Currency union and buses

Studies on the fiscal implications of constitutional change are a bit like buses, nothing for ages and then a series of contributions all at once.

It would be remiss of me not to modestly point out that the Red Paper Collective published one of the earliest contributions to this debate. My chapter in ‘People Power’ last September covered this ground and highlighted the limitations on monetary and fiscal policy of the SNP’s‘Sterling zone’ plan. This plan has been fleshed out in the work of the Fiscal Commission Working Group that I have previously commented on.

The Treasury have now chipped in their tuppence worth, actually a lot more than that at 113 pages! They, not surprisingly, argue that the UK is one of the, “most successful monetary and fiscal unions in history”. This claim is largely based on the pooling of risk and resources, in contrast to the Euro. No opportunity is missed these days to have a pop at the EU, to assuage Tory back benchers!

The Treasury correctly points out that an Independent Scotland would need to establish its own institutional framework. The notion argued by some in the Yes campaign that Scotland owns part of the Bank of England and the pound is frankly risible. It then sets out the currency options, including the SNP’s preferred plan of a formal agreement on the use of Sterling. If such a plan could be agreed, then an Independent Scotland would need to agree, “a negotiated set of constraints on its economic and fiscal polices”. The paper makes it clear that there is not a clear economic rationale for rUK to agree such a plan, citing the Euro experience. That leaves Scotland with the even less attractive option of using Sterling with no agreement and no control over monetary policy.

SCDI have covered similar ground with their Future Scotland‘Macroeconomic and Fiscal Sustainability’ paper. They set out in some detail the economic context and consider the fiscal position of an Independent Scotland. They also highlight that a rUK Government may seek to limit flexibility over spending and borrowing and the Bank of England would set an interest rate for the rUK, not an Independent Scotland. SCDI highlights the concerns over these arrangements for key service industries like finance. Not to mention the less publicised implications for credit ratings and a potential risk premium for borrowing.

CPPR has published a briefing paper ‘Measuring an Independent Scotland’s economic performance’. This concisely looks at growth and standard of living and asks what does this mean for the constitutional debate. They make the point that GDP per capita is not the same as household income. A point reinforced this week by Brian Ashcroft in his Scottish Economy Watch blog. Scotland’s GDP would be highly dependent on erratic oil prices a significant proportion of which is overseas owned.

There is also a chapter on this issue in a new book ‘Scotland’s Future’ by Professor John Kay. He clearly sets out the currency and policy options for an independent Scotland and considers historical precedents. He agrees that the Sterling Zone option would be the best for an Independent Scotland, but points out that any membership of the monetary policy committee would be an economist with Scottish connections, not a Scottish representative. He concludes that, “Monetary policy for Scotland would therefore be determined by a mechanism over which Scots and Scottish interests would have at best marginal influences and, by design, no political influence”. However, his key point is that a small country close to its major trading partner has limited economic independence anyway.

A different perspective comes from the Reid Foundation with a paper by Jim Cuthbert that makes the equally valid point that the UK’s economic performance reflects chronic long term mismanagement. In particular, the underlying balance of trade and focus on the financial sector that was not in the interests of the wider economy. It exposes the UK economy to a credit risk and makes us sensitive to external shocks. On this basis he argues that Scotland should not remain in a ‘sub-optimal currency union’. This line has been picked up by many in the wider Yes campaign last weekend, including the Greens and the SSP. Of course it also used to be Alex Salmond’s position, as Andy Nicholl reminded us in his column in the Scottish Sun. However, it would appear that his statement, “Sterling is like a millstone around Scotland’s neck” no longer applies, even if his new allies wish it did! Mind you he also once said, “The SNP believe that entry to the Euro would be in Scotland’s economic interests”. Of course, in fairness, he was not alone in that view at the time.

So where does all this take us? I would argue back to my initial analysis in last September’s Red Paper booklet. A currency union with rUK may well be the best option for Scotland, although personally I am not convinced, but it comes at a price – fiscal and monetary policy directed by another country. This is a strange sort of independence and one that gives us less influence over these issues than we have at present, or could have with greater devolution. The political conundrum for the SNP is that if they abandoned the pound, the polls show a big drop in support for Independence. They may therefore just have to accept John Kay’s economic reality – that Scotland is tied to its major trading partner, Independent or not, and the best we can do is tinker at the policy edges.

