UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 1608-v

House of COMMONS

Oral EVIDENCE

TAKEN BEFORE the

Scottish Affairs Committee

the Referendum on Separation for Scotland

Wednesday 14 March 2012

PROFESSOR JOHN KAY and MARTIN WOLF CBE

MATTHEW ELLIOTT, WILLIAM NORTON, KATIE GHOSE and WILLIE SULLIVAN

Evidence heard in Public Questions 358 - 525

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Oral Evidence

Taken before the Scottish Affairs Committee

on Wednesday 14 March 2012

Members present:

Mr Ian Davidson (Chair)

Fiona Bruce

Mike Freer

Jim McGovern

Iain McKenzie

David Mowat

Pamela Nash

Mr Alan Reid

Lindsay Roy

________________

Examination of Witnesses

Witnesses: Professor John Kay, visiting Professor of Economics, London School of Economics, and Martin Wolf CBE, Chief Economics Commentator, Financial Times, gave evidence.

Q358 Chair: Gentlemen, thank you very much for coming along to see us today for what I hope will be a very interesting session. I warn you at the beginning that, as I was discussing with my colleagues earlier, I have an economics qualification, having done O-Grade economics at Standard level in Scotland. If you could keep it to monosyllabic terms that lay people are likely to understand, that would be helpful.

If I may start with you, Professor Kay, in your written evidence you give an indication of the various currency options that would be open for a separate Scotland to adopt. First, would you run through those very briefly?

Professor Kay: There are three basic ones: currency union with the euro; currency union with what I will call, for convenience, England rather than the rest of the UK, which is basically retention of the pound; and an independent Scottish currency. There are variants of these options that have some of the characteristics of each, but as a starting point, it is best to focus on these three core options. My personal view is that in looking for the intermediate options you tend to get more of the disadvantages than the advantages of the extremes.

Q359 Chair: Mr Wolf, do you see the same three options?

Martin Wolf: Yes; they are broadly the options. Clearly, there are some important variants in joining another currency union. I tend to agree with John, but it is possible to use another currency without being part of its monetary area. You can do this by adopting the other currency as your own. You can dollarise, euroise, or I suppose, sterlingise, though I think that has never happened, without having access to its central bank. A variant of that is that you can create a currency board in the foreign currency that backs one to one your own domestic currency, so that in some way Scottish pound notes would be backed by Scottish euro notes, or Scottish pound notes would be backed by English notes; but the crucial point is that you would not be part of the monetary area, because in both of those variants you would not have access to a central bank.

Professor Kay: To exemplify this in terms of what are, as it were, three unilateral options, one would be Hong Kong, which for the last 30 years has pegged its currency to the US dollar. There is a fixed exchange rate between the Hong Kong and the US dollar. Hong Kong has done that without consulting the US. There was the Irish option before floating exchange rates in the early 1970s, when the Irish pound traded at one to one with the British pound but was a separate currency; or there is what I call the Montenegro option. There is the odd case of Montenegro, which has adopted the euro as its currency. It has no currency of its own, and it has done that even though it is not a member of the EU and has no proximity to any EU state. These exist as options. In the end, all of them look less attractive than the core options, but there are many variants, as Martin said.

Chair: We want to work our way through some of these.

Q360 Lindsay Roy: Good afternoon, gentlemen. Thank you very much indeed for the very interesting and comprehensive documentation you have given us. I want to explore some of these issues further-first, the option of a separate Scottish currency. How might that work, and who would establish such a currency?

Professor Kay: If it was a separate Scottish currency, there would be a Scottish central bank. It would issue the Scots pound or, to distinguish it, let’s call it the groat.

Lindsay Roy: The bawbee.

Professor Kay: So we have the Scots bawbee. There would be an exchange rate against the English pound, which could and would fluctuate from time to time, but, given that England is overwhelmingly Scotland’s dominant trading partner, you would not expect it to fluctuate very much against the English pound, and there would be problems principally for Scotland if it did. That would involve one in having to change money when you crossed the border, and it would create more uncertainty for both exporters from Scotland and investors in Scotland.

Q361 David Mowat: If it was a separate currency in the way you describe and Scotland was an oil-based economy because its proportion of oil revenues would be so much greater than the UK’s, would it not potentially have some of the characteristics of a petrocurrency?

Professor Kay: Yes. It is not necessarily the case.

Q362 David Mowat: It would not stay close to the pound; it could rise with oil prices and have all the characteristics of currencies that do that.

Professor Kay: I do not think so. It could still be true that Scottish exporters would need to sell their goods predominantly into England. Equally, it would not be possible for consumer prices in Scotland and England to get too far out of line.

Q363 David Mowat: Yes, although they would be selling their oil in dollars, would they not, albeit to English companies perhaps to be refined here? It does not seem to me to be quite so straightforward just to say they trade with England because of the impact of the oil.

Professor Kay: Yes. If the oil price went up, it would improve the Scottish balance of payments, but would that improvement necessarily lead to an appreciation of the Scottish currency or simply a capital inflow into Scotland, which might be offset by capital outflow if the oil price depreciated? There would be some link to oil prices, but I still think that what was happening to the English currency would be the main determinant of the fluctuations of the Scottish currency.

Martin Wolf: Let me comment on this. I broadly agree with John that this gets into fairly complicated areas of monetary economics. Let us assume that Scotland is an independent country with its own central bank. It is a small monetary area, but there are other small monetary areas. Denmark is in this situation. Denmark has basically adopted what used to be the D-mark and now the euro, which was the policy John described for the putative Scottish central bank, namely, it adopted a peg. That was a decision by Denmark. It is not part of the euro, but it is a completely credible peg, which it has maintained for decades. Effectively, it is in the euro area in the sense of how it works economically, but it has a separate currency and, in theory, it could change at any time.

There is another policy option for Scotland. It would be perfectly possible for Scotland in this situation to have a floating currency and to allow the price of this Scottish putative currency to fluctuate in accordance with the market. In this situation one of the things that might affect that, to which I will come in a moment, is its perceived economic potential, which might well be related, among other things, to the price of oil.

The problem of pursuing that policy, for what would be a small and very open economy, is that it will generate a large amount of price instability within Scotland. Most countries, but not all, with very small monetary areas whose trade overwhelmingly is with another trading partner, which we are talking about here, adopt pegged rates. It would be possible. A very interesting borderline case, which in relative size would be very similar, is Canada and the United States. Canada has a floating currency. It is also a resource-based economy in very significant ways. For the last half-century it has floated against the US dollar, which has created problems from time to time, but it is possible for Scotland to pursue such a policy and accept the consequences in terms of relative price instability.

Considering this resource question, it might be helpful to think analytically about this issue in this context in two stages. Imagine that at the moment Scotland remains in the Union but all the revenues from oil are passed to the Scottish Government. In this case, exactly the instability you mention would flow through to Scotland in both directions. I am assuming that there will be an offsetting adjustment in some way in tax sharing in other respects. When there is a boom in oil prices, Scotland would have a boom in revenues. The Scottish Government would be in exceptionally good shape and would probably be able to spend more; Scotland would probably have a boom, and the reverse in other cases. In this situation there would probably be rises in some prices in Scotland, basically non-tradables, which, as John said, will basically be fixed because they would be set by prices in England, but non-tradables would go up and down and therefore there would be instability.

Going to your own currency that floats merely means that domestic prices are adjusted via exchange rate changes rather than via all domestic prices moving, which is what would happen if Scotland were in the Union and you handed over the revenue to the Scottish Government. All I am suggesting is that, considering this analytically, it may be helpful to think about stage one, which is handing over all the oil revenue to the Government of Scotland and making a counterweight adjustment, which itself would generate interesting instability in the Scottish economy and involve price changes, rather than the question of how the exchange rate would work.

Q364 David Mowat: Effectively, I think we are at stage one because Scotland keeps all of the oil revenue, which is a de facto adjustment for Barnett. If you looked over the last 20 years, arguably, the amount of extra that Scotland has had through Barnett more or less equates to what it would have had if it had all its own oil. Maybe that is just a coincidence, but that is the effect of it. That has not created any instability in the way you imply.

Professor Kay: It is broadly true that over a long period the generosity of the Barnett formula, as it were, has been offset by the Scottish oil revenue component, but it does not offset on a year-to-year basis. In effect, what has happened is that the UK has insured Scotland against the instability.

David Mowat: It has smoothed it.

Martin Wolf: It remains a pooled insurance arrangement, but if it was completely independent in this sense fiscally, with just a fixed flow from England, there would be instability in Scottish revenues, and it would face exactly the same problems that resource-based economies with very heavy dependence on resource revenues have all round the world. There is nothing very special about this; there are lots of economies in that situation, and as for the currency regime you follow, there are many different possibilities

Q365 David Mowat: But what tends to happen in other countries across the world is that a higher exchange rate displaces other industries.

Martin Wolf: Of course.

Q366 David Mowat: That is a risk for Scotland.

Martin Wolf: What I am suggesting is that, if you have an oil boom in a country where all the oil revenues go to the Government and where the oil industry is a big part of the economy, it will tend to displace those other industries whatever the currency arrangement. The currency arrangement is not crucial. What is crucial is the role of the resource sector in your economy. Obviously, if the Scottish Government received all those resource revenues without offset in the short to medium run, Scotland would become more of a resource-dependent economy. That would generate advantages but also instability, which is inevitable.

Professor Kay: Martin has mentioned Denmark as one country on the edge of the eurozone that is relevant to us. There are two others that it might be worth taking a moment to think about, which are Norway and Switzerland. Norway, as we know, has oil revenues that are relatively larger than even the Scottish ones would be. That means the Norwegian krone has a very high value in terms of purchasing power, as anyone who has ever been to Norway has discovered rather quickly. That has the effect of displacing other Norwegian exports in the way we describe. Despite that, the Norwegian krone is high in terms of value, but it still does not fluctuate that much relative in value to the euro. It is quite important to the Norwegian Government, if necessary, to make sure that it does not, so in effect it is sterilising some of the effect of oil price fluctuations.

The Swiss case is a peculiar one because the Swiss currency has a particular international value in its own right that no other small country currency has or is likely to have. We know that in the last two years that has created special difficulties for Switzerland. The Swiss Central Bank has been trying to insulate the rest of the Swiss economy from that by trying to prevent the Swiss exchange rate appreciating too much against the euro.

Q367 Lindsay Roy: You mentioned instability several times in relation to a separate currency under a central Scottish bank. Is that an option you would recommend in your professional view?

Professor Kay: Personally, I would not.

Q368 Lindsay Roy: For what reason?

Professor Kay: There are pros and cons in all the three options I have described, but in my view the balance of advantage points to currency union with England.

Q369 Lindsay Roy: One of the options you mentioned earlier was the Scots pound being pegged to sterling, as happened with the Irish punt. Can you explain exactly what that would entail? How would it be managed?

Professor Kay: Then there would need to be a Scottish currency board of a Scottish central bank acting as such a currency board willing to buy or sell the Scottish currency to try to maintain a roughly fixed exchange rate against the English currency, in the same way as the Hong Kong monetary authority maintains the understood fixed parity with the US dollar. The difference between that and the currency union is that that is something the Hong Kong monetary authority does unilaterally, not in conjunction with the US Government.

Q370 David Mowat: In Hong Kong are they busy buying and selling dollars to keep the parity? Is that how they do it?

Professor Kay: Yes; that is how they do it.

Q371 Chair: If Scotland was in the position of being resource rich, there would be constant upward pressure on the value of the bawbee, groat or whatever it was, and therefore there would be constant pressure, as Switzerland experienced, of trying to keep it down, would there not?

Professor Kay: That, indeed, is the position that Hong Kong is in. If the Hong Kong dollar were allowed to float freely, it would almost certainly appreciate significantly against the US dollar. The result is that the Hong Kong monetary authority is a net buyer of currency and has been accumulating what is now quite a large balance in order to maintain parity at a fixed rate.

Martin Wolf: This is very complicated. First of all, there are many different models of pegged exchange rates. We can go through them all if you want. We are discussing something here that is fairly close to a currency board. The important thing about a currency board is that there is a more or less one-to-one link with foreign and domestic notes, and it reduces almost to nothing the degree of freedom in monetary policy terms of your domestic central bank. It is very limited. You would have to ask what sort of independence it gives you. Being independent with a currency board does not give you much. The alternatives are pegged and adjustable rates, and they generate instability of a different kind.

It is not to be assumed that, merely because Scotland has resources, it would have a chronically strong currency. That depends on other structures of the economy, which I think at this stage we would not be able to guess. In periods when oil prices are very high, that is likely to be the case, but the crucial question would be: would Scotland turn out to be a country with a structural current account surplus? I do not know. I am assuming there would be no exchange controls, so private Scottish and other people would be free to decide whether to invest in Scotland or outside it. It is perfectly possible to imagine that the desire to invest outside might be sufficient and the structure of the balance of payments would be such that, for most of the time, the Scottish currency would be neither particularly strong nor weak. I do not think one can assume that, just because there are resources involved, it would necessarily be particularly strong. If you look at the resource revenues for Scotland against the Scottish economy, it is rather unlikely that it would be a structurally strong currency like Norway’s. It is just not big enough. It is possible, but I do not think you should assume that.

Professor Kay: To go back to the Hong Kong case, the potential strength of the Hong Kong currency is not because of Hong Kong’s resources; it does not have any. It is because of the strength of its manufacturing and entrepreneurial capabilities.

Q372 Lindsay Roy: I take it that, like the previous option, it is not one you would particularly recommend.

Professor Kay: No, it is not.

Martin Wolf: With a currency board-type arrangement, you get all the disadvantages of having no flexibility. You do not have the advantages of no flexibility, which is being inside a larger currency union. I tend to think that it is the worst of both worlds. Hong Kong could not be part of the American monetary union because China would not let it, so it is not relevant.

Professor Kay: Nor would America.

Martin Wolf: Nor would America; so they made the best of what they had. I have always tended to the view that, if you want a separate currency, the reason is that you want to be able to adjust it; otherwise, there is no point in having a separate currency. Therefore, a non-adjustable separate currency strikes me-this is where John started-as the worst of both worlds. It does not seem to make sense. Either you want an adjustable currency, which has advantages and big disadvantages, or you do not want the currency. What is a non-adjustable currency for?

Q373 Lindsay Roy: We understand that the preference for the euro has gone and that the nationalists would prefer a link with sterling. What are the implications of that for an independent country-a separate Scotland-if that was to be the case?

Professor Kay: What would be the implications of joining the euro?

Lindsay Roy: No; the sterling currency.

Martin Wolf: Remaining within the sterling area?

Lindsay Roy: Yes.

Professor Kay: For the purposes of monetary policy, things would be much as they are now. There would be a Bank of England Monetary Policy Committee. I think there would be an argument for having a Scottish representative on such a committee. That argument might well be conceded. It would be a reasonable argument, but I do not think it would go beyond that. Then there would have to be some discussion between the Scottish Government and the rest of the UK Government on the broader analogue in the European case of the stability and growth pact or the kind of fiscal arrangements that are now being made on what element of coordination of fiscal policies and other economic policies between Scotland and England there would have to be. That would have to be discussed and negotiated as part of the agreement over the currency union.

Q374 Lindsay Roy: But the Bank of England would be the bank of last resort.

