Author: John Sloman

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The effects of Scottish independence: a question of known unknowns?

Economic journalists, commentators and politicians have been examining the possible economic effects of a Yes vote in the Scottish independence referendum on 18 September. For an economist, there are two main categories of difficulty in examining the consequences. The first is the positive question of what precisely will be the consequences. The second is the normative question of whether the likely effects will be desirable or undesirable and how much so.

The first question is largely one of ‘known unknowns’. This rather strange term was used in 2002 by Donald Rumsfeld, US Secretary of Defense, in the context of intelligence about Iraq. The problem is a general one about forecasting the future. We may know the types of thing that are likely happen, but the magnitude of the outcome cannot be precisely known because there are so many unknowable things that can influence it.

Here are some known issues of Scottish independence, but with unknown consequences (at least in precisely quantifiable terms). The list is certainly not exhaustive and you could probably add more questions yourself to the list.

• Will independence result in lower or higher economic growth in the short and long term?
• Will there be a currency union, with Scotland and the rest of the UK sharing the pound and a central bank? Or will Scotland merely use the pound outside a currency union? Would it prefer to have its own currency or join the euro over the longer term?
• What will happen to the sterling exchange rate with the dollar, the euro and various other countries?
• How will businesses react? Will independence encourage greater inward investment in Scotland or will there be a net capital outflow? And either way, what will be the magnitude of the effect?
• How will assets, such as oil, be shared between Scotland and the rest of the UK? And how will national debt be apportioned?
• How big will the transition costs be of moving to an independent Scotland?
• How will independence impact on Scottish trade (a) with countries outside the UK and (b) with the rest of the UK?
• What will happen about Scotland’s membership of the EU? Will other EU countries, such as Spain (because of its concerns about independence movements in Catalonia and the Basque country), attempt to block Scotland remaining in or rejoining the EU?
• What will happen to tax rates in Scotland, with the new Scottish government free to set its own tax rates?
• What will be the consequences for Scottish pensions and the Scottish pensions industry?
• What will happen to the distribution of income in Scotland? How might Scottish governments behave in terms of income redistribution and what will be its consequences on output and growth?

Of course, just because the effects cannot be known with certainty, attempts are constantly being made to quantify the outcomes in the light of the best information available at the time. These are refined as circumstances change and newer data become available.

But forecasts also depend on the assumptions made about the post-referendum decisions of politicians in Scotland, the rest of the UK and in major trading partner countries. It also depends on assumptions about the reactions of businesses. Not surprisingly, both sides of the debate make assumptions favourable to their own case.

Then there is the second category of question. Even if you could quantify the effects, just how desirable would they be? The issue here is one of the weightings given to the various costs and benefits. How would you weight distributional consequences, given that some people will gain or lose more than others? What social discount rate would you apply to future costs and benefits?

Then there are the normative and largely unquantifiable costs and benefits. How would you assess the desirability of political consequences, such as greater independence in decision-making or the break-up of a union dating back over 300 years? But these questions about nationhood are crucial issues for many of the voters.

Articles

Scottish Independence would have Broad Impact on UK Economy NBC News, Catherine Boyle (9/9/14)
Scottish independence: the economic implications The Guardian, Angela Monaghan (7/9/14)
Scottish vote: Experts warn of potential economic impact BBC News, Matthew Wall (9/9/14)
The economics of Scottish independence: A messy divorce The Economist (21/2/14)
Dispute over economic impact of Scottish independence Financial Times, Mure Dickie, Jonathan Guthrie and John Aglionby (28/5/14)
10 economic benefits for a wealthier independent Scotland Michael Gray (6/3/14)
Scottish independence, UK dependency New Economics Foundation (NEF), James Meadway (4/9/14)
Scottish Jobs and the World Economy Scottish Economy Watch, Brian Ashcroft (25/8/14)
Scottish yes vote: what happens to the pound in your pocket? Channel 4 News (9/9/14)
What price Scottish independence? BBC News, Robert Peston (12/9/14)
What price Scottish independence? BBC News, Robert Peston (7/9/14)
Economists can’t tell Scots how to vote BBC News, Robert Peston (16/9/14)

Books and Reports
The Economic Consequences of Scottish Independence Scottish Economic Society and Helmut Schmidt Universität, David Bell, David Eiser and Klaus B Beckmann (eds) (August 2014)
The potential implications of independence for businesses in Scotland Oxford Economics, Weir (April 2014)

