The release of the yearly Government Expenditure and Revenue Scotland (GERS) report is one of the most intensely debated topics within the Scottish constitutional question. The debate on this report exists in two parts. Firstly, on the methodology of the report itself and how accurately it represents the Scottish economy within the UK. Secondly, what the data suggests is what an independent Scotland’s fiscal balance could look like and what challenges this could entail.
These two debates lead to a healthy and largely informative discussion that introduce activists to new macroeconomic concepts. Alas, the debate also reinforces orthodox economic language and misleading claims that exist on both sides of the debate. This fundamentally comes from a misunderstanding how the macroeconomic system works in the UK today. Responding to these issues will be the main purpose of this article, whilst leaving room to discuss methodology in the future.
GERS functions as a positive advertisement for membership of the UK because its data suggests that Scotland is subsidised by other UK regions. The argument that follows is that Scotland’s notional deficit, which as part of the UK was £15.1 billion in 2020, could only have been achieved from the spending of the UK Treasury.
Some of the wilder responses to this year's report include the idea that in order to ‘balance’ Scotland's fiscal books, it could no longer employ anyone in the NHS, or that pooling and sharing resources across the UK benefits Scotland. These assertions are fuelled by a misunderstanding of how modern governments operate with the fiscal levers that are available to them.
Claims on either side of the constitutional debate include:
An independent Scotland would have to “balance the books” to control its finances.
Scotland is subsidised by taxpayers from the rest of the United Kingdom.
Independence will allow Scotland to better manage a deficit compared to devolution.
The first claim is a dangerous route to austerity, the second claim is wrong from an operational analysis and the third claim is true from a macroeconomic perspective.
1. Must Scotland “Balance the Books?”
The first problem around the GERS discussion is the sole focus on one sector of the economy - that is the government sector. By focussing the narrative around the government as if it were a currency user, as opposed to a currency creator, political and economic commentators ignore two other vital sectors that must be included in any analysis of Scotland’s overall fiscal position - private domestic sector and foreign sector. The best framework to look at any country’s overall macroeconomic position is to use the Sectoral Balance sheet.
When using the sectoral balance framework, the net sum of all equity of the economy is equal to zero. If the private sector is in a surplus, then that requires one of the other sectors to be in a deficit. In this case, it is posited by the GERS data and analysis that Scotland has a government deficit. So is this correct and does it matter?
When the government sector is in deficit, the private sector is in surplus and can therefore expand, increasing economic activity. A government deficit quite simply adds net-financial pound assets to other parts of the economy. This increases our income, which is spent into the private sector, which can then afford to expand projects and production, and in turn generate more growth and jobs. By increasing our productive output and further utilising our resources, we create a stable and functioning economy. This is completely normal and necessary in order to run a healthy economy. Thus thinking that deficits are somehow economically wrong has no logical basis.
In fact when governments attempt to ‘balance the budget’ they can face serious challenges. Before the global pandemic, the UK government had moved towards a surplus, whilst the private sector has been moving to a deficit. With both the coalition and conservative governments imposing austerity on the population of the UK, there are now less pound assets in the economy, less spending and thus a fall in private incomes.
If those in the private sector want to limit the damage caused by their lost income, they must use their savings, sell their assets or borrow from commercial banks. Less money in the private sector spent on goods and services strangles growth and increases private debt. That is exactly what has happened when governments have attempted to balance the books and it is a recipe for recessions.
The realities of monetarily sovereign government accounting are largely ignored within the GERS debate and the sole focus on the government sector and what that means for ordinary people is equivalent to describing the score in a football game as - Celtic 1.
Thus a Scotland, either within the UK, or as an independent country should embrace a government deficit to mitigate the current austerity measures that have been imposed over the last decade. In Debunking the Public Debt and Deficit Rhetoric , Economics Professor Eric Tymoigne states,
“If a growing public debt is so concerning to some, it is because it is supposed to raise interest rates, slow economic growth, raise inflation, and raise tax rates. Even a casual look at the evidence shows that these concerns are not warranted and that prior beliefs should be reversed. Deficits help to stabilize the economy, deficits do not raise interest rates, deficits are not necessarily inflationary, and a rising public debt does not lead to higher tax rates. The public debt and fiscal deficits provide several benefits to the rest of the economy.”
2. Is Scotland Subsidised By The Rest Of The UK?
Thus we have concluded that the Scottish government’s notional deficit is, in current circumstances, necessary to reverse austerity, but the next debate is where Scotland would find the money to fund such a deficit. Most commentators in the GERS debate frequently use the (TAB)S framework - taxing and borrowing precedes spending. This framework argues that there is only two options for the state to increase its spending; to tax the population more or to borrow our savings, suggesting that a government’s budget is like that of a household or private business.
This is factually wrong.
The (TAB)S framework is a dated concept that does not reflect the realities of monetary operations for modern day economies with their own central banks and free-floating fiat currencies. An updated framework for macroeconomic thinking is S(TAB) – spending precedes taxation and borrowing. This framework describes how modern day governments credit currency into relevant bank accounts first, which is then followed by taxation and borrowing. Taxation, at a UK level is not required for government spending per se and in our modern economy taxation is used to control equity, social behaviour, demand and inflation. As for government borrowing, this is not really borrowing in the sense that we, as currency users, understand it and our article provides more detail.
