The spectre of the 2 ‘B’s: Scotland, the Bond Markets and Brussels

An independent Scotland may not possess their own currency come 2016, but its citizens will expect the country to have its own fiscal policy powers. No one north of the border would be wise to get too excited about these. New pressures from beyond Scottish shores , namely from the bond markets and the EU, will leave such new ‘powers’ heavily curtailed, leaving ‘economic independence’ looking rather hollow as a result

 

Economists of various different persuasions have been sceptical, if not scornful, of Alex Salmond’s economic plans for an independent Scotland. last week preeminent economist Paul Krugman stuck his oar in, equating the problems faced by an independent Scotland as comparable to that endured by countries like Spain as a member of the post-crisis Eurozone. Bank of England Governor Mark Carney also put in his two-penneth, arguing that a Sterling Union would be “incompatible with sovereignty”. The debates over economic ideas is undoubtedly one had with one’s head as supposed to one’s heart. If you feel – as an actual or domiciled Scot – that Scotland should be independent then perhaps this is enough for a YES vote. A more head-based costs-benefits calculation based on economics is difficult, simply because the two campaigns and aligned groups have used often tenuous sets of numbers which are either far too predictive in nature or are laced with horribly biased assumptions. What complicates this further is the role of important forces and actors in the global economy, that effect any independent European country, that are simply being ignored by the YES and NO camps. One relates to the broader EU question, the other to the bond markets that an independent Scotland will need to turn to to borrow money.
The broader ‘European Question’ has formed part of the debate. The nature of what the European Commission will demand for Scottish EU reentry however has not, nor have issues concerning the bond markets and Scotland’s ability to borrow. The bond markets, the European Commission and the European Central Bank (ECB) have been on a full blown austerity kick responsible for the most ruthless agenda of fiscal retrenchment we’ve seen in Europe since 2008. Scotland would be far more exposed to this as an independent country. For the grand prize of national self-determination this maybe worth it­—or maybe it won’t be; it depends how important this idea of ‘economic independence’ is a Scottish voter. It is perhaps ironic that a NO vote that produces some form of Devo-Max might provide the fullest degree of economic independence to Scotland; particularly given the SNP’s idea of a ‘Sterling Union’ where most economic policy will still be in London! Scotland would be greatly shielded from the bond markets and Brussels and would have greater tax raising and limited borrowing powers. However, in the event of independence, the two-pronged fork of Euro and bond market-induced austerity will not be kind on a country (one assumes) run by a self-avowed progressive nationalist party that have set themselves apart from the austerity politics so popular in London.

 

Bound to the will of the Bond Markets

 

“I used to think if there was reincarnation, I wanted to come back as the president or the pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody.”

 

This quote from Bill Clinton’s election guru James Carville has been churned out a number of times since 2009 when the bond market, accompanied by their credit rating agency handmaidens, started flexing its muscle. In Europe they made it painfully clear to Eurozone countries, many of whom embarked on extensive post-crisis spending, that austerity had to become the new rule. The ability for countries to borrow became much more expensive as the yields (rate of interest) attached to their government-issued bonds jumped. As Krugman rightly argues in his recent Scots, what the heck? article, Spain, as a member of the single currency, was left with few macroeconomic policy tools (interest rates and exchange rates) to revive their collapsing economy post-2008 and the fiscal policy tools that remained where taken off them by the EU, the IMF and the bond markets as they demanded on-going debt consolidation plans in exchange for bail outs. Governments must borrow, and despite the existence of large public deficits needed to borrow more amidst the rubble of Lehman Brothers. This gave the already powerful bond market greater power to shape public policy agendas and political debate. The bond market, and the layers of secondary markets underneath, is the world’s big debt market. Post-Lehman Bros. the bond markets and the credit rating agencies succeeded in blackmailing governments onto an austerity path leaving national governments to make the political argument for austerity. With public accounts already straining, the pressure even in the UK, who still possessed means to affect monetary policy and external value of their currency unlike Eurozone countries, bowed to this new agenda. The public accounts of some countries were in better condition than they were 10 years prior when the bond markets didn’t have a problem lending them money.  France got its debt downgraded in 2012 before Britain did (2013), despite the debt levels in Britain being in a worse state. The difference being that the bond markets saw Britain doing its job in public deficits, while the French were, at the time, more ambivalent (although this didn’t stop an eventual downgrade in the UK).
So, austerity became the new rule, but none of this happened because these overlords of global neo-liberalism were correct to force this painful medicine down the throats of Europeans – they weren’t. This alliance, with the bond markets at its heart, successfully formed a new conventional wisdom that extreme fiscal retrenchment was right and just. A phenomenon built on discourse, market sentiment and politics rather than economics and raw numbers.
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This poses a pretty important question: in the event of independence, how will the bond markets respond to Scotland’s level of public debt and what will this mean for Scottish public spending choices? Will the bond markets slap punishing yields on Scottish bonds that will force the sort of fiscal retrenchment the nationalists want to avoid? If so, for how long will this last? Or will something more benign occur? Will the global lords of finance impose its view despite its own economic logic being so hollow, as it was from 2009 onwards? Of course, the interest rates of bonds (yields) change over time and also depend on the length of issued bonds (some are 2 years, some 5, 10 or 20 or sometimes longer). But a newly independent Scotland will want to use bonds with a longer time horizon for new infrastructure spending projects (These longer run bonds also provide strong indications of market sentiment of a country’s real interest rates). If things start off rocky in 2016, things may improve later as invested borrowings bear their fruit (when used properly). However if the longer run bonds yields get too high early on it’ll be harder to get these infrastructure plans off the ground. Any delay in this will seriously hamper long-term public spending plans.
There are two starkly competing sets of figures in judging Scotland’s level of public debt: those produced by the London-based Institute for Fiscal Studies (IFS) and those by the Scottish Government Expenditure and Revenue Services (GERS). Such numbers are produced despite us having little idea what things like a tax system, spending priorities and economic growth will look like, nor how North Sea oil will be a) divided geographically and b) how much oil and gas is still produced. It’s very difficult to make credible predictions like these without these! Both organisations have proven themselves unreliable sources of data for these reasons and exhibited some sort of bias as a result. The bias of the IFS is one more ideological in terms of economic theory and is in near lock step with the UK Government’s OBR and the broader austerity agenda in London. The IFS suggest that a Scottish fiscal hole of anywhere between £3bn and £10bn beckons, the sheer breadth of which must raise serious questions as to these numbers’ plausibility. GERS produces far a more benign sets of figures on Scottish debt but has so obviously slanted its numbers and accompanying analysis to the nationalist cause that one can’t help but question these.
Nonetheless, the actual numbers, and whose is right or wrong, doesn’t really matter. The real issue is this: Will the austerity-drunk bond markets set a yield regime for Scottish debt closer to the IFS-type numbers or the figures from GERS? the argument here is not controversial: GERS may indeed by right, but the bond markets, the ECB and Commission are likely to push Scotland down an austerity route based on numbers that will look much more like those of the IFS. This raises further questions: will this be worse than the regime of fiscal retrenchment Scotland must currently endure? Would ‘Devo-Max’ (whatever version wins out) better aid Scotland’s ability to manage its finances ‘independently’? these are all interesting questions. Although there are many problems of prediction with these, the ruthlessness of the bond markets in the current austerity era is however beyond question.

