It is the UK’s parlous position, that is giving financial markets their ongoing jitters, not Scotland’s economic prospects argues James Meadway. Reading the media representation would make you think it’s the other way around.
Respected economist Paul Krugman, a vociferous opponent of austerity, has turned his attention to the Scottish independence debate. With less than two weeks to the vote, and with considerations over the economy at the forefront of the argument, there’s no doubt that his voice will be taken as an authoritative intervention. It’s a shame, then, that his brief analysis has a glaring hole in the middle: the UK’s trade deficit.
Krugman thinks that Scots should “be afraid”, reckoning that, without its own currency, an independent Scotland would be like Spain inside the euro. Spain’s housing bubble blew up early on in the crisis but, with a government unable to issue its own currency, it could do little to soften the impact. The housing bust turned into a fiscal crisis, dragging Spain into a slump.
But this is to miss the core feature of the eurozone crisis – one that applies not just to Spain, but all those southern European countries hardest hit by the slump. Stuck inside the euro, with their exchange rates effectively fixed on entry, they ran huge current account deficits – they imported more than they exported inside the eurozone, mostly from Germany. During the good times, this was fine; the gap between imports and exports was covered, in effect, by borrowing from eurozone banks, notably French and German. When the crash came, that lending dried up and, as it did so, the slump followed in train. (You can read more on this argument here.)
The critical element in the eurozone crisis is the international imbalance – that some countries had persistent current account deficits, and some had persistent surpluses. These, in turned, fuelled the debt bubble, and then helped cause the eventual crash. It’s a little odd for Krugman to miss this international dimension, not least because he won his Nobel Prize in part for his work on international trade.
But the international dimension is central to the UK story, too. As I blogged last week, and as Robert Peston confirms today on the BBC blog, the UK runs a persistent current account imbalance. Year in, year out, we import more than we export, and we have done for decades. (We’ve had deficit on trade in goods trade every single year since 1983!) Last year, the current account deficit hit 4.4% of GDP. This has caused us fewer problems than might be expected because we have relied on our financial system to mobilise borrowing from the rest of the world. The UK now has an external debt second only to the USA, at 406% of GDP.
However, that current account deficit is there even with North Sea oil. Oil is still an enormous export earner – accounting for £39.3bn of sales overseas last year. If Scotland takes its geographical share of North Sea resources, the UK will lose almost all of that revenue. Without North Sea oil, our current account deficit would have leapt from 4.4% of GDP, to 6.9%.
It is one thing to run 3-4% current account deficit, year after year, and expect to borrow to pay for it. But a near-7% deficit is another thing entirely. Either the pound has to fall in value, so we cut imports and sell more abroad, or we (as Peston suggests) start selling off overseas assets, or interest rates have to go up. Under these circumstances, it would be hugely to the remaining UK’s advantage to conclude a formal currency union with an independent Scotland as rapidly as possible. This need not be a long-term agreement; Krugman is right, over the longer term, that an independent country needs an independent currency. But it would do for now.
It’s uncertainty over the future, and knowledge of the UK’s parlous position, that is giving financial markets their ongoing jitters. If Whitehall wanted to end them, it could do so immediately, by making clear its plans for how a post-independence currency union might work and offering some proposals. Nicholas Macpherson, head civil servant at the Treasury, has admitted that “contingency plans about contingency plans” are being drawn up. But that sensible option appears to have been ruled out in the interests of political positioning.
We can return to Krugman’s analogy. It isn’t Scotland that’s like Spain. With its gaping trade deficit and its housing bubble, it’s the UK.
James Meadway is writing in a personal capacity.