Questions

  1. What is a currency union? What implications would there be for Scotland being in a currency union with the rest of the UK?
  2. If you could measure the effects of independence over the next ten years, would you treat £1m of benefits or costs occurring in ten years’ time the same as £1m of benefits and costs occurring next year? Explain.
  3. Is it inevitable that events occurring in the future will at best be known unknowns?
  4. If you make a statement that something will occur in the future and you turn out to be wrong, was your statement a positive one or a normative one?
  5. What would be the likely effects of Scottish independence on the current account of the balance of payments (a) for Scotland; (b) for the rest if the UK?
  6. How does inequality in Scotland compare with that in the rest of the UK and in other countries? Why might Scottish independence lead to a reduction in inequality? (See the chapter on inequality in the book above edited by David Bell, David Eiser and Klaus B Beckmann.)
  7. One of the problems in assessing the arguments for a Yes vote is uncertainty over what would happen if there was a majority voting No. What might happen in terms of further devolution in the case of a No vote?
  8. Why is there uncertainty over the amount of national debt that would exist in Scotland if it became independent?
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Edging closer to full QE

As we saw in the blog post last month, Eurozone becalmed the doldrums, the eurozone economy is stagnant and there is a growing danger that it could sink into a deflationary spiral. Last month, several new measures were announced by the ECB, including a negative interest rate on money deposited in the ECB by banks in the eurozone. This month, the ECB has gone further including, for the first time, a form of quantitative easing.

So what has been announced, and will it help to kick-start the eurozone economy? The measures were summarised by Mario Draghi, President of the ECB, at a press conference as follows:

The Governing Council decided today to lower the interest rate on the main refinancing operations of the Eurosystem by 10 basis points to 0.05% and the rate on the marginal lending facility by 10 basis points to 0.30%. The rate on the deposit facility was lowered by 10 basis points to –0.20%. In addition, the Governing Council decided to start purchasing non-financial private sector assets.

The Eurosystem will purchase a broad portfolio of simple and transparent asset-backed securities (ABSs) with underlying assets consisting of claims against the euro area non-financial private sector under an ABS purchase programme (ABSPP). This reflects the role of the ABS market in facilitating new credit flows to the economy and follows the intensification of preparatory work on this matter, as decided by the Governing Council in June. In parallel, the Eurosystem will also purchase a broad portfolio of euro-denominated covered bonds issued by MFIs domiciled in the euro area under a new covered bond purchase programme (CBPP3). Interventions under these programmes will start in October 2014.

To summarise: the ECB has cut interest rates, with the main rate cut to virtually zero (i.e. 0.05%). This represents a floor to interest rates, as, according to Mario Draghi, there is now no scope for further cuts. (Click here for a PowerPoint of the chart.)

In addition, the ECB will begin the outright purchase of private-sector securities. This is a form of quantitative easing as it will involve the purchase of assets with newly created money. In the past, the ECB has simply offered loans to banks, with assets owned by banks used as collateral. This form of quantitative easing has been dubbed ‘QE light’, as it does not involve the purchase of government bonds, something the German government in particular has resisted. The ECB recognises that it would be a sensitive matter to buy government bonds of countries, such as Greece, Spain and Cyprus, which have been criticised for excessive borrowing.

Nevertheless, if it involves the creation of new money, purchasing private-sector assets is indeed a form of QE. As Mario Draghi said in response to a question on this matter:

QE is an outright purchase of assets. To give an example: rather than accepting these assets as collateral for lending, the ECB would outright purchase these assets. That’s QE. It would inject money into the system. Now, QE can be private-sector asset-based, or also sovereign-sector, public-sector asset-based, or both. The components of today’s measures are predominantly oriented to credit easing. However, it’s quite clear that we would buy outright ABS only if there is a guarantee.

So with appropriate guarantees in place about the soundness of these securitised assets, the ECB will purchase them outright.

But will these measures be enough? Time will tell, but there are now several measures in the pipeline, which could see a large stimulus to bank lending. The main question is whether banks will indeed take the opportunity to lend or merely hoard the extra reserves. And that depends in large part on the demand for credit from businesses and consumers. Boosting that is difficult when the economic climate is pessimistic.

Articles

Draghi’s ECB surprise puts off bigger quantitative easing for now Reuters, John O’Donnell (5/9/14)
ECB President Mario Draghi pulls stimulus lever at last, but still no quantitative easing for eurozone Independent, Ben Chu (5/9/14)
ECB cuts rates and launches stimulus programme BBC News (4/9/14)
Draghi Push for ECB Easing Intensifies Focus on ABS Plan Bloomberg, Stefan Riecher and Jeff Black (4/9/14)
Draghi Sees Almost $1 Trillion Stimulus as QE Fight Waits Bloomberg, Simon Kennedy (5/9/14)
Draghi’s Case For ECB Quantitative Easing Forbes, Jon Hartley (8/9/14)
ECB’s last roll of the dice BBC News, Robert Peston (4/9/14)
Draghi’s eurozone steroids BBC News, Robert Peston (2/10/14)
Draghinomics – Abenomics, European-style The Guardian, Nouriel Roubini (1/9/14)