 

The European Commission, the new Scottish government and EU austerity agenda

The EU question is probably the weakest part of the independence offer. Salmond and Sturgeon have been very very poor on this subject. When Nicola Sturgeon stood in of the Scottish Parliament in December 2013 and said the ‘European Commission is not the final arbiter’ on EU accession decisions, students of the EU tore their hair out. Ignoring the role of the EU’s executive body in EU accession process is profoundly stupid. As we found out, the ‘legal advice’ this statement was based upon was fictitious. It is clear that some form of prolonged negotiation process must be undertaken for Scotland to resume its place in the European project, either through a formal accession process (very likely) or through some backdoor means negotiating with the Commission (very unlikely). The chances that Scotland will be able to reenter the European ‘club’ on the same terms it currently enjoys are very small. The Commission has an agenda to push to integration process as far as possible and there are number of things that it will want to impose on Scotland in exchange for re-entry. in short: the Commission will want Scotland to go through a re-negotiation process. The member states situation is more complex, but there will be plenty of recent entrants to the EU who will not like that idea of Scotland becoming a member without having to jump through the same hoops they did, even if they were already a member as part of the UK. Issues concerning Spain and Catalonia have been covered a great deal on this question. But it does underline the importance of politics rather than law in this. The Treaty says nothing about this scenario of a country seeking to join after becoming independent from an already existing member state (Oddly. Perhaps someone should fix this?!). The lack of law in the area doesn’t make this any easier. The bothersome politics is enough, not least that represented by the Commission who will impose a good deal on Scotland for it to get on the Commission’s side.
This will include a liberalisation agenda that Scots thought they’d seen the back of from London, it will most certainly include an austerity agenda that will entail cuts in public spending as well as demands to liberalise labour markets. Scotland will be mandated to join the 2012 ‘euro-pact’ that the UK is currently exempt from and will dominate Scottish fiscal policy whilst monetary policy will be left in London! Scotland very well might be able to negotiate its place outside of EMU, but this will have its cost elsewhere in its negotiations with the Commission. In any event, Scotland won’t avoid the dreaded Euro-pact. This will not only see an austerity agenda forced upon Scotland that the SNP has repeatedly stated it doesn’t want, but it also will see the permanent loss of  crucial areas of economic sovereignty.

 

Double trouble

In a way, the argument above indulges in the similar sort predictive conjecture that most of the independence debate (on both sides) has been marked by. There are however two differences. One: I am prepared to admit this! (shock!!) Two: this is based not on numbers and economistic logic but on notions of political power and dominant discourse. This may be more slippery to define, but is certainly no less real.
On the subject of the currency, Salmond may well seek to create a new Scottish currency in 10 years or so. But he was a student of economics, he knows what the bond markets will do if they aren’t convinced of Scottish growth and debt, but obviously for the sake of politics he can’t say this. On the issue of Scotland’s EU intentions however, he has unfortunately engaged in the sort of political fraud that cannot simply be corrected ‘at the next election’. This is for life.
Being half Scottish, having lived there, studied there and worked there, I share the sentiments concerning Scottish nationhood and the abuses that London – in the last 35 years in particular – has inflicted upon Scotland. The dominance of southern political whims and southern interests over the rest of England, Wales and Scotland has long made many, quite rightly, angry. So we must understand the role emotional impulses and in more positive ideas of identity and nationhood play. But if a Scottish friend of family member of mine is voting YES on September 18th, make sure it’s for emotional, identity based reasons – the arguments based on economic independence are likely to be a Trojan horse filled with the legions of austerity.
So, Austerity if you do, austerity-plus if you don’t.
Links
Paul Krugman – Scots, What the Heck?
IFS – 2013. Government spending on public services in Scotland: current patterns and future issues 
IFS – 2013, Fiscal Sustainability of an Independent Scotland
CPPR Briefing Paper, ANALYSIS OF SCOTLAND’S PAST AND FUTURE FISCAL POSITION