Scottish Economy Watch

Inequality and constitutional change

In an earlier post I noted the evidence on the rising degree of income inequality in the UK. The key chart from the OECD's recent report Divided We Stand: Why Inequality Keeps Rising is below

The high and rising level of income inequality in the UK was, I suggested, put into sharper focus by recent political developments. Specifically, the UK government's austerity programme with associated rising unemployment and real income constraint, and the concern about banker's bonuses and CEO pay.

It was therefore a surprise to learn from an excellent article by Alf Young in Saturday's Scotsman of this recent comment by Michael Gove, Secretary of State for Education in the UK Government:

We live in a profoundly unequal society. More than almost any developed nation ours is a country in which your parentage dictates your progress. Those who are born poor are more likely to stay poor and those who inherit privilege are more likely to pass on privilege in England than in any comparable country. For those of us who believe in social justice this stratification and segregation are morally indefensible.

As Alf Young points out this

was an astonishing critique, given that it was coming from a member of a party that proposed, in opposition, to ease dramatically the burden of inheritance tax and has, in government, agonised over how quickly it could remove Labour's 50p levy on the incomes of the highest earners.

Gove's particular interest was to seek to highlight the role that private education was playing as a gateway to privilege and power across all major professions in the UK. Hence, as Alf suggests, buttressing the case for Gove's reforms of state education in England.

Alf's main point in his piece was to ask where is the debate on the role of private and state education in Scotland. Gove's writ does not run to Scotland. The Scottish Government is responsible for education here. Moreover, an independent Scotland would certainly have responsibility for a policy choice on income inequality and that would also likely be true for Devo-Max and probably Devo-Plus.

So why no debate here?

Alf Young notes that the issue of private education might be considered less salient here since pupils attending independent schools in Scotland account for only 4.31 per cent of all pupils compared to some 7 per cent in England. But he shows that the significance of private and private secondary, education is much higher in the city of Edinburgh and areas such as Perth and Kinross.

Moreover, the significance of private education should, in my view, be viewed as a symptom of the degree of income inequality.

How does Scotland compare on that score? Data from the Scottish government offer the following comparison with the Great Britain

Measures and comparisons of income inequality are fraught with difficulty - see here - so one needs to be cautious. But what these data show is that while the degree of income inequality is lower than in GB it is still quite a bit higher than the OECD average. Since 1995 the Scottish Gini coefficient has ranged between 30 and 35 while the OECD average has ranged between 30 and 31. And the OECD average is quite a bit higher than many countries that Scotland would seek to compare itself such as the Nordic countries and Germany.

Moreover, the above chart shows that income inequality was rising more rapidly in Scotland than GB since 2004-05, so that by 2009-10 there was little difference between the two: Scotland 35, GB 36.

So why no debate about this in Scotland? Why isn't this issue, given its roots in political struggle since time immemorial, a key feature of the so-called "big-debate" on Scottish independence and constitutional change?

My guess is that the parties advocating independence, especially the SNP, and those supporting the union, especially Labour, are frightened of the topic. Reversing income inequality does not give wins for everyone. There has to be losers and a few rich, and perhaps not so rich, ones at that! Therefore, better not antagonise the donors, or the business fellow travellers. We hear from some Labour party figures that when they get up in the morning they think social justice, in contrast to nationalists who think separatism and break-up of the UK. But this is surely a charade since the Labour government did little to roll back rising income inequality in Scotland and the UK. The introduction of the 50p tax on high income earners being the exception. How do they propose to operationalise their concerns about social justice if Scotland continues in the UK?

The Scottish people should be told what are the specific options and policies being proposed by nationalists and unionists to deal with rising income inequality. And we need to be told now, not reassured that everything will be fine in the nirvana of Scottish independence, or a UK union with more constitutional change.

Devolution and Fiscal Policy

As I noted in my previous post, devolution can offer fiscal policy options that are just as credible as the policy mix that would be available under independence. And these options could be available without some of the costs of independence.

Let us be clear what I am talking about here when I refer to 'fiscal policy'. By fiscal policy I mean the use of variations in tax rates, tax bases, tax instruments, spending mix and spending levels to achieve economic policy objectives. These objectives can be stabilisation, growth and distribution. I focus on stabilisation here leaving growth and distribution for later posts.

The target of stabilisation is usually a level of GDP, and employment where there is no economically usable spare capacity in the economy. That is, where the output and unemployment gaps are small, or close to zero, and unemployment is almost wholly 'structural'. More technically the economy would be at the Non Accelerating Inflationary Rate of Unemployment (NAIRU), currently estimated in the UK to be around 5% of the workforce. Scotland's NAIRU should be similar.

It is broadly accepted by economists that in 'normal' times - i.e. when interest rates are not at a lower or zero bound - that a sovereign state with its own currency would tend to use monetary policy to meet its stabilisation objectives. However, when nominal interest rates are close to zero then monetary policy is much restricted and the burden of stabilisation as Simon Wren Lewis notes falls onto fiscal policy. Now for sovereign states and regions that are part of a monetary union the position is much the same. Monetary policy is not available at the level of the state or region. Fiscal policy becomes the only tool to realise stabilisation objectives.