Professor Kay: I think the question of what we mean by the bank of last resort and who would serve that role is something we ought to take as a separate issue.

Martin Wolf: At its limits, there would be no change. You can imagine a set of arrangements such that the monetary management of Scotland as part of what we will call the putative sterling area would be exactly the same as it is now. From a monetary point of view nothing would have changed. Presumably, the inflation target would remain the sterling area inflation target, so it would take into account the weight of Scotland in the total, Scottish price movements and so forth. Monetary policy would be made for the entire area, so on the monetary policy side nothing would change. The counterpart would be that you would have in the precise sense zero monetary independence, not even 0.1. It would be exactly the same as being part of the Union.

There would be some very big questions to be asked about the sharing of seigniorage for the profits of the central bank, regulation of financial institutions and how that would be managed, and fiscal policy. Those would be very big side issues, which would have to be settled, presumably as part of a treaty between the new Scottish state and the rest of the UK.

Q375 Lindsay Roy: There would be a dependency culture and not independence in the truest sense.

Martin Wolf: You have said that. I could not possibly comment.

Q376 David Mowat: There would have to be a treaty, would there not?

Martin Wolf: Clearly, there would have to be. The treaty would have to cover the monetary arrangements, the seigniorage, which is part of the fiscal and regulatory arrangements, and it would have to be comprehensive.

Q377 David Mowat: But the treaty would have to say that the deficit could not be too great, rather like the Germans are trying to do to the Greeks now before it brings down the whole currency bloc. The remaining bit-the English or British-would be entitled to say that Scotland may not run a deficit that would jeopardise its currency bloc, would it not?

Professor Kay: I think the question becomes how extensive the fiscal union or fiscal agreement would have to be. It is clear there would have to be a fiscal agreement of some kind. That would be a condition of negotiating a currency union.

Q378 David Mowat: But what is in it for England?

Professor Kay: I am not sure it would have to be as extensive as the one the EU now visualises for the eurozone. My reason for saying that is that it appears the EU has talked itself into a position under which it wants member states of the eurozone to be jointly and severally liable for one another’s debts, so that the eurozone as a whole, in the way they want things to develop, would be standing behind, if not for the moment the debt of Greece, at least the debt of Portugal and so on. I would assume that, if independence for Scotland meant anything at all, part of it would be that Scotland would have its own borrowing capability and, conversely, would not expect the English Government to stand behind Scottish borrowings. That allows Scotland to have more freedom in fiscal policy than, say, the Germans are willing to accord to the Greeks, although it could not have complete freedom in fiscal policy.

Q379 David Mowat: I do not understand that. Is that not exactly the situation of the Greeks under the euro? They had the ability to borrow. The difficulty is that they borrowed too much, so it is analogous to Scotland doing the same thing, potentially.

Professor Kay: No. What happened is that, after the creation of the eurozone, markets, for one reason or another, came to believe that Greek and German debt were practically the same thing. Therefore, Greece was able to borrow unrepayable amounts of money at rates that were rather close to German interest rates. We are now in the position where in effect people in markets are expecting the German Government to fulfil the implied expectation that Greek and German debt were much the same.

Q380 Chair: Are you saying that in a currency union between Britain and Scotland the British Government would not guarantee Scottish borrowings, and therefore it would be entirely possible that Scotland could get into the same sort of difficulties as Greece? What is in it for England or Britain in those circumstances? Why should England want to have responsibility for bailing out a separate Scotland if they behaved irresponsibly?

Professor Kay: I can see no reason why England should take on that liability-I do not expect that it would-any more than the United States takes on responsibility for Californian debt, even in a federal system, or Australia takes on responsibility for Victorian debt. This debate has been influenced to my mind by the slightly surprising assumption that the Germans would take on liability for Greek and Portuguese debt. That is not a necessary part of a currency union.

Martin Wolf: My views are perhaps a little different.

Chair: Good; we welcome that you give us two alternative views.

Martin Wolf: Let me focus for a moment on the relationship between Scotland and the rest of the UK in this putative union. To step back, there are two possible political models underlying this, and the differences are very profound; we have not discussed this, and we should. One possibility is that the new sterling area really was like the eurozone. By that I mean that the rest of the UK Government’s relationship with the central bank, even though it was a much bigger entity, would be exactly the same as the new Scottish Government’s relationship with the central bank-namely, it would be a fully independent central bank, like the ECB, operating outside the control of any single state. It would no longer be a national central bank; it would be a shared central bank like the ECB. That would give you at least in a formal sense sovereign equality between Scotland and the rest of the UK. In my view, no Government of the rest of the UK could accept that, and the biggest single lesson of the eurozone crisis is that serious sovereigns do not allow their central bank to get out of their control.

I have said to colleagues that I would regard any such decision by the rest of the UK Government in such a negotiation as an act of treason, but the implications are very profound. In other words, the Bank of England would remain in the full sense the central bank of the rest of the UK, subject to the law of the rest of the UK, and, in extremis, responsible for helping the rest of the UK to manage its public debt, which is what ultimately a central bank is for. By the way, that was why the Bank of England was created.

That means that the Scottish Government in a new area would not in terms of sovereignty be equal to the rest of the UK; they would clearly be a subordinate Government and would not have the same control over the central bank, which would be created under the rest of the UK’s law. It would be part of Scottish law in some way, but it would not have control, which is quite important. That means that, in a serious crisis, they could not know how that bank would respond. They could discuss it ex ante but they would not know how the bank would respond. It becomes quite credible in this situation that the central bank might indeed not help the Government of Scotland if the latter got into a serious liquidity problem with their public debt. In that context, it would also be relatively but not completely credible to say that, if the Scottish Government had borrowed too much and could not pay their debt, they would go into the sort of proceedings the Greeks have just gone into; they write down their debt and just live with it. But that is not a position of sovereign equality within this putative monetary area.

The structure I have just envisaged where a central bank covers two countries, but its relationship with one of them is quite different legally from its relationship with another of those countries, is to my knowledge not one that exists anywhere in the world. It is a different model from the one that currently exists.

The alternative is to make the sterling area like the eurozone. I think that is an extremely problematic structure from the rest of the UK’s point of view. I am not going to go further into the question of whether they could have avoided the back-ups and all sorts of questions, but there is a fundamental question about the legal relationship between the central bank, the rest of the UK and Scotland in this putative monetary area.

Professor Kay: I broadly agree with Martin. He is right to say it is hard to think of a precise analogue of this arrangement anywhere else. An approximate analogue that might help us think about it a bit would be the one I described earlier of the US Government, which has the Federal Reserve System as its central bank, and the state of California. Neither the US Government nor the Federal Reserve Bank stands behind the debt of California. Californian debt now is of a yield that is at a very material premium; it is about 300 basis points of straightforward debt to US Treasury debt, because markets do not have any confidence either that California will remain indefinitely solvent when it manages its affairs as it currently does or that, if California did fail, either the federal Government or Federal Reserve System would stand behind it. That, in a sense, is somewhat analogous to the Scottish situation. Scotland would have the rather minimal influence over UK Government policy and the Bank of England that California has over federal Government policy and the Federal Reserve System.

Martin Wolf: The analogy goes too far, but it has very powerful implications. It means that, in this model where Scotland remains in the sterling area, with a central bank that is not its central bank but which it shares under strict rules, Scotland would not be sovereign and equal to the rest of the UK Government from a monetary policy point of view. Therefore, you would have to ask yourself whether under those circumstances Scotland could claim to have achieved independence. That is a political judgment. On John’s analogy, Scotland is California; the UK is the federal Government. Obviously, the situation is not equal. That pushes it too far; it would not go that far, but there are very profound questions about the relationship between the two Governments within such an arrangement.

Professor Kay: I do not want to push the analogy too far either; I am just describing that situation as a means of helping us think about these things.

Chair: I think we now have a grasp, or as much as we are likely to get, of the monetary issues. That leads us to the point that Iain wants to make about fiscal and related issues.

Q381 Iain McKenzie: From what I hear, I think you are both agreed that a monetary union would practically necessitate, if not require, a fiscal union.

Professor Kay: I do not think it would. What is demanding the fiscal union in the eurozone is the belief that it is both necessary and desirable that there be, as it were, European debt rather than Greek, German, Portuguese and French debt. There is a fiscal union in the federations we have been talking about, in the sense that there is a set of shared functions performed by the federal Government, but, within that context, states-whether they are in the United States, Canada or Australia-have a good deal of freedom to determine their own fiscal policies.

There are other constraints on the fiscal policies of an independent Scotland, but I am trying to think through the maximum degree of independence that one could achieve given the particular situation of Scotland. I could visualise a situation where there was a distinct Scottish budget, but the Scottish budget would decide its own surplus or deficit, it would undertake its own borrowing and would have its own debt, which the Scottish Government alone were responsible for servicing. It would not be necessary or desirable in that world to impose a requirement that either the rest of the UK Government, or a UK group taken as a whole, supervised the level of Scottish debt in the way the German Government by proxy now seek to do.

Q382 Chair: To be clear, are you saying that, with monetary union, there would be no constraints upon a separate Scottish Government?

Professor Kay: I am not saying there would be no constraints; I am just not going to the other extreme Mr McKenzie described and saying there would have to be fiscal union.

Q383 Chair: What constraints would there be, and by whom would they be agreed?

Professor Kay: There would be some agreement on coordination of fiscal policies, because it would be impossible to sustain a monetary union if there were wholly disparate approaches to fiscal policy, but it would not in itself be impossible, for example, for the Scottish Government to decide in the present situation that it wished to adopt a less restrictive fiscal policy than the UK Government did and finance it through a mixture of higher taxes and a larger deficit in Scotland, if markets were willing to support that higher deficit. They might or might not be depending on what the numbers looked like.

As to the rest of the UK-I will continue to call it "England" because it is so much easier-England would want to maintain some degree of control over that, because if it became wholly irresponsible, it would jeopardise the monetary union as a whole, but the Scottish Government could have scope for pursuing wise or foolish policies of that kind without having to be constrained from doing that.

Q384 David Mowat: What I do not fully understand about the situation you have just set out though is that, if Scotland were to do that and, say, they had a big deficit in conventional terms, quite often that has an exchange rate penalty. That would not be possible for Scotland on its own because it is tied to the whole bloc. Therefore, would not that exchange rate penalty be translated to the whole bloc?

Professor Kay: No.

Q385 David Mowat: By acting in that way, effectively Scotland can bring down the value of sterling in its entirety a bit.

Professor Kay: No, because it is a credit risk rather than exchange rate issue.
To go back to the Californian case, which is not an exact analogue but helps pin us down, people believe that it might go bust. That is why Californian debt sells at a substantial discount to US debt, but they do not believe that California will leave the dollar.

Martin Wolf: The crucial question is linked to the point I would make. Let us assume that it was credible, because of the arrangements made in setting up this new structure, that Scottish debt would never be monetised by the Bank of England and rescued by the Government of the rest of the UK. In this situation, to put it very crudely, Scotland could, if it was badly managed, go bust, and I am not suggesting in any way that this would happen. It would then default like any other defaulter. The assumption would be that it is not a huge part of the total monetary area. Under these assumptions there is no reason to expect an inflationary policy by the Bank of England; there is not expected to be any huge knock-on effects on the rest of the UK’s economy-there will be some-so it is something nobody need bother about. Basically, Scotland would go bust. The Scottish Government would have to restructure its debt, as Greece has done, and reach a deal. To the extent there was a risk of that, it would show up in the interest rates, and that would itself be a constraint on the activities of the Government of Scotland in managing its affairs.

Therefore, the key question here would be: can you make it credible that there are no circumstances whatsoever in which, if the Government of Scotland got into difficulties, it would be rescued either by the central bank or the Government of the rest of the UK? My view is that the Government of the rest of the UK and the Bank of England would take the view in negotiations that that cannot be made fully credible ex ante. As a result, if it were to be the case that Scotland behaved irresponsibly because this constraint is not fully credible, some cost would be borne in the interest rates in the rest of the UK, and possibly in the exchange rate. That is not a risk they would like to bear, so I would guess-I think that is where John is going-they would want some constraints, the nature of which we can discuss, on the extent of the borrowing by the Scottish Government, because there are some, although not huge, spillover effects, and we can debate how significant those would be.

My guess is that a prudent Government of the rest of UK in the negotiations would like some sort of constraint, and I would not be terribly surprised if the Government of Scotland thought it was in their own interests because it would make their debt more credible in markets, at least initially. Once they have established a record over 20 or 30 years, they would not need it; everybody would be comfortable. That is where the negotiation would lie; it is about credibility.

There is, however, one other area we cannot avoid discussing because it is an important part of this and is one of the big lessons of the eurozone crisis, which is the financial system. It turns out to be quite difficult to have a financial system that operates freely across an entire currency area and is backed not by a pooling of fiscal resources but the resources of individual states. Because bankrupt states cannot back their financial system, the collapse of that system has systemic effects. That is what people think. Therefore, there is tremendous pressure on the central bank to rescue everybody. That is what we are seeing in the eurozone at the moment. We can agree or disagree on whether that is a good idea, but that is essentially what has happened.

Most people who have observed the eurozone situation believe that one of its lessons is that there must be some pooling of the back-up for the financial system. Of course, if the financial system could be wound down without any taxpayer or central bank support, that issue would go away, but it does not seem very likely. My view is that in the negotiation of the new compact there would have to be some deal on who regulates and who backs financial institutions operating in the monetary area. That will be particularly relevant for those institutions based in Scotland that are very large relative to the Scottish state. That is a fiscal and also a central bank issue. Therefore, one of the big questions that would have to be sorted out is regulatory, lender of last resort and fiscal responsibility in the event of a disaster for financial institutions operating throughout these areas.

Chair: Could we maybe come back to that? You will appreciate that the staff tell us what questions to ask. We have a set of questions dealing with banking at the moment, and I know some of my colleagues want to follow this up.

Q386 Mr Reid: If the two countries are in a monetary union, is it practical for them to have wildly varying rates of corporation tax?

Professor Kay: I do not think it is the monetary union that is the problem. The central problem is the transfer of profits between jurisdictions. We now have a large global problem with corporation tax, as people are more widely recognising, which is that the difficulty of pinning down where profits arise is sufficiently great that large companies operating internationally can exploit almost whatever rules are devised to shift the jurisdiction in which they pay tax.

If we think about that in the Scottish connection, we realise the problems immediately. In the days when Royal Bank of Scotland claimed to make profits, in what jurisdiction were the profits obtained or earned? Even if you had asked that question of the management of Royal Bank of Scotland, they would not have been able to give you a clear answer to that question.

We have the same issue in relation to the Scottish whisky industry, for example, where the profits earned from Scottish whisky-which are considerable-are earned not only outside Scotland but outside the UK for tax purposes. The amount of corporation tax that is paid by the large whisky producers to the UK is currently small. We have a substantial problem of jurisdiction, which is an entirely general one in relation to corporation tax.

We know that Ireland has attracted a lot of attention in Scotland. Ireland did rather well out of instituting a 12.5% corporation tax rate in two ways. It did well by attracting a good deal of footloose assembly and delivery-type activity, whether there was actually some activity-even if it was not at a very high level-taking place in Ireland as a result of the attractiveness of that rate. There is also a very large amount of profit ostensibly being earned in Ireland by companies whose operations in Ireland are rather modest in relation to their total operation.

