Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday 6 March 2014

Economics, Politics and Naivety

I’m no fan of UK Chancellor George Osborne’s economics, but he is a pretty good politician. He pulled out all the stops a few weeks ago when he ruled out a monetary union if Scotland became independent. (For the background, see here.) Not only did he get his Labour opposite number Ed Balls to agree, but he also had the Treasury’s Permanent Secretary take the highly unusual step of publishing personal advice that monetary union was unwise.

What has rather amused me since has been the reaction of some that this is only a bluff. Incredulous indignation brimmed over from Kevin McKenna in the Observer: “Is a UK chancellor of the exchequer seriously asking us to believe that he is contemplating damaging the entire UK economy following a yes vote?” The chair of the Scottish government's fiscal commission working group, Crawford Beveridge, whose other members are Professors Andrew Hughes Hallett, Sir Jim Mirrlees, Frances Ruane and Joseph Stiglitz, said that none of them believed "for a minute" that chancellor George Osborne was serious.

Why was I amused at the idea that George Osborne could not possibly plan to do something that would be damaging to the economic interests of the UK economy? Just yesterday in opposite pages of the FT were two news items that gave clear examples of where for the Conservatives politics trumps economics. First, the chief executive of the engineering company GKN warned that the possibility of Britain leaving the EU following the proposed referendum was harmful to UK companies and was already being used by competitors against them. The second was on a report that migrants to the UK set up one in seven new UK companies.

Now you could argue that planning a referendum on leaving the EU and curbs on immigration are not ‘true’ Conservative policies, but are being forced on the party by the rise of UKIP. I’m not sure about that, but it is not the point. Both policies are clearly harmful to the economy as a whole (don’t forget the damage that the current immigration policy is doing to one of our more successful export industries, higher education), yet are being adopted for political reasons. Politics is dominating economic interests.

And then there is the small matter of fiscal austerity, which the OBR estimates has reduced UK GDP by a total of over 5% of annual output up to last year. That is a large economic price for the political goal of a smaller state.

Perhaps the bluff idea comes from the perception that once the Scots have voted yes, the political incentive to say no to monetary union disappears. That seems naive. Losing Scotland will be deeply humiliating for this government, and unpopular among remaining UK voters. The political imperative after a Yes vote will be to make it appear as if the Scots have made a mistake. In that situation, are politicians likely to quickly turn around and say they have changed their minds on monetary union?

The incentives of the Scottish government after a Yes vote are more interesting. Without a monetary union, will they continue to use sterling or will they create their own currency? While keeping sterling will be the least disruptive option, in political terms it would vindicate Osborne’s strategy, because the remaining UK would get most of the benefits of monetary union without the costs. [1] A new currency would give Scotland more independence, which would seem to be where the Scottish National Party’s heart is, particularly if they could say that this is an option they had been forced to take by the ‘auld enemy’. So I think my money is still on a new currency if there is a Yes vote. 

[1] (Postscript) This option has clear economic costs for Scotland, as this post by Angus Armstrong makes clear. 


  1. No doubt a currency union would be very beneficial. For Scotland.

    It seems to me to be much more doubtful whether it would be in rUK's interests, for the reasons given by Wolf here

    We just had a very large demonstration of the folly of monetary union, absent fiscal and banking union.

    In any event, the political timetable is ignored in the above. The referendum is at the end of September. the next GE is at the beginning of May. From there on it will be Balls Salmond will be negotiating with, not Osborne. What Osborne thinks will be neither here nor there.

    Balls won#t be entering into a currency union either, for precisely the same reasons Osborne would not.

  2. Interesting game theoretic problem - is George Osbourne's threat credible? A few possibilities as I see it. If the game is repeated he may want to follow through on this statement to build a reputation - unlikely in this case (too isolated a situation). Second, Osbourne suffers few costs from harming the UK economy - more interesting this point. Will he be derided by the public for damaging rUK interests or applauded as a result of our sudden willingness to hurt our new neighbours? Third, Osbourne is bluffing and the sequential equilibrium tells us if Scotland vote Yes Osbourne will allow them to keep the currency. This seems most likely

  3. I was wondering how a new currency would interact with the national debt? The yes campaign says they might take on a debt equivalent to 72% of Scottish GDP ( If they then move to a new currency, they suddenly have a very large foreign currency debt. How would bond holders view this? If you have say 5p in every pound of debt UK debt transferred from AAA UK debt to a potentially lower rated Scottish debt, isn't that technically a default?