This is not a ground-breaking revelation. John Maynard Keynes in his two-volume masterpiece “A Treatise of Money” writes in page 30,
“There can be no doubt that, in the most convenient use of language, all deposits are ‘created’ by the bank holding them. It is certainly not the case that banks are limited to that kind of deposit, for the creation of which it is necessary that depositors should come on their own initiative to bring cash or cheques.”
From a modern day perspective, Professor of Economics Stephanie Kelton concludes in her paper “Can Taxes and Bonds Finance Government Spending”
“An analysis of reserve accounting reveals that all government spending is financed by the direct creation of HPM (bank reserves and outstanding currency); bond sales and taxation are merely alternative means by which to drain reserves/destroy HPM. The choice, then, is between alternative methods for draining reserves in order to prevent the overnight lending rate from falling to zero. In light of these findings, it is, perhaps, time to reconsider our definitions of monetary and fiscal policy as well as our treatment of taxation and bond sales as ‘financing’ operations.”
The Bank of England shares this same analysis in their working paper Money Creation in the Modern Economy
“Banks making loans and consumers repaying them are the most significant ways in which bank deposits are created and destroyed in the modern economy. But they are far from the only ways. Deposit creation or destruction will also occur any time the banking sector (including the central bank) buys or sells existing assets from or to consumers, or, more often, from companies or the government.”
Based on current monetary operations, taxpayers from the rest of the UK do not subsidise Scotland, which is the tacit implication of GERS. It is the Bank of England marking up relevant accounts on behalf of the UK Treasury with credit creation that results in higher spending in Scotland. If Scotland were to become an independent country, it would require its own currency and central bank in order to carry out similar operations to credit the relevant accounts. If this can be set up during the transition period towards independence, then the question is not if Scotland can finance its public services, but if it has the domestic resources (labour, skills, physical capital, technology and natural resources) to carry out public services and programmes. However, what an independent Scotland’s spending priorities would be is entirely down to political decision making.
3. Independence will allow Scotland to better manage a deficit compared to devolution.
This last argument is largely a political one and will depend on how we define ‘manage’. In this case, under the current devolution settlement the Scottish Government is limited in its abilities to reshape the economy in a manner that matches that of monetarily sovereign countries of its size. Without monetary control and limited tax/borrowing powers, the current devolution model forces Holyrood to use the (TAB)S framework and this influences how many commentators discuss the economic opportunities and challenges an independent Scotland could face.
However, opportunities for political control and change for Scotland come down to having the fiscal levers to invest into government programmes and to be able to fully utilise our resources, which includes the people in Scotland. If Scotland were to adopt an economic model of Sterlingisation then we would still be bound by the (TAB)S framework. This means the monetary operations discussed above would not apply to us, and instead an independent Scotland would be forced to raise taxes and/or cut public services. We could also borrow within this framework, but as we discuss in our bonds article this leaves us open to bond vigilante predation and default risk. Thus, not independence at all.
An independent Scotland has the capabilities to better manage its current government deficit compared to the current devolution model.
Further Comment – Tax and Regional Inequality
There has been an interesting discussion on the issue of Scottish taxation between economist George Kerevan and chartered accountant Richard Murphy. Kerevan presents the argument that Scotland’s taxation levels, as a percentage of GDP, are relatively low compared to international standards. He cites a few interesting examples, including Norway which has almost a 20% taxation gap compared to Scotland. Kerevan also acknowledges the potential risk of capital flight, but argues that a mix of capital controls, new opportunities for taxation and monetary sovereignty could mitigate any potential damage.
Murphy’s response is that, whilst raising taxation has clear benefits, the real case to be made is in spending. Murphy uses the S(TAB) framework and points out that government spending comes before taxation, and that as the aggregate tax rate rises so does GDP. His conclusion is that higher taxation should come into force later.
So who is right? Both economists come from similar economic positions. As stated above, Murphy’s use of the S(TAB) framework is accurate, though for the short to medium term there could be the case to raise certain taxes. Tax liabilities creates demand for any currency, and when launching a new Scottish currency post-independence it would not be unreasonable to present tax rises in certain areas. Which areas this could be will be dependant on your politics, but a reasonable position would be a gradual tax rise in line with growing GDP.
Finally, GERS again raises the discussion of regional inequality within the UK with the two arguments against that summarised here:
No, the UK does not have some of the worst regional inequality in Europe
Even so, the fact this wealth is redistributed shows the UK is working.
One source cited in this argument is in the Financial Times, however it does not make the fundamental connection between years of political choices and the economic results. If any government were to over-invest in one city and the surrounding region they would achieve the same result. The inequality that has been created in the UK is an indicator of inept, laissez faire governance.
Philip McCann, chair of Economic Geography at the University of Groningen offers another insight in his paper “Perceptions of regional inequality and the geography of discontent: insights from the UK” he concludes:
“the UK is one of the most inter-regionally unequal countries in the industrialised world. Wide-ranging evidence suggest that on many levels the UK economy is internally decoupling, dislocating and disconnecting, a reality which the UK’s highly centralised, top-down, largely space-blind and sectorally dominated governance system is almost uniquely ill-equipped to address.”
There is certainly a discussion to be had as to how to evenly spread resources across the whole of the UK, instead of the simplistic view of the South East as some sort of economic protector for other regions. This is a serious structural issue and not simply a problem that can be tweaked. Further discussion on the issue can also be found by Dr Craig Dalzell, where you can his analysis on GERS by clicking here.
The publication of GERS has become an engine for further research and has probably helped fuel the huge expansion of Scottish political engagement. However, discussing macroeconomics with one eye shut leaves voters and political commentators misinformed, which harms democracy.