UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE
To be published as HC 140-iv

House of COMMONS

Oral EVIDENCE

TAKEN BEFORE the

Scottish Affairs Committee

The Referendum on Separation for Scotland

Wednesday 12 June 2013

Dr Angus Armstrong and Carl Emmerson

Evidence heard in Public Questions 3289 - 3386

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Oral Evidence

Taken before the Scottish Affairs Committee

on Wednesday 12 June 2013

Members present:

Mr Ian Davidson (Chair)

Mike Crockart

Jim McGovern

Graeme Morrice

Pamela Nash

Lindsay Roy

________________

Examination of Witnesses

Witnesses: Dr Angus Armstrong, Director of Macroeconomic Research, National Institute of Economic and Social Research, and Carl Emmerson, Deputy Director, Institute for Fiscal Studies, gave evidence.

Q3289 Chair: Welcome to this meeting of the Scottish Affairs Committee. As you may be aware, we are undertaking a series of sessions looking at what the impact of separation might be in Scotland. We are being driven by the desire to make sure that people, come the referendum, have the maximum amount of information. We are hoping at this stage to produce various reports that will ask both Governments or both sets of protagonists to answer or clarify a number of points that we identify in our sessions. All of this is very much a work in progress and we would welcome having drawn to our attention issues that you do not necessarily have answers for but which require to have responses from various Governments. I hope that is acceptable to you.

Could I ask you to identify yourselves and describe the work that you are doing as part of the ESRC initiative?

Carl Emmerson: My name is Carl Emmerson. I am Deputy Director of the Institute for Fiscal Studies. We have one of the grants under the ESRC’s programme "The Future of the UK and Scotland". The work we are doing is looking at the fiscal challenges that an independent Scotland would face and the fiscal opportunities that they would have. We are looking at how much tax revenue they would get, where their public spending goes and what the gap between the two is in the near term.

We are looking to produce some forecasts for the long-run public finances for Scotland. They would be similar to the ones that the Office for Budget Responsibility does for the UK as a whole. We are also looking to see whether there are obvious things that economists might recommend that Scotland should do to its tax and benefits system. These may be things that we would recommend that the UK should do to its tax and benefits system. There may be things that are distinct to the Scottish situation that would suggest it should do something a little bit different from the rest of the UK.

Dr Armstrong: My name is Angus Armstrong. I am Director of Macroeconomic Research at the National Institute of Economic and Social Research. I have an Economic and Social Research Council senior Scottish fellowship to look into currency and fiscal options for an independent Scotland. This covers a number of areas. One part of it is to create what I think will be the first global econometric model for Scotland to go through some scenarios for various consequences of different currency and fiscal arrangements of economic shocks that could occur in the future to an independent Scotland. It will also look at the costs and benefits of different currency and fiscal arrangements.

Q3290 Chair: I was at the seminar earlier on and I know that both of you had sets of slides. It might be helpful if you would let us have copies of those. We could probably just attach those to the report of this meeting and it would help illuminate some of the issues that are raised.

Mr Emmerson, could you give us a short summary of the UK’s overall fiscal position as a background to a discussion about Scotland?

Carl Emmerson: In 2009-10, the UK’s deficit reached its highest level as a share of GDP since the second world war. This was as a result of the financial crisis and the associated recession. It did a lot of damage to the UK’s public finances. We are now in the process of trying to repair that damage. Some of that deficit will go away through growth, but unfortunately most of it is thought to be structural and therefore requires tax rises, benefit cuts and public service cuts to deal with it. The current UK Government is embarking on a fiscal consolidation plan that is set to run right the way through to 2017-18. It will not be until then that we get the deficit back to the path it would have been on had we never gone through this crisis. It is basically eight years of pain, starting in April 2010 and running right the way through to March 2018. That is the short-run challenge. It is an eight-year period to get the deficit back to pre-crisis levels.

In 2018, we will still have debts that are much higher than we had coming into the crisis. The OBR is forecasting that the UK’s debt will be nearer to 90% of GDP, whereas it was just below 40% of GDP before the crisis hit. We will have a relatively high level of debt compared with recent historical standards in the UK. The IMF is projecting that the UK’s debt will be high by international standards too.

Over the longer term there are a number of fiscal challenges facing the UK. The most obvious is an ageing population, which will add to pressures for spending on the NHS, social care and pensions. We also have challenges because some of our tax revenues may be at risk of decline. In particular, fuel duty revenues will fall as people drive more efficient cars and as they shift gradually to more electric cars. North sea oil revenues will decline as North sea oil production declines. There may well be a continued threat to corporation tax receipts if profits prove to be more mobile in an increasingly competitive global environment.

Q3291 Chair: That was the good news, was it? You are a bit of a doom-monger, is that correct?

Carl Emmerson: These are based on official forecasts. They are a central expectation. There is a chance that things could be a lot better than the scenario I have pointed out. There is also a chance that things could be worse. It is worth pointing out, if you think about the NHS, that it has dealt with a lot of ageing over the last 50 years. These are not challenges that are entirely new to us. UK policy has had to adapt to challenges in the past. We have had problems with our public finances in the past and we have dealt with them. It is the case that, when the UK Government choose to put up taxes or cut spending, that tends to happen. We have solutions in our hands. We also have a fair amount of science suggesting that we could run our tax system better. The policy could be made to operate better. We could, for example, collect as much tax as we do and be as redistributive as we are currently but do it in a more efficient way if we chose to. There are opportunities there as well.

Q3292 Mike Crockart: That is a very good summary of the UK position. Turning now particularly to Scotland’s position, can you tell us on what data you base your estimates for Scotland’s fiscal position?

Carl Emmerson: The analysis we have done to date has used the data from the GERS publication, which tries to estimate how much tax revenue is being paid by individuals within Scotland and how much public spending is going on within Scotland.

Q3293 Mike Crockart: What is your opinion of those figures? Are they robust and of good quality?

Carl Emmerson: In terms of public spending, there are some areas where you can just see where the spending goes. We know where NHS spending goes and we know where school spending goes. That is pretty uncontroversial. There are other areas of spending where you have to make some assumptions. I know the GERS accounts disagree with the Treasury figures in some areas. These are on things like railway spending. Should that be allocated to the area in which it is located or are railways something that are of benefit to everybody in the UK, no matter where they are? GERS allocates just the railways in Scotland to Scotland.

Similarly you have to make decisions about the London Olympics and who will benefit from that. I think you could decide either way. I do not think I would assert that either assumption would be unreasonable to do.

On the tax side, there are some tax receipts for which you can observe where the tax is being paid, such as inheritance tax. There are some taxes where we don’t have the data and you have to try and estimate it using other sources. For VAT revenues, they use surveys of consumer spending and allocate VAT revenues proportional to how much consumer spending goes on in Scotland on VATable goods. Again, that does not seem like an unreasonable thing to do.

The area that is hardest to do and likely to be pretty important is corporation tax. It is clear that we have enough problems trying to measure how much corporation tax we think should be due to the UK Exchequer within, say, the European Union. The idea that we could accurately measure exactly how much corporation tax is paid by Scottish companies compared with companies elsewhere in the UK is clearly a very difficult thing to do.

The GERS accounts use the gross operating surpluses of the firms located within Scotland. Again, that is not a bad thing to do, but it is probably one of the areas where the assumption could be wrong, and it would matter because corporation tax revenues are pretty big. Over the coming months, that is something we might try and do a bit more research on and it is almost certainly something that should get more attention paid to it.

Q3294 Mike Crockart: Do you have any feeling of what the percentage difference is on the expenditure side between the GERS figures and the UK Government’s figures? Do you have any feeling for the percentage plus or minus? Is it marginal or could it be quite major?

Carl Emmerson: I think the judgments they are making are pretty marginal and you could decide either way. As I say, the one where I look at it and I think, "That assumption is not an unreasonable one but it might well matter" is this corporation tax one. It is just because it is a sizeable area, as well as gross operating surpluses not really being a perfect proxy for what corporation tax is trying to get at.

Q3295 Mike Crockart: But you are going to be doing further work on that.

Carl Emmerson: It is something we hope to be able to do further work on. It will depend on our resources but also what proves to be possible. If I was asked to highlight where these accounts would benefit most from extra analysis, that would be the area I would point at.

Q3296 Chair: You mentioned that you would like to do some more work on that. Those watching will have noted that bid for financing. What time scale do you have for that and when might we expect answers on these things?

Carl Emmerson: The project we are running at IFS runs until the end of November this year. We are planning a launch event in November/December-time in Scotland and probably a follow-up in London too, where we will launch all of our findings. That will reveal exactly what we have managed to do and where we have prioritised our work. In particular, the long-run public finance forecast is still very much a work in progress. We will be presenting that and also, as I have discussed, what things Scotland might want to do to its tax and benefits system. Given what we have recommended already that the UK Government should do, are there any differences in what we would say an independent Scottish Government should do?

Q3297 Mike Crockart: With the provisos that you have already mentioned, is it fair to say that Scotland’s fiscal position is similar to that of the UK, with oil revenue taken into account?

Carl Emmerson: On public spending, it seems pretty clear that across the board there is more spending per head on public services in Scotland than the UK average. Outside of oil, the tax revenues look pretty similar. That feels quite sensible. GDP per head is pretty similar in Scotland to the rest of the UK, so the idea that tax revenues are at a similar level feels about right. There is a gap between non-North sea oil, tax and spending. In recent years, since about 1990 onwards, that gap looks like it is pretty close to the amount. It is in fact perhaps slightly smaller than the amount raised by the geographical share of North sea oil revenues.

If you go further back and look in the early 1980s, when North sea oil was much more lucrative for the UK Exchequer, that gap would have been swamped and Scotland’s fiscal position would have been much stronger. If you look out into the very long run going forward, as North sea oil revenues decline, obviously North sea oil revenues go away and you are left with this higher level of spending per head in Scotland and the same level of tax revenues. Something would need to be done to close that gap were Scotland to be independent.