    1. No. The deal would have to be that Scotland issues debt denominated in its own currency, with rUK as the creditor to a sum equivalent to its proportion of the UK debt. rUK can then sell it or not as it sees fit. rUK remains the debtor for all the current sterling debt.

  4. A few years ago Alex Salmond said the pound Sterling was a millstone round Scotland’s neck. Then when he is threatened with being ejected from the Sterling area he says he’s being bullied. He’s in seventh Heaven. Either way he can claim victimhood.

  5. I have read a few essays recently by J G A Pocock, the pioneer of New British History, who has attempted since the 1970s to create a movement in which British history is assessed in a way more than just English history with the other smaller regions tacked on at the end.

    How well is it going?

    Too soon to say.

    But certainly the idea of Britishness has its origin in Scotland, and so if you remove politically Scotland from Britain in 2014, how robust the unity other regions will be is a big question.

    And given that the Tory Party is pretty much an English party, if not a south-east England party since the Thatcher period, I would say Osborne is a product of his time rather than a shrewd politician. I don't see him making the running, just following out trends that in the Tory Party have been in train for some decades.

  6. I think this is exactly wrong. Osborne got the economics right and the politics wrong.

    The economics: the eurozone crisis tells us that a currency union without political and fiscal union is a bad idea. There can be no equal risk-sharing between an economy of 5 million and one of 55 million. It would not be in rUK's interests. Any possible formal currency union would require tight fiscal rules - defeating the point of independence.

    The politics: if you vote the wrong way, we'll take your toys away and you'll be fucked.

  7. Balls wasn't agreeing with Osborne - Osborne was agreeing with Balls ...Ed B having said much the same things in October

  8. Regarding the view that austerity has reduced GDP by 5%. Surely the idea is that in the longer term, the UK's economy can more than make up that difference by becoming better.

    For example less state means less tax which means less dead weight loss and clearer price signals leading to better allocation of resources.

    1. Maybe, but if you wait until after the recession to reduce the size of the state, then the short run costs largely disappear.

  9. The only reason I can see for scotland saying they wish to keep sterling is a psychological one to help the yes vote. After the vote, it will be of no interest.

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  11. I almost always agree with Simon. But I am convinced that a full currency union with Scotland would not be in rUK's interests, for reasons I have tried to lay out in several columns.

    But, beyond that, it seems to me weird for Scots to argue at one and the same time that "we must be an independent country, but also a small part of a currency union in which our fiscal and monetary policies would be dictated by a country over which we would no longer have any political influence." And this would NOT be reciprocal. rUK would (and should) not allow Scotland to dictate its fiscal policies. Nor would (or should) it permit regional interests per se to dictate monetary policy. On the contrary, the modus operandi of the Bank of England would need to be as it is now: it would have a committee that does not consist of representatives of regions, but rather one dedicated to the stability of the entire economy of which Scotland would be a very small part.

    In what sense would this be independence?

    1. I'm Scottish, I live in Scotland and I'm voting YES. If you have paid attention, you would have picked up that regional representation for ALL the regions of the Sterling zone on BoE committees is the monetary union that Alex Salmond seeks.

      Mr Wolf seems to think that it is acceptable for one region to have total control and dictate terms to the rest of the union, so how does he reconcile that view with what we have now? BoE is an organization which is under the thumb of the City and looks after the City to the exclusion of all others. I suspect the City is in a quandary, it wants to have both the prop of Scottish oil money, and to retain control of BoE. In the event of a YES vote, they will have to give one up.

      Personally I would be quite happy with the second option – no formal union, and a currency board - especially as it would put a curb on the banks and financial firms - something the Westminster government has conspicuously failed to do. The scorn with which those same Westminster politicians heaped on Panama (which uses the US dollar and a currency board) shows the depth of their ignorance in financial matters, and probably also their personal greed which is based on short term get rich quick profiteering. Yes Panama did not have a boom - but then they did not have a bust either - they have had steady but unspectacular growth. Which policy has been better over the long run for the people of Panama?


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