Scotland, the pound and the euro

Tobermory, Mull, Scotland

After independence, either of these options effectively involves Scotland using a foreign currency as the domestic currency.

Europhiles will tell you that the Euro is the domestic currency of all its members. This is theoretically true and for all practical purposes absurd. In practice, the Euro is a DMark-lite and the German economy is hugely more influential in determining its Forex value, monetary policy and ultimately fiscal policy than any other member.

A country that uses a foreign currency as its domestic currency forfeits the right to determine its own monetary policy. It is not possible to set a monetary policy for several countries at once unless those countries form an Optimum Currency Area (OCA). This means (inter alia) that there must be no significant obstacles to labour and capital mobility between the members, there should be wage flexibility between the members, and the members have more or less synchronised business cycles. Where these conditions do not obtain, there will be a need for a mechanism of fiscal transfers between the members to mitigate the damage that an inappropriate exchange rate and monetary policy will do to the weaker economies.

At present, the Eurozone lacks a number of features that enable an OCA to function effectively. Hence every few years we have a Eurozone crisis from which one or more weaker economies emerge worse off.

Scotland could be considered to be more of an OCA with the rest of the UK than with the EU. Language is always an important barrier to labour mobility; another is the portability of pension rights. Currently, Scotland has both of these links with the UK, with which it also does almost four times as much trade as it does with the EU. The UK business cycle is regularly out of step with the EU business cycle because, unlike almost all other EU member states, the UK does more trade outside the EU than within it.

As a member of the UK, Scotland has been marginally disadvantaged by using the same currency as the rest of the UK but has received compensating fiscal transfers. This has avoided excessive unemployment or depression of wages compared to the richer south.

(To forestall political objections to the foregoing sentence, let me point out the simple fact that it is less cost-efficient to buy and sell in low population densities, which is much more typical of Scotland than England).

Luxembourg

Once it is a non-member of the UK, such fiscal flows to Scotland would presumably cease, unless a transitional agreement with the UK were to be negotiated. Moreover, there would be no obligation upon the UK to consider the impact of its monetary policy upon Scotland. Continuing to use the pound after independence in these circumstances (without the above mitigations) would probably lead to additional downward pressure on Scottish wages and employment, but not so great as the impact of joining the Euro. (Consider the impact of the latter upon Greece, Italy, and Spain for example.)

I have suggested elsewhere that the UK single market could survive Scottish independence. This would be to Scotland’s considerable advantage. However, the UK single market could not survive Scottish membership of the EU single market, which requires ring-fencing. In the latter circumstance, Scotland, like any new EU member (not to be confused with existing members who have exemptions) would be required to join the Euro. So not only would there be a hard border with England, but there would also be a change of currency at the border. This is a really bad idea unless you want Scotland to be poor.