In effect, you could say that Ireland is stealing tax revenue from other jurisdictions. It is a little bit of a tax haven in this respect. The consequence of that is that other people are not going to allow that to happen again. That is why my view is that a separate Scottish corporation tax rate is a debating point, but, within the context of the UK, the UK Treasury is not going to allow this to happen, and in the context of an independent Scotland negotiating membership of the EU, the EU will not allow it to happen.

Q387 Chair: Leaving aside the question of the EU at the moment, if Scotland was part of a monetary union with the rest of the UK, I fail to see what the rest of the UK could do about it if Scotland decided to slash its corporation tax to, say, 5% and thus cannibalised corporation tax from the rest of the UK by attracting companies to Scotland. Surely, they would have no levers to pull.

Professor Kay: But they might ask for levers. As Martin has explained-and it is important we should all understand this-if there is to be independence for Scotland, there will be lengthy and difficult negotiations over a whole variety of issues between the Scottish Government and the rest of the UK. Given that the threat to have a 12.5% or low rate of corporation tax in Scotland is on the table, that issue will be raised in negotiation. None of us knows what the outcome of that negotiation would be. There is no logical reason why Scotland should not have complete freedom to set its corporation tax within a monetary union, but it would surprise me very little if some restriction on Scotland’s freedom on corporation tax was not one of the issues that came up in negotiation of the economic agreement between the two countries.

Q388 Chair: But many of these negotiations under the proposals being put forward by the Scottish Government would take place only after there had been a referendum, in which case people would be voting without knowing the result of those discussions.

Professor Kay: Of course.

Martin Wolf: Of course. I have no idea how it would work constitutionally, but logically, there is a decision to go for independence and then negotiation to determine the new constitutional settlement, which would include the elements we have discussed. One might imagine that people would be consulted on whether those were appropriate arrangements. Whether that would happen, I have no idea; that is a constitutional issue for Scotland, but essentially we are talking about the constitutional settlement for the new country and its relationship with the rest of the UK.

The issues John raises are fundamental. There is no direct relationship between being part of a monetary area and the tax system, as we can see in the eurozone, but it would be remiss, to put it mildly, for the rest of the UK Government to give what is a very important asset of being part of a sterling area that has real value without having some quid pro quos. Probably, the most obvious quid pro quo is in the tax area. Getting into a situation of tax competition with Scotland over the location of businesses, which would just pop across the border and stop paying corporation tax to the UK, should be regarded by any responsible Government of the rest of the UK as impermissible, and therefore they would treat that as part of the negotiation. They might take the position-I am not suggesting they would-that, if they do not want to reach a deal on these tax issues, they can just leave the sterling area and go somewhere else. It is pretty theoretical.

Professor Kay: We can talk only about the economics of this. If there were to be a yes vote in a referendum in 2014, it is obvious that in the economic area there would have to be very extensive negotiations among the Scottish Government, UK Government and the EU, and those negotiations would establish the detail of the economic arrangements surrounding an independent Scotland.

Q389 Chair: If an agreement was not reached on these fiscal matters, it would be entirely possible for the British Government to say, "No. We will refuse to have monetary union with you."

Martin Wolf: They can refuse that anyway.

Q390 Chair: I want to hear you say it.

Martin Wolf: Let us assume that Scotland votes for independence. There will then be negotiation. One of the questions in the negotiation will be the future monetary arrangements. Maybe-I have no idea-the Scottish Government will suggest it would like to remain part of the sterling monetary area. I would assume the rest of the UK Government would respond by saying, "That’s a very interesting idea. Let’s discuss the implications." All the issues we have just been discussing would come up for negotiation. It is perfectly possible that no agreement would be reached. Thinking about the many difficulties we have discussed just in the monetary area, it is completely possible that this arrangement, which in my view is an unprecedented one, could not be agreed.

Q391 David Mowat: Could they not go for the Montenegro solution?

Martin Wolf: Of course.

Q392 David Mowat: They just print their own pounds.

Martin Wolf: They would have to import sterling, as it were, and use it. It is like Panama, which is another example. Panama uses the dollar. It is not part of the formal dollar area and has no Federal Reserve backing. It uses dollar notes. You can deposit dollars in Panamanian or American banks. You could have the rest of the UK banks operating in Scotland, which would therefore effectively be operating offshore within the European Union. You can discuss that possibility, by the way, but in this case Scotland would operate outside a monetary area. In the strict sense, it would have no central bank.

Professor Kay: If you ask in Montenegro where the euros come from, the answer is German tourists, who hike their mountains and lie on their beaches.

Martin Wolf: Or remittances or exports.

Professor Kay: I hate to think where the Panamanian dollars come from.

Chair: But Montenegro cannot print its own euro currency legally.

Q393 David Mowat: But Scotland does print its own pound notes now, does it not?

Martin Wolf: If they did that without backing, they are in their own monetary area and they would have their own central bank. We come back to the beginning. One possibility is that Scotland has its own Scottish pounds, floating or pegged; it has a Scottish central bank; it has fully independent monetary sovereignty. The alternative is that they could back Scottish pound notes one for one with English pound notes. Effectively, it would be part of the English monetary area, except that it would not have the backing of a central bank. That is where Panama is.

Q394 Chair: So it is very much the case that, unless these negotiations are settled before a referendum takes place, we are buying a pig in a poke.

Professor Kay: Chairman, you are saying that and not us.

Martin Wolf: You are. If these arrangements are not agreed, you would have decided on independence, but you would not know the content or reality of it.

Mike Freer: Chairman, I have a point of order to raise. Given that we have spent an hour on only about a third of the topics we wanted to cover-

Chair: I think we have covered some of the other ones already.

Mike Freer: I was going to suggest that this is fairly crucial to the debate on the referendum. I wonder whether we ought to have another session with the witnesses, as it is proving very enlightening.

Chair: The next set of witnesses is in the room. I am sure they are enjoying this as well. The other witnesses have got to leave by midnight, as I understand it. Let’s see if we can move on and we will see how we do in terms of timing. You had a particular point about the euro.

Q395 Mike Freer: I did. You described a scenario where independence is a badge. There is little latitude on fiscal union, economic policy and monetary policy. The other option is simply to uncouple and become an independent state as part of the EU. Is that not a better option for an independent Scotland?

Martin Wolf: I am assuming that an independent Scotland would seek to become and be a member of the EU. The monetary arrangements we have talked about are independent of that decision. I am pretty sure there would not be a problem with the rest of the EU if they could agree. There would be separate negotiations for joining the EU, obviously; effectively, it is a new country. There would be lots of difficulties, but I am not going to go into that. If this new country decided to enter the EU while retaining membership of the UK sterling area, it seems to me that theoretically it would be perfectly possible. It has never happened before, but theoretically it is perfectly possible. They could, in theory, be a member of the EU and the sterling area.

Q396 Mike Freer: Mr Wolf, let me rewind that. If the negotiations show that being an independent country and part of the EU, but with monetary union with the rest of the UK, gives no extra latitude, and so they choose to join the euro, what implications are there for monetary and fiscal latitude in this new country?

Martin Wolf: They would be subject to all the rules and regulations of the euro, and we know what they are. There is the fiscal compact, which has been agreed. Obviously, that would be required. The treaty is quite explicit about the fiscal requirements on structural fiscal deficits, which would have to be essentially zero. On debt, the monetary arrangements would be determined by the ECB, and they would be subject to all the requirements of the ECB on collateral and all the rest of it. Bank regulation would be as it is in other euro members. That is the model. Although that model is changing, it is reasonably clear what it is. It would be like any other small member of the eurozone, provided it was accepted into the eurozone. I think that, in its initial position, it would not meet the criteria, but that is a separate matter. The deficit would be too large and the debt too high, for the same reason the UK could not join the eurozone currently. If at some point it was agreed that Scotland could join the eurozone and the criteria were met, it would be like any other eurozone member.

Q397 Mike Freer: To follow through on that, if they wanted to pursue that route and qualify for membership, they would have to adopt the austerity measures that we see across the rest of Europe today.

Martin Wolf: They would have to meet the fiscal criteria of the eurozone on both debt and deficits, which are becoming reasonably clear. The structural deficit would have to be zero. The structural deficit for an oil-producing country with a heavy dependence on oil revenues is very difficult to work out, and to determine what it was would be quite a negotiation, but the criteria are reasonably clear. There are many applicant members, and Scotland would be just one of them.

Chair: Perhaps we may turn now to issues related to banking and banking matters.

Q398 David Mowat: To finish off the last section before we turn to banking, what is in it for the English taxpayer to agree to have Scotland using sterling? I understand you can minimise the risks by doing the various things in the discussions, but, other than that, suppose we did not want to and we thought that, notwithstanding we could minimise the risks in that way, we just were not that bothered; why should we? If I am an English politician accountable to his electorate, why would I agree?

Martin Wolf: Let us look purely at the economics and leave aside any thrill one gets out of having a slightly larger monetary area, which is not generally the sort of thing that people get excited about. I would have thought the only benefit to the rest of the UK economy is that an element of instability because of possible fluctuations in the currency against England would be eliminated, but, since the rest of the UK is roughly 10 times as large, the benefits would be really small. Another way of asking exactly the same question is: how much would the US gain if Canada, all other things being equal, decided to become part of the dollar area? The answer is that, for the rest of the US, it would be quite unimportant.

Q399 David Mowat: That negotiation becomes a very intensely important political question in England, potentially.

Martin Wolf: Clearly, it would be a question in England, but the rest of the UK might take the view that it does not matter much either way so long as the risks are managed.

Q400 David Mowat: Except that, potentially, we have an independent country on our doorstep that wishes to cut corporation tax and so on.

Martin Wolf: But that is quite separate; that is not part of the monetary area issue. If a country is independent and that is agreed, that is not part of the monetary issue.

Q401 David Mowat: But we do not need to allow them to use our currency and let them do that.

Martin Wolf: We could do that, but in the context of tax competition, the currency per se is an nth order issue.

Professor Kay: It has been my assumption that, if the Scots did vote for independence in 2014, there would be a mutual desire to try to accomplish this on reasonable and amicable terms. I think that is what we are talking about.

David Mowat: Fair enough.

Martin Wolf: To go back to my earlier point, what is important for the rest of the UK-it is not important either way whether Scotland is in the monetary area or not-is that the relationship between the Bank of England and the rest of the UK state is not fundamentally changed. That is of vital interest.

Q402 David Mowat: I understand that from your evidence. Just on the Bank of England under this currency union and with Scotland using the same currency, effectively we still have the MPC setting interest rates for the whole currency; so that is clear. As you say, potentially, there would be a Scottish representative on it. Why not?

Martin Wolf: I would be opposed to that, because the basic principle of the MPC is that there are no regional, industrial or special interests. The general idea is that everybody there represents the whole. I would not like to go the way of the ECB, which is problematic. While I would want to take into account nationality in some sense, there should be no representatives of particular areas on the MPC; but that is a personal view and the Treasury and Government might take a different one.

Q403 David Mowat: The implication of it, though, is that the economic cycles of Scotland and England economic cycles would stay similar, because, otherwise, the concept of an MPC does not work, does it? Interest rate cycles become-

Martin Wolf: It might or might not be similar, which is merely to say that it may or may not be the case at any particular moment that the monetary policy set for the whole sterling area is or is not suitable for Scotland. That is a problem now potentially, and it would be the same.

Q404 David Mowat: Would it imply that the FPC and all the other regulatory things that are now coming in would have to cover Scotland as well, or could Scotland set up its own structures?

Martin Wolf: In my view, yes.

Professor Kay: My view on that is different.

Q405 Chair: Before we get to the detail of regulation, I want to return to the question of banking and seek clarification from you about who would be the lender of last resort in a separate Scotland. What is the significance of being the lender of last resort?

Professor Kay: I think we should start with the second of these questions, because when I was a student, the concept of lender of last resort had the traditional meaning that, in old-style banking, it was the nature of banks to make long-term loans to individuals and businesses and they took in short-term deposits. As a result of that, from time to time a solvent bank was in danger of running out of money on a short-term basis, and the agreement of a central bank to be lender of last resort and provide support against good loans on the bank’s books at a penalty interest rate was a sufficient mechanism for stopping bank runs.

The banking world in which we now live has become vastly more complicated, and lender of last resort has been translated into being there to bail out not solvent but illiquid banks-but hopelessly insolvent banks whenever they feel in need of cash. What we really need to do in all this discussion is define and restrict more clearly what it is that Governments are and are not willing to do in relation to supporting the banking system, and from that work out what these arrangements would be in the case of an independent Scotland.

My view, for example, is that an independent Scotland plainly could not have bailed out the Royal Bank of Scotland in the way the UK Government did. The Scottish Government certainly should not have done that, nor in my view should the UK Government have done it. It takes one into a wider debate about the role of Government in relation to banks.

Q406 Chair: Indeed. That means that the Icelandic Government and the Irish Governments guaranteed it.

Professor Kay: The Icelandic Government did not; the Irish Government did, and they made a very serious mistake by doing so, as we now see.

Martin Wolf: This is an incredibly important and difficult area. John is saying that, if we lived in a different world, which in his view is a more sensible one, in which states did not back banks, and, when they got into a serious crisis basically banks were wound up or radically restructured, essentially at the expense of their creditors, including, in extremis, depositors who are not insured-we have not yet discussed insured depositors and how that would work-it really would not matter very much who backed banks and how they were backed. I agree with that, but it is not the world we live in.

In the world we now live in, which I expect will continue to be the case whether or not Scotland decides to become independent, the question of who in the last resort backs banks in major crises is important, and it would, inevitably, become part of the negotiation. One could envisage a number of possible arrangements. One example that one could not envisage is that RBS becomes a Scottish bank and the Scottish Government stand behind the deposit guarantees of RBS, because it could not. The deposit guarantee scheme of the UK banking sector is not self-standing. As it stands, one could easily imagine a crisis in which it would not hold up. By the way, that was what happened with Iceland; it could not meet its deposit insurance guarantees on the offshore deposits in the Icelandic banks. We know that was what happened.

In my view, the Government of the rest of the UK could not allow a major UK bank to be in a position in which the depositors could not be confident that their claims will be met in the event of a crisis. Therefore, it could not fall on the Scottish Government. Essentially, what I am saying is that what we would need to do would depend on how we think the whole banking system would be run and regulated. I am assuming that certain features that now exist in this banking system, which John and I do not like, would continue. Under those circumstances the relationship of the Scottish Government to institutions who do most of their business in the rest of the UK and are extremely large relative to Scotland would become a major issue.

Professor Kay: I think we need to look at that issue carefully. What the Scottish Government could not have done is what the UK Government did in terms of implicitly, at least, underwriting the whole of the liabilities of Royal Bank of Scotland. That is not the same as saying that the Scottish Government could not have provided deposit protection to the Royal Bank of Scotland. Imagine the Royal Bank of Scotland with an independent Scotland and operating in Europe. The situation would be that Royal Bank of Scotland had a number of retail banking subsidiaries, of which the most important were Royal Bank of Scotland, which was a Scottish bank, NatWest bank, which was an English bank, and some US subsidiaries, which we can put to one side for a moment. In that situation, under the European rules, depositor protection in the Royal Bank of Scotland would have fallen under a Scottish deposit protection scheme of some kind. That is something the Scottish Government could have managed. Deposit protection in relation to NatWest bank would have fallen on the English deposit protection scheme, which again the English deposit protection scheme could have managed. What would not have been covered would have been the other obligations of the Royal Bank of Scotland of the group as a whole.

