New Scottish powers come with fiscal responsibilities

One or the more perceptive pieces written about the referendum came from the acclaimed writer Ewan Morrison, describing his journey to and from the Yes camp during the referendum. Morrison’s disillusionment sprung from the realisation that, primarily, it had become anathema to discuss what the economy or country would be like “after the revolution”, much the same as his experiences as a Trotskyite in the Socialist Workers Party in the Eighties. Not to put words into Morrison’s mouth, but it sounded as if, for the Yes campaign, the referendum had become like breaking an egg before working out what to do with it.

The other concern that sent Morrison to the No camp was the internal inconsistencies of the rainbow coalition of the Yes camp. How could the Greens reconcile themselves with the “Celtic Saudi Arabia” ambitions of the latent Scottish oil barons? How could the radical Left jig alongside the pro-capitalist Business for Scotland group and former SNP leader Alex Salmond’s promises of lower corporation taxes while enthusiastically embracing the controversial Transatlantic Trade Investment Partnership, which reduces the barriers to privatisation of national services?

The short answer is this: you can’t. And so what Scotland’s new First Minister and future Scottish governments are now faced with is greater and greater demands to fund more and more expenditure through the distribution of taxes and increased borrowing in order to keep this uneasy amalgamation of forces together and the momentum for independence on the road. It resembles the quivering jelly of particles at the heart of a Uranium atom held together by the electromagnetic forces of competing interests. But as we know, it takes only a single high energy-particle to come along to blow that arrangement apart catastrophically.

To stop the disintegration of this fissionable coalition, increased borrowing in the name of Scotland is inevitable once the details of the new powers are set out by the coalition of Westminster parties. Spurious accuracy has abounded during this campaign as to the “right” interest rate for an independent Scotland compared to the AAA-rated United Kingdom. Some have suggested it should be about 1.5pc higher than UK Gilts, but this was for a new, fully independent Scotland. The referendum result creates a hybrid: a sort of twilight world between the status quo and a new emergent borrower. It wouldn’t be too fanciful to suggest that a new entrant to the bond markets, a novice in market discipline, should pay a few fractions of a per cent more than the UK Government just to help investors along the way. Still, that gets you to something like 0.25pc–0.5pc higher than the UK Government benchmark. In today’s market terms that would put Scotland unflatteringly, and misleadingly, alongside Portugal and South Korea.

Like many people, I became increasingly tired of rehearsing the currency question early on in the referendum process. To me it was always a red herring – no matter what the result, the UK was always, and is, in the position to dictate the terms of any currency agreement. One of the results of this referendum, and the still-cherished hope that Scotland will achieve full independence one day, is that the UK should start preparing for it now. A fully independent Scotland may well use

sterling for a period of time but in the same way that countries outside the United States use the US dollar, they aren’t allowed to issue their own version of it. In that case, the agreement whereby Scotland deposits notes with the Bank of England, which allows it to issue its own bank notes, needs to end. The arrangement, attributed to Sir Walter Scott, has no place in a sterling zone. Scotland and also Northern Ireland should use, exclusively, Bank of England notes.

The new powers of taxation and borrowing are a mixed blessing for Scotland. Ideas of increased social justice, the eradication of child poverty and free education can now be realised, if that is what is desired, by the Scottish people. But it will have to be paid for and it will be interesting to see if the new First Minister will be the first politician to raise taxes and borrow money with the backing of the Scottish electorate. But with that comes responsibility. So I’ll give the final word to Blanche DuBois: “I don’t want realism. I want magic!” Yes, magic! Unfortunately, markets don’t do magic. As future Scottish governments are about to find out – they do reality.

Stewart Cowley is investment director, fixed income and macro, at Old Mutual Global Investors.

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