Q3298 Mike Crockart: Broadly, we have two curves and we are at the point of intersection at the moment where the extra spending is matched by the extra income that a geographical share of oil gives us. It used to be much more and it will eventually be much less, but, broadly, at the moment, it is pretty even.

Carl Emmerson: I think that is right. It has been pretty matched since about 1990 through to the present day. Before that, there were much bigger surpluses from North sea oil. The short and medium-run forecasts for North sea oil vary a lot, depending on who you talk to. They are very uncertain. We can be pretty confident that in the very long run the North sea oil revenue will go away.

Q3299 Mike Crockart: If oil revenue is taken out of the equation, how much is the gap between what we are spending in Scotland and what we will raise through tax?

Carl Emmerson: The extra spending is worth just over £1,000 per person in Scotland. That is the size of the challenge you would have. North sea oil money would perhaps give Scotland some time to make an adjustment, if you think about it in terms of the annual deficit that it would be running.

Q3300 Mike Crockart: You say that, broadly, we have been in this position of extra spending versus oil revenue since about 1990. I know it is difficult to project into the future, but how far into the future do you think that situation is likely to pertain?

Carl Emmerson: It is an area where I strongly suspect any answer I give will be proven wrong within two years. The IFS has not produced a forecast of what we think is going to happen to oil production or oil prices. We leave that to others to try and do and to get wrong. I note that the CPPR in Glasgow has pointed out that this gap could go away pretty quickly. It could go away within four or five years, so by 2017 or 2018, but I would stress that there is a huge amount of uncertainty there and we should not bank on that being right. Indeed, if a country was trying to plan its public finances and it had a lot of money coming from oil revenue, it would have to think very carefully about the design of its fiscal rules so that it was thinking about the ups-well, the extreme variation in the revenue source that it would have. That would have to be handled with a lot of care. I almost said the ups and downs of the oil price movements, but it is not like a cycle. They move all over the place and it would be a big challenge to work out how to handle the oil revenues.

For example, the UK Government are currently aiming for a balance on their current budget. They are saying, "In the medium term we want to pay for day-to-day spending; we only want to borrow to invest." That is very similar language to that which Mr Brown used when he was Chancellor. You could imagine that, in Scotland, an appropriate fiscal rule might say, "We want to cover our day-to-day spending and we want to exclude the oil revenue from that." It might be a sensible thing to view the oil money a bit like a windfall investment and, therefore, perhaps that should not be used to cover your spending. Then the only decision to be made would be what time scale you aim for. Do you try and get back to balance in five years, or do you want longer to adjust if you think you have to make a big adjustment?

Q3301 Chair: I want to be clear on this. You are saying that, if the oil money is used to fund current spending, there is no surplus for building up an oil fund. If you use the oil money for an oil fund, then there have to be cuts to bring the budget into balance.

Carl Emmerson: That is true, except I would not describe it as building up an oil fund. I would describe it as paying down the debt that we have. The UK is forecast to have debt to GDP of almost 90% in 2017-18. If Scotland was to be given debt to GDP of about that level, that is quite high by international standards in 2018. As forecast by the IMF, it may well be that it should try and pay that down.

I also think there is an attraction to saying, "If we think borrowing to invest is okay because it benefits future generations, then maybe the revenue we get from North sea oil should be used to benefit future generations as well. Maybe we should not be using that for current consumption." Given that both the last Labour Government and the new coalition Government seem to think it is okay to borrow to invest and they are thinking about it in terms of generational equity, it would seem to me that the oil money should be treated in a similar way. It would sidestep the problem of what you do when suddenly you have a lot of oil money. Is it okay to spend that, and then a couple of years later you find that your oil money has disappeared because the oil price has collapsed and all of a sudden you have to make cuts? It would allow you to smooth that out.

Q3302 Chair: I just want to be absolutely clear about this. The price of having an oil fund is having to make cuts in public expenditure. Sorry, nobody records a nod of the head. It is necessary for you to answer.

Carl Emmerson: That is right. You have your money from oil, but you can only spend it once. You could spend it on running down the debt; you could spend it on building up an alternative fund if you wanted; or you could spend it on financing lower taxes or higher spending. If you are choosing to build up an oil fund-or, as I would suggest, just run down the debt you have inherited-then you would either have to cut spending or increase taxes to close this gap that Scotland would inherit.

Q3303 Chair: This does seem to me to be a somewhat heretical view. We have repeatedly heard the idea from the Scottish Government that the oil money can be spent several times over on building a fund, cutting down the debt and maintaining current expenditure. You are saying that that package of alternatives is not possible. I just want to be absolutely clear.

Carl Emmerson: I can be absolutely clear that that is not possible. There are very few things in economics that are so clear-cut, but that one will be. You could use the oil money to fill the gap between non-oil tax revenues and spending. That would fill that gap for a period. Alternatively, you could say that you want to use that money to pay down the debt, in which case you would need to close that gap in some other way.

Q3304 Mike Crockart: How does your estimate of Scotland’s proportion of the debt relate to oil revenue per year? You are saying that one of the three possible uses of the oil revenue is to pay down the debt. How long would that take?

Carl Emmerson: It is going to be extremely sensitive to the amount of oil revenue we are getting in. It is fair to say that it is not going to be a huge amount relative to the stock of debt that we are inheriting. I do not want to try to do the sum off the top of my head. I can come back to you with that.

Q3305 Mike Crockart: As I understand what you are saying, even if UK coalition plans were followed and we got to a position in Scotland where income and expenditure were broadly aligned in 2018, we would then still have the choice of what to do with the oil revenues. You could either pay down debt or create an oil fund, but you could not do both.

Carl Emmerson: That is right.

Q3306 Mike Crockart: But that is accepting austerity and significant cuts in spending going forwards anyway.

Carl Emmerson: It is. I would point out that, in the longer term, the UK will have to implement further austerity anyway because of the challenges outlined at the start. Scotland would have this additional bit to do. There is a reasonable question of how quickly they should do it. If you want to manage your public services as best you can, you might want to say, "We have a big adjustment to make and it will take us seven years to do that in an efficient manner," for example. You could imagine the oil money smoothing that transition to being one where you get the deficit back to appropriate levels. I am not saying you would have to do it in three or four years or anything like that. It may well be sensible to take a little bit longer about it for micro-reasons.

Q3307 Mike Crockart: In actual fact it is worse than I outlined, because it is not just the plans as they stand at the moment. There would still be that extra level of spending that happens in Scotland that would have to be dealt with.

Carl Emmerson: That is right. The UK Government will get the UK as a whole in a position of fiscal balance in 2017-18, if their plans turn out to be correct. Excluding the oil money, Scotland would still have this deficit in that year. It could use that oil money to finance that deficit for a period and then it would have to increase taxes or cut spending to close that gap.

Q3308 Chair: You are making the assumption in all of this, are you, that Scotland gets a geographical share of oil revenues?

Carl Emmerson: That is right-90% of the oil revenues.

Q3309 Chair: On what basis are you making that assumption? As with the question of the national debt and Trident, presumably all of these things will have to be the subject of negotiation. Lots of things will be done on the basis of population. I can understand why, if I was in the Scottish Government’s position, I would argue for the geographical share, but it is not necessarily going to be the geographical share of the national debt. It is not going to be divided according to acreage. Is there any basis in precedent elsewhere that makes you assume that it is going to be on the geographical basis?

Carl Emmerson: That is probably a question for a lawyer rather than an economist.

Chair: But you are here.

Carl Emmerson: My understanding is that using the geographical share is not an unreasonable thing to assume. You are right that you would have to make the negotiation over how to allocate the national debt. You could allocate it per capita or per unit of GDP. That would lead you to pretty much the same answer. You could allocate it in some other way. You would also want to think of the assets that the state owned. It owns lots of buildings in Scotland. Does it naturally get all of those because they happen to be in Scotland or do we try and value them in some way? The answer to that question will depend on a political process, to which I do not know the answer. You are right that there are some key assumptions built into the numbers I am giving you.

Q3310 Chair: Mr Armstrong, you have been silent during this because the interrogation has been of Mr Emmerson. This is not your area, is it, unless you know everything about everything? I was assuming that the fiscal stuff was Mr Emmerson’s area. Do you want to add anything to that?

Dr Armstrong: At the risk of not wanting to sound like I know everything about everything, I would point out a couple of things. On fiscal adjustment, as the gentleman here asked, the average tax revenue from oil for the last three years has been about £8 billion. One of the great things is how you are going to share the public sector debt. This is one of the things that have not been discussed. If you take a population basis, that is reasonable. It is 2016 of course-you do not have last year’s debts; it is in 2016. According to the OBR, that is £1.5 trillion for the whole of the UK. So you get 8.4% of that. That gives you not far off £130 billion, if the population is the method you use. Your £8 billion surplus contrasts with £130 billion. I have had time to think about that while Carl was answering the questions. I just point that out to give some sort of order of magnitude.

Of course, it might not be on a population basis. The Scottish Government pointed out in their latest economic report that it should be on an historical basis, which gives you a much smaller share of the public sector national debt.

Chair: It has to be assumed that, in negotiations, each side will have a starting point that is greatly to their advantage and that things will then move on from there. One of the issues that we discussed in a previous meeting was all the sunk costs of Trident, Faslane and Coulport, which are absolutely and utterly enormous. That would have to be balanced off in some way-possibly. But could we move on?

Q3311 Pamela Nash: We have already touched on public spending. The figures that have been published show Scotland’s public spending per head at £1,200 a year more from 2010-11. Could you first of all tell us why that is the case?

Carl Emmerson: Some of it is on social security. The Scottish population is a little bit older than the rest of the UK, so, with an older population, it is going to receive a bit more in pensions. At every single age we have found that people in Scotland are slightly more likely to be receiving a disability or health-related benefit than people in the rest of the UK. There is more spending on the NHS and on schools. You might think that that is because a more dispersed population is slightly more expensive. If you wanted to deliver the same standard of service, you might need to spend a little bit more-for example, to get travel time to your local hospital or to your local school-to be the same.

The other answer to the question, "Why?", in part, is because Scotland had more public spending than in England in the late 1970s before we introduced the Barnett formula, and that gap is very gradually being shut, but not in a very carefully designed way. It is historical; it has happened through history.