The Scottish Government could not have taken on responsibility for these. The English Government could and, conceivably in these circumstances, might have wished to do so, or-which would have been the best and most likely way out of that situation-there would have been some agreement reached rather quickly among the Scottish, English and American Governments, which would have taken over the wholesale operations of the Royal Bank of Scotland. But we have to go through some of the detail of this.

What is really important about that detail is that, at the moment, we have a socalled passport system operating within the European Union, which was very relevant in the Icelandic case. Of the two main Icelandic banks, one operated in the UK through a UK subsidiary, which meant that the liabilities of that bank fell largely on the UK deposit protection scheme. The other one operated in the UK through a branch, which meant that the liabilities fell on the Icelandic deposit protection scheme, which was incapable of handling these liabilities. Therefore, it is a big but rather technical question whether the international operations of banks are managed through subsidiaries or branches. Essentially, the Royal Bank of Scotland was, as a matter of fact, organised through subsidiaries and that is the way the fallout from the failure of that institution would have been dealt with.

But there are two points, one of which would be a development of Martin’s point. We need to think about the evolution of the banking system in a broader context. The most absurd argument one hears in this debate is the suggestion that we need to have big countries because the only way we can bail out big banks is to have big countries. There should be a better way of solving the problem of big banks than that one, and there is. But the ways in which these responsibilities are allocated depends a great deal on the detail of how banks are structured and regulated, which, again, would need to be the kind of negotiation which everything we have said has emphasised the need for.

Q407 David Mowat: One gets into issues like whether Vickers applies to banks that are headquartered in Scotland and all that goes with that.

Professor Kay: What is critical to me is that Vickers, in which Martin played such a large role, is part of what takes us to the answer to this, because it would lead us towards the situation that I would have regarded as the desirable outcome in the RBS case-namely, if there had been an independent Scottish Government, it would have seized the Scottish retail operations of RBS. The English Government would have taken over NatWest bank; the American Government would have taken over citizens in the US operations; and the central wholesale activities of RBS would then have been liquidated.

David Mowat: The difficulty with that would have been contagion-

Q408 Chair: Martin, are there other points you want to add to that?

Martin Wolf: It is not a disagreement, but there are two points on that. Under this model, which of course would not have been relevant before since we have a unitary state, NatWest would be regulated by the rest of the UK as a subsidiary of the rest of the UK, and the RBS bit would be regulated presumably by the Government of Scotland, though in some arrangement with the Bank of England, because there is always some relationship between the Government and the central bank if and when lender of last resort operations occur. The special liquidity operations of the Bank of England, agreed between the Bank and Alistair Darling when he was Chancellor, involved a Treasury back-up. I do not think we are going to get away from that. So, presumably, that would be part of the agreement for the whole monetary area, or the Government of Scotland would have to have a separate agreement in some way with the central bank if and when such operations were applied.

Essentially, the point is that the regulatory structure would be broken up. The rest of the UK Government would want to regulate the subsidiaries operating in the rest of the UK. I think it would be pretty uncomfortable about having those subsidiaries regulated outside it, because it gets into the branching thing. However, under EU law branching is allowed, and there is a very big question about how that would operate in this context. While John is absolutely right about the risks, it happens to be the law. Technically, banks set up in Scotland could apply to branch into the rest of the UK. That would create a very big dilemma for the rest of the UK.

The other point raised was about the Financial Policy Committee. The reason I think it would have to apply to the whole monetary area is that it is concerned with the stability of the monetary area. It is dealing with macro-prudential policy, which is concerned with the stability of the monetary area. I would have thought that the rest of the UK Government and the Bank of England would want to be sure that the Financial Policy Committee’s oversight of monetary stability applied to the entire monetary area. They could take the view that Scotland was not important enough, but I would be surprised if they took that view. So, here too, some big issues would arise.

Professor Kay: I would agree that the Financial Policy Committee should be part of the monetary union.

Q409 Chair: This is an area to which we will have to return in due course. Would it be fair to say at this point that these issues about the control and regulation of banking would be part of the negotiation process, and, before any rest of the UK Government agreed to monetary union, they would want to be satisfied on all of these points and essentially would have the whip hand?

Martin Wolf: There are two points here. They would also be governed, consistent with the question asked here, by European law, which is very important in this area, but, if in addition to European law, specific arrangements were being made about the monetary area, which is sui generis, they would be part of that as well.

Q410 Fiona Bruce: Martin, your note says that a prolonged period of uncertainty in relation to Scotland’s constitutional future could be costly, as in the case of Quebec. Could you pick that up and perhaps elaborate on areas you have not touched on before about what those costs could be?

Martin Wolf: Uncertainty is itself costly. We have discussed a great many complicated matters about the future monetary and fiscal arrangements; the future tax system; the future exchange rate regime governing Scotland; and the relationship between Scotland and the rest of the UK. In the case of Quebec, there was radical uncertainty about this that lasted for most of a generation. In Canada, there is a widely held view, which I think has very substantial evidence, that, as a result of this uncertainty, since the residual Canada was so much bigger economically than Quebec, though the relationship is nothing like as extreme as between Scotland and the rest of the UK, a great many financial institutions and other businesses decided that, to mitigate the uncertainty, they would move their businesses from Montreal to Toronto. I have never seen any unambiguous study, but it is a very widely shared view that it had a blighting effect on Montreal simply because of a generation-long uncertainty.

For this reason, it would seem to me to be very much in the interests of all concerned to minimise the period of uncertainty and to get to the point at which one understands the subsequent regime one way or the other as quickly as possible. But the loser inevitably will be the smaller, party because that is where the uncertainty is likely to bite most, and it could affect Edinburgh therefore as a financial centre. That was the implication of my remark.

Q411 Mr Reid: Do you have any view as to whether or not a separate Scotland would retain the triple A credit rating that the UK has at the moment?

Martin Wolf: Yes, I have controversial views. I do not know whether John shares them.

Chair: Good.

Martin Wolf: My view-I was subsequently attacked for it, but it was supported by some of the credit rating agencies-was that it would be extremely unlikely to continue with this rating. I think the UK itself is on the margin. It would be different if one started off with an unambiguously healthy economy. I do not want to exaggerate the significance of this either, but that is another question.

Several factors might lead people to think that the rating should be lower. One is simply that it is an untried Government; it does not have a track record. We do not know how it will behave. You need to get a track record. That helps. Over time, that will be solved, but obviously the UK has a very long history of managing its public debt successfully. Scotland is new. The second is that, compared with the UK, it would be relatively dependent on resource revenues. It would be a higher share of its revenues, and they are inherently more unstable-and we know that they are more unstable. Thirdly, the deficit initially, even with the resource revenues applying to Scotland, as far as I can see, would be very similar to the UK’s, so it would start off with a very big deficit. It does not start off with a Swiss-type situation, which is a bad starting point. Finally, inevitably being a much smaller economy, it will be less diversified and more subject to shocks.

For all these reasons, I would expect the rating agencies in looking at this new country to start off with a lower rating and then see what happened. I would not guess on how far down it would go. There are not many triple As any more in the world, and the small countries that are in that category are really triple A. We are talking about Switzerland, Finland and Norway. If the UK was applying completely afresh in its present configuration, it would be nowhere near triple A.

Q412 Mr Reid: What are the implications if the country did not have triple A rating?

Martin Wolf: The initial borrowing costs would be somewhat higher than they are for the rest of the UK. How much higher would be uncertain, but the initial cost would certainly be higher. That would be one reason why a prudent Scottish Government would have to start off with a very prudent fiscal policy.

Professor Kay: But I suspect it would not be massively higher. In a way, it is not very useful to have this discussion, given the list of unresolved issues that would have to be negotiated and decided before we knew what an independent Scotland looked like-the list we have been discussing this afternoon. But I am bound to say that, for the reasons Martin has described, it is very hard to see any reasons why an independent Scotland would have a better credit rating or would be a better credit risk than the UK as a whole currently is.

Q413 Chair: What would that mean to real people, in the sense that Scotland had a higher borrowing rate? Would that translate into higher mortgage rates?

Professor Kay: No.

Martin Wolf: Logically, it is possible that you could even get into a situation where, although for private individuals it is less likely, companies can borrow more cheaply than a Government within a currency area. That is the situation of Spanish banks visà-vis the Spanish state at the moment. Assume for the moment that we are in the monetary area and so it is fully part of this. Scotland is a small part of the monetary area from a fiscal point of view. We have already agreed that it would not threaten its stability. It is perfectly possible that mortgage rates would not be higher, but tax rates might be, other things being equal, because borrowing costs are higher for the Government. It is an open question.

In that situation what are we talking about? It would be a percentage point, maybe a little more or that sort of figure. I am assuming that Scotland would inherit a pro rata share of the public debt, so we know roughly what that is. I am making that assumption, but it would be the plausible way of breaking it up. If you can apply a modest increase in the interest rate, you can work it out that, on that debt, maybe it will be 1% of GDP or something like that. These are not hard numbers, but that would be an amount by which, caeteris paribus, taxes would have to be raised or spending would have to be cut-other things being equal. There would be some effect, not a dramatic one, on the fiscal position of the Scottish Government.

Q414 Mike Freer: You said that the relationship between California and the Fed was that the former’s borrowing rate was 300 pips higher than the Fed, which, from memory, is about 3%. Would you say it is not of the same order? What is the impact on consumer costs in California, or would that not translate to Scotland?

Professor Kay: Essentially, it is zero.

Martin Wolf: It is a credit risk to the California government. Therefore, it is a credit risk to those entities that depend on the California government. If I were looking at the credit rating of companies that sell a large part of their output to the California government, or depend in one way or another on that government, I would expect that to be part of their credit rating, but for ordinary households in California, it depends on the performance of the California economy as a whole, which is not fundamentally determined by the health of the California government.

Professor Kay: Larry Page is a much better credit risk than the state of California.

Q415 Mike Freer: There is a spread but it is not a 3% spread on the consumer credit scene.

Professor Kay: From the point of view of a borrower on mortgage, the fact that he lives in California and in a badly run state from a financial point of view has no impact on his borrowing.

Martin Wolf: I think it would have some. Pretty obviously, if a government were to become insolvent, it would have to cut all its police force, fire service and its teachers. The schools would close; business would fall. Inevitably, that affects an area.

Q416 Chair: But, apart from that, it would be all right. It would have no impact on the individual.

Martin Wolf: If a very big local government covering a very large area gets into serious fiscal difficulties, the people who live there are affected by it, and it would affect the credit rating of many businesses that are dependent on it. It would not affect Apple, because it does not matter at all, but it would affect some businesses; of course it would. I am not predicting this. This is a very important difference. Scotland would be more vulnerable in this sense. Two thirds of Government spending in the US is federal spending. They are responsible for social security, Medicare, defence and all the rest of it. There is a lot that the federal Government do. In the arrangement we are now describing, all of those functions would presumably be performed by the Scottish Government, so the effects of a serious fiscal problem-I do not in any way predict it-would be more like the sort of thing we see in Greece or Spain because there is not a European or federal Government. In this respect, it is more important that the Government remain solvent and credible, because they are providing essentially all the public services.

Q417 Jim McGovern: You are well aware that Scotland is home to a large number of financial institutions who do most of their business outwith Scotland. Would separation mean a change in the relationship between those institutions and the rest of the UK? If so, why? If not, why not?

Chair: We have covered a lot of that already, have we not?

Jim McGovern: Probably.

Martin Wolf: The interesting question is about the insurance companies. We have talked about banks. There would have to be some deal. If you take major insurance companies that provide a large amount of insurance business in the UK, the rest of the UK Government will want to be sure that they are properly regulated by somebody. I do not have any strong feelings about where they would want that to happen, but they will want to be absolutely sure that they are properly regulated by somebody, because they do not want to be in a situation when there is a problem about them meeting their obligations in the rest of the UK and there is no accountable authority for what has happened.

My own guess would be that the initial position of the Government in any negotiations of this kind-and certainly the one I would advise them to take-is that these institutions should be regulated by the rest of the UK regulators, but that might not be where it would end up. It will be very important to be sure that the businesses we are talking about are properly and prudently run, as they always have been, and will continue to be.

Professor Kay: The way Martin has framed that answer and a number of other answers is the kind of perspective from which I would expect the UK Treasury to start in the negotiation over independence that we are describing-that is, that any element of independence would be something they would resist. There would be an initial phase of the negotiation in which the Scottish Government would have to say, and could in the end say successfully, "Independence means independence. Although you will wish to retain control over a whole variety of activities taking place north of the border, the mood of the Scottish people is that you will not be able to do so." As a matter of fact, I think we are going to that kind of negotiation anyway in the next 10 years regardless of the results of this particular referendum.

Martin is right that the UK Treasury at least will wish to retain the regulation of, say, insurance companies rather as it is now. In the end, they will not succeed in doing so on an issue like that, because there is not a compelling reason why they ought to do so, especially in the context that the regulation of insurance companies is now very largely an EU rather than a purely domestic UK matter.

If one looks at the main areas of financial services in Scotland, we have talked at some length about banks already. As to the two other large ones, one is insurance. There is a difference here between life insurance and general insurance. General insurance is now mainly a matter of administrative functions taking place in Scotland. Life insurance is large in Scotland, but that takes one into asset management, which is the other large Edinburgh financial services sector. I think Edinburgh would continue to be an asset management centre in financial services in much the same way as it is now, whether or not independence happened.

Martin Wolf: I start off more close to the Treasury. As John says, this is not wrong. In its own interests and the interests of its financial services business, the new Scottish Government, if they retained regulatory control, would have to convince the clients of these businesses that they were regulating it as effectively as it had been regulated before.

Professor Kay: That might not be terribly hard.

Martin Wolf: It might not be very hard at all. The quality of regulation would be one of the competitive advantages that Scotland will have to retain.

Q418 Chair: John, I take it that, when you were suggesting that Martin was reflecting the viewpoint of the Treasury, that was not intended as a compliment.

Martin Wolf: And I take it as one. I take it that it would be not only the position of the Treasury but the position, therefore, of very important Ministers in the rest of the UK Government, whatever their political complexion might be. Therefore, these subjects will be part of the negotiation. I am not as confident as John as to where they would end up, but clearly they would be nothing like as vexed and fundamental as in the case of banking.

Q419 Jim McGovern: You speak about the position of banks, insurance companies or other institutions and the impact that separatism would have on Scotland. What would be the impact on the rest of the UK?

Martin Wolf: Let us take a major insurance company. If it continued to exist as a company doing the functions it now does, whether regulated by the Scottish Government or the rest of the UK regulator, the rules would be much the same. Its business will continue as before, provided it could persuade its clients, the policyholders and all the rest of them, that it was proceeding to manage its business in exactly the same prudent way it had done for the previous 200 years. As long as that had been done, I do not see any fundamental change. Standard Life could continue as it is.

Q420 Chair: That has been very helpful. My head is completely filled now. The only thing that remains for me to ask is whether or not there are any answers you had prepared for questions we have not asked. We have covered the field pretty well, but I just wonder whether there are any final points you thought it would be negligent of us not to draw out.