Pensions and constitutional change

The Institute of Chartered Accountants of Scotland (ICAS) has published a useful introductory paper on pensions and constitutional change. This is an area of the constitutional debate that has been given little attention so far. We also need to get past the lurid media headlines on the report and the equally inadequate Scottish Government brush off. Difficult issues like pensions cannot be ducked – they are too important to all of us.

The paper poses questions covering the state pension, public service pensions and private pension schemes. It also recognises that Scotland only data is limited.

The state pension is paid from general taxation each year. There is no fund as you would have in a company pension scheme, so in pension terms this is called an unfunded scheme. With all the current focus on welfare reform, we should not forget that state pension payments total £82 billion, representing 40% of all social benefit payments and 13% of UK expenditure. There would need to be complex negotiations post independence to allocate liabilities given that the population is getting older. Data is limited and there is no UK, let alone Scottish, measure of accrued liabilities. There are also EU rules on pension payment therefore Scotland’s membership, or not, of the EU becomes an issue again.

Then we have public service pensions. The largest scheme in Scotland is the Local Government Pension Scheme (LGPS) that I am currently in the process of renegotiating. I don’t see any major independence issues here, as the Scottish scheme is already separate from the England and Wales scheme, has its own funds, regulations and is in good shape. Given the unwarranted interference in the scheme from Westminster, I would welcome some separation or complete devolution!

However, the other schemes (NHS, Teachers, Police etc) are unfunded in the language of the ICAS paper. I prefer the description ‘pay-as-you-go’, because they are funded each year by employee and employer contributions. This means that in any one year there can be a surplus or a deficit, but the balance is not retained. The UK Government calculates unfunded public sector pension liabilities at £893 billion and the Scottish Public Pensions Agency (SPPA) calculates Scottish unfunded liabilities at £66 billion. These are big scary numbers, but must be treated with caution. All public sector workers are not going to retire tomorrow and they will continue to pay contributions into the schemes. So long as governments at Scottish and UK level stop pushing them to opt out, through increased contributions and the 2016 National Insurance increases.

How you allocate past and future liabilities will be a very complex negotiation indeed. For example, the NHS scheme is currently in surplus each year, so if I was the Scottish Government negotiator I would be looking for some recognition of that. I would also want some credit for past employer contribution shortfalls. On the other hand, there are schemes currently in revenue deficit and those liabilities might pull in another direction. We should also remember that the cost of public service pensions is declining as a percentage of GDP. Changes to the schemes including RPI to CPI and later retirement ages will reduce costs further. The ICAS paper doesn’t really offer any solutions, but rightly calls on both governments to do some calculations. The Government Actuary Department (GAD) ought to be able to produce some numbers to better inform the debate.

Private pension schemes add another level of complexity. We have UK regulatory bodies the FCA and the PPF and new bodies would need to be established. Financial regulation (FCA) is relatively straightforward but pension protection (PPF) would require detailed negotiation and probably transitional arrangements.

If Scotland is in the EU then the IORP Directive provisions apply. This is supposed to stop cross-border pension deficits by ensuring schemes are fully funded. Many schemes are currently in deficit recovery mode over many years and would certainly not welcome having to plug that gap in one year. It could bury some companies. However, again we shouldn’t panic as there are ways around this, most obviously by splitting funds between English and Scottish members. Although this could be difficult for some schemes as the Scottish element might be too small to be viable.

Tax is another complexity identified in the ICAS paper. This is already being addressed by HMRC because of the tax varying powers in the Scotland Act 2012. These arrangements will also be useful should there be further fiscal devolution including all income tax as proposed in the recent Scottish Labour paper, and indeed in my own contribution to the Red Paper. There are further complications for those in Defined Contribution schemes that purchase an annuity. But again, these are not insurmountable.

There are few more important issues than security in retirement. This means pensions from all sources are hugely important and need serious consideration as part of the referendum debate. ICAS should be congratulated for this helpful contribution to the debate, once people get past the headlines and the Scottish Government response. The Treasury and the Scottish Government both need to do some serious and credible work to address this issue.