Q3312 Pamela Nash: In your opinion, are there areas where you would consider that there is too much being spent in Scotland?

Carl Emmerson: People will have different preferences over where they think the state should be providing goods-whether they think they should be provided for free at their point of use or we should charge for some of them. It is notable that in England, for example, we charge more for higher education than Scotland does. We charge more for personal and social care than Scotland does. There is some economics there, but there is a lot of politics there.

If Scotland were to spend the same as it currently does as an independent country on defence, it would find itself as a very high spender on defence compared with most other small countries. An obvious question for an independent Scotland would be, "Do you want to be a relatively high spender on defence?" That might be an opportunity for them to make some savings. Independence would offer up some opportunities as well as some challenges.

Q3313 Pamela Nash: It has already said that it would cut spending but have even more personnel than it has at the moment. We are not quite sure how it will manage that.

Do you think there are opportunities, if Scotland does separate, for it to increase its tax income?

Carl Emmerson: There certainly are. We have recently done some work looking at what a tax system should look like for an advanced economy in the 21st century and tried to write down some lessons for the UK.

Q3314 Pamela Nash: Is that published?

Carl Emmerson: It is; it is the Mirrlees Review. We have lots of recommendations for what the UK Government should do to their tax system. We are trying to answer the question, "Could you do as much redistribution as you currently do but have a more efficient tax system?" You could have bigger GDP but as much redistribution. There are many areas of the UK tax system where policy is not as good as it could be. An independent Scotland could take advantage of that and just do policy better. In very many areas we have identified changes we would like to make to the benefits system and to the tax system. That would give opportunities if Scotland wanted to tax a bit more but not harm the size of its economy. It could try and do that.

Sitting suspended for a Division in the House.

On resuming-

Q3315 Pamela Nash: We were discussing what opportunities there would be to increase the tax income in a separate Scotland. Do you think income tax would also be part of that mix? How far up the rankings would that be in terms of how to raise the tax income?

Carl Emmerson: In terms of which taxes are bad in the UK, income tax is not high on the list. If you look at the areas of tax that the UK Government get very badly wrong, you would look at something like the taxation of housing, where we have a stamp duty tax. If two people want to sell a house to each other-a mutually beneficial trade-we are going to tax that and discourage it. There is no economic justification for that.

We have a council tax that is based on the value of your property in 1991. It would make much more sense to tax people on the basis of the value of their property now and not 20-odd years ago. It is based not on the value of your property but the value of your property in eight bands, and the vast majority of houses are in the bottom three bands. A sensible tax for housing would say, "We are going to tax you on the basis of the current value of the property that you own," and it would be based on a continuous percentage of the value. We would use the revenue raised from that to get rid of council tax and stamp duty. You could do that in a revenue-neutral way and it would look much more sensible. You could choose to raise more money if you wished. As an example of a very bad tax in the UK, stamp duty is arguably one of the worst that we have. I think income tax is far down the list.

Q3316 Pamela Nash: I am not an economist. You say income tax isn’t a bad tax. I understand that, but why would you primarily use the bad taxes as opportunities to change?

Carl Emmerson: Where I would look for opportunities I would be saying, "Where is the UK Government currently taxing things very badly, and therefore I can get rid of those bad taxes and replace them with other taxes that are improvements?" That means I could raise the same money and do less harm, or, if I want to do the same amount of harm to the economy, I could raise more money.

Q3317 Pamela Nash: I am specifically asking about increasing tax income through a change.

Carl Emmerson: It would be an opportunity to reform those taxes that are operating particularly badly. You can do that in a revenue-raising way if you wish. You can raise more money through income tax if you want. I just think it is not screaming out as a tax that needs massive improvements made to it.

Q3318 Chair: It would certainly be your recommendation that a new Scotland, starting from scratch, would undertake a re-evaluation of housing and would then introduce a new property tax in some form.

Carl Emmerson: I would recommend that England, Scotland and Wales should all do that, yes. I am disappointed that we don’t do it in the UK. I would hope that an independent Scottish Government could take the opportunity to tax housing in a more sensible way.

Q3319 Pamela Nash: I am still not clear on this. I am not asking about income tax as it stands at the moment. Is there an opportunity to raise income from income tax?

Carl Emmerson: Yes; you certainly could increase the rates of income tax and raise more money in that way if you wanted to. You could raise significant sums and it would raise them in a relatively progressive way. It is not something that we typically do in the UK because successive Governments have increased VAT or national insurance and tended to cut the rates of income tax, but there is no reason why you could not use income tax if you wanted to.

Q3320 Pamela Nash: Are there any other taxes that would raise the income rather than just being restructured?

Carl Emmerson: If the exercise is just, "Can I use existing taxes to raise money?", you would naturally look at income tax, national insurance or VAT because they are the biggest taxes. Your decisions among them will depend on who you want to affect. If you use national insurance, you are exempting pensioners. If you use income tax, you are being more progressive. If you use VAT, you are still probably being mildly progressive but not as progressive. You could use any of those three really.

Q3321 Pamela Nash: If Scotland did separate, what would you predict the fiscal stance of the first Scottish Government to be in 2016?

Carl Emmerson: They would need to set out a plan for tax rises and spending cuts into the future. I don’t know how quickly they would need to do them, but they would need to set out a plan. A commitment to do it does not mean immediate pain, but it is pre-announcing in order to restore the gap between tax and spending that we spoke about earlier in order to put their public finances on a sustainable trajectory.

If Scotland does not become independent, it may well be that the UK Government would have to do the same thing anyway. Scotland may just need to do a bit more than what the UK would have to do.

Q3322 Pamela Nash: To be clear, you would see that as a priority and it is more likely that there would be spending cuts than tax increases.

Carl Emmerson: The balance between tax and spend will depend on the new Scottish Government and how big they want their state to be. I think they would need to set out a plan for closing the gap between the two. How they do it is very much down to their own political choice.

Q3323 Pamela Nash: But they would need to do one or the other.

Carl Emmerson: Yes, or a combination of both.

Q3324 Chair: Is it reasonable to expect those proposing the change of constitutional structure to put that forward before people come to vote in the referendum? Given that our objective is to try and make sure, as far as possible, that people are not buying a pig in a poke, and given that the UK Government have been making relatively clear what their strategy is and that people have to know what the balance would be between, as you said, tax rises and spending cuts in the event of a separation were the SNP to win, is it reasonable for us to expect that we would have a statement along those lines as part of the Scottish Government’s declaration of intent in November or so of this year?

Carl Emmerson: I think it is reasonable for the Scottish population to be given as much information as possible about what the pros and cons of independence would be. That is one of the reasons why we are doing this research. I would never argue that they should not have as much information as possible. I don’t have a view, though, on when they should get it-whether they should get it this year or whether 2014 would be acceptable. That is a finer judgment, but I certainly think we can give people what we think our best guess of the answers to these questions is. We can highlight the uncertainties where there are uncertainties, and I think we should provide this information to people.

Q3325 Chair: I understand that, but, in terms of the choice that has to be faced between tax rises and spending cuts or a combination of both, you indicated that you intend to produce your documents in November or December, if I picked you up correctly. Your documents will contain, if not concrete proposals, at least an indication of the scale of the difficulty and the range of options that might have to be tackled. In those circumstances, would it be reasonable for us to expect those proposing constitutional change to spell out before the referendum date what their mix of options would be? Again, wanting to avoid a pig in a poke, people could then understand that, if they voted for separation, those conducting the negotiations-who would be the present Scottish Government-would hope to get a deal along the lines that they will spell out and then go straight into that pattern of tax rises and spending cuts as they had previously indicated.

Carl Emmerson: There are two slightly separate issues. One is: should people be aware of what the pros and cons of independence are, and, for example, how much bigger the gap between tax and spending might be for an independent Scotland than it would be if they were to remain with the United Kingdom? That is something people should get information on.

There is a second question about how they choose to fill that gap, which presumably would be down to the manifestos that the individual parties would present to an electorate for an independent Scottish Government. Different parties would be able to offer different packages.

Q3326 Chair: But, presumably, people who are arguing for a change of constitutional structure are doing it for a purpose. Therefore, they would presumably want to put forward, "We want to have the right to make this decision between the tax and spend mix in order that we can do x, y and z." What we have been trying to avoid is having a situation where the Scottish people vote and then something gets proposed afterwards and they say, "We never thought you were going to do anything like that."

I can understand why those who want to keep the Union don’t necessarily feel obliged to spell out what they would do in the event of separation, but I can’t see why those who are in favour of separation should not spell out what they would do in those circumstances.

One of the issues that is very important and is coming forward from this session is your clear statements that there will need to be a combination of tax increases and spending cuts after any vote for separation. I do not think we have had that spelled out quite as helpfully before. As a result of that, we are now exploring what is necessary to inform the public.

Carl Emmerson: I feel able to say that, yes, the public should be told about the scale of the timing that would be required. From a professional point of view, it seems harder for me to say, "Oh, and people should be presented with exactly the option that a particular Government would take in terms of spending cuts or tax rises." That is a harder judgment call for me at least. I do not think I am able to advise, "Yes, there is a definite answer to that question."

Q3327 Pamela Nash: Would the fiscal choices that a Government would take in a separate Scotland have any impact on the options available to them in terms of currency?

Carl Emmerson: It certainly would. I think Angus should step in here and talk about the currency and I can learn more.

Dr Armstrong: I would really put it the other way round. The currency choice, to a large extent, will determine the degree of flexibility around fiscal policy. For example, if an independent Scotland were to enter a monetary union with the rest of the UK, there is every chance-and I think the Scottish Finance Secretary has acknowledged this-that there would have to be some fiscal constraints. That is if they take that option. If they take a different option, that constraint, from a negotiation with the rest of the UK, would not be there, but they would have the other constraint of having to sell a lot of bonds at some point to pay for the public sector debt that they were going to take over. There, you have a constraint about what would be acceptable from investors’ point of view. That could be a very different constraint, which, unfortunately, is not such a negotiation. It is one that you find out when you are doing it.