Martin Wolf: I think we have covered most of the possibilities one could imagine in these negotiations. The big lesson I would spell out is that independence can mean many different things.

Professor Kay: I agree with that. There are two main conclusions from this discussion, one of which is that there would have to be very extensive and detailed negotiation over the mechanics of what an independent Scotland looked like. The second is that the degree of economic independence that a small country can enjoy in a global economic environment is very easily exaggerated; it is quite limited, and it is not primarily dependent on the constitutional arrangements.

Martin Wolf: There was one thing that we did not raise. You raised corporation tax. I believe that the general rule would be that, with the exception of corporation tax, the real problem for Scotland is that in almost no area-resource taxes, land taxes and so on-could it have higher taxes than in the rest of the UK. That is quite an important constraint.

Professor Kay: It could have a bit higher taxes-

Martin Wolf: The difference would be small.

Professor Kay: But Scotland would broadly be in the position that Ireland is now. There is rough alignment on the design and structure of tax rates as between Ireland and the UK. The rates, structure and base are not that different. In Ireland, overall the rates are a bit higher, and that is a possible and probably the likely position for Scotland.

Q421 Pamela Nash: Except for corporation tax.

Professor Kay: Except for corporation tax.

Martin Wolf: You compete on the most mobile factors.

Professor Kay: Which is the one we could not get actually.

Q422 Chair: But presumably that will be part of the negotiations.

Professor Kay: There would be some other tax issues that would be subject to negotiation, but in most cases it would just be forced by circumstances. The consequences for Scotland of having radically different tax structures would turn out to be complex and difficult. That is what has created the similarity, as it were, between Ireland and the UK. I think in that sense Scotland is in the same position. I am reminded that the other large area we have not discussed is the set of issues around welfare and pensions, but that is almost a subject for another session entirely.

Chair: We will not start on that just now. This has been much more fun than I expected. It has been very stimulating for us. It took me way beyond my O-Grade economics. Thank you very much for coming along, gentlemen. It may very well be that in future we invite you back as the debate progresses, and I hope you would be willing to do that.

Examination of Witnesses

Witnesses: Matthew Elliott, Campaign Director, NOtoAV campaign, William Norton, Referendum Agent, NOtoAV campaign, Katie Ghose, Yes to Fairer Votes campaign and Chief Executive, Electoral Reform Society, and Willie Sullivan, Scottish Director of Electoral Reform Society and head of field operations, Yes to Fairer Votes campaign, gave evidence.

Q423 Chair: First, I apologise for delaying you. I am conscious that some of you have to be off in a little while. We wanted to make sure we got the full benefit of the previous speakers. I think it would be helpful if we started by asking you to introduce yourselves and indicate your place in the various organisations.

William Norton: I am William Norton. I was the responsible person for the NOtoAV campaign in 2011. I was also the referendum agent for the no campaign in the north-east in 2004.

Matthew Elliott: I am Matthew Elliott. I was the campaign director for NOtoAV.

Willie Sullivan: I am Willie Sullivan. I was head of field operations on the Yes to Fairer Votes campaign, and currently I am the Scottish director of the Electoral Reform Society.

Katie Ghose: I am Katie Ghose. I was chair of Yes to Fairer Votes, and I am chief executive of the Electoral Reform Society.

Q424 Chair: From our point of view, you will have seen from earlier on that we like it best when people disagree, so if there are disagreements between you we want to have those drawn out, so that we know what they are. We have had the benefit of quite a substantial document from the no side, as it were; we have had something from ERS but nothing from the yes side. I presume that you have seen the no side’s evidence.

Katie Ghose: We have seen it.

Willie Sullivan: Yes.

Q425 Chair: If there is anything in it with which you disagree, it would be helpful if we drew that out. We will presume that you are resting on your evidence, as it were. To start off with the no side, are the existing regulatory referendums fair and effective? What are the main points where you would want to see changes in the context of what has happened and moving forward into the Scottish referendum?

Matthew Elliott: I would point out two areas that I think should be changed, both on the funding side of things. The first is with the transparency of donations to campaigns. As you will be aware, in the case of elections, parties have to declare donations over £7,500 every quarter and, during the election, every week. In the case of referendum campaigns, there is no obligation for either side to do that, although in the event of the AV referendum both sides did do it periodically during the campaign, so greater transparency on the funding of campaigns is important.

The second point would be on the funds given to the designated campaigns by the Electoral Commission to carry out funding. The rules around them are quite fiddly. Basically, they fund the operating costs of the campaigns rather than the campaigning itself, perhaps having in mind what certain taxpayer groups would say. Having experienced a referendum campaign, I would say that more general funding for the campaigns would be better-to allow campaigns to produce leaflets, TV broadcasts and what have you-rather than purely on the operational side of things.

Q426 Chair: What about the yes side?

Willie Sullivan: I guess it is important to know that we do agree in some ways, because we do not agree on a lot of things. I agree entirely with those points. One thing that needs to be looked at is when one of the campaigns does not declare as a lead campaign, as happened in Wales, when the no campaign decided not to. During our campaign, we were always considering and worrying about whether they would or would not register as a campaign. I am sure they did the same. For that to be a tactic in the campaign is wrong, and we need to find ways to stop it. What happens is that the other campaign cannot spend up to the limit; it can spend only as a permitted participant, which has a much lower spending limit.

Matthew Elliott: It also would not get leaflets, free deliveries or the referendum broadcast, which is also important.

Willie Sullivan: I entirely agree with the public grant. That is limited to office space and core administration costs, and it is impossible to spend it.

Q427 Chair: Why is it impossible to spend it?

Willie Sullivan: Because you can spend it only on really restricted things like offices.

Chair: I am sorry; I misheard that. I did not catch that.

Willie Sullivan: Maybe an important point to make is that the difference between the AV campaign and the Scottish referendum campaign will be the level of public engagement, media interest and stuff. Living in Scotland, I know that interest at the moment is far greater than it was in the last weeks of the AV referendum at a UK level. The onus on the campaigns to create the debate and get the information out perhaps will not be at the same level as it was during the AV referendum when, to be honest with you, most of the media and a lot of voters were not at all interested.

For future referendums, we have some points. The important point about PPERA is that it should be a generic set of rules that no Government can change, so that it is beneficial towards their outcome.

Q428 Chair: Would you generally be in favour of the recommendations or analysis made about the AV referendum being applied to the legislation and then to the Scottish referendum? Is that too crude, or is it a straightforward way of looking at it?

William Norton: I do not want to pre-empt the views of the other witnesses, but our view is that PPERA itself has now had a few years of life and it is due a bit of a freshening up. There is a case for changing PPERA irrespective of what happens in Scotland. I think that, if you are going to change PPERA, you should do so before there is a referendum in Scotland, simply because those are the rules. If you have a set of rules that you apply to any referendum, then they should apply to any referendum for precisely the point Mr Sullivan makes.

Q429 Chair: Would you also agree with that?

Willie Sullivan: Yes.

Q430 Pamela Nash: I understand that the NOtoAV campaign was the designated lead no campaign. I am a little bit less sure on how it worked in the Yes to Fairer Votes and the Electoral Reform Society.

Katie Ghose: The Yes to Fairer Votes was a coalition, and we were the designated yes campaign.

Q431 Pamela Nash: Was the Electoral Reform Society part of that?

Katie Ghose: The Electoral Reform Society was one of the coalition partners.

Chair: We have to go and vote. We will divide yes and no, but not in the same proportions as for the AV referendum.

Sitting suspended for a Division in the House.

On resuming-

Chair: I apologise that we had to go off and that it ended up being two votes. I appreciate that you want to be away reasonably early, and we will try to make what arrangements we can. We will just flag up, if we have not got through the business, that at some stage we might want to meet you again. I think you have indicated that in principle you are willing to do that. We will see how we get on with things.

Q432 Pamela Nash: I want to turn to the complexities of a referendum campaign as opposed to political campaigning of different parties. There are different people in different groups in each camp. How do you think it will work for the referendum we are discussing on separation? What additional complexities would there be if it was a multi-question referendum-in particular, the sort that the Scottish Government are proposing at the moment where there won’t be clear options? It will be two questions and three options.

William Norton: The simple straightforward mechanics will depend on which Act of Parliament is regulating it. If we assume it is PPERA, what you have is a series of framework rules as to how referendums are fought. As they currently stand, they do not include the question, date and other matters relating to things such as how much returning officers can charge for the costs of holding it, and other rules relating to the conduct of the actual ballot itself.

There will be some other legislation-it might be another Act of Parliament or primary or secondary legislation-that will say, "There shall be a referendum on the following question on a certain date, and here are other associated regulations relating to the conduct of the ballot." At that point, it will define something called a referendum period, which is the legal control period for the conduct of the referendum. At the start of the referendum period, it kicks in a number of controls, one of which is that you cannot spend anything on campaigning above £10,000, or whatever the limit is.

Q433 Pamela Nash: It is equivalent to a short campaign period.

William Norton: Yes; it is a similar sort of idea, but it deals with referendum expenditure, so it is purely on the referendum question itself.

You would then have to register with the Electoral Commission as what is called a permitted participant, if you are planning to spend more than £10,000. Among the permitted participants, you can apply to be what is called a designated organisation, which is the lead group on either the yes or no side. You then apply to the Electoral Commission and they sift all the various applications. There is a particular time limit within which you have to apply. If there is only one application from both sides, then, fingers crossed, both sides get designated. That was the case in 2011.

There is a provision that, if the commission consider one person to be so absolutely hopeless or laughable that they cannot possibly designate them, you have what is called the "both or nothing" rule, which is that you can do only a yes campaign and no campaign; you cannot have one only. When you have a designated organisation, it is entitled to the mailshot to voters and the referendum broadcast on the television. There are other requirements relating to use of public rooms similar to a general election. That is really it. From then, you are up and running. They then fight the campaign throughout the period until there is a polling date.

How would that differ with a multi-question referendum? First, in theory, you can potentially have designated organisations for both questions. Within PPERA, there is a facility where the commission can just say, "We’ll designate only one question rather than the other." That would be the main issue. The other one would be to have to distinguish between which referendum you are fighting and how you declare against your spending totals.

I was involved in 2004 with what amounted to a two-question referendum in the north-east where the main question, which applied to the whole of the north-east, was, "Do you want a regional assembly?" In Northumberland and County Durham, there was also a second question about abolishing a county council and what happened afterwards. In the north-east, we completely ignored the second question. Very few people took any direct interest in the second question; it was just steamrollered.

Q434 Pamela Nash: I do not think that will be the case here.

William Norton: I suspect not. That in itself raises other practical issues. I cannot speak for my two friends, but our view is that one question at a time is just a nightmare.

Q435 Chair: I understand your position is that you want only a yes or two alternatives, but, since we are examining the legislation, if there were three alternatives, how do you believe the campaigning would be organised?

William Norton: That is a very good question. Theoretically, I think it is in PPERA somewhere. If you have a non-yes/no question, I think the commission has to pick which ones it designates. I think it is in section 110.

Matthew Elliott: Do you mean one question, three options?

William Norton: Yes.

Q436 Chair: Three options. People tell us that if you have three options you ought to have three questions, or is it four questions?

Willie Sullivan: Our position is that there are three options, which there appear to be when you look at the polling. All the polling experts agree that there is a clustering around the status quo, a clustering around more power and a clustering around independence. Our suggestion is that the way to test that is to have a gateway question, "Do you want change, or don’t you want change?" and then a straight choice between devo-max and independence.

Q437 Chair: Should that be the way in which it progresses?

Willie Sullivan: If that was to progress it, yes.

Q438 Chair: You have three political positions. Would you have three designated campaigns?

Willie Sullivan: That would be the way you would do it.

Katie Ghose: My understanding of the law is that, if there are three outcomes, if you like, there could be three designated campaigns. That is my reading of the law, but the Electoral Commission would be the experts on that.

Willie Sullivan: Plus, we do not know whether that is the law we are using yet, although we all agree that should be the law that is used.

Q439 Lindsay Roy: I understand there have been about 12,000 referendums throughout the world and 98% have been binary referendums with a straight yes/no. Why is that?

Willie Sullivan: There is no doubt that it is easier and less confusing to have a binary referendum. The problem in our situation is that you can have a binary referendum, but the issue of devo-max would be a campaign issue. If you want a clear decision, then the no has to be clear as well. A lot of people will vote no thinking that they will get devo-max in the future. It is often referred to as an off-ballot paper issue. We completely accept that a binary referendum is a lot easier than a three-option referendum, but, on balance, we think that, because the interest in the issue in the media is that high-when you look at the polling, people already understand or want a question on devo-max already-it comes down in favour of having three rather than two options, although we totally accept that there is difficulty.

Q440 Lindsay Roy: Is it not the case that the 2% where there have been multi-option referendums have been on fairly minor issues? When I say "minor", in Australia maybe it is not minor. For example, it is about the national anthem.

Willie Sullivan: The big one is the one in New Zealand held under the electoral reform system where they had the gateway question, "Do you want to stay with the current system or change?" and there were options after that.

Q441 Chair: To be fair, the "after that" options were on another date, were they not?

Willie Sullivan: No. The ballot paper was on the same day, but I think there was to be a-

Q442 Chair: There was to be an affirmative referendum at a later stage, was there not?

Willie Sullivan: Yes.

Q443 Chair: Therefore, it took place on more than one day.

Willie Sullivan: What happened was that they never voted for change anyway, but, if in the gateway question they had voted for change, one of the other options on the ballot paper would have been to take forward proposals, and there would have been a further confirmation referendum.

Matthew Elliott: I think the big problem is the unusual outcomes you get from either way of doing the three-option referendum. If you did one single question with three options- for example, in the European debate some suggest that we should have "stay in the EU", "renegotiate" or "get out"-theoretically, you could have a situation where you had 34% for one, 33% for another and 32% for the third, and there is no really clear outcome from that sort of referendum.

If you have two questions on the same day, let us say the first question is about the status quo versus independence. Perhaps you have 52% in favour of independence, but, on the second question of independence versus devo-max, let us say 75% want devo-max. What is the outcome of that? I think it would be very confusing.

Willie Sullivan: That is why we cannot dismiss both of those options. I wonder whether Matthew can say what the problem is with the change/no change gateway, and then a straight choice between devolution-max and independence.

Matthew Elliott: I think it would be very confusing for the campaign and electorate, and it would not lead to a very clear outcome or fair referendum.

Katie Ghose: I do not see why it would be confusing if, already, the public debate is beginning to be about a number of options. Already, we are seeing that public opinion is quite divided on this, and it is the same sort of clustering around. What matters is getting a high-quality public debate. I have to say that the indications in Scotland are much better than they have been in, say, the AV referendum. It is about the quality of the public debate being good. I do not think voters would be remotely confused by having to deal with two questions on a ballot paper. They have to choose between different candidates in elections, and I think they could cope with that.

Q444 Pamela Nash: We are not clear what devo-max is at the moment. It is difficult to say that people are gathering around the option of devo-max when we do not know what it is, and it is also not clear whether we need a referendum; that is already happening through the Scotland Bill at the moment. Devolution has been a constant process rather than a yes or no choice since 1997. You talked about having three options with two questions.

Willie Sullivan: Three options need two questions.

