Should an independent Scotland use the pound? To see if this is a good idea for Scotland let’s take the recent real life example of Greece:
- Greek Government spending went out of control and they borrowed so much money they could not afford to pay the interest on the debt.
- Unions and left-of-centre politicians had pushed up salaries and labour costs to a point where its industries and businesses were becoming too expensive and were losing sales to cheaper more efficient competitors in international markets.
- Unemployment was rising due to the failure of these businesses, which further pushed up Government costs with the increased welfare and unemployment benefits.
How does the Government get out of this seemingly intractable downward spiral? Before Greece joined the Euro, it had its own currency – the Greek Drachma. What it would have done is devalued its currency. This is how it works: Suppose on international money markets 100 Greek Drachmas is worth 1 Euro. So a product which Greece was producing for 200 Drachmas costs 2 Euro in Germany. During the crisis the Drachma is revalued to 200 Greek Drachmas to 1 Euro. Now when Greece exports its products to Germany its prices are much lower. A product which costs 200 Drachmas to make is now selling for only 1 Euro, whereas before it was 2 Euros. This increases exports of Greek products to Germany which supports Greek businesses and creates employment. The Greek government gets more tax from successful domestic businesses and has lower costs because there is less unemployment and associated welfare costs. Of course this also makes Greek imports more expensive. Now if Greece wants to buy products and raw materials from Germany it has to pay twice as much. To import a product from Germany which cost 1 Euro is now costing Greek businesses 200 Drachmas instead of 100 Drachmas. This has the effect of causing Greek consumers and businesses to buy their products and raw materials from within Greece, which further boosts their economy. It reduces imports and boosts domestic trade. Furthermore Greek workers are still on the same salaries, which have the same buying power within Greece. They will not notice a difference to their living standards unless they go on holiday in Germany where they will find prices very high. This will encourage them to holiday at home further boosting the Greek Economy. Also Germans will find being on holiday in Greece very cheap, so they will come in larger numbers, further boosting the Greek tourist trade. So the ability to devalue a currency helps to smooth the problems of an economic crisis in poorly managed economies. Now let’s consider the options for the Greeks if they share the same currency as Germany. The Government cannot afford the interest payments on its loans and cannot borrow more so it must reduce Government spending and pay off some of the loans. It must pay its workers less salary and reduce government spending. Greek industries are uncompetitive so they must reduce their costs too. They must also pay lower salaries and find further cost saving in its production. This is not easy and lower salaries in Greece means lower spending by consumers causing the economy to slow further. Germany has no incentive to buy Greek products or visit Greece on holiday, because it is just as expensive for them. Unemployment stays high which increases the costs of the Greek Government in unemployment benefit. This means less money for investing in Greek infrastructure and industry in order to make them more efficient. The situation is made worse for Greece if the German economy starts booming. The value of the Euro will rise causing Greek exports to be even more expensive on international markets, which will cause their economy to slow even more. This is because exchange rates are set at a level appropriate for the German Economy, not the Greek economy. Actually, the Eurozone crisis has helped German exports because it has made the Euro exchange rate lower than it would have been which makes German exports cheaper. But the exchange rate is still too high to help Greek businesses. Both economies have to be aligned otherwise the exchange rate will work in one country’s favour (Germany) and to the detriment of another country (Greece). To ensure that countries like Greece do not mismanage their economies to cause a crisis in the first place it is important that their taxation and spending policies are aligned with countries like Germany. This is what happens in the USA, which has a single currency and each state has broadly similar tax and spending policies (at least compared to Europe). The exchange rate tends to be more appropriate for all states. Also unemployed workers in a poor States like Michigan can easily move to a richer state like California. This is good for Michigan because it reduces its unemployment levels and the associated welfare costs and