Q3328 Lindsay Roy: Before we move to currency choices, can you clarify this? If Scotland remains within the UK in 2016, the Barnett formula will still apply, although to a lesser extent. To what extent will there be additionality per head in Scotland?

Carl Emmerson: There would still be higher spending per head in Scotland than there would be in the rest of the UK.

Lindsay Roy: Would it be around £800 per head?

Carl Emmerson: I do not know the number off the top of my head, I am afraid.

Chair: It is at the moment, isn’t it?

Lindsay Roy: It is about £1,200 at the moment.

Carl Emmerson: It is £1,200 per head at the moment.

Lindsay Roy: There would still be that advantage in terms of the Barnett formula.

Carl Emmerson: There would certainly still be higher spending in Scotland, yes, and there would be more fiscal consolidation to come for the next two or three years.

Q3329 Lindsay Roy: Can you explain the main currency choices facing a separate Scotland? What would they be and what are the issues surrounding them?

Dr Armstrong: There are a number of obvious currency choices, but then there is a whole different subset below them. To take the first cut, you can either use sterling or the euro or your own currency or another currency, at least hypothetically. Once you have decided those-and we will stick to the main options of sterling, the euro or your own currency-then underneath that you have a whole different set of questions. How are you going to use sterling? Are you going to use it as part of the monetary union or without any formal agreement with the rest of the UK-the so-called dollarisation or the sterling equivalent? If you have your own currency, are you going to peg it to sterling; are you going to have a float; or are you going to have a quasi-fixed exchange rate and so on? You can see that there is the simple question of what physically the currency is, and then there is a question below that of what the currency arrangement is, given the currency you have chosen.

Lindsay Roy: So it is multi-layered.

Dr Armstrong: Yes, there are at least two layers in this.

Q3330 Lindsay Roy: The Scottish Government have said they are in favour of a continued sterling currency union. Is this a practical proposition, given that the UK Government have been distinctly negative about the possibility?

Dr Armstrong: It could be done. The question is to what extent it would be in both parties’ interest. A monetary union requires the permission of both parties. For a monetary union, you need to have a single payments system within a banking union. In other words, you are using sterling just like you do today. If your bank, headquartered in Scotland, requires some liquidity support, the Bank of England is the bank that you go to, or it would be through a new central bank of Scotland to the Bank of England. That is possible.

The question then becomes: is it something that the rest of the UK would find desirable? There are a lot of pluses to using the same currency, in that you minimise the exchange rate costs whenever you do a trade or visit north or south of the border. That is an obvious gain. There is a degree of certainty over what the exchange rate will be in the future, so you don’t have to hedge your risk that, when you carry out a contract with a date of delivery in one year’s time, the exchange rate might be different.

There are lots of these advantages, but against that you have the costs. Because you share the same financial system, if something goes wrong, the taxpayer behind the central bank will have to pay-or at least will be at risk of paying.

Q3331 Lindsay Roy: What about interest rates?

Dr Armstrong: If it is within a sterling monetary union and it is understood that the central bank-the Bank of England-stood fully behind Scottish institutions, then there is no reason to assume that the overnight interest rate would be any different between Scotland and the rest of the UK. But that is a lot of ifs.

Q3332 Lindsay Roy: Who would decide?

Dr Armstrong: It is for the UK Government to make the decision on this. The Bank of England will report to the UK Parliament. The Bank of England, like any other central bank in any other country, is underwritten by taxpayers.

Lindsay Roy: Would this not be a form of new colonialism?

Dr Armstrong: This would be going forward when this would be a new country. Scotland would effectively become, astonishingly, a foreign country as far as international finance is concerned.

Lindsay Roy: It would be dependent on other people for decision making.

Dr Armstrong: Yes. I would say it is hard to find situations where one country has, without any limitation or restriction, offered full financial support to a financial system of another country. That would be the surprise. There are clearly restrictions you can put on this to make it work, but without those restrictions I think it would be a surprise. The Scottish Finance Secretary has acknowledged that.

Q3333 Lindsay Roy: Are there any other conditions to make a currency union work?

Dr Armstrong: To make a currency union work, ultimately you need to have the Government of the joining country willing to pay for any losses that occur in its financial system in its country. In order to do that, the host Government have to be confident they are going to get payment on the day that this event occurs, if it ever does occur of course. How are you going to be confident that you can make payment? The day you might have to make payment is the day something has gone wrong. You have a financial problem and so your economy is not in a good situation.

One way to make sure that you can get payment is to try and form an agreement beforehand. That agreement might be something like, "You can only borrow a certain amount," or, "You can only run certain-sized fiscal deficits," and so on. That is one way.

Lindsay Roy: A contract.

Dr Armstrong: A contract. That contract can clearly be quite intrusive, depending on how many restrictions you put on it. As we are finding out in other countries now, ex-post cross-border contracts are very hard to legally enforce. Europe has been very impressive in coming out with lots of growth and stability pacts. The question is how you make them stick, particularly when you have a crisis.

Q3334 Lindsay Roy: So an independent Scotland would be highly dependent upon the UK.

Dr Armstrong: Under a monetary union-again it is for the UK authorities to decide this-I would expect the UK to require restrictions on the fiscal capacity and the fiscal position of an independent Scotland, if they are to have a full monetary union.

Q3335 Lindsay Roy: The First Minister has said that they cannot be deprived of sterling because they own it. Do you agree? Is currency an asset?

Dr Armstrong: To you and me sterling is an asset; it is what we have in our pocket. But it is a liability of the people who issue it. The person who issues sterling at the moment is the Bank of England. The Bank of England is an agency of the state. To the British taxpayer, it is a liability. To you and me it is our asset and it has been spread around a lot.

The right way to look at this is that, as a means of exchange and what I have in my pocket, then yes, that is my asset. You could say that, if we look at the total notes and coins available in the United Kingdom, that is about £60 billion. You would get 8% of that and so you would get a certain amount of the notes and coins.

However, those notes and coins are also backed by liabilities because the Bank of England’s balance sheet adds up. If you are going to take a share of the assets, you will presumably take a share of the liabilities, and funnily enough they will be equal. You might have this asset to use as a means of exchange. But the real question for monetary union is sterling as an asset in the future. At the moment a certain amount of sterling has been issued by the Bank of England, and that is a liability of the UK taxpayer. In the future, if perhaps there was another banking crisis, and who knows what the next crisis could be-it could be a natural disaster; we just don’t know-it could be necessary to print much more of this stuff. This would mean more liabilities for the UK taxpayer.

Do foreign independent countries have an entitlement to those liabilities? Not in the future. Certainly up until now you could say, "We will take a share of where we are today," but once you are independent that is hard to argue.

Q3336 Lindsay Roy: The First Minister has also said that, if a currency union is not agreed, they would default on their share of the national debt. Is that a realistic proposition?

Dr Armstrong: I am not quite sure what words were used. You can only default once you have debt, and so far they do not have debt. The whole thing is slightly circular. There is clearly going to have to be a negotiation between the rest of the UK and an independent Scotland in the event of independence about what proportion of the public sector national debt is transferred to Scotland. That negotiation clearly has to happen.

You could say that it is a population share or you could be very extreme and say it is zero, which would be unheard of. The likelihood is that it is either going to be a population share or some negotiation around those numbers. The Scottish Government have said, "What about a historical share?", and they have given an estimate of that.

Q3337 Lindsay Roy: But you don’t think they could walk away from a proportion of debt.

Dr Armstrong: I don’t think they could walk away from accepting public sector debt. The question is how much. It would be very difficult to walk away on two grounds. You are expecting the UK in a currency union either to co-operate because it depends on them to participate in a monetary union-as I said, it requires both sides-so that would be an unusual way to negotiate it, or, if you were to introduce your own currency and you started off by doing something that was clearly not responsible behaviour, then that would not be a very reassuring sign to international investors, whom you are presumably going to have to attract in the future.

Q3338 Lindsay Roy: The other currency options we discussed earlier today at the meeting were joining the euro or a separate currency. Can you tell us more about these?

Dr Armstrong: Having a commitment to join the euro would be part of the conditions for entering the European Union. One of the requirements of that is that you have your own currency in advance of joining the euro.

Lindsay Roy: For how long a period?

Dr Armstrong: I think it is two years, but these are negotiable. Sweden, for example, has made this commitment and it seems to be a never-ending and very long-term commitment. How long is required is elastic.

Lindsay Roy: This is to establish credibility.

Dr Armstrong: Exactly. You effectively have to join the ERM. You have to show that you can keep your currency fairly stable against the euro for a period of time. In order to do that, you also have to have your own central bank. Rather awkwardly, there has to be a transition into having a new currency on the way to joining the euro. It is hard to miss out that middle part.

Lindsay Roy: It is a very complex and bureaucratic process.

Dr Armstrong: It is complex and bureaucratic. However, because of the state that the euro area is in, all the rules have a degree of negotiation around these things. On almost all of them there have been Treaty articles that have been effectively overridden. In this circumstance, what would be required of an independent Scotland? We would just have to find out as part of the negotiation. I don’t necessarily think that all of the rules in the past need necessarily apply.

Q3339 Lindsay Roy: To clarify the point, what makes a currency union stable or unstable in your view?

Dr Armstrong: In my opinion, it is ultimately the degree of political commitment to make it succeed. If you have a currency union between various countries that are committed to make this thing work and that have total political commitment, then you can arguably make it work. The obvious example here is Europe, where there are very serious problems, but what is not really in doubt is that almost all countries are very committed politically to the project.

The situation here is quite interesting because, politically, you would be going the other way. You would have to get Scotland and the rest of the UK Government to be completely politically committed to make this work.

Lindsay Roy: So it is a joint commitment.

Dr Armstrong: Very much so. It is very much a joint and firm commitment. It would have to be unwavering.

Q3340 Lindsay Roy: Can you give any examples of unstable unions?

Dr Armstrong: Many.

Lindsay Roy: Are there any lessons to learn from that?

