Scotland's fiscal position

Yesterday (18 April) the Scottish Government published along with its latest quarterly GDP figure a long-run series for Scottish and UK GDP in current terms going back to financial year 1980/81. The novelty of the series is that the GDP estimates for Scotland include a population and geographic share, respectively of North Sea oil production (technically a share of extra-regio activities). These data can be combined with the data on Scotland's and the UK's net fiscal balance going back to 1980-81, which were published on 7 March of this year. It is worth noting that the data are classified as 'experimental' as part of the Scottish National Accounts Project (SNAP) and so do not carry the Office of National Statistics (ONS) 'kitemark'.

With these new data it is now possible to compute an estimate of Scotland's fiscal balance since 1980-81 and compare with the UK. I have done this for the case where Scotland is allocated a population share of oil production and revenues and for the case where Scotland is allocated a geographic share of oil production and revenues. The estimates of the geographic share are based on the methodology and modelling of Kemp and Stephen (2008). For a sample of their earlier work on North Sea oil see their 2001 and 2005 papers.

The charts for the two cases are below

There is something in these figures for both proponents of Scottish independence and those who advocate staying in the UK union.

The table below tries to draw some conclusions on the fiscal balance by first taking averages for the whole period up to the start of the Great Recession in 2007-08. The period after 2007-08 is excluded because I assume that it is untypical. It is clear that with a geographic share the Scottish position is far superior to the UK. Both are above or better than the 3% deficit which is the limit set out in the EU Stability Pact. This is the figure that would probably be demanded of Scotland as the limit of its deficit within a sterling union. But Scotland's favourable position is seen to depend on oil revenues. When Scotland is allocated a population share of these revenues the fiscal deficit deteriorates to -5.3%, clearly above 3%.

The second set of estimates is based on the period 1990 to 2007. This excludes the initial rush of oil production as the North Sea boomed and oil revenues were exceptionally high in real terms. On this basis, even with a geographic share, the Scottish fiscal deficit is averaging slightly above 3% and above 6% if only a population share of revenues is allocated. The UK remains under 3% in both cases.

Fiscal balance as % GDP		Sco average 1980 to 2007		UK average 1980 to 2007	Sco average 1990 to 2007	UK average 1990 to 2007
Geographic share oil revenues		1.5		-2.4	-3.6	-2.6
Population share oil revenues		-5.3		-2.4	-6.5	-2.6

Of course, production of oil and gas in the North Sea is set to decline. There is a question mark about the rate of decline because it depends on oil prices and the extent of new discoveries. The best estimate is provided by Kemp and Stephen 2011 and is based on a real oil price of $70 per barrel and a gas price of 40p per therm - the oil price will be higher than $70 in nominal terms because of inflation. This scenario has for them the greater probability than a $90 and 60p combination.

The time profile of hydrocarbon production is shown below

Of course, we don't know what this implies for oil revenues because it also depends on the tax rate, as well as the price of oil and gas, and levels of production.

The main conclusion would appear to be that an independent Scottish government cannot rely indefinitely on oil revenues to ensure that it remains below the 3% deficit benchmark over a sustained period. But it can probably do so for a reasonable period. In the longer term, other sources of tax revenue will need to be found and/or public spending shares reduced.

Comments

[Angus McLellan]

Interesting stuff.

I notice that the difference between Scotland's geographical share fiscal balance 1990-2007 and the UK one is slightly less than difference between average UK (and by GERS' methods, Scottish) and Danish defence spending over the same period, which was 2.85% vs 1.63% using SIPRI data. (I use SIPRI rather than NATO data as this allows broader comparisons. For example Irish defence spending averaged 0.83% of GDP and New Zealand 1.3% over the same period.)

[Ian Jenkins]

Within what global fiscal framework will Scotland be operating?

Answer: Whatever the US decides that is acceptable to China.

A guide to the US position comes from the stances of democrat Barack Obama and republican Mitt Romney.

Both plan to reduce the deficit and debt by cutting public spending. The Economist reports: "Mr Romney has also promised to keep national defence spending at 4% of GDP, 50% more than the level it is heading for, even without the automatic cuts scheduled for January. That means he must shrink entitlements and other discretionary spending even more."

Maybe this republican surge in defence spending is because Romney says he will designate China a currency manipulator on his first day in office. The Economist points out this would jeopardise the most important bilateral relationship in the world. Who knows where this will lead.

Consequences for the rest of the world? This might give NATO a second wind.

[Alan Weir]

Interesting statistics indeed. One thought which naturally occurs, when looking at the huge differences between the Scottish (with geographic share) and UK balances in the 80s, and the enormous surpluses, relative to the size of the Scottish economy, in the early 80s, is where would Scotland's economy have been, in 1990, if those surpluses had been invested with a modicum of good sense in the Scottish economy, in infrastructure for example (or a mix of that and investment in a Scottish oil fund). (Whether invested by an independent Scotland, or a fiscally autonomous Scotland or even directly by the UK government.) I've no idea how robust a guestimate one could get for that, but surely the likelihood is it would be in a better place and the 1990-2007 percentage would have been higher.