Cebr: Latest Scottish Government Deficit Assessment

11 Sep 2014 10:09 AM

Independent Scottish Government would start with a deficit of at least 6.4%

It is conventional wisdom that if Scotland is independent there will be a need for fiscal austerity, claimed by the CBI, the IFS and various City analysts including most recently Societé Generale.. But new figures recently available make it clear that the problem is even worse than had been thought.

First, Scotland’s share of UK public spending now appears to have been 9.6% in 2012/13 according to new data released by the ONS at the end of July in Public Expenditure Statistical Analyses, whereas its share of the UK’s on-shore economy was only 8.0%. Assuming taxes roughly proportional to shares of GVA, this would imply a non oil deficit of 1.6% of UK GVA, which may not seem much but amounts to 20.6% of Scottish on shore GVA.

Second, although this deficit has traditionally been partly covered by oil revenues, these revenues have collapsed. Scotland’s share of oil revenues in 2008 amounted to nearly 8% of Scottish on shore GVA which would have left the overall deficit for Scotland as a share of GDP much in line with the rest of the UK. But UK oil revenues fell from £12.42 billion in 2008 to £4.7 billion in 2013. They should rise slightly over the coming years to £6.4 billion in 2016/17 but  are unlikely to rise dramatically unless the sterling price of oil jumps sharply. So the oil revenues in the future will do rather less to close the gap than has occurred previously.

We now estimate using the new data that for 2013/14 the total Scottish deficit as a % of GDP (we have constructed a new series for Scottish GDP that includes off shore activity and scales up the GVA data) was 9.9% compared with a UK deficit of 5.7%.

Looking out to 2016/17 which would be the first full year in which Scotland might be independent, austerity measures already in place and some rise in oil revenues should bring down this deficit to 6.4% of Scotland’s GDP (with the UK deficit at 2.2%). This compares with the IFS estimate in June of 5.5% of GDP for Scotland for the same year, which was close to the 5.8% which we estimated before the new data became available.

All this of course assumes that the Scottish tax base is sustained  in the independence scenario. But with uncertainty hindering investment, Scotland has been growing more slowly than England in recent years. And it is clear that part of the financial service sector would have to leave Scotland if it were independent. And of course there are also startup costs for an independent country which Cebr estimates at a total bill of £2.4 billion though this would be phased over a number of years. So the probability is that the fiscal pressures on the new government of an independent Scotland would be substantial. Our maths suggest that the new government would have to issue around £9 billion of new bonds which would certainly have to be sold at a substantial interest rate premium by the new government if indeed they could be sold at all, which could be problematic given the negativity towards independence in financial markets.

It is deeply ironic that Scotland might even start its independence already in the hands of the IMF!

And yet these calculations could cut both ways in the independence debate. Devo-max and fiscal independence, which is the most likely consequence of a No vote, would mean that these fiscal issues would still have to be addressed, though without the complication of reduced financial service revenues and probably over a longer timescale. Arguably achieving popular consent to austerity measures would be easier if Scotland were independent than it might be if there was uncertainty about the extent to which the problems could be blamed on the English and the London government.

Either way, the next 5 years at least look set to be some of the toughest years economically that Scotland has faced since between the wars.