Dr Armstrong: Yes. Why do currency unions fall apart? They fall apart because private individuals lose confidence that their Government will continue to support this, and so they move their savings out of one country into the other country. It is capital flight. Capital flight occurs when people get worried about the safety of their savings. That occurs when people think that the financial details of a monetary union have not been fully worked through.

The obvious example was the so-called "velvet divorce" in Czechoslovakia. I think it lasted three weeks. With the first pay check of the Slovaks, their money went into their pensions-the capital markets were held on the Czech side-and it soon became clear that money was coming out of Slovakian banks and into Czech banks, which was the beginning of the end of it.

Q3341 Lindsay Roy: There is some uncertainty here too. I have a senior Army official who has opened a bank account in Newcastle.

Dr Armstrong: There is a high degree of uncertainty, but we just don’t know. This is one of the most dramatic things about the referendum. We have one side saying they want this and the other side saying, "We are not sure it is in the rest of the UK’s interest." I am not quite sure how people make a decision on it.

Q3342 Lindsay Roy: Today, we heard your colleague, or perhaps you, saying that the euro was a currency looking for a country. What lessons are there from the euro experience?

Dr Armstrong: That was my colleague. The lesson from the euro experience is that, before you go into a monetary union, you must make sure that it is economically completely coherent. At the time they created the European monetary union many economists pointed out the weaknesses in the system and how it could prove in the event of some event-a destabilising shock-unstable. That is the first thing. Any compromise on the coherence and integrity of the financial system will come back to become a problem.

The second thing is that you need to have political commitment from both sides. But the first is a necessary requirement; you cannot do without it.

Lindsay Roy: Thank you very much. That has been very helpful.

Q3343 Graeme Morrice: I want to ask a general question to clear up what apparently seems to be confusion over some of these issues that we have just discussed. The SNP Scottish Government, on the one hand, are saying that an independent Scotland will be within the sterling zone. Another assertion made by them is that an independent Scotland will apply for, and be accepted into, membership of the EU. My understanding is that a new member state applying and ultimately being accepted into membership of the EU would have to go into the eurozone. Could you give me some clarity over these two assertions? It seems to be a contradiction in terms?

Dr Armstrong: I can understand where the contradiction arises. This goes back to a slightly earlier question. It is only consistent if the entry into the eurozone is a commitment but deferred for what could be a very long time. For example, again, Sweden has made a commitment to join the euro at some point in the future, but that point seems to be as far away today as it was when it entered. Here, if Scotland was to form part of a sterling zone or a sterling monetary union, it is perfectly reasonable for it to join the EU with a commitment to say, "One day we will join the eurozone." It is only inconsistent if you start saying, "You have a time limit on this."

You can say, "Isn’t it a slightly disingenuous commitment if you have no intention to do this?" It seems that countries have been allowed at least to interpret this quite flexibly and elastically.

Q3344 Graeme Morrice: Certainly sometime ago SNP policy was for an independent Scotland to be part of the EU and, therefore, to adopt the euro as currency. More recently they have absolutely ruled that out. How could they then go into a situation of deferring it when they have ruled it out indefinitely?

Dr Armstrong: I don’t follow the political comment enough. As far as I understand it, upon independence, the preferred option of the Scottish Government is to become part of the formal sterling monetary union. I do not think that means they have always ruled out anything in the future. I would say, of course, that the UK is also committed to joining the euro and every year has to do a small part in the budget saying what this is what its recent statement is. Again, Scotland would not be alone in this.

Q3345 Chair: I want to come back to the question of the sterling zone and pick up for the record the question that I asked you in the earlier seminar. What is in it for the UK to have a sterling zone with Scotland?

Dr Armstrong: There are two or possibly three things I would say. The first is that for people in the rest of the UK, either doing business or travelling to Scotland, it would be awfully helpful if we didn’t have to go through a change in the currency to do so, or there was a high degree of uncertainty, because that is going to be a negative for people in the rest of the UK.

The second thing is that the current level of exports going through the balance of payments accounts in sterling, although for a different country, would be the same. In other words, you would not have the oil exports going into a different currency. Whether you think that is a good thing or a bad thing-should sterling be higher or lower?-depends. That is a fairly open question.

The third thing is that one can see how a sterling monetary union would probably be the most advantageous arrangement from an independent Scotland’s perspective. It would be in the rest of the UK’s interests to have a prosperous Scotland. There is something about seeing your neighbour prospering rather than having difficulties. A sterling monetary union would be the best way to do that.

They are the reasons why the rest of the UK may be interested in this.

Q3346 Chair: I want to come back on each of those. On the first one- the question of the diminishing transfer costs-that is a very strong argument for joining the euro and was advanced at the time. It was felt that other factors made it inappropriate to join the euro then or, indeed, virtually within the conceivable future.

I want you to explore how much of an advantage that is. What disadvantages would overcome the UK’s position of having a sterling zone like that in the way that there was a disadvantage to joining the euro?

Dr Armstrong: One of the main issues for sterling joining the euro, looking back, was the issue of having a monetary policy set at a different level than is suitable for the UK conditions. The structure of the Scottish economy and the cycles, as far as we can see it from the data, in the Scottish economy are pretty close to the average for the UK. It would be quite beneficial and there would not be a huge cost of sharing the same interest rate. Some of the negatives or the costs of joining the euro-

Q3347 Chair: There is a difference there. In the context where the UK joined the euro, the euro would be an interest rate taker. Where Scotland remained in the sterling zone, the UK would still be an interest rate maker. Therefore, the interest rate issue does not make any difference one way or the other to the UK.

Dr Armstrong: The key is whether the interest rate being set by the outside power is aligned to your economic conditions. If the UK had joined or does in the future join the eurozone, then the outside interest rate maker would arguably be less consistent with UK conditions, because the UK has a lot of peculiarities, such as the housing market and lots of interesting things. In this case, the outside interest rate maker-the rest of the UK and the Bank of England-would set an interest rate. How different would that be to Scotland and the needs of a Scottish economy? It would not be that different because their economies are quite similar. There is a lot more similarity between Scotland and the rest of the UK than there is between the UK and the euro area. So that cost is not quite as great.

Q3348 Chair: I draw a slightly different lesson there, in the sense that it does not make any difference to the UK. There is no negative to the UK from the point of view of setting interest rates if Scotland is part of the sterling zone. I can see that there might be a negative for Scotland because it would not necessarily adjust, but there is not as much of an adjustment.

The second point is the question of the impact upon the currency if Scotland were split. Scotland on its own presumably, being an oil currency potentially, would have a tendency for the currency to rise. It would be a strong currency, and it would then be a bit like Australia, where the manufacturing industry has been devastated by the strong currency.

I can see in those circumstances it being advantageous for the UK, in a sense, to lose the oil element of Scotland in order to allow sterling to drift downwards. That would then make UK exports more competitive internationally. That would potentially be something that was a downside for the UK of having that sterlingisation. What I don’t know is how much of a downside that might be and what positive factors might counterbalance that. Can you help?

Dr Armstrong: Yes. This is quite a difficult area. First of all, I would start off from the Scottish side, looking at the Scottish external accounts. Unfortunately, the Scottish external accounts is one of those areas where there is very incomplete data. The truth is that on some of these issues we simply don’t know enough. At the moment there is a balancing item in the experimental national accounts in Scotland. A balancing item is exactly what it says; we are really not sure. However, that balancing item is negative. We know that, if a country is running a large fiscal deficit that is not offset by excess savings in the private sector, there will probably be an external deficit. There is every likelihood that Scotland is running an external deficit.

On independence, of course, the oil-assuming it is a geographic share so that it is a large part of it-becomes a Scottish export so that will help its current account. You have offsets against that, which go into your balance of payments, such as the repatriation of profits by overseas companies that make profits based on the oil. That goes through on the negative side of your balance of payments, but it will be a positive for the Scottish balance of payments. Conversely, it will be a negative for the UK balance of payments.

How you interpret those things is a much more subjective decision. Would it be better to have a weaker balance of payments and have sterling somewhat lower than it currently is today? You can make an argument both ways. If you are interested in the price of consumption, then the answer to that question might be no. If you are interested in the competitiveness of your exports-your non-oil exports-then the answer to that question might be yes. It just depends.

What we do know is the value of oil exports that currently go through the UK. That has been about £9 billion or £10 billion each quarter. In terms of a share of total UK exports, that is about 10%, so it would worsen things. Again, you would have the offset, but would that be a dramatic impact on the balance of payments to the UK? I would not expect it to be a dramatic impact. It would make it worse on the margin, but no more than that.

Q3349 Chair: The third point you touched on was that, undoubtedly, a sterling zone was best for Scotland. I am not clear whether or not, in these circumstances, this is a zero-sum game in a way and whether or not being best for Scotland means it is less good for the rest of the UK. Even if it is best for both, it is clearly more essential for Scotland, which then clearly places Scotland in a much weaker negotiating position because it needs it more than the rest of the UK. Is that a fair assumption?

Dr Armstrong: Yes. There are two things that I would point out. First of all, the idea that it is beneficial for Scotland and the rest of the UK is from a means of payment approach-in other words, for doing transactions every day, you or I going north of the border or carrying out trade north or south of the border. There, I would say that because of the degree of interaction of both economies it is actually mutually beneficial.

However, you then have the issue of what it means for the financial systems. In the case that I have been giving, this is the one that creates the problems. If you now say it is a currency being used in another country and your financial system in that country is to be a reasonably advanced financial system, so it has to have access to a central bank, then the host country is starting to get itself exposed and, one day, that banking system might have a big problem. On one level, yes, it is mutually beneficial, but on the other level-the banking side-you can see how this introduces risk.

Q3350 Chair: That is right, and that was the next point I had. It is the whole question of the risk that the rest of the UK is being asked to bear without, as far as I can see, an equivalent advantage. The advantages are marginal but the risk is potentially enormous.

