NIESR Press Release: Real devolution means the power to borrow: for Scotland, Wales, Northern Ireland and within England
12 Sep 2014 11:57 AM
In the event of a "No" vote in the Scottish referendum, both Government and Opposition parties have committed to a major further devolution of powers on tax and spending to Scotland. In a research paper published yesterday, NIESR's Dr Angus Armstrong and Dr Monique Ebell argue that devolution can only be meaningful if Scotland - and, crucially, Wales, Northern Ireland and local government in England - have the power to borrow on their own account. Contrary to received Whitehall and Westminster wisdom, such borrowing powers are both feasible and desirable.
Real devolution within the UK must mean that Scotland makes its own decisions on economic policy, leaving monetary policy aside, and that it can succeed or fail. That in turn must mean that, just as with states and municipalities in many other countries, it should be able to borrow and be responsible for that borrowing. Only then will local representatives be responsible for their actions and then be held to account by the electorate. The difficulty for the UK is the deep-seated doubt about devolving borrowing powers away from the centre of government. The paper shows why this doubt is unfounded and how borrowing powers can be devolved without putting sensible economic management at risk.
The paper argues that, given the respective size of Scotland and the UK, the latter would have both the incentive and the ability to bail-out Scotland if it faced either a funding crisis or even threatened to default on its obligations, whatever the political or legal constraints. The result is moral hazard, since Scotland would have an incentive to borrow imprudently. A Scotland-only solution to the borrowing problem would be risky and unstable.
This can only an only be tackled by addressing ‘the elephant in the room’ - devolution of more powers, including powers to borrow freely, to other levels of government in the UK. Because England is large relative to the rest of the Union, a key task is determining the right level of regional government to devolve borrowing powers to. With 353 local councils in England divided between nine regions (and 22 councils in Wales), new arrangements could devolve economic decision-making, including decisions on and responsibility for borrowing, to regional or local level. The result would be far more diversity, a far less powerful central government, and both the ability and incentive for central government to bail out sub-national borrowers would be far less.
Scotland's borrowing costs, as estimated in Scotland's Currency Options by Armstrong and Ebell (2013, NIESR Discussion Paper No. 416) are likely to be higher than for the UK, due to liquidity and the volatility of tax revenues, as our research has shown. However, within the existing currency union there is no currency risk premium which may be required if Scotland is outside of the currency union. This means Scotland could have the capacity to borrow, as we argue - real devolved power, but without the higher borrowing costs of being outside of a currency union.
These would be dramatic changes in UK constitutional arrangements indeed: but the current crisis of confidence in those arrangements revealed by the Scottish referendum could be the catalyst for real change.
Dr Armstrong said:
"Meaningful devolution of economic power to Scotland means letting Scotland borrow freely - without any prospect of a bailout from Westminster if things go wrong. That is both feasible and desirable - but, politically and economically, it will only work if the same powers are available to local authorities and regions in the UK."
"We show how borrowing powers can be devolved without putting sensible UK economic management at risk. This involves solving ‘inflation bias’ and 'bail-out bias' problem, much feared in the Treasury and indeed Brussels and Frankfurt. These are solved within a political union by maintaining an expert monetary policy committee and addressing the 'elephant in the room' devolution in England and Wales as well as Scotland."
"Full borrowing powers could be devolved to the Scottish Government in the short term. This would be real local economic responsibility and accountability. Moreover, because Scotland would be within the existing currency union it would not face an additional currency risk premium and higher borrowing costs that would arise outside of the existing currency union."
ENDS
Notes:
The research paper is entitled “Real Devolution: the Power to Borrow”.
For a full copy of this paper, please see the publications section of the NIESR website, or contact the NIESR Press Office:
Brooke Hollingshead on 0207 654 1923 / b.hollingshead@niesr.ac.uk
To discuss the article, please contact:
Dr Angus Armstrong is Director of Macroeconomics at NIESR. Dr Monique Ebell is a Research Fellow at NIESR. The authors have published numerous papers on the macroeconomic and financial implications of Scottish independence, and they are available here:http://niesr.ac.uk/research-theme/economics-scotland
We also created an animation which we hope introduces the main ideas to as wide as possible audience http://www.youtube.com/watch?v=mBC0mLFz91o
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Real Devolution: The Power to Borrow