to control as best we can for all the other determinants of interest rates.
It is important, because it is a small-country effect, to say that we should not assume that it would go through to private borrowers.
It would affect the Government more than it would affect individuals or companies.
That is my view.
Fair enough; that links in with my next point.
We have talked about the possibility that the financial sector might suffer and that some companies might move south if we were to become independent. However, it strikes me that Switzerland is a small country, but a lot of people have greater faith in Swiss banks—probably for historical reasons—than they have in banks in their own countries, so although it might be normal for an American to trust an American bank more than a Japanese or Chinese one, a lot of people throughout Europe would trust a Swiss bank. Is there also the potential for Scotland to do it the other way round and to have a reputation for really good financial skills?
Yes. Scotland would have to build up that reputation. When I ask the same question, people tell me that the Swiss financial sector is not the same kind of financial sector as the one in Scotland, because the one in Scotland is a kind of offshoot of London’s financial sector. Similarly, there is a huge financial sector in Luxembourg and it does perfectly well. It would be perfectly possible for Scotland to have a very strong financial sector, but I suspect that it would probably have to change quite a bit from what it is now.
Where would we rank now in the view of people around the world?
We would rank very high, despite what we have done in terms of our banks. In asset management, we currently have precisely the type of reputation that John Mason described. The concerns about the financial sector are largely the kind of vague unease that I described previously. It is real, even if there is no basis for it, and I do not think that there is much basis for it.
The other concern is the fear, which I think is also rather ill-founded, that Scotland might have particularly inept regulation. I suggest that there is no particular reason to think that it would be more inept than any other regulation, although people are, at any rate, familiar with other regulation but not with ours.
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I am sure that ours will be better.
I move on to a different subject. The Barnett formula has been mentioned, although we have not spent a lot of time on it. It has been suggested that £4 billion could be taken off the Scottish block grant if Barnett was revised. Would that have a big impact on Scotland and the Scottish economy?
That would be the case if that happened. No party has said that it wants to revise the Barnett formula—they have all shied away from that—but there is a lot of pressure in England and Wales for it to be revised. The Holtham commission in Wales concluded that Scotland gets too much and Wales gets too little, which is perhaps unsurprising, since the commission was Welsh.
The problem is that, if Scotland is to defend a public expenditure level that differs from that in the rest of the UK while remaining in the UK, it must have some justification for that. At the moment, nobody knows what a needs assessment would throw up. The methodology for any needs assessment is quite difficult. The Scottish and UK Governments would have to agree on the methodology before the assessment was carried out.
The only needs assessment that has been done is the one that the Treasury did in the 1970s, which showed that Scotland deserved a higher public expenditure level than the rest of the UK, partly because many of its communities are scattered and partly because of deprivation in the west of Scotland. At that time, Scottish GDP per head was much lower in relation to the UK figure than it is now.
Joel Barnett keeps saying that the situation has completely changed, because Scottish GDP is more or less at the UK average, whereas it was not in the 1970s. I wrote to Lord Barnett to say that that was not the only consideration and that things such as deprivation and the scattered population were important.
When I was part of a national health service review group, I was struck that the costs of providing comparable health services in places such as the Western Isles, the northern isles and even the Borders are much higher than in Lothian, for instance. All of that needs to be taken into account in any proper needs assessment.
I guess that, if a needs assessment were done, it would still show that Scotland should have a higher public expenditure level than the UK average, for all the reasons that I have given. However, it probably would not justify a level that is as high as the current level. That was the conclusion of the Welsh study. It said that, if the formula for determining public expenditure was applied to various parts of England, Scotland would not be able to justify spending that is 10 per cent higher—that is approximately the figure at the moment—although it could justify something that is a bit higher.
We do not know the position. Governments have shied away from the subject. That is all very well, but it means that defending the present system is difficult.
There are political sides to that, too.
Yes.
Professor McGregor mentioned the social wage and—if I understood it correctly—the concept of taking more of a partnership approach, which would involve the unions, the Government and employers talking together about whether we want a bit more tax so that we get a better education system and so on. Do other countries do that better than us? Could we do that better than we do at the moment?
I must be honest—I am not an expert on wage bargaining systems in other countries. However, I understand from people who know how such things work that such an approach has traditionally been a much more accepted feature of wage bargaining in the Nordic countries, although that might be facing tension and might be subject to change.
Could the approach be better here? I am not advocating anything. We have just tried to say what factors might influence the outcome. If Governments could persuade unions and employers to think in the proposed terms, benefits could be gained.
All the proposals—even the pro-union proposals—imply the ability to shift tax and expenditure levels significantly towards either the levels of Scandinavian countries or those of Baltic countries. That is not a narrow economic choice; it is a choice about the society that we wish to live in. In that context, it is appropriate to think about a more collaborative view of wage bargaining. I do not know how feasible that is but, if it was implemented, it could have benefits, and experience elsewhere suggests that it could have benefits.
That concludes questions from the other members of the committee. I have a couple of brief questions, the first of which is for Professor McCrone.
You touched on welfare. In your submission, you say:
“I do not see why a large part of the responsibility for welfare should not be transferred to the Scottish Government and Parliament.”
Some provisions have been transferred, of course. Responsibility for council tax benefit was transferred, but only 90 per cent of the revenue was transferred with it, which cost local government and the Scottish Government £40 million. We understand that the bedroom tax may be devolved as well. The mitigation costs there are £50 million. I take it that you believe that, if responsibilities are to be devolved, the money should follow the policy.
Yes, absolutely. I think that housing benefit should be devolved and that carers allowance, attendance allowance, even disability living allowance, which the personal independence payment has replaced, the winter fuel allowance and television licences for people over 75 could perfectly well be devolved. That is in a devolution context, not an independence context, of course. If there was independence, the whole lot would go.