I do not know whether or not this is an adequate and appropriate read-across. When I borrowed huge amounts of money from a bank they wanted the house as security, because it was for the house I was taking the loan. Is there an equivalent that happens between nations? Do they say, "We will give you that guarantee, provided that we can seize half your oilfields if you fall into a crisis?" Presumably, in order for the UK to persuade its citizens to accept this arrangement, it is going to have to persuade them that the risk is minimised and that there is a gain. I am not clear how exactly they would go about arguing with their own citizens how they would minimise the risk. As a Glasgow MP, I can see it somewhat differently from a Portsmouth or Burnley MP.

Dr Armstrong: The first issue, just to revisit the trade aspect, is that I don’t think it would be right to say that the mutual advantages would just be marginal. They will be sizeable. However, the financial risks, as we now know from our experience of the last five years, are sizeable. Financial crises aren’t "never to happen again" things. They happen, and they happen surprisingly regularly if we look at economic history.

Is there a way to mitigate this? The best example I would use is that, during the crisis, the US Federal Reserve carried out dollar swaps with other central banks around the world. It is engaging with offering dollar liquidity in offshore financial centres. It did this to central banks where they are backed by their Governments in the knowledge that their Governments stood behind them. That is the key. They are doing it with full knowledge that there is fiscal backing here.

What would be required in this case is that you would be confident, on the day there is a terrible event, that the Scottish Government would be able to meet their obligations to the rest of the UK. You said what about collateralising it? Exactly; that is one way to do it, and you could conceivably say there is an arrangement where, should an event happen, the rest of the UK has a right to certain assets that may be transferred to an independent Scotland. That is one way. The main asset, of course, which is internationally tradeable, is North sea oil.

Q3351 Chair: What happens if the incident that occurs is a collapse in the oil price?

Dr Armstrong: This is where your collateral goes down. In your example of when you got your mortgage, unfortunately, the host country-in this case the rest of the UK-would have a loan. This is the occasion when it gets into trouble. The value of the collateral behind that loan is not what you thought it would be. The smart thing is to ask for a lot of over-collateralisation in the first place. You would have to be comfortable. You would perhaps have to have other restrictions if you were to pursue this approach. Of course, the other approach is to put limits on the fiscal flexibility and capacity of-in this case-an independent Scotland.

Q3352 Chair: On this question of putting limits on the fiscal capacity of an independent Scotland, that presumably would cover things like corporation tax. One of the difficulties I have is grasping why a UK Government, which were being asked to share a great deal of the risk of a sterling zone, would be willing to stand by and see a separate Scotland poach companies by offering a lower corporation tax. It would seem to me they would just turn round and say, "No. Part of the deal is you just simply don’t do that." Is that reasonable?

Dr Armstrong: First of all, this would be part of negotiation. However, we hear a lot of businessmen saying, "One thing you can do is to reduce corporation tax." One of the difficulties is that the resources should be allocated within an economic area based on where the most efficient place is to produce them, not on differences in tax rates. That is just artificial. That is biasing it one way compared with another. That is not to say that one country doesn’t want to compete against another country, but it would be quite unusual to say, "We are going to hand you a competitive advantage against us." There, you have a situation where, if you look at the welfare of both countries together, that can be net negative. It is not offsetting.

Q3353 Chair: Absolutely, but, if you are running a separate Scotland, the fact that taking an action to reduce corporation tax affects somebody else adversely is not your problem, unless they make it your problem.

Dr Armstrong: Exactly.

Q3354 Chair: If I do something that brings in £10 to me, even though it loses someone else £100, that is still a net gain to me. What I am not clear about is whether or not you are saying to us that, as part of the negotiations about forming a monetary union and assuming a degree of risk, the United Kingdom Government are likely to be in a position to veto-not just express dissent to-any corporation tax cut by a separate Scotland.

Dr Armstrong: My point is that in order to make a monetary union work you have to have both sides agree. You can’t do it without the rest of the United Kingdom agreeing to it. Whether they choose to exercise the area of negotiation that they will insist on, I can’t tell. It depends on the negotiation. It would seem unusual-no, let me stop there. I don’t know how they would seek to negotiate this. What I am prepared to say is that there are circumstances where having competition over corporation taxes can not only end up bad for the country that is not reducing them, but when you look at the two together it is more bad for this country than it is good for the other one and it becomes destructive.

Therefore, I would be surprised if that was not part of the negotiation. I can’t say the extent to which it would be negotiated over. What I can say is that you would require the permission of the rest of the UK in order to form a sterling monetary union. You cannot do it without having a central bank and, therefore, the UK taxpayers being part of this function. We are discussing fiscal restrictions. There is also the thorny issue that it is very hard, in the middle of a crisis, to make these restrictions binding. There are not many cross-border agreements that become binding.

Q3355 Chair: Am I wrong then in thinking that there is a case that can be made for a monetary union, if everything is going smoothly? Given everything you are saying to us, the balance of risk is that any sensible UK Government would say, "Look, we would rather not be involved in this; thank you very much. We will minimise the risk to our own taxpayers. We can’t see all that much of a positive side. The negative side is just enormous and we would much rather not be involved in it, unless of course you choose to bribe us by agreeing to a whole number of other things that we might want." One of those might very well be Trident, for example, which then comes in as a non-fiscal or economic policy but something that would clearly be of considerable significance to the UK.

Dr Armstrong: Leaving out the non-economic parts of the negotiation-Trident and so on, which is a significant issue-it would be beneficial to the rest of the UK if sterling was used for these transactions, as I have explained, and to have a stable and prosperous neighbour. The difficulties of having a monetary union, where you have pointed out that you would expose yourself to various risks, comes down to how confident or comfortable you feel with these cross-border restrictions in terms of fiscal capacity. That depends on the preferences of the Government of the rest of the UK, but I think it is acknowledged on both sides that there would be restrictions required.

Q3356 Chair: If there was no agreement and Scotland just simply decided to continue using sterling-this concept of sterlingisation-I don’t quite understand what the implications of that are, both for the United Kingdom and for Scotland. Presumably the United Kingdom could not stop Scotland using sterling.

Dr Armstrong: That is correct. If Scotland wants to use sterling, then it can do. It could use the dollar if it wanted to. It could use lots of different currencies if it wanted to. Sterling would be the obvious and most advantageous one to use. The difference between dollarisation and a monetary union is that, if you just use sterling without any formal agreement, you don’t have any access to the central bank. If you have a payments problem within your financial system and all of a sudden you need to get hold of some liquidity, then either you have to have savings to provide this liquidity yourself, presumably through the new Scottish central bank, or you have a problem. If you don’t have enough savings already, then you are limiting the size of the risks that you can insure in your domestic financial system. That is why countries that dollarise, whether it is Montenegro using the euro, Panama or other states or some African countries, don’t tend to have sophisticated financial systems.

Q3357 Chair: That is what I wanted to follow up on after one other question. I can see why in those circumstances, from the UK point of view, having sterlingisation is a better option in the sterling zone, because you have the advantage of trade but none of the risk. The system does not pick up nods and therefore you have to say something for it to be recorded, but you are nodding.

Dr Armstrong: I was nodding in following your point rather than in agreement.

Chair: As distinct from agreeing; okay. In those circumstances is it better for the UK to have sterlingisation rather than a sterling zone, because they get the trade flow freely and they don’t inherit the risk?

Dr Armstrong: The disadvantage of dollarisation is that it is much more difficult to have a developed financial system for that country.

Chair: That is a problem for Scotland.

Dr Armstrong: Again, you want to have a prosperous neighbour. This is quite an important industry for Scotland, obviously. With regard to the extent to which you are handicapping this industry, you don’t want your neighbour to be poorer; you want them to be richer, because that helps you.

Q3358 Chair: What would happen to the financial industry in Edinburgh and Glasgow in these circumstances? Would they not just move to Leeds or Manchester? Would they move to somewhere else in the UK? To what extent is their existence predicated upon being in the sterling zone, so that they would move somewhere else in the sterling zone as distinct from not being in London? They might move to Dublin.

Dr Armstrong: The size of financial institutions ultimately depends on the potential fiscal support of the state behind it. Obviously you don’t want to come out and say, "We will always back you," but countries that have large and successful financial systems-whether it is the States, Hong Kong, Singapore or other countries-tend to have very little debt and a lot of assets.

If an independent Scotland were to dollarise, using sterling, it would have to accumulate its reserves over time by running fiscal surpluses. It would have to run current account surpluses over time to accumulate some foreign exchange reserves. That would take a long period of time before you can ensure the whole financial system.

What would these banks do if Scotland were to dollarise? My view is that they would pretty soon move most of their operations south of the border.

Chair: So the entire future of the financial industry is dependent upon the UK agreeing to there being a sterling zone.

Dr Armstrong: Or Scotland introducing or reintroducing its own currency.

Q3359 Pamela Nash: How likely is it and how easy would it be for Scotland to create its own currency? What are the practicalities? What would they have to do in order to do that?

Dr Armstrong: How likely is it? The Scottish Government have said pretty clearly that their so-called plan A-although they have not said there is a plan B-is to form a monetary union. Something would have to go wrong with that negotiation in order for you to go to this alternative. That, of course, depends on negotiations.

Q3360 Pamela Nash: I have to say that is their current line, but in recent years at one point they have said they would want their own currency. They have also said that they want to join the euro. It is not unforeseeable that they might change it again.

Dr Armstrong: That is correct. There is a difference when you have a referendum and you have the opportunity. In the past, it was somewhat hypothetical because there was no agreement to have a referendum at that point, but I take your point.

Since their preferred option is a monetary union, something would have to break down in those negotiations in order for them to look for another solution, because upon independence you obviously have to use a currency. What would be required to introduce or reintroduce a Scottish pound? You would have to set up a number of institutions quite quickly. That would include a central bank, a treasury, a tax collection authority-some of these you would need anyway-and perhaps a fiscal commission. You would need to have a debt market to issue your own currency debts. You would presumably need equity markets so that companies can raise money in their own countries. There is a whole array of institutions that you would have to create.

The next thing is that you would have to introduce a redenomination Act where you redenominate, first of all, Government contracts into the new currency. The redenomination would also take place on loans within Scotland, particularly those under Scots law. It would be most mortgages, for example, and some company loans. The issue gets a little bit more difficult where the loan has been agreed outside Scottish borders. If it is not in Scots law, then some of these redenominations might get challenged.

