PRINCETON –As Scotland prepares for this month’s referendum on independence,
the United Kingdom – indeed, all of Europe – must brace itself for the
impact of a successful bid. Scottish independence would revolutionize
the British and European constitutional frameworks, and give a
tremendous boost to other European separatist movements, from Catalonia
to northern Italy. The economic impact of independence, however, is far
less certain.
Advocates
of independence have long insisted that they are motivated primarily by
the distinctiveness of Scottish identity. But Scotland’s history and
traditions,while undoubtedly its own, have been shaped by centuries of
interaction with England and other parts of the British Isles.
The more
immediate issue for Scots is money. The question of whether an
independent Scotland could or should continue to use the British pound
has dominated discussions over the last few months of the referendum
campaign. The outcome –for Scotland, the UK, and Europe – could vary
widely, depending on which path Scotland chooses.
So
far,Scottish nationalists have insisted that an independent Scotland
would retain the pound. But, given how much easier it would be to make
the case for a separate currency – not to mention the fact that
Chancellor of the Exchequer George Osborne has explicitly rejected Scottish First Minister Alex Salmond’s proposed currency union – such declarations amount to an own goal.
The problem with the Scottish
nationalists’ vision is a mirror image of the eurozone’s main
shortcoming. Given that a single currency cannot function without a
common monetary policy, and that economic conditions across the currency
union differ,individual members will, at times, be subject to
unsuitable policies.
For example,during the
construction boom of the 2000s, Ireland and Spain should have had
tighter monetary conditions, higher interest rates, and lower loan/asset
ratios. But their eurozone membership meant that government and
private-sector borrowers alike benefited from very low interest rates.
After the financial crisis erupted, and policymakers began seeking ways
to compel banks to revive lending in these and other struggling
countries, it became apparent that there were no available tools to
employ.
Today, the
UK faces a similar dilemma. The property boom in the London area
demands tighter monetary conditions. But higher rates would wreak
economic havoc on the rest of the country, where the recovery remains
anemic.
Moreover,like Germany, London
maintains a huge current-account surplus (8% of GDP) – a potentially
serious problem, given the deflationary effect that Germany’s surplus
has had on the rest of the eurozone. Already, the rest of the UK runs an
external deficit that is higher than that of any industrialized country.
The
behavior of a currency can be driven by one powerful and preeminent
sector of the economy; in the pound’s case, it is the financial sector.
Some viewed the pound’s rapid decline in 2007 and 2008 – a 30%
depreciation in trade-weighted terms – as a much-needed economic
stimulus, given the boost that it implied for export competitiveness.
The UK’s independent monetary policy provided it with a level of
flexibility that the eurozone economies lacked.
But the revival of confidence in the financial sector has caused the pound to rebound sharply
(by 18%since the end of 2008), eroding the UK’s competitiveness gain.
What is good for the City of London is not necessarily good for the rest
of the economy.
There is
thus an unmistakable appeal in escaping an economic arrangement that
shackles Scotland to London – an appeal that the great Scottish
economist Adam Smith would have recognized. Indeed, his most influential
work, The Wealth of Nations, was motivated by the belief that the interests of the London merchant community were distorting British commercial policy.
The alternative to retaining the pound, however, presents its own challenges.According to the Scottish economist Ronald MacDonald,
an independent Scotland should have its own currency,which would behave
like a petro-currency, owing to the economy’s dependence on North Sea
gas and oil.
But
replacing one dominant sector with another is probably not good for the
rest of the Scottish economy, which would lose competitiveness whenever
surging energy prices pushed up the exchange rate. As less competitive
industries were driven into loss and insolvency, economic activity would
become even more concentrated and specialized.
Placing
the burden of adjustment on the exchange rate is not the answer. The
small, open economies of Switzerland and Norway – important models for
Scotland – struggled with sharp currency appreciation during the global
financial crisis. For Switzerland, the solution was to implement a
ceiling on the franc’s exchange rate against the euro.
This
should inspire Scotland to pursue association with a larger currency
area and a more diversified economy. How about adopting the euro?
Harold James is Professor of History and International Affairs at
Princeton University, Professor of History at the European University
Institute, Florence, and a senior fellow at the Center for International
Governance Innovation. A specialist on German economic history and on
globalization, he is the author of The Creation and Destruction of Value: The Globalization Cycle, Krupp: A History of the Legendary German Firm,and Making the European Monetary Union.