If that approach was taken, around a third of what the Department for Work and Pensions currently spends would be devolved. If that is added to what the local authorities and the Scottish Government are currently responsible for, the figure would amount to around half of the social welfare cost in Scotland.
I do not see any reason for not doing that. It seems to me to be an important advantage. People constantly say that they would like more welfare to be decided in Scotland. There is no reason why the rates for the things that I mentioned should not be different from what they are in the rest of the country.
Yes, as long as there is not an opportunity to cut our budget further by not funding them.
Exactly. The money must follow them.
I will try to end on an optimistic note. We have heard about all the uncertainties and risks with independence, and we have heard the question about how we would grow the Scottish economy. I will throw my question open to you all. You are all professors of economics, so I imagine that you are all bristling with ideas about how to make Scotland a more dynamic, prosperous and thriving nation. Assuming that it is a yes in six months—of course, the opinion polls suggest that it might not be but let us assume that it is—what would you do so that, 10 years from now, Scotland would be the dynamic, prosperous and thriving nation that we all want to see? Do not all rush to answer that question.
I mentioned three things. The training system needs to be beefed up so that we have first-class vocational training and decent apprenticeships.
We need to look at takeovers, how they are decided, and what the rules would be for examining them. When Norman Tebbit was Secretary of State for Trade and Industry after the Royal Bank of Scotland affair—it was bid for by the Hongkong and Shanghai Banking Corporation and Standard Chartered Bank; I was very much involved in that at the time—he changed the law because he was so against what was ultimately decided, which was to keep the Royal Bank of Scotland as a separate entity. He took the regional consideration out of the Monopolies and Mergers Commission’s remit in looking at the effect of mergers. I would like to see that going back in somewhere or other in the new legislation.
I would also like us to look at how on earth we can promote entrepreneurship and small business more effectively than we have done in the past.
I would take a fairly traditional economist’s view—I think that that is where Gavin McCrone was coming from, as well. It is not that demand is not very important, but in the long run we need to stimulate the supply side of the economy in order to stimulate growth. That implies capital, investment and the labour force, although not just the quantity of the labour force, which is important. We can influence that in Scotland, potentially through migration flows, but we can certainly influence the quality of the labour force. The Scottish Government routinely does so through higher education—I have to mention that as a possibility—and innovative activity. Innovation and the creation of knowledge are often emphasised in higher education. That is very important, but what is crucial is the graduates that we produce and the skills that they possess.
A large percentage of the graduates that are produced in Scotland remain in Scotland and contribute to the quality of the labour force. Education generally and training are therefore definitely important and augment the quality of the labour force. However, another factor that is much more difficult to pin down is entrepreneurial spirit, if I may call it that. There may be ways of stimulating that, but I am by no means an expert on that.
The Scottish Government has sought to identify growth sectors, a number of which would probably be agreed across the parties, and there may be policies there that could help matters. Until fairly recently, there was widespread agreement that renewable energy is a potential growth area. There are a number of sectoral areas that people could look at, as well as the overall picture.
I understand that food and drink and the biosciences are other potential growth areas.
A large proportion of graduates stay in Scotland but, equally, a large proportion do not. We should be emphasising business. I had not known, until the past few days, that the chairman of Pfizer is a Scot. There are many people in important positions in large international companies who originated in Scotland but who have not been working in Scotland over the past 20 years. If we could get even quite a small proportion of those people back in Scotland, that would make a difference in creating the vibrant business community that we are talking about.
For me, the largest part is understanding that the big cap in the provision of finance is on funding to cover the start-up losses of new small businesses. That is where funding is needed but, if anything, banks have withdrawn from it, as they have withdrawn from everything. Venture capitalists have also withdrawn because they have found it easier to make money by funding buy-outs of established businesses and through various kinds of financial engineering. It will be key to create institutions that provide a mixture of angel-type funding and private money. I suspect that Government funding would be better directed towards helping on the procurement side than towards providing the finance—it would be better if that were done privately.
Those are the kind of issues on which we should concentrate, and that is the emphasis that Gavin McCrone and Peter McGregor have been talking about. How we can create effective small businesses and entrepreneurship in Scotland seems to be the big issue in the debate about where we will be in 10 years’ time.
I was involved in setting up the Scottish Development Agency in the 1970s. One of our aims was to get the SDA to help to provide finance for business start-ups and so on, and it did that to an extent. However, whenever a company failed the agency was hauled before the Public Accounts Committee of the House of Commons and given a hell of a grilling. We have to expect that some of them will fail—it is in the nature of the thing.
I agree with John Kay that it would be better for the private sector to provide the finance, but the public sector must be ready to lend a hand until the private sector gets adequately geared up, stops lending so much for people’s mortgages and starts lending rather more for the promotion of small business.
The private sector should provide the investment and the public sector should buy the product.
It is obvious why so many Scottish graduates leave Scotland. I worked in the pharmaceutical industry, and because it is headquartered in the home counties people have to move there if they want career progression, whether it is in research and development or in management. A lot of the management are Scots—I worked for companies that were all Scots—because they are seen to be sociable but assertive at the same time. Ireland is an independent country, so the whole infrastructure is there; companies have headquarters in Ireland, but nothing in Scotland.
Does anyone want to make any final points before we wind up this evidence session?
I have a brief point to make. The percentage of graduates who remain in Scotland is actually really high—it is of the order of 90 per cent. I do not deny that the export of human capital is an important issue. If we could retrieve some of that, that would be great. However, we retain a higher proportion of graduates than any other part of the UK, which is beneficial.
Thank you for your evidence, which has been fascinating. I also thank my colleagues around the table for their wide array of questions.
Meeting closed at 13:00.Previous
Scottish Fiscal Commission