After you have redenominated that side of the balance sheet, you have to look at the other side of the balance sheet. All of this is difficult and you have to do it in such a way that Scottish citizens don’t get concerned about the value of their savings and start moving their money south of the border. Technically, it is difficult. You don’t want to have a breakdown in monetary union discussions and then start saying, "What’s the alternative? Let’s think of this other plan." You really have to think this through and think about how you are going to introduce these measures well in advance. That is exactly when these sort of capital flight issues occur. This is an important issue. There is a lot of institutional work that would be required to be done.

Q3361 Pamela Nash: Are there any examples of other countries doing this that we should be looking at?

Dr Armstrong: Not many that exactly portray this example. The tricky bit is that you have a sophisticated financial system here to deal with. There are some. With the break-up of the Soviet Union, you reintroduced currencies with nations that broke away, but they did not have sophisticated financial systems so it was much easier to do it. It was much harder for them to do capital flight.

The one that I think is potentially interesting-again, it is not a perfect parallel-is when the sovereignty of Hong Kong was called into question. In advance of the British-Sino agreement to make Hong Kong a special administrative region, because it wasn’t quite a transfer, a currency board was put in place at least several years ahead. In fact it was in place ahead of the British-Sino agreement and well ahead of the actual transfer. That is an example of where people realised that there was this huge political uncertainty coming along because it wasn’t obvious what was going to happen. People acted pre-emptively to make arrangements well in advance. That is one example of how you can do it by acting pre-emptively and thinking all the way through these things. That is obviously an exceptionally different case. Unfortunately, all the others are ones where you don’t have a big financial system so it is quite hard to draw lessons. The break-up of the Soviet Union was very different.

Q3362 Pamela Nash: That is really interesting; thank you. You mentioned that other countries do not have the financial systems that we have, but what type of policies are followed by small countries that have their own currencies at the moment? What do they need to undertake in order to maintain their exchange rate?

Dr Armstrong: Here it depends on the economic situation of that country. Small countries tend to benefit from having a fixed exchange rate. The reason is because their trade, as they are quite small, tends to be a large share of their output. Having export and import prices moving around a lot is problematic. Smaller countries are more likely to have fixed exchange rates. The US does not, for example, and Japan does not. Lots of little places like Hong Kong, Singapore and south-east Asian countries tend to manage their exchange rates. Big countries tend to have them floating.

Again, one of the intriguing issues here is how much of the public sector national debt Scotland would be expected to accept. If we assume that it is population share, so roughly £130 billion-it is of course up for negotiation, but let us take that figure-then they have to issue bonds in this new currency in order to fund that. That is quite a lot of money from a standing start to issue bonds. You need to issue them with sufficiently long maturity that you don’t have rollover risk-the risk that you have to refinance these things every couple of years.

How are you going to do that? You are going to have to do that by encouraging and persuading investors to think that their investments won’t be eroded through currency depreciations over time. This is where the exchange rate comes in. You are going to have to persuade domestic investors that inflation won’t erode their real returns. Their real returns are going to be higher because you are going to have a very productive non-oil sector of the economy and you are going to have enough foreign exchange reserves that you can protect this thing if that is required. That only comes through running external surpluses, which is very much what Ireland did after it became a Free State in 1922. It pegged the Irish currency to the pound, and the main thrust of economic policy was defending that exchange rate. That meant that it had to run external surpluses, and, of course, it proved quite difficult for the Irish economy for a long period of time.

Q3363 Pamela Nash: Just to be clear, Scotland wouldn’t be able just to let its currency float; it would have to manage it.

Dr Armstrong: It would be very hard to sell this sort of volume of debt with a floating currency and with a small economy. That would be surprising, and they would run the real risk that at least in the interim people would think, "Which way could this currency go?" You are unlikely to make it more expensive. You raise the risk of capital flight again.

Q3364 Pamela Nash: We were talking earlier about the euro and the fact that Scotland would have to have its own currency for two years prior to going into the euro, if that was the case. Is it absolutely necessary? Can you foresee any situation where Scotland would be allowed to jump from the pound to the euro?

Dr Armstrong: As part of the UK, yes, it could, but as an independent country, within the euro and the European Union, this crisis has not been resolved. There are very fundamental questions being asked. I think it would be unwise to say it is impossible. Would the eurozone members be likely to welcome a country with no track record of managing an exchange rate? That is perhaps a bit more challenging.

Q3365 Chair: I want to follow up a couple of the points that you are making there. You seem to be saying that, if things were quite agreeable, the negotiations with the UK could go through quite quickly, but, if they were not agreeable and if you ended up with a situation where you had to establish your own currency, then the timetable would be quite long compared with what the SNP are suggesting at the moment. They are suggesting that, if they win the referendum in 2014, they would declare separation or independence before the elections in 2016.

I want to clarify whether or not the various actions that you said would be required to be taken to establish the structures and so on and so forth could physically be done in that time scale.

Dr Armstrong: First of all, you only have to give this commitment to join in the eurozone in order to join the European Union. You can make a commitment.

Q3366 Chair: I did not make myself clear. In terms of establishing your own currency, establishing the central bank and all the rest of it, is two years a reasonable time span for that to be undertaken? When I think about it, some of that will be taken up with negotiations that have not yet broken down. You would have to have the negotiations, they would then break down, and then you would try and go to the stage of establishing dollarisation going forward.

Dr Armstrong: The most likely approach here, if there was an agreement that an independent Scotland decided that it was going to reintroduce its own currency, would be that many of the institutions could be set up quite quickly. They sound a lot more difficult than they are. I won’t say the hardest one but one of the more difficult ones is going to be the capital markets because they require private investors to be part of this. It is not just an administrative thing like the central bank. That is a fairly administrative duty. I don’t want to make it sound very simple, but we have a long track record of setting up central banks around the world.

The way that I would envisage it happening would be that the rest of the UK would co-operate and say, "We will have to work on a timetable that is agreeable if this is what you want to do, and, therefore, over this period we will find some way perhaps of maintaining sterling within what would be an arrangement over a fixed period of time in order for you to be able to do this." That would be something that would be negotiated, if that was to be the outcome, because, again, it is in the rest of the UK’s interest to have a prosperous Scotland.

Q3367 Chair: I understand that, but we are moving into a situation where negotiations take place in a whole number of areas and on a whole number of levels. We have to assume that it is possible that they might break down, because, otherwise, Scotland ends up in a position, if they have to get success in the negotiations, where they have to agree to everything that somebody else puts on the table.

Dr Armstrong: Given that the Scottish Government have made it clear that their first priority or desired outcome is to have a sterling monetary union, if they are now saying, "We will reintroduce our own currency," I am presuming that talks have become problematic and agreement could not be found. We are in that world already.

Given that we are in that world, from the UK’s point of view, if that can’t be resolved-this is hypothetical and we are assuming that it can’t be resolved-the rest of the UK would presumably want to have a stable and prosperous Scottish economy, conditional on the fact that you couldn’t reach resolution, and would negotiate to reach the best outcome for both parties.

Q3368 Chair: What was the timetable for that? Is it feasible to think about having anything other than a sterling zone in less than two years?

Dr Armstrong: Can I defer that answer? With the number of institutions, I think I would have to think about that quite hard. It is a demanding agenda; let me put it that way.

Q3369 Chair: Let me just clarify why I am asking that. The Scottish Government have said that they want to have the referendum in 2014. They want to have independence declared shortly before the elections in May 2016, and they want to have negotiations with the EU and with the UK in that time scale. It just seems to me that that is an incredibly weak negotiating position because you have already committed yourself to a successful conclusion by that time scale. That would suggest that anybody with whom you are negotiating will be inclined not to give all that much. The only sanction or backstop that Scotland would have is the freedom to walk away in these circumstances. That is why I want to clarify how realistic a threat to walk away is; otherwise you just end up having to unilaterally accept whatever it is either the EU or the UK places on the table.

Perhaps you could reflect on that and tell us. If you can’t work it out this afternoon, then some time later on by all means write to us on it.

Q3370 Graeme Morrice: Dr Armstrong, you mentioned the example of Ireland earlier in response to a question from Pamela. What lessons can be drawn from the experience of, say, Ireland after independence-or Denmark today? Is a small country inevitably driven to pursue a conservative fiscal policy to maintain its currency?

Dr Armstrong: With a small country that inherits a reasonably high level of debt that it has to fund, investors need to have confidence that they will not lose value by investing in that debt. In those circumstances, having either inflation or currency depreciation would contradict that. Therefore, economic policy, because you have to get foreign investors, would have to make sure that there is low inflation and a currency that is not prone to weakness.

The short answer to the question is that domestic policy would have to be targeted towards a fairly restrictive economic situation.

Q3371 Graeme Morrice: Was that the experience of Ireland and the situation with Denmark today?

Dr Armstrong: The tricky bit with drawing any comparisons across countries is that they are never quite the same. Ireland did not have a sophisticated financial system. In this situation it is a huge part of this. There are always difficulties comparing across countries, but what I can say is that the Irish authorities have made it quite clear that almost their sole aim of policy was to maintain this exchange rate. They ran a fairly tight fiscal policy in order to make sure that they repeatedly had balance of payments surpluses, which meant there always was a way of accumulating more reserves and avoided a loss of confidence and currency depreciation.

The consequence of that in the situation of Ireland was that it wasn’t a prosperous time for many years, but again the analogies are not always the same. Here again, this is where analogies can be misleading. Graeme Morrice: But nevertheless periods of austerity.

Dr Armstrong: That was a case of it. It is hard to argue, from what Carl was saying, that, whether you are part of the UK, independent or part of the rest of the UK, you have got austerity coming. The question is really the extent. "Would it be more or less?" is more accurate.

Q3372 Graeme Morrice: What are the connections between outstanding debt, capacity to borrow and having your own currency? What does it mean to have a "hard" currency, and why would a country wish to do so?

