Rebuttal to Stiglitz on Scotland: Reality of Independence Is Frightening

September 16, 2014 1:00 PM

The overwhelming majority of macroeconomists who have commented on the impact of Scotland leaving the United Kingdom have said that the economic costs to Scotland so doing would be very high—I have made this case as well. This professional consensus includes such notable progressives or Keynesian commentators as Paul Krugman and Simon Wren-Lewis. Joseph Stiglitz, however, has published a contrarian view, claiming "there is no basis for this scaremongering." While Stiglitz's willingness to buck conventional wisdom has been often been insightful in the past, this is not one of those times.

The claims that Stiglitz makes about the economics of Scottish secession are a jumble of wishful economic theorizing (assume what I want to be true, is, and what I don't want, isn't), social democrat idealism (only selfish special interest nastiness keeps the world the way it is, we can easily do better), and 60s hippiedom (act local, we can set up our own community not subject to the Man). I am no neo-conservative, but I have been mugged by reality enough to view that as an irresponsible basis for policy advice. The article also ignores or misrepresents some facts about the Scottish and European situation, presumably because those facts don't fit the theory or ideals.

Among the main things to be corrected:

The claim that leaving the United Kingdom is alright for trade if Scotland stays in the European Union

The European Union is not a large integrated market that can substitute for the United Kingdom. The European Union is not one market in reality, except for a few simple goods. In high-end services and in agriculture, there are huge barriers to foreign imports between nations within the European Union—and those are what Scotland primarily produces. Barriers to credit flows are even worse. Right now, the whole of southern Europe is suffering a huge credit crunch because businesses are being judged on their basis of nationality rather than their merits. Leaving the United Kingdom will be a huge blow to Scottish commerce.

The mischaracterization that the concerns about losing the pound are overblown

Giving up monetary union within the United Kingdom is more than an "arcane" and unimportant matter. As many of us have argued, Ireland and Spain demonstrate just how costly it can be to have no political say over how monetary policy is set. This is especially true when something happens specifically to the peripheral country (also known as an idiosyncratic shock). Euro area monetary policy has been set for the core economic bloc tied to Germany, so it ignored the huge overstimulation and creation of bubbles in Ireland and Spain in the mid-2000s, and it has largely ignored the horrible bust and ongoing depression in those economies since. If Scotland leaves the United Kingdom, but stays pegged to the pound, then it will go from its outlook having to be considered when the Bank of England sets monetary policy, to its situation having to be ignored whenever it diverges from the main UK trajectory. It's like going from being the Fifth Federal Reserve District to being Ecuador with respect to the dollar and the Fed.

But the monetary reality is worse than that, it means the euro. This bad enough situation assumes that Scotland stays pegged to the British pound. If Scotland wishes to be part of the European Union as a sovereign nation, however, by international treaty, it has to adopt the euro. By adopting the euro, which has a Germanic business cycle focus, the Scottish economy will be repeatedly more out of sync with policy than in the United Kingdom, promoting boom/busts. But Scotland would first have to get over the long list of economic and institutional hurdles required by treaty to be admitted to the euro area—which is a multiyear period of great vulnerability, as Greece and Italy experienced in the 1990s.

And it is still worse than just that, the euro area is not good to peripheral members. The euro area has no fiscal transfers between nation states, except for the very small cohesion and convergence funds, which Scotland would not qualify for. In fact, Scotland would probably be a net payer into those funds. So there would be no cushioning of the idiosyncratic shocks or currency attacks. Those are built in to Scotland's membership of the United Kingdom and would disappear.

The assertion that because a few small countries do well, Scotland will be fine

Small countries on their own really do suffer more turbulence. Yes vote supporters in Scotland's referendum assert that there are rich small countries that do fine, like Denmark and Norway, and Stiglitz suggests that Scotland could be like Singapore, Sweden, or Hong Kong. Denmark, however, proves just the opposite: Denmark has the deep integration with Germany that Scotland would give up with the United Kingdom, but that not EU membership is what shields Denmark from trouble. The other small countries in the euro area that are not in such tight economic union have been made miserable. (Norway, on the other hand, proves nothing except that if you have 10 times the oil Scotland does with the same population, you can be rich.) Meanwhile, Sweden, Singapore, and Hong Kong all suffered terribly from financial crises in the 1990s and huge capital inflows of late, far worse than Scotland did from its big banks blowing up while part of the United Kingdom.

It's the turbulence and uncertainty that really do harm to the poor. As Joe Stiglitz has written passionately about elsewhere, and I agree, one of the terrible things about recessions is that the most vulnerable —youth exiting school at the wrong time, workers at the most risk of unemployment, those who are scarred by being trapped in long-term unemployment, families dependent on government assistance—are hit hardest. Even when recovery comes, an environment of ongoing uncertainty hurts most those who are economically vulnerable through many channels, including higher interest rates on government debt constraining public spending. Pointing out the existence of rich small countries misses the point: at whatever level of income, citizens of a small economy are more subject to insecurity and so is their government than their larger peers. This is why progressive votes for an independent Scotland will be self-defeating because independence will make it harder to protect Scottish people.

Yes, that increased uncertainty constrains the public sector. Stiglitz assumes in his article that Scotland will be able to afford a more generous welfare state than it currently has after independence. This is very questionable, and smacks of a wishful experiment. Many small open economies do have generous welfare states, but as I mentioned, neither Denmark nor Norway are relevant to Scotland's ability to have one. Sweden does have one, but had to cut it back hugely in the 1990s following its financial crisis and global pressures. Most other rich small economies without huge oil reserves—including Canada, Singapore, Hong Kong, and New Zealand—either had to cut them back or never had them. Everyone is more generous than the United States, but that already holds true for current Scottish social provisions while in the United Kingdom. Meanwhile, we do know that economic volatility and average interest rates are negatively correlated with size, all else equal. Seems like a pretty bad bet to be taking with the Scottish welfare state and the lives of the people who depend upon it.

Thus, Stiglitz's arguments should not be used by Scottish voters for a "he-said, she-said" kind of throwing up one's hands that each side has its economists' backing. That is false. Just about every independent serious economist—including many liberals who have long had public differences with the current UK government in Westminster, and many others who have no particular stake in Scotland or the United Kingdom—thinks independence is a bad idea on an economic basis. In fact, most of us think that the economic harms to Scotland from independence would be so great that they would undercut the stated political and social goals of many Yes campaigners. And that is what makes sense, and cannot be wished away.

The author is president of the Peterson Institute, and served on the Bank of England's Monetary Policy Committee from 2009 to 2012. The views expressed here are solely his own.