ECB Press Release
Introductory statement to the press conference (with Q&A) European Central Bank, Mario Draghi, President of the ECB (4/9/14)
Webcast of the press conference 4 September 2014 European Central Bank, Mario Draghi, President of the ECB (4/9/14)

Questions

  1. Summarise the ECB’s monetary policy measures that will be coming into effect over the coming months.
  2. How does the QE announced by Mario Draghi differ from the QE that has been used by the Bank of England?
  3. Would it be a realistic option for the ECB to reduce its main rate below zero, just as it did with the deposit facility rate?
  4. What is meant by ‘securitisation’. Explain how asset-backed securities (ABSs) and covered bonds are forms of securitised assets.
  5. Why will the purchase of mortgage-backed securities not necessarily give a boost to the housing market?
  6. How does the effectiveness of any QE programme depend on what happens to the velocity of circulation of created money?
  7. What determines this velocity of circulation?
  8. Why are ‘animal spirits’ so important in determining the effectiveness of monetary policy?
  9. Are there any moral hazards in the ECB actions? If so what are they?
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Eurozone becalmed in the doldrums

The eurozone recorded 0.0% growth in the second quarter of 2014. While the UK and USA are now experiencing relatively buoyant economic growth, the eurozone as a whole is stagnating. Some of the 18 eurozone countries, it is true, are now growing, including Spain, Portugal, Ireland and the Netherlands. But the German and Italian economies contracted in the three months to the end of June, while France experienced zero growth.

This will put growing pressure on the ECB to introduce quantitative easing (QE) through the direct purchase of government bonds or other assets. Although this has been a key policy of many central banks, including the Bank of England, the Fed and the Bank of Japan, up to now the ECB has focused mainly on providing cheap funds to banks to encourage them to lend and keeping interest rates very low.

In June, the ECB did announce that it would explore the possibility of QE. It would also introduce €400 billion worth of targeted long-term lending to banks (targeted longer-term refinancing operations (TLTROs)), and would cease sterilising the extra liquidity injected through the Securities Markets Programme, which involved the purchase of existing bonds on the secondary market.

These plans and their implications are examined in the blog post, The ECB: tackling the threat of deflation.

But even if it does eventually introduce QE, this is unlikely before 2015. However, the first €200 billion of TLTROs will be introduced in September and the remaining €200 billion in December. The ECB hopes that these measures in the pipeline will give a sufficient stimulus to rekindle economic growth. But increasingly there are calls for something more dramatic to be done to prevent the eurozone as a whole slipping back into recession.

Articles

Eurozone economy grinds to halt even before Russia sanctions bite Reuters, Michelle Martin and Martin Santa (14/8/14)
ECB under pressure to boost growth, analysts say BBC News (14/8/14)
Eurozone growth at zero as Germany slumps, France stagnates Deutsche Welle (14/8/14)
Eurozone crisis: The grim economic reality BBC News, Gavin Hewitt (14/8/14)
Eurozone growth splutters to a halt as crisis enters new phase The Guardian, Larry Elliott (14/8/14)
Eurozone can learn from George Osborne and Bank of England stimulus The Guardian, Larry Elliott (14/8/14)
Broken Europe: economic growth grinds to a standstill The Telegraph, Szu Ping Chan (14/8/14)
One-in-three chance the ECB conducts quantitative easing next year – Reuters Poll Reuters, Sumanta Dey (13/8/14)
Eurozone’s Unravelling Recovery: What’s Going Wrong Across Troubled Currency Bloc International Business Times, Finbarr Bermingham (14/8/14)
France calls on ECB to act as eurozone growth grinds to a halt The Guardian, Larry Elliott (14/8/14)
That sinking feeling (again) The Economist (30/8/14)

Data

GDP stable in the euro area and up by 0.2% in the EU28 eurostat euroindicators (14/8/14)
Statistics Pocket Book ECB
European Economy: links to data sources Economics Network
Euro area economic and financial data ECB

Questions

  1. Explain how quantitative easing works.
  2. Why has the ECB been reluctant to introduce QE?
  3. What is meant by sterilisation? Why did the ECB sterilise the effects of the assets purchased under the Securities Markets Programme? Why did it cease doing this in June?
  4. How have events in Ukraine and political reactions to them influenced the eurozone economy?
  5. Should QE be ‘fast tracked’? Would there be any dangers in this?
  6. What is the ‘Funding for Lending’ scheme in the UK? Is the planned introduction of TLTROs similar to Funding for Lending?
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A growing debt burden

The linked article below from The Guardian paints a disturbing picture of the long-term problem of servicing both private-sector and public-sector debts.