Q445 Pamela Nash: One of those questions would be as between separation and remaining with the status quo.

Willie Sullivan: No. The first question would be, "Do you want things to stay the same, or do you want change?" It would be structured in a way that was a yes/no answer probably, as you usually do. So it is just a change/no change question, and the second question would be devo-max against independence.

Q446 Pamela Nash: The second one would be valid only if they voted for change in the first place.

Willie Sullivan: Yes. It is a gateway.

Q447 Chair: Did you read the evidence that we had last week? I forget the name of the dead Frenchman who invented some system-

Willie Sullivan: Condorcet.

Chair: Which said that, if you had three options, you had to have three questions, so it was one against two, two against three, and then three against one. That was the only fair way of making sure, because all of the witnesses said that, if you had three choices, the way in which you order the questions and you ask them can affect the result.

Willie Sullivan: It can, but because they are on a continuum running from no change to devo-max to independence, you probably would get to Condorcet. There is a problem. We have explored the potential of a Condorcet referendum. There is something called a loop where it is not necessary. You might prefer A to B and C to A, but it just becomes a circle; you prefer that one to the next one and the next one. There are problems with it. I do not think a Condorcet solution would work in this case. Certainly, John Curtice has suggested a two-question referendum, but Matthew has already explained the potential political problem with that. That would probably arrive at a Condorcet winner, but, if you got 51% for independence and 64%, or whatever, for devo-max, the Condorcet winner is still independence, but how are you going to sell that politically?

Q448 Chair: No, it is not.

Willie Sullivan: According to John, it is.

Chair: We can discuss that later on.

Q449 Jim McGovern: One of the witnesses who gave evidence last week seemed to imply that to say the Scottish people would not understand such a multi-option referendum was a slight on the Scottish people, but, Willie, you just lost me completely there, and we are politicians.

Katie Ghose: But the voters do not do the counting. Condorcet is a kind of evaluation of whether or not you have got the result you want. Voters do not have to do the counting; they just have to deal with a ballot paper that has different options on it. I would say that voters have proved themselves more than capable of doing that.

Q450 David Mowat: Isn’t the difficulty of the example that you gave-you say you can choose between several candidates-that the options are mutually exclusive, and that is why you get into more difficulty with gateway questions and all the rest of it? The concept of devo-max is not a discrete thing; it is a continuum. In fact, the whole referendum is a continuum, and one endpoint is separation, although even that has different attributes. But then you have devo-max, which is a massive continuum, and "stay the same", which I suppose is a discrete thing. The real issue is that you are trying to put down questions to evaluate a continuum when most elections look at discrete outcomes, like a north-east chamber, or whatever it is. That is the reason why the analogy you gave that it is similar to an X with four candidates is not a good one. Here, the complexity of the continuum is what you are trying to sort out, and it is very difficult. There will always be a tendency to go for the middle ground, and devo-max will become necessarily popular because people think, "Why not do something?" You will just drift towards it and it has no rigour at all.

Katie Ghose: Voters do vote on policies, not just personalities, as it were, so I will not take that analogy too far. This is quite an early stage in the debate, so these things have not yet been properly defined by politicians and groups campaigning on it. I completely take your point on that. If it becomes the case that that is a defined option that a chunk of the population wants, all we are saying is that at least we have to explore that as being an option on a ballot paper; otherwise, I cannot see that the referendum will get a true result.

Willie Sullivan: None of the options is risk-free; there is no perfect solution to this. I think an important point of this is the testing and resources that are given to the Electoral Commission to make sure that they can test the different options.

Q451 Chair: Let me come back to the Electoral Commission in a moment. I think the ERS submission said it had some sympathy with Peter Kellner’s position expressed to the Scottish Affairs Committee that, once negotiations take place, the proposals agreed between the two Governments should be put to the Scottish public in a second referendum. The idea is that, if you vote for independence, to some extent it is a pig in a poke because it depends, as we heard in the previous session, on what is actually going to be agreed. That package would then have to be put to the electorate in a second referendum to confirm the exact details of it. When an organisation says, "We have some sympathy", that usually means it does not want to come off the fence. May I press you about whether or not you are actually saying that you think there should be a second referendum?

Willie Sullivan: It is a moving debate, and on further consideration, we probably have less sympathy with that position than we did at that time.

Q452 Lindsay Roy: Why would that be?

Willie Sullivan: It is because you get referendum after referendum, and everything. Peter Kellner made some valid points, and, as we heard from the previous witnesses, there is a lot of negotiation to be worked through, and if there was a vote for independence, that might be a stronger case than if there was a vote for more powers.

Q453 Lindsay Roy: Is it not the case that one of the key criteria is clarity about what you are voting for?

Willie Sullivan: Yes, it is. In some ways, we have got into a situation where we hold referendums on issues of devolution and more power. That has become the way we do these things, and just by the very nature of referendums, you have to ask for a yes/no answer to some pretty complex questions.

William Norton: But at least in our legislation it is defined. In the north-east, we knew what a regional assembly would have been. Whether you liked it or not, Mr Prescott produced a draft Bill. He said that if you voted for these things this is what it would do. Under AV, we knew how AV voting would have worked; in Wales, they knew what powers they were being offered. There is an issue as to exactly what any of these concepts mean. You say, for example, that there are three possibles; in fact, it could be four possibles. We do not quite know exactly how it breaks down.

Willie Sullivan: There are four possibles, if you look at the Scottish Social Attitudes survey. You could go back to before devolution, but nobody really supports that position. What you are testing is where you know there is a significant amount of public opinion. There is no point in testing something that nobody wants. I entirely agree that these things have to be defined; there has to be a process of discussion and debate about what devo-max means if you are to have that choice, and if you are to have independence what exactly that means. It has to be spelt out.

Q454 Chair: That is the issue, is it not? We heard earlier about the extent to which there would have to be a process of discussion, debate and negotiation between the British Government and the Scottish Government should there be a vote for independence. This is all argument in favour of a second vote, essentially, is it not, for which you had sympathy a few minutes ago but now you don’t? I understand that position. We are just trying to feel our way through all of that. The point that originally Pamela was picking up was the question that, if you have three possible options, do you then have to have three separate registered main organisations, each of which campaigns on its own behalf?

William Norton: Thanks to the assistance of my friends discussing something else, I have now found the answer.

Q455 Chair: To be fair, that was why we did it.

Lindsay Roy: It is called a diversion.

William Norton: You are feeding me a line, Chairman. It is section 108. Apparently, what you do is you decide at the time.

Q456 Chair: I am glad we waited for that. Can you give us your observations?

Willie Sullivan: I would say that you do inevitably, because, if you want clarity on those positions, you need a campaign that puts forward why it is arguing for that position. It would be a disservice if you did not.

William Norton: It has to be the case that, if instead of a yes/no referendum you have an ABC referendum, you have to have an A, B and C campaign within the one question.

Willie Sullivan: And there are dangers in that, obviously.

William Norton: Yes, there are dangers.

Q457 Pamela Nash: Is that dependent on the design of the question?

William Norton: Yes.

Q458 Pamela Nash: I do not mean how many options there are but the design of it.

William Norton: It is easier to solve the ABC referendum than the gateway question referendum.

Willie Sullivan: But an ABC referendum would not give you a settled position. As you said, there are problems with that.

William Norton: You do not get a knock-out winner.

Willie Sullivan: In some ways, it is not the design; you start from the options and the things you want to test and design the question towards that. There are three possible options. We are saying there are three possible options, because that is what the polling shows. Therefore, you design a question that is a consensus between the three possible options.

Katie Ghose: But the interesting thing is who would come forward if there was to be a discrete campaign on that; so there could be an issue there.

Q459 Chair: It is clear who would be in favour of separation. As to the other two, it is not quite as clear at the moment; and it is also not clear whether or not it would be devo-max or "devo a bit".

Katie Ghose: That is what I mean.

Q460 Mr Reid: I have some concerns about the gateway question and how a voter would approach it that I want to put to Willie. The difference between more devolution and the status quo is a question of degree, whereas the difference between more devolution and independence is a quantum leap. Say I am a voter and I would prefer more devolution, but I definitely do not want independence. Then I am forced to take a gamble in the first question, because I am gambling in the first question that the second question is going to go in favour of more devolution. Is that not a flaw with the gateway question?

Willie Sullivan: It is a problem with it, yes. You go to vote and you really want devolution-max.

Q461 Mr Reid: I prefer more devolution over the status quo, but I really desperately do not want independence, so you are forcing me to gamble on the first question. I have to predict how people will vote on the second question.

Willie Sullivan: There is a slight disincentive to vote for devo-max. None of these options is perfect. If you prefer devo-max, you might vote for no change on the first question, but is that better or worse than the possibility of having the outcome of a greater majority for devo-max than independence? That is another two-question option. The other option is to separate them both and have them on different days or periods apart. That solves the question of the complexity and the slight disincentive for devo-max supporters, but it does not allow you to compare all three options at the same time; it allows the devo-max issue to be an off-ballot paper issue within the debate. All of them have flaws, but you have to decide which one you most want to choose.

William Norton: What we found with the two-question referendum in the north-east is that it was not as burning a question as what happens to Durham county council or Northumberland county council, but the people who were interested in the second question and realised they would lose the second question switched over to the no campaign, because the second question did not become operative if they killed off the main one.

Q462 Chair: But that was a subsidiary question, was it not? It is a bit like the second yes in the Scottish referendum.

William Norton: Effectively, this is the same thing. What happened in 2004 was that effectively, "Do you want a regional assembly?" was a gateway question to, "What do you want to happen to your county council?" You can argue that they do not have the same sort of significance, but structurally that was how it worked. If you have people who are really interested in the second question, you can almost call it a Sudoku voter trying to work out where all the numbers go.

Chair: That is a dead Japanese person.

William Norton: It is a multi-cultural society; so I suppose you can all vote. What would happen is that, if you are going to lose the second question, you will stop campaigning on the second question; you will try to kill it off at the first level, will you not?

Willie Sullivan: The polling would have to change dramatically for that to be a real issue.

Q463 Chair: But the polling could change.

William Norton: The reason we have votes is that we do not know the answers.

Q464 Chair: I want to come back to the issue of the question itself. To what extent do you think the wording of the question makes a difference? In particular, was it an advantage to the debate that your two groups had to have a yes/no? Would it have been better-particularly for the side that lost-if it had been two statements? Did being yes disadvantage you in any way, or do you think you got a benefit from it? Similarly, would those on the no side have preferred it to be two separate statements rather than a yes/no? Do you think either got an advantage or disadvantage from it being no? I turn to yes first.

Willie Sullivan: There are definitely effects in how questions are set out. In the case of the AV referendum, the effect was probably quite marginal. We think that the Scottish Parliament-if you ask me why, I will tell you-should make the proposition for what it is you want to test but should not be allowed to choose the actual words of that proposition. That should be for the Electoral Commission.

Q465 Chair: I understand why the Scottish Parliament should propose, but should the Electoral Commission then be able to overrule them completely, or would it have to report back to the Scottish Parliament, which in turn could reject its advice?

Willie Sullivan: We have said that it should probably report to both Parliaments, but the political reality is that, as I think happened during the AV referendum, if they did not accept the recommendation of the Electoral Commission, there would be no confidence in the referendum. It is all about getting confidence in the referendum, is it not?

Katie Ghose: We know there has been precedent for good changes by the Electoral Commission to make wording more intelligible to voters, and in part that is why we feel so strongly that there should be adequate time for the testing of any questions.

Willie Sullivan: If the Electoral Commission went back to the Scottish Parliament with the question that it had recommended and tested and the Scottish Parliament tried to change it, organisations like ours and others-hopefully, everybody-would make quite a fuss about it and say they had no confidence in it.

Q466 Chair: I understand what the political consequences might be, but I want to be clear that, in circumstances where a question is proposed, it goes to the Electoral Commission. You are then in favour of the Scottish Government having the chance to change that question if they wish. Yes, it might attract political opprobrium, but you are not in favour of having the initial proposal overruled by the Electoral Commission without the Scottish Parliament having a chance to do something.

William Norton: You get into questions like who guards the guards.

Q467 Chair: That is why I am asking.

William Norton: If you have the Electoral Commission writing the question, that is ultimately a political act. Whichever Parliament enacts the legislation, it is a matter for that Parliament over which it has the final say; nobody is sovereign to that Parliament in that particular question. You have the ultimate situation where there is a question; somebody independent, like the commission, has to look at it. If they say that is a dodgy question, Parliament, whichever it be, can then say, "Thank you very much, commission. You’re quite right; it is a dodgy question, and we’re going ahead with a dodgy question." That then becomes a referendum issue in its own right. If they had gone ahead with the original question, certainly in the AV referendum, we and the commission suggested it should be rewritten. We did not quite agree on the wording we wanted, but we were on the same page. It would have been a nice gift to a no campaign to say, "You are now going into a referendum with a dodgy question." Therefore, it is in the interests of the Parliaments themselves. They cannot be legally forced to; nobody can be forced to do that.

Q468 Chair: I understand that. You are saying they should not be legally forced to accept the proposal from the Electoral Commission.

William Norton: If whichever Parliament enacts the question wants to go ahead in plain sight of everyone with a piece of advice saying it is a dodgy question, on their own heads be it.

Q469 Jim McGovern: I think the wording of the question is very important. Back in the 2007 Scottish elections the top of the ballot paper said, "Alex Salmond for First Minister", because it was done in alphabetical order, so a lot of people automatically put a cross there. I will use words that the Chair has often used. Do you agree that a question that starts with the words, "Do you agree?" is a leading question, and therefore the Electoral Commission should rule against it and decide what the question will be?

Matthew Elliott: I think that, if you asked a pollster to ask that sort of question, they would say you were trying to rig the poll. It is a leading question.

William Norton: You have the benefit of our advice, or our advance notice, where we suggested they might have to think again about the wording of that question.

Willie Sullivan: Our position is that Parliament can make the proposition in general terms, but the Electoral Commission should come up with the question.

Q470 Chair: I have got that bit. Do you agree that a question beginning, "Do you agree?" is a leading question?

Willie Sullivan: Yes, entirely, but it points out that the players should not be the referee.

Matthew Elliott: To go back to your original point about whether it is an advantage to be in the yes or no campaign, in the 1997 referendum on devolution it was two statements rather than yes or no, but it turned into being a sort of yes/no campaign, and the media often filter it in that way.

Willie Sullivan: That is true.

Chair: It is just a question of where that gets us.

Q471 Jim McGovern: Everybody has answered that question except Katie.

Katie Ghose: I think it has been answered already.

Q472 Chair: I want to be clear about what your view is or whether or not it does not matter. Is it your view that it is better to have a yes/no or to have two statements, or does it not matter?

Matthew Elliott: I think that from a campaigner’s point of view-I would be interested in your thoughts-it depends on the mood of the country at the time. Looking back at last year, with the economy not doing so well and the mood of the country not being that good, being a no campaign was perhaps an advantage. I would say that in more prosperous times when people feel more positive about things perhaps a yes campaign has an advantage, but it is slightly in the balance.

Willie Sullivan: I think it is also about context. The words are not as important as what you are asking for. It is often much more difficult to argue for change than for the status quo, because you can make up anything you want about something that is not there. You can more or less represent only what already exists.

