Sleepwalking towards what?

In the end, everything tends to come back down to a country’s current account – its economic ledger with the rest of the world (everything from trade to financial flows).

A country with a large current account deficit (in other words, one that imports and borrows from the rest of the world) will, over time, become more and more vulnerable. It will be more exposed to financial crises. It may have to devalue its currency to become competitive.

A country with a big current account surplus, on the other hand, will be able to build up a financial cushion to protect it in the future (AKA reserves). It will be more resistant to financial crises, though it may need to allow its currency to appreciate.*

To give you an idea, countries with big current account deficits in recent years include the UK, the US and Greece; countries with big surpluses include Germany and China.

You would have thought, then, that much of the debate in the Scottish referendum would have come down to the question of Scotland’s current account balance — both with the rest of the world, and with the UK.

After all, should an independent Scotland run a permanent deficit with the rest of the world, it may be incapable of maintaining a currency union with sterling, and supporting its financial sector – unless it chose to impose deep austerity. Moreover, understanding Scotland’s current account balance with the rest of the UK will help us understand just how badly independence could damage the rest of the UK.

Disturbingly, although the referendum is now only days away, neither side in the campaign has set forward a full estimate of the size of Scotland’s balance of payments. The people of Scotland are being asked to decide their future (and the future of their currency) while being deprived of one of the most important numbers that will underlie it.

Scotland’s balance of payments — a best guess

In the absence of an official current account balance figure, one instead has to try to cobble together a figure based partly on Scottish Government numbers on exports (they only tell a portion of the story), on experimental reports on gross national income [pdf] and on other occasional reports produced by Scottish statistical authorities. Put it all together and what one learns goes broadly as follows:

1. Scotland is running a current account surplus of about £5bn (or was in 2010, the base year for which we have the necessary bits of data). To put it in percentage terms, over the past 15 years, Scotland has had an annual average surplus of 2.7% of GDP. This is, most importantly, in positive territory, however it is far shy of Germany (5% plus in the past five years) or fellow oil exporter Norway (10% plus in the past decade).

2. Predictably, the surplus relies entirely on oil exports, without which Scotland would be £17bn (well over 10% of GDP) in deficit. A deficit of this scale would ring alarm bells among investors, being well beyond the comfort zone of being vulnerable to a financial crisis.

3. North Sea oil output is expected to continue declining, meaning the surplus might conceivably turn into a deficit in a matter of years.

4. However, if one presumed that Scotland could maintain oil exports at their current rate, or even increase them, it could feasibly maintain a currency union (official or unofficial) with the UK. Provided it maintains control of its public spending and…

5. Builds up its foreign reserves. The Bank of England Governor signalled this week that if Scotland wants a self-supported banking sector (any banking sector — not necessarily the enormous one it has currently) it would need between £10bn and £100bn extra foreign reserves (as a backstop in case things ever went wrong). Clearly it would take some years to generate such a backstop, even presuming that North Sea oil flows remain strong.

The picture sketched above is hardly a reassuring one: it suggests that while Scotland could rely on a positive balance of payments for a few years, this might conceivably disappear in the following years. If iScotland was locked in an official or unofficial currency union, it would, at some point, need to cut spending and impose austerity to keep within the union (eg precisely what Greece is having to do).

This helps explain why many economists believe iScotland’s best bet would actually be setting up a new separate currency (a new Scots pound), which it could easily devalue when the current account so demanded. However, Alex Salmond seems to have ruled out this eventuality.

Scotland’s balance with Britain

Then there’s the question of the balance of payments with the rest of the UK which would have a major bearing on whether the rUK would face an economic crisis were Scotland to leave. In its White Paper [pdf], the Scottish Government indicated that rUK was seriously reliant on Scotland, saying: “The Sterling Area’s balance of payments will be supported by Scotland’s broad range of assets and exports, including North Sea oil and gas. North Sea oil and gas production boosted the UK’s balance of payments by £39 billion in 2012/13.”

This might give you the impression that the rest of the UK’s current account would, when deprived of North Sea oil, suddenly plunge deeper into the red (£39bn being equivalent to more than 3% of GDP). This, in turn, is a scary prospect, since Britain’s current account deficit is already about as big as it’s ever been. The problem is, such a notion is simply wrong.

As Brian Ashcroft has laid out, the departure of Scotland might increase the rest of the UK’s current account deficit by a few billions, but the impact would be nothing like the £40bn suggested in the White Paper. That’s because that figure fails to take account of the fact that 1. Much of those oil exports are balanced out by money leaving the Scottish economy back to the owners of oil companies and 2. The rest of the UK already has a non-oil trade surplus with Scotland.

In other words, don’t believe scare stories that the rest of the UK would be in big economic trouble without Scotland’s oil – this simply isn’t true.

A final open question is how much difference the departure of RBS and Lloyds from Scotland would make to the balance of payments. What we do know I that the financial services sector accounts for a whopping 15% of Scottish trade and 9% of its GDP. One presumes that if finance companies do indeed leave, this would adversely affect the balance of payments, further undermining the country’s economic stability.

It is lamentable, however, that so little of this is being discussed at an official level. The euro was the product of years if not decades of research into current account levels, into precisely these kinds of issues. But now the people of Scotland are being asked to decide on their independence (and by extension a possible change in their currency) without either side even pretending that the key numbers at the heart of the debate are readily available.

* In case you’re wondering, the budget (or “fiscal”) deficit is a little different, measuring the extent to which a government is spending more than it’s raising in taxes. That’s important when one’s considering the prospect of austerity and higher taxes, but less important than the current account when one is considering stuff like currency choices.