With interest rates at historical lows, the problem has been masked for the time being. But with interest rates set to rise within a few months, and significantly over the coming years, the burden of debt servicing is likely to become severe. This could have profound effects both on long-term economic growth and on the distribution of income.

As the author, Phillip Inman states:

The funding gap is growing and with deficits on so many fronts, it is hard to see how promises to pensioners and health service users can be met without a dash for growth that is unsustainable, a switch to dramatic cost-cutting in other areas or higher taxes on those who came through the recession relatively unscathed.

You are probably facing the problem of growing debt yourself. How long, if ever, will it take you to repay your student loans? What impact will this have on your ability to spend and to have a ‘decent’ standard of living? Will you be able to afford a mortgage large enough to buy a reasonable house or flat? Will you be able to afford to do a masters degree or PhD without support from your parents or relatives or without a scholarship? And even if you manage to secure a well-paid job, will you be able to afford a reasonable pension for when you eventually retire?

The article looks at the nature of the problem and its causes. It concludes by saying:

Britain has become expert at putting off decisions and hoping for something to turn up. Without a return to ultra-cheap commodities, another technological/productivity revolution, or a return to more modest living and delayed gratification, it’s a plan that is running out of time.

Article

Trouble in store: the grave future of British public and private debt The Guardian, Phillip Inman (20/7/14)

Report

Fiscal sustainability report Office for Budget Responsibility (10/7/14)
Fiscal sustainability report – Executive summary Office for Budget Responsibility (10/7/14)
Fiscal sustainability report – Supplementary data series Office for Budget Responsibility (10/7/14)

Questions

  1. Why is public-sector debt likely to continue rising significantly over the coming years unless there is a concerted policy to make cuts in public expenditure?
  2. What factors are likely to lead to a rise in private-sector debt over the coming years?
  3. What factors have caused a redistribution from the younger to the older generation?
  4. How have ultra low interest rates affected the distribution of income?
  5. What is likely to happen to the gap in wages between ‘graduate’ jobs and ‘non-graduate’ jobs? Identify the factors likely to influence this gap?
  6. What is meant by ‘hire purchase’? Are leasing schemes for car purchase a form of ‘hire purchase? Are there similar schemes in the housing market?
  7. Does it matter if a country’s debts rise (either public or private) if the creditors are in the same country? Explain.
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Galvanised into action

The Competition and Markets Authority (CMA), launched in October 2013, has been operating since April of this year. It is the successor to the Office of Fair Trading (OFT) and the Competition Commission. One of the current cases under investigation by the CMA is that of suspected criminal cartel activity in the supply of galvanised steel tanks.

On 11 July, Clive Geoffrey Dean, a former director of Kondea, and Nicholas Simon Stringer, a former director of Galglass, appeared before Westminster Magistrates Court. They were charged with dishonestly agreeing with others to divide customers, fix prices and rig bids between 2004 and 2012. The deals were with a number of companies. The charges are under section 188 of the Enterprise Act 2002.

This is the second prosecution in this case. On 17 June 2014, Mr Peter Nigel Snee, Managing Director of Franklin Hodge Industries, pleaded guilty to similar charges.

Under the Act, directors found guilty face custodial sentences of up to 5 years and unlimited fines. The CMA and government are keen to send the message that they will not tolerate cartels and that board members had better beware of colluding with other companies. Indeed, the CMA is committed to pursuing cases of suspected criminal cartels more frequently and more rigorously.

The question is whether this will deter criminal collusion or whether it will simply make companies more careful to keep collusion hidden from the authorities.

Two men face charges in ongoing criminal cartel investigation CMA Press Release (11/7/14)
The First Real Test of Sentencing for the UK Cartel Offence Competition Policy Blog: UEA/ESRC/ccp, Andreas Stephan (24/6/14)
An Important Watershed in the CMA’s Prosecution of the Criminal Cartel Offence Eversheds (18/6/14)

Questions

  1. What types of restrictive practices constitute ‘cartel agreements’?
  2. In what ways are cartels against the interests of their customers?
  3. Are there any ways in which consumers might gain from a cartel?
  4. What factors are taken into consideration in deciding whether a director is guilty under section 188 of the 2002 Enterprise Act.
  5. Find out what other cases are being considered by the CMA. Choose one or two and examine how the activities of the firms/people involved might adversely affect consumers or other firms.
  6. Is anti-cartel legislation in the UK similar to that in the EU for cartels operating in more than one EU country?