Katie Ghose: Also, the wording of the question tends not to feature that much in the debate itself and in the run-up to the vote. The media will frame things in a certain way and characterise it, and here it will be independence versus whatever, but I take your point that, when you are faced with a ballot paper, at that point the question can be significant. I think we need to draw that distinction.

Willie Sullivan: It is about how it is framed.

William Norton: The precise wording of the question would of course matter as to the campaigns teams assembling, particularly if you were to have, say, an ABC referendum where precisely how A, B and C on the continuum divide-up might make a difference to campaigners. My personal preference is for a question that is answered either yes or no, simply because it is a personal preference.

Q473 Chair: If you had a choice, would you rather be a yes or a no?

William Norton: This will sound pompous, but I would like to think I could win with either.

Q474 Chair: So you only side with campaigns that you think will win. Is that how it works?

William Norton: It is how it works out.

Q475 Iain McKenzie: Referring to the current controls over campaign expenditure, do you believe they are effective enough, or do you believe they need to be tightened?

William Norton: Campaigning by whom? Do you mean normal campaign organisations or Government officials?

Q476 Iain McKenzie: The expenditure on a campaign; how much a body is allowed to lavish on a campaign.

William Norton: I would love to be able to lavish money.

Q477 Iain McKenzie: Some have more to spend than others; they have built up a war chest to spend on it.

William Norton: Ultimately, there is a spending limit that will apply to any campaigner in a referendum, depending on whether they are a political party, a normal organisation or the official designated campaign group. Personally, I do not have a problem with those limits, certainly not in regard to a designated campaigner, simply because they are set so high that they have never been exceeded. No doubt, the time will come when there will be a particularly vigorously fought referendum and somebody will try to push the limits. I do not have a problem with those limits or indeed some of the rules as they stand. We have some technical comments to make on them, which we put in our note, but we are pretty much okay with the principle as it stands. Is your point that they are too high, too low or just that there should not be a limit at all?

Q478 Iain McKenzie: The point was whether you think it is too high or too low, or do they need a bit of tightening-up in that respect?

Matthew Elliott: It is worth saying that neither campaign in the AV referendum spent anywhere near the limit of £5 million, from memory. I think we ended up spending about £3 million and you spent £2.5 million.

William Norton: We spent £2.5 million.

Matthew Elliott: Neither of us was anywhere near the £5 million limit. I think it was more than sufficient for what we had to do, but it was an extremely short campaign. The legislation left here only in February and there was a 10-week campaign period, so it was a very short time.

Q479 Iain McKenzie: Do you think a ceiling of £5 million for the UK leaves too much of a variance in there?

Willie Sullivan: Probably, £5 million for the UK is okay. It depends on the issue.

Q480 Iain McKenzie: Would it be pro rata for Scottish referendums?

Willie Sullivan: There is a pro rata suggested for Scotland. I think the Scottish Government themselves suggested £750,000 for the lead campaign and £250,000 per political party. That is probably about right. I think they now want to change it. The difference between the AV campaign and this campaign in Scotland is the level of media interest and engagement in it. Both campaigns probably should have spent a lot more in order to communicate the debate, so that people could make a choice. I do not think that will be such an issue in Scotland. You have to be careful that one side can buy the referendum in a way. They need to be equal. I think that keeping it down to about £750,000 per lead campaign is about right, and then allowing the debate to be had in the broadcast media and the campaigns to challenge each other and be questioned by others.

Matthew Elliott: It is far easier to raise money for a campaign that is campaigning to change something rather than one that defends the status quo, which is always more difficult to get off the ground.

Katie Ghose: I would disagree with that; I do not think that is true. I do not think that was the experience of AV at all. There were lots of people who were willing to put money into it. A lot of people had power vested in the status quo, so there was a perfect willingness to give money.

Matthew Elliott: It was pretty tough to get people interested in the campaign. We have more stories.

Katie Ghose: I am sure we can both share our experiences about raising money. I simply do not agree that the status quo is necessarily harder to fund-raise for.

Willie Sullivan: There are people that have got an interest in the status quo.

Q481 Iain McKenzie: You spent less than these chaps on the AV referendum. Would it have been fairer and easier if you had just said both were allowed to spend so much and that is the ceiling?

Willie Sullivan: It is a trade-off. It would be good if we could both spend the same amount and it did not rely upon being able to raise money, because the spend from the public interest point of view is about getting the debate and issues out there and that people are allowed to vote on it. It is useful to compare the AV referendum with the Welsh referendum, which is the most recent one we have had on more powers to a UK nation. We got John Curtice to look at all the research about why people voted the way they did during the AV referendum. Party cues was a huge issue. When the Prime Minister came out in support of the campaign, almost 90% of Conservative identifiers voted no, and because the Labour Party gave a confused cue, most Labour Party voters voted no as well.

If you look at the Welsh referendum where an All Wales Convention was set up to take the message and issues out to the people-it was done probably over a two-and-a-half-year period-most people voted on the constitutional issue. Obviously, local party cues were quite important. Richard Wyn Jones and Roger Scully in a book on the Welsh referendum said, "To some extent, voting choices were influenced by individual party attachments, and by their perceptions of the effectiveness of the devolved institution. But most important seem to have been basic attitudes towards how Wales should be governed." You want people to make the decision on the real issue, which does not really happen that often in referendums. People often vote on things that are off-ballot paper and are peripheral to the actual question.

Q482 Chair: Perhaps I may come back to the question of money. We have focused on the amount of money each side can spend up to, but that was only in the relatively short period when the ballot was actually running. Say that we are having a referendum in 2014. Is there not an anxiety that the regulations will control only the endpoint, and, if somebody happened, for example, to have a couple of million pounds in the bank just now, they could be campaigning vigorously with that money until such time as the whole process formally started? Therefore, in some way it ought to be controlled at a much earlier point in the process. Is that fair, and, if so, how could that be done?

Willie Sullivan: I think the Governments have to get on and agree a section 30 order and agree the rules by which the referendum is to be run. There is a period of a year under PPERA, which in a long referendum campaign is not that long. People spending money now will not be controlled. You are right.

Katie Ghose: This also strengthens the case-I hope this is something the Committee might take on board-for a generic set of referendum rules rather than reinventing the wheel every time. It is possible that if you had that you could bring in some of these extra regulations, if you like, but again we are faced with a situation where the Electoral Commission made some sensible recommendations that were taken on board in other referendums, but they are not part of our law now, so here we are reinventing the wheel again.

William Norton: Part of the problem is that we do not know when the referendum will be, so we do not know when a suitable time to set a limit will be; otherwise, you will have a blanket rule that says that, on the off chance somebody might want to have a referendum about driving on the other side of the road-

Q483 Chair: Anything other?

William Norton: Yes. There is a logical problem about what you would ban and when. Unfortunately, I do not think you can stop people campaigning now before the referendum is set or the legal control period comes in.

Q484 Chair: Taking the points that both of you made, would you argue that as soon as the Governments agree, even if it is to be in 2014, say in the course of the next month, some sort of regulation on spending should apply from the first identifiable point when the process starts, or would you still leave a lacuna-a gap-until it started maybe only six months out, or what have you?

Matthew Elliott: I think that at the very least you need transparency as to where the money is coming from. Just as parties declare donations throughout the Parliament, you need to have that transparency in place straight away.

Katie Ghose: Of course you need permitted participants or designated organisations to be in place, and that can take time. It may be you could improve on the current situation, but you might not be able to do it the minute the section 30 order is done.

Willie Sullivan: The longer the period that expenditure is controlled, the better. What we are guarding against is one side having so much more money than the other side that it is not really a fair debate.

Q485 Chair: Would you both agree that the earliest possible time it can be introduced would be desirable in order to stop someone raising this money?

Willie Sullivan: Within reason. You cannot say three or four years before you have to start running a campaign, but a longer period would be better. I think it is a year at the moment, but that is probably a little too short.

William Norton: It is a year for things like Scottish parliamentary elections, is it not? There you can do that because you know when the Scottish parliamentary election will be, so you can say 12 months out or 12 months before a general election a control period will start for third-party campaigners, or whatever it is. For the referendum, it all depends on each individual one. Each referendum is defined on its own basis, because it has its own referendum period for when the control period starts. The test then is: if you use something during the referendum period to campaign for the referendum, you have to declare that and where you got the money. If somebody was stockpiling money now, which was just sitting in a bank account and was not used until a referendum period, it would become declarable at that point. If they are campaigning now-handing out leaflets-it is a free country; there is nothing to stop them. There is no law that bites on what they are doing. If you wanted to bring in a one-off one-line Act of Parliament just to catch people on the off chance that there might be a referendum on something, I can think of other things we can do with the time.

Q486 Chair: You are taking this too far.

William Norton: I do not disagree with that. I like to think about how to work things out.

Q487 Lindsay Roy: Perhaps I may go back to the point about voting off-question. Can you tell us what you mean by that and what can be done to avoid it?

Matthew Elliott: I am sorry; I did not catch it.

Lindsay Roy: Somebody mentioned voting off-question and not focusing on the referendum question.

Willie Sullivan: Voting on an issue other than the one on the ballot paper.

Q488 Lindsay Roy: Can you give us some examples of that? What can be done to try to avoid it?

Willie Sullivan: People think it happens in most referendums. If a Government propose a referendum and it is not a particularly popular Government at that time, people will vote on the popularity of the Government, for example. The Wales example was where the All Wales Convention took time to make sure people understood the real issue. On the AV referendum, the time scale was short. Both campaigns could be criticised from both sides about being quite negative and not informative. I think that is inevitable given the short period of time involved and the fact it was left entirely up to campaigns.

Q489 Lindsay Roy: Is it the effectiveness of the campaign that leads to people voting on-question?

Katie Ghose: That is an element, but it is also about the media. The Scottish media are already behaving very differently. One of the experiences I had with AV was that quite senior broadcast journalists wrote off the referendum as dull before even giving it a chance. They saw it entirely as a general election and treated it as such. It is not; it is a referendum campaign. It is supposed to be a lively public debate involving the public. We should do what we can to make a referendum what it should be, not just see it through the eyes of a general election. If you see it through that prism, you see it entirely through the fortunes of the political parties. With AV, it was that people saw the dynamics of the coalition partners. A lot of journalists were interested in just that. That is a factor, but hopefully, it will be different in a positive way in Scotland.

Matthew Elliott: A big reason for that happening during the short campaign-I do not want to get into small issues-was that yes campaign supporters like Vince Cable, Chris Huhne and people like that were going on the TV every weekend to criticism the negativity of the no campaign. They turned it into a very partisan, coalition-based issue. If you cannot rein in your supporters-

Katie Ghose: To be fair, that happened, but I am talking about conversations, tone and framework set by a lot of journalists quite early on in the campaign. I entirely accept what you say about some people going off piste and talking negatively, but I think the framework of it had already been set a long time before. The challenge in Scotland will be whether it can be a lively positive campaign that gives all citizens a chance to decide.

Q490 Chair: How can we avoid a campaign being either a referendum on the First Minister or the Scottish Government? I am not quite clear about what sorts of things you suggest should be done, apart from people behaving better.

Katie Ghose: I don’t think it is about people behaving better. It is about every single person taking responsibility all the time for bringing it back to the issues. You have just done your bit by having a session on money. What is going to happen to fiscal matters in Scotland? That is content; that is a meaningful thing. You were saying: what does it mean to ordinary people in their lives? Every single person, whether it is a civil society group, should have a discussion or hustings on it. To be realistic, journalists will be interested in political personality issues, but if those journalists say, "Hang on. I’m going to hone in on the issues. What’s Scotland going to look like and feel like?" and every single person, organisation and the campaigns themselves tried to take some responsibility for that, overall, you would have a better chance of having a debate on the issues.

Q491 Chair: That comes back to the provision of unbiased and impartial information, if such a thing exists. Who would be given responsibility to produce anything like that, if it can be produced?

Willie Sullivan: I think the debate in the broadcast media and thorough questioning is much more important than that sort of material. It probably should be available. Our experience in the AV campaign was that the neutral material was probably pretty damaging to us, because the no campaign fought on issues of complexity and stuff like that, and the neutral material reinforced that messaging. It is down to the Electoral Commission at the moment to produce and circulate that material. I just hope that in Scotland, because it is a much more engaging issue in which more people are interested, it is open to much wider debate than just the Electoral Commission.

Q492 Chair: You are not suggesting that, say, the role of the Electoral Commission should be expanded considerably to produce substantial amounts of material.

Katie Ghose: No.

Q493 Chair: You are all shaking your heads. I am afraid shakes of the head are not recorded. All of you disagree with that proposal.

Matthew Elliott: Yes.

Willie Sullivan: Yes. There might be a wider issue about the role of public service broadcasters and what their responsibilities should be during a referendum. They have a duty to educate citizens about it, and that is the best way to do it. Sending leaflets to people’s doors has very limited impact in educating them on issues like this. I think it should be up to public service broadcasters. I do not know whether you can make that a responsibility in law or not, but it is something worth thinking about.

Q494 Chair: Is that your view as well?

Matthew Elliott: It is very difficult to legislate for that sort of thing. To come back to the Electoral Commission’s booklet for the AV referendum, we had quite a few issues with it. None of our issues with the booklet were accepted, but one of yours was, so perhaps it was tilted your way, if anything.

To move to the 1975 referendum on the EU, a lot of people now say that basically that the then Electoral Commission’s document was very pro-Common Market membership. It is extremely difficult to write these things in a neutral and balanced way. I think that AV is a lot less complex to explain than, for example, Scottish independence, which will be hugely complex.

Willie Sullivan: With the amount of money spent on it, there have to be questions asked about the value of it and whether that money might be better spent on more broadcasts.

Katie Ghose: Particularly since how we consume information is changing with social media network channels. That needs to be taken into account.

Q495 Chair: I understand your point about balanced media coverage. Do you have any proposals for us based on your experience about how that ought to be done and whether or not you wished any particular things had taken place during the referendum? I do not know whether or not you sat down together with broadcasters, or whether or not that worked properly. Are there any lessons from that that we ought to pick up?

Katie Ghose: I take your point on legislation-that is difficult-but there could definitely be some guidance and briefing for key journalists on referendum campaigns and how they differ from general elections. Something proactive could be done by the Electoral Commission and others just to get a little on the front foot to deal with the issue we came across, which was a near-universal switch-off and a bit of a dismissal based on it being dull because of its content.

Matthew Elliott: One change I would make is to party political and referendum broadcasts, in the sense that having a four or five-minute slot is just much too long. People are not used to watching an advert of that length, and a much better thing for both elections and referendums would be more frequent, shorter slots, which people are more used to in terms of getting information over.

Q496 Chair: I think the final point from me is the question of legislation. Both of you have outlined that you think there ought to be changes based on the recommendations that have come forward before. The no side has given us a pretty comprehensive view, which I think generally the yes side are indicating that they support. It would be helpful if you responded either with your equivalent or clarified whether or not you did support some of the proposals in there. We will look at them in more detail, but we are probably inclined to pick up a lot of them and then pass them on. Unless we hear from you to the contrary, we will assume that you agree with them.

Willie Sullivan: I think we agree with all the ones to do with the generic rules. There are quite a few about the specific terms of the Scottish referendum with which we disagree, like the number of questions, the timing and where the draft Bill originates. I think you said that the draft Bill should originate here.

Q497 Chair: Rather than expecting you to do it from memory, it is probably fairer to you, given they have put something on the record, to get the staff to do the work in clarifying where there is agreement. If we are happy with that, we will take that forward.

Willie Sullivan: Yes.

Q498 Pamela Nash: Could I reflect on what Alan said earlier? We have looked at dates when we were talking about the timing of the campaign. What is the right period of time to prepare for a referendum campaign? You thought it was too short for the AV campaign. We are looking at different dates at the moment for this one. How long is too long?

William Norton: Our view is that 10 weeks for a control period is too short. That is the experience I have had. This time around it was very short. It is mainly to do with the mechanics of sending a free post to every voter. You have to register with the commission as a participant; you then have to find out whether you are the designated organisation; you have to get hold of electoral registers from every single local authority in the area; and you have to find a printer who is prepared to deal in that sort of volume for a reasonable price. It all adds up.

In 2004, we had a contested designation, and we only just managed to get our leaflets done in time. There was a problem on the evening before: the ink would not dry on the leaflets. In two hours we would have missed the deadline. This time around, we had to start before we knew we were designated. It is simply unworkable with a 10-week minimum. You need a 16-week minimum. That will scale up to a certain minimum period for the referendum. If you adopt some of the recommendations to change PPERA, the amount of time to hold a referendum will be shorter, because you will already have the rules about how you conduct a ballot in statute-in stone.

Other than that, I think we would all agree that the period of time over the 2011 AV referendum was too short, largely because it was combined with other elections, but still 10 months is too short; 12 months is just about doable, if you do not have a problem with the question and you are not combining it with other elections. All of those are the mechanics; 12 months is an absolute minimum for the mechanics. That would include the commission vetting the question, lining up all the returning officers and other issues such as those, and designation; but that assumes you know what you will be fighting on.

Q499 Pamela Nash: You have talked about a minimum period of time. Is there a period of time that is too long, considering what we have just been discussing about the funding of campaigns and how long they go on for? One of the major players in the campaign has announced that they will start their official campaign in May of this year-

William Norton: Well, good for them. My personal experience is that you would need 12 months. Bearing in mind all the fun and games and the maximum enjoyment I have had in referendums over the year, I would say that the ideal period is probably 12 months and a week, but you cannot specify a maximum. I do not think the problems of this referendum are the mechanical ones of lining up returning officers and ballot papers; it is agreeing, as our friend said, what you are actually going to be voting on. Your Committee’s report on the unanswered questions isolates part of the problems.

Q500 Chair: Willie, I thought you expressed signs of life there.

Willie Sullivan: It’s good to know I am still alive. The issues have to be defined. The mechanics are one thing. I agree the period of 12 months for the mechanics, but the issues and the quality of the debate and discussion have to be defined. What is going to be a fiscal stability agreement? What about monetary union, let alone devo-max? We favour a longer rather than a shorter period.

Q501 Chair: With a longer period, is there not a danger that people start losing the will to live, as it were? They just switch off. They think, "Oh, not another bloody broadcast about AV" and stuff like that. Did you have any information about how many people had made up their minds at the beginning and how many made up their mind as things progressed? Is it the case that most people have a defined view?

Willie Sullivan: No; it shifted quite significantly in the period of the campaign. The conventional wisdom on second-order issues like yes/no change referendums-this might not be true on such an engaged issue as independence-is that the change campaign needs to be 15 to 20 points ahead at the start of a short campaign, because it will shift dramatically to no during a short campaign.

Q502 Chair: That is not because it is yes/no; you mean change versus the status quo, however it is expressed.

Willie Sullivan: Yes.

Q503 David Mowat: I am still troubled by the issue of devo-max. I am surprised that you are so sanguine about the mechanics of this. We have three outturns. The two end ones are at least definable to an extent: the status quo, where we still have 56 Scottish MPs coming to Westminster; with independence, we have none. What independence means may not be clear, but at least that bit of it is-there will be none. Then we have devo-max, which seems to be almost certainly all things to all people. Do we cut the number of Scottish MPs by 10 or 20 for this or that much devolution? I know you have said in that it is up to the campaign to define it, but I do not think it is definable. Therefore, you are heading towards a referendum in which you have two relatively rigorous outturns and this mushy thing in the middle, which is almost not comparable because of the level of definition around it. That seems to me potentially to invalidate a hard question approach to it.

Willie Sullivan: The same could be true of independence.

Q504 David Mowat: Yes, it could be, but it is less true.

Willie Sullivan: It depends on how well people decide to define devo-max. If it is just fiscal autonomy, it is not that much different from the complexity of independence.

Q505 David Mowat: It is really, is it not? You would have to define how many Scottish MPs you would lose for how much fiscal autonomy, and what the negotiation would be. At least the independence option solves the West Lothian question, for example, whereas devo-max brings it to front stage; it makes it a major thing. It would seem to me that there would be a requirement for very significant negotiation between the rump and whatever the new Scotland is, which could not just be handled by a prospectus put out by one side. Therefore, it almost becomes an invalid option.

Willie Sullivan: But we have started a convention that we have referendums on devolution of power. We have had one in Scotland before, and we had one in Wales last year. You might argue that those negotiations and debates are best made by elected representatives, but we have a convention.

Q506 David Mowat: What troubles me is that you can do that, but doing it at the same time as two outcomes is relatively rigorous. It becomes all things to all men and therefore is hard to criticise and hard to pin down, and it wins by default. Who would not want a bit more devolution? Why should we lose any MPs, if that is all we are going to get and so on? It is actually a false choice.

Willie Sullivan: It is certainly a problem that has to be balanced against whether there should be a straight independence/status quo vote with devo-max already being there in the background and being an off-ballot paper issue, and people voting no when they want devo-max.

Q507 David Mowat: Is it not at least fairer to have it in that sense? I will just reflect on your gateway question and Alan’s point. If you vote yes for the gateway, then you ask about devo-max or full independence. Do the people who say no to the gateway automatically go to devo-max option in the next count?

Willie Sullivan: They probably would.

Q508 David Mowat: You would do that.

Willie Sullivan: I am not saying they would; they probably would.

Q509 David Mowat: I was interested in that.

Willie Sullivan: They probably would.

Q510 Mr Reid: Is there not a risk that, if they vote no, they think the next question does not matter and they would abstain?

Willie Sullivan: There is a risk on turnout issues being different on the same lines, but there is a lower risk with the turnout issue being on the same day. It is about education. There is a risk of separating them, because your turnout issues might be hugely different.

Q511 Mr Reid: Say I am a believer in the status quo and vote no to change. Is there not a risk that I say, "I don’t believe in either of these two options. I’ve voted no to change, and that’s it"?

David Mowat: In that case, you could automatically count it as a devo-max vote in the next vote, could you not? Would that not be logical?

Mr Reid: There is a certain logic there.

Willie Sullivan: I do not think you could do that.

Q512 Chair: It is French logic, is it not?

William Norton: On the point you make, certainly that happened to an extent in the north-east and possibly also in Scotland in 1997, although I gather there was a lower turnout technically for the second one. It seems that people who regard the gateway as shut then do not go and vote in the second one, certainly in the north-east. I cannot comment on the Scotland one in 1997.

Katie Ghose: I think that in New Zealand it was on the same day. I cannot share the figure because I do not have it to hand. It was a reasonably high turnout of voters completing the ballot paper.

William Norton: But not 100%.

Katie Ghose: Not 100%, no.

Q513 Mr Reid: But 4% or 5% could make all the difference between being independent and being not independent.

Katie Ghose: We have been honest in saying that none of these options is perfect, but it will be very interesting to see what happens over the next few months and years. If there is something voters want and have a chance to explore and that is not on the ballot paper, that is a real problem.

Q514 David Mowat: But this other thing feels so amorphous.

Katie Ghose: I would disagree with you. At this point, these things do feel quite amorphous. Independence is quite amorphous to everybody, so I think it will be for everybody to try to get more of a definition around it. I do not think it is impossible to do that.

Willie Sullivan: There is an advantage in having a debate on this, because more power is on the agenda anyway. There is an advantage in focusing people’s minds on having the debate to understand what it is about.

William Norton: The risk of having an ABC-type referendum, whether it is done as a gateway or otherwise, is that one of them will emerge as being the "none of the above" default. The answer to that is that you have a vigorous debate on all three discussions, but it is a practical risk.

Q515 David Mowat: Why have only one devo-max; why not have half a dozen?

William Norton: Yes.

Chair: Now, now; you are taking this too far.

David Mowat: That is the logic of the position that says let them all get defined.

Q516 Chair: I think it was Peter Kellner last week who suggested that if you had three options you could rate them in order, until we pointed out to him that that was the one system that had been overwhelmingly rejected in a referendum.

Willie Sullivan: It would not work.

Q517 Chair: Let me draw this to a conclusion if I can. Finally, are there any particular points that you want to make or any answers you had ready to questions we have not asked you?

Matthew Elliott: I have one quite important point. We have talked a lot about the funding of different campaigns and what have you. Let us say the referendum period here is the autumn of 2013, which is 18 months away. It could be a year after that, so that is two and a half years away. There is an issue of how public money is used by the Scottish Government through different quangos and NGOs perhaps to push different agendas. I think that that should be something you consider, because certainly with the AV campaign certain NGOs and groups in receipt of public funds were part of the yes campaign coalition. That is not to have a dig, but the use of public funding by the Scottish Government, who are so clearly identified with one of the options, should be looked into.

Willie Sullivan: It is something to be considered, but the flip side of it is that in Scotland we have quite a vibrant civil society, and we would like that civil society to be engaged in the debate. One of the things that the no campaign did during the AV referendum was to close that down completely by bringing in charity law to stop them being able to do that. There is a valid question about whether charities should be allowed to campaign for political parties or interests.

Matthew Elliott: That is publicly funded groups.

Willie Sullivan: Yes. You used the charity laws to stop any groups in that campaign, but you are saying it would not be the same in Scotland.

Matthew Elliott: There are two different issues here. There is the whole point about charities and how they cannot campaign in referendums, which is an important point.
They should not be seen to be part of a political debate, but there is also a point about NGOs funded by public sector bodies, who then take a stance in a referendum.

Q518 Chair: There is already a certain amount of concern that some voluntary sector organisations are seen to be acting as mouthpieces for the Scottish Government and also that the Scottish Government have made it clear to various organisations informally that it would be inappropriate for them to be expressing a view contrary to that of the Government. I can see that as a dilemma. On the other hand, if you have an organisation that is providing good works, as it were, and may be getting 10% of its money from the Government, should that preclude it from having any view whatsoever on anything? For example, Citizens Advice might want to express a view on the implications of independence for, say, housing benefit and how it would work and so on. Because they get a chunk of money from central Government, or the Scottish Government, does that mean that under your system they would not be able to express a view?

Matthew Elliott: I am not bringing it up as an issue in that anybody in receipt of public money should not be able to express a view. I think it is just an issue that should be on people’s agendas more. I am not sure whether it is 10%, 50% or 90% of funding. There is obviously a continuum, but when you are in government with a lot of money at your fingertips and groups under your control you can use that influence to push political debates in certain ways. When it comes to having fair outcomes in referendums, that is quite a big concern.

Q519 Chair: I understand the point about influence. We have got cybernats in Scotland who will violently attack, through social networks, anybody who disagrees with the latest pronouncements by the SNP. It is quite intimidatory to a number of people in various ways. Restrictions are being placed informally on various organisations in receipt of Scottish Government funding. But I am not clear what you are saying to us, other than that we should just be aware of it.

Matthew Elliott: I am flagging up an issue and saying you should be aware of it rather than proposing a solution, because I have not thought about it enough.

William Norton: There are two points and both cropped up to different degrees in the AV referendum. One is on charities. We did not close down the debate; we just reminded charities that the law of England and Wales on charities prevented them from saying, "Vote yes".

Katie Ghose: And the effect of it was to scare them off having any reasoned debate.

William Norton: I did not write the law of England and Wales on charities. I just happen to think people should follow it.

Willie Sullivan: That is true. On the other hand, you do want a vigorous and vibrant civil society engaging in debate about the future. You want them to be law-abiding well, but maybe there are questions about the detail of that law.

Q520 Chair: How would you handle that? The voluntary sector organisations who are acting in some cases as arms of the state, which are delivering services and so on, should then be free to campaign.

Willie Sullivan: No, I would not go as far as that at all. I think they should be allowed to express their view.

Q521 Chair: When is expressing your view campaigning and when is it not?

Willie Sullivan: I guess the trade-off is that, if you say to them that they cannot express a view, what are we doing to create a civil society?

Q522 Chair: I understand that. I am just seeking clarification from you.

Willie Sullivan: Again, I do not think there is an easy answer to this, and it probably needs further investigation.

Katie Ghose: The Charity Commission in terms of elections gives guidance about what is campaigning, what is political activity and all the rest of it. I think this is really important. The example you gave of Citizens Advice and housing benefit is a very good one. Citizens Advice has quite an evidence-based approach to its policy work from people coming through the door. It may well have something to add to the debate about housing benefit. It would be a great shame if that was lost. I think all Governments have a duty to try, where they can, to separate out the giving of funds from listening to evidence from these organisations, whether or not you call that campaigning. That is a principle across the board. It is concerning to hear about how already that debate may be closed down, because, at the end of the day, you will get less informed discussion overall if you shut out those organisations from this discussion.

William Norton: Certainly, the England and Wales Charity Commission did send out a set of guidance on what was and was not acceptable. I think the guidelines as they stand as to what charities can do during a referendum or, for that matter, an election are fine. It is just that they cannot compromise their independence and take a side. For example, if you are a particular charity dealing with housing benefit, you can say, "It seems to us that these are the implications in this particular issue." What you are not doing is saying, "And go out and vote yes/no, devo-max, option D, or whatever is on our shopping list."

Q523 Chair: But you have a situation at the moment where the devo-max campaign is essentially being driven out of the First Minister’s office by front men in the voluntary sector. To what extent is that campaigning, and to what extent is that seeking and disseminating information? How would any proposed guidelines either of you want to see deal with something like that?

William Norton: It would probably come down to the mechanics of the accountability of public money and the use of it. I would have to think through it a bit further. For instance, on the issue of charities, I am not sure what the legal position is in Scotland and how it differs from England and Wales. I would have to have a think about that, but, presumably, there is some sort of mechanism for auditing how public money is used in Scotland.

Q524 Lindsay Roy: There are also issues that we are aware of from a previous dialogue where an umbrella body might take a particular view, and we am not sure how representative that umbrella body is of the organisations it represents. From the dialogue, it appears that they were not all that representative, and the bodies who were part of it complained, so there is also that internal democracy.

William Norton: That also cropped up in the AV referendum.

Q525 Chair: Again, what fun we have had today. We will assume, Willie, that you agree with all the stuff that the no campaign has written to us, unless you tell us to the contrary.

Willie Sullivan: We would submit written evidence with reference to the no campaign submission only pointing out what we didn’t agree with.

Chair: That would be helpful. If subsequently any points occur to you, it would be helpful if you let us know. We are hoping to produce a brief report just after Easter in order to inform debate and discussion, but we will probably return to some of these issues. Thank you very much for your participation and we apologise for holding you back because of the previous discussion.

Prepared 22nd March 2012