Dr Armstrong: Economists typically define a hard currency as a currency where that country can borrow, using that currency, over the long term. It can issue long-term debt. That is one definition. Another definition is that foreigners are willing to hold it as a form of savings. Sterling is a hard currency. The euro is a hard currency. Hard currencies are won over time. It takes time for both domestic and foreign investors to say, "I am willing to tie my money up for 10 years in this new currency that has not existed before." It takes time to win the confidence of people to be able to do that.

What sort of policies do you need to do that? As I have mentioned, you need low inflation, strong external accounts and a productive economy to make sure that you have high real returns over the life of the investment.

Why would you want to do it? You would want to do it because you have to sell some bonds. If you don’t have to sell some bonds, then it is not such an issue, but the presumption here is that you have some public sector debt that you have to repay or take over in the separation from the rest of the UK.

Q3373 Graeme Morrice: An independent Scotland not in the sterling zone would have an issue in terms of confidence when it came to international trading and markets.

Dr Armstrong: Compared with using sterling, that would be the case, because international investors have no history of this new currency and so it would take time to build up the creditworthiness and credibility of the independent Scottish Government’s record. It may be that that happens quite quickly. Their statements have made clear that that is what indeed they seek to do by behaving in a way that would be consistent with that, but it will take time.

Q3374 Graeme Morrice: Certainly in the short to medium term it would be absolutely critical for an independent Scotland to be in the sterling zone.

Dr Armstrong: Not absolutely critical. You could go that route. As we have mentioned, there would be a lot of institutional things to do.

Graeme Morrice: It would certainly be advantageous.

Dr Armstrong: Yes, it would be advantageous to stay in the sterling zone, but again this is the issue of those potential costs.

Q3375 Graeme Morrice: It therefore flags up what we mean by "independence". If an independent Scotland was in the eurozone, then inevitably its monetary and fiscal policy would be determined by a central bank of a foreign country.

Dr Armstrong: Not quite-one of which you are a member. If you are in the eurozone, then the ECB is the central bank of the euro system, which is a collection of nations within the eurozone. Each country has its own central bank that is part of the ECB, so to speak, and has a vote on the Monetary Policy Committee. You are one of several.

Graeme Morrice: That is if you are in the eurozone, which we are not.

Dr Armstrong: If you are in the eurozone, absolutely, but one can see why that can be quite attractive. You become one of several. It does not mean to say that you determine your own outcome, but neither do you have no say. If there is an EU-wide deposit insurance and if there is an EU-wide banking union-but these are big ifs because we don’t know yet.

Q3376 Graeme Morrice: But you could not be in an independent country in the sterling zone where your monetary and fiscal policy is dependent on the whims of a central bank of a foreign country. That is not really independence, I would not have thought.

Dr Armstrong: Absolutely. In the sterling zone, you are quite right that the Bank of England would set UK interest rates, which, because you are part of the same monetary union, would become your interest rates. The fiscal policy would come down to the negotiation that we discussed earlier. It is not so much the fiscal policy, but the constraints and the capacity for you to conduct fiscal policy would come down to the negotiation to create this monetary union.

Q3377 Graeme Morrice: What would be in it for the rest of the UK for an independent Scotland to be in the sterling zone?

Dr Armstrong: UK businesses and citizens have the advantage of having exchange rate certainty, of not having to have conversion and of having, arguably, a more prosperous neighbour to the north. These are the advantages.

Q3378 Graeme Morrice: What are the disadvantages?

Dr Armstrong: The disadvantage is that to have a monetary union you have joint liability for the risks that are taken. The smaller state may run up some large risks that have to be paid by the taxpayer in the other country. The question is whether UK taxpayers are happy to bear that risk.

Q3379 Chair: We will just start to draw things to a close. It was recently floated that Scotland’s oil revenues could be hypothecated in some way to pay off its share of the UK national debt. Could you expand on that?

Dr Armstrong: As my colleague was saying, the tax revenues from North sea oil can only be used once. You can’t spend it and still have it.

Chair: This will come as a great disappointment to many in Scotland.

Dr Armstrong: No, I don’t think that is the case.

Chair: You have not been reading sufficiently widely, I can assure you.

Dr Armstrong: What would be the implications? This again relates to the issue of what proportion of existing UK public sector debt will become Scottish in the event that it becomes independent. That is a massive question. If it is a small amount-none of them are relatively small-and one was to agree an historical share, that is a lot smaller than if one was to agree a population basis. In the Ireland case back in 1922 it was on a population basis. There are precedents for the population basis.

If it is on a population basis and you have these oil revenues, one option, as you have pointed out, is to set up a sovereign wealth fund. The question is what return you would get from the sovereign wealth fund compared with what cost you are paying to borrow for your debt. If the cost you are paying to borrow for your debt is higher than the return you could get from your sovereign wealth fund, economically the most sensible thing to do is to pay off your debt first. If it is the other way round, then, fine, don’t pay off the debt and put it in the sovereign wealth fund.

However, given that this is a lot of debt, one can see the arguments. Taking the oil to repay the debt would also be a real commitment towards being a hard currency, to show that Scotland is absolutely committed to being a low-debt, frugal and financially sound economy. But then you don’t have the money to go into the fiscal accounts, so your fiscal deficit won’t improve because, again, the oil can’t go into lots of different things. The GERS data, which Carl was alluding to earlier on, show what the deficit would be without the oil revenue. In 2010-11 the number was £13.9 billion. If we say that GDP, including oil to work out the fiscal burden, is about £150 billion, then that equates to just over 9% of the GDP deficit, if you are going to either create a wealth fund or repay the debt, which again is where the fairly aggressive or significant fiscal tightening is required.

Q3380 Chair: I want to get some guidance from you. If you start paying down your debt with the oil money, you can do it at anywhere between 1% and 100%. What sort of percentage would be considered appropriate? I do not know whether or not there is a norm in international financial terms or given Scotland’s position. Then I want to come on and clarify what the fiscal implications are of that.

Dr Armstrong: The answer to that question is what level of debt to GDP is thought to be a so-called dangerous or difficult-to-finance level. That depends on lots of parts. The issue becomes what level of debt an independent Scotland would take over upon separation, on independence. That is the crucial issue. If it is a relatively small number, perhaps you don’t need to repay the debt straight away, but the higher the debt that you inherit the more this becomes-

Q3381 Chair: Am I right in thinking that, unless we know what the outcome of any debt negotiations are likely to be before the vote, we are then consequentially unlikely to know how much of the oil fund would have to be hypothecated or directed towards paying off the debt, and therefore unlikely to know how much was then available for balancing the fiscal accounts?

Dr Armstrong: It is not quite "have to be", because it will always come down to the Scottish Government’s policy choice. Suppose it was a population share; there is still nothing to say that you have to pay it back. You may consider that you are going to get much higher returns in a sovereign wealth fund and so that is the best thing to do. You may, but it is their choice; that is what independence is.

I would accept that we have very few parameters or red lines, nor a notion of where at least their starting negotiating position would be. It becomes very difficult to start thinking about what the parameters of fiscal policy would be without at least having some notion of that ahead of the referendum. I think it would be advantageous to voters, to the Scottish people, at least to have what those parameters might be.

Q3382 Chair: Mr Emmerson, we have not come back to you for a while, but in terms of the fiscal implications of this discussion I am presuming that, once people’s negotiating positions were known, then various consequentials can all be worked out with what the range of options are.

Carl Emmerson: That is right, yes. You need a starting point for debt, for the deficit, and you want to know what fiscal rules the new Government would adopt. Then you could say, "These are how you could achieve your fiscal rules; these are the kind of size of tax rises or spending cuts. This is what it would mean per person or off different public services." You could certainly crunch all of those scenarios.

Q3383 Chair: Presumably a lot of this depends upon what the current estimates are of how much oil is left in the North sea and how much is recoverable at various prices and so on. I do not know whether or not you have looked at that. Obviously I am aware that that is another area of economics. The figure of £130 billion was mentioned. Is that the sort of figure that sounds familiar to you and that you would use to work on?

Dr Armstrong: The figures that I have seen are larger than that. It does depend on the oil. We have basically tended to take other people’s estimates so far in almost all of our calculations. The official estimates, OBR estimates and so on are what we use. It is simply because we are not experts in this.

Q3384 Chair: As I indicated before we came in, we always ask our visitors whether or not there are any answers they had prepared to questions that we have not asked. Are there any points that you feel we have not touched on that would be helpful for us to be aware of in order to set what you have already said in context?

Carl Emmerson: No; I feel we have covered everything. I would just stress that we have a lot of work under way that we will be launching before the end of the year. We would very much welcome a chance to come back and tell you about the rest of our analysis at a later date.

Chair: That is very helpful.

Dr Armstrong: Clearly it is a negotiation, but at least knowing what people’s position is in advance might help you figure out where the negotiation would go. Information on public sector debt would be informative to the electorate, which is what this should be. What would be the process for transferring this debt would also be a useful thing to have in public.

Q3385 Chair: I must admit we had not been as aware of the issue of process as we are of the issue of scale. We will reflect on that and pick that up.

We have been having discussions with various people, as I mentioned before, about Trident. Clearly the attitude of the UK Government on how much debt they wish to transfer will not be seen in isolation from all sorts of other things as well. The extent to which people are being good neighbours will obviously affect the extent to which there is a degree of coming and going.

The final point I have is to clarify whether or not you would advise me and the other members of the Committee to be opening bank accounts in England in order that we could minimise risk for ourselves. Would that seem to be a sensible thing for people like ourselves to do?

Dr Armstrong: There is certainly no reason to do that now or in the future, assuming negotiations go smoothly.

Q3386 Chair: Yes, but that is a big if, though, isn’t it? If negotiations don’t go smoothly, then it might be too late to open a bank account.

Dr Armstrong: I am optimistic that some positive outcome will be found. I can’t think that the negotiations will go so badly wrong. It would be a complete surprise that, overnight, things would go askew.

Chair: You would say we should just live with the risk then.

Dr Armstrong: I think you have to look after your own personal finances.

Chair: On that very happy note, I thank you very much for coming along. We apologise for keeping you perhaps a little longer than we anticipated, but this has been very helpful to us.

Prepared 25th June 2013