Is there evidence that fiscal policy can influence the level of GDP at the individual state and regional level within a monetary union? The answer to this appears to be, yes. See this post and chart from Paul Krugman

The chart shows the relationship between changes in real government consumption and changes in real GDP as share of initial real GDP in eurozone states. Krugman acknowledges that for some states observed here the causation might run from GDP to government spending as a consequence of the credit crunch, but two conclusions would appear to follow.

First, the austerity view that cutting government spending raises GDP does not appear to be supported - note this graph does not show full fiscal changes because tax changes and transfer payments changes are not accommodated. Secondly, within a union and where states have a high degree of fiscal autonomy, the possibility of using fiscal policy to influence GDP change seems real.

What does this say about Scotland?

Well, first, it suggests that an independent Scotland as an accepted part of the UK sterling monetary union should be able to adopt a different fiscal policy stance to stabilise GDP than rUK. However, it also suggests that providing the degree of fiscal devolution is sufficient to allow changes in tax and spend that can influence aggregate demand then this option is also available within the UK political union. Further academic research is required on the appropriate form and degree of fiscal devolution for effective stabilisation but there is little doubt that stabilisation at the level of nations and regions within the UK is feasible.

Moreover, if an independent Scotland is part of the sterling monetary union the Bank of England and rUK government will almost certainly require that the Scottish government abide by a set of fiscal rules - see this earlier post. The fiscal framework could be little different under devolution from that under independence. Under devolution, Scotland could have a separate stabilisation policy as well as the benefits from the risk pooling arrangements e.g. social security, bank bailouts etc. that are available as part of the UK. It is true that the high levels of trade with the UK would make it difficult for fiscal policy to chart a radically different stabilisation path from rUK but that would apply to an independent Scotland too.

And the moral of this story?

Scotland does not have to accept a Tory-Lib Dem austerity policy. But it doesn't have to leave the UK political union to do so.

Regional pay: the first step to fiscal federalism?

It is alleged that Chancellor George Osborne and the Treasury plan to scrap national pay rates for some public sector workers in the UK. The reason? Well, public sector unions argue that the government is simply trying to save money and help it to reduce taxes on the rich. But the rationale given by the Treasury for the proposal is the variation in private sector salaries for comparable jobs across the regions of the UK. With public sector workers paid the same for similar jobs across the country the regional gap between public and private salaries varies considerably. So the FT notes that

The Treasury estimates that the so-called "pay premium" between public sector jobs and their private sector equivalents ranges from 0.5 per cent in the south-east to 18 per cent in Wales. ... Mr Osborne sees the move as a way of ensuring public sector pay reflects local market conditions and of avoiding private sector employment being crowded out in poorer areas of the country.

There is folly, insight and potential unintended consequences in Osborne's proposal.

The folly lies in the implication that lack of job creation in some regions of the UK is due to civil service wages being too high relative to private sector wages. At the present time the UK is labouring under a significant deficiency of aggregate demand with the unemployment rate at 8.4%. This is affecting all UK regions and nations. Some regions such as the North East are more affected by the drop in aggregate demand hence their high unemployment rates. Because of this the rate of growth, and possibly the level, of private sector wages paid is low relative to the public sector. With such a deficiency of demand and high levels of unemployment and spare capacity it doesn't make sense to argue that public sector activity is crowding out the private sector. Indeed, cutting public sector wages or restricting their growth relative to the private sector will limit the growth of demand further and so contribute to the problem of relative demand deficiency in such regions.

The insight in the proposal for regional pay lies in the possibility that in more normal times, when the regional economies of the UK are closer to full employment – more technically, closer to the non-accelerating inflationary rate of unemployment (NAIRU) or the 'natural' rate of unemployment – a lowering in public sector wages relative to the private sector could help boost the competitiveness of the local private sector. And this particularly in regions/nations where the public sector is relatively large. In such circumstances, the price effect on private sector competitiveness is likely to be more significant than the effect on regional aggregate demand of the incomes of public sector workers being a little lower.

But even if there was a positive effect on private sector competitiveness would lowering or slowing the rate of growth of public pay in so-called 'poorer' regions be warranted?

In simple theory, a market economy will pay workers according to the value of their marginal product. It is difficult to argue that the productivity of a nurse, or any other public sector worker, at the margin is lower in the North East than London. However, if prices and incomes are lower in the North East then the value in monetary terms placed on the work of the nurse might be lower. This might justify a lower wage than in London. But who is to determine the monetary value placed on the provision of a public good in a region such as the North east? Should it really be left to the UK Chancellor of the Exchequer?

An alternative view that chimes better with the ethos of regional variation and the rejection of national pay is that it should be the people in the North East themselves, who should decide. But to do that they would require a government that raises and spends taxes in the region according to regional preferences. In other words, it seems to me that the logic of regional variations in public sector pay is fiscal federalism with regional governments having responsibility for a range of taxes and the provision of public services including setting the pay rates of public workers.

Scotland has already gone a considerable way down this route and is likely to go further. While John Swinney, the Scottish Cabinet Secretary for Finance and Sustainable Growth has said that

the Scottish government will go absolutely nowhere near this proposal for the areas of pay policy that are under our control.

It does seem likely that the Scottish government will eventually pay its public sector workers according to how it values their services and according to what it can afford. It will not let London decide. The English regions might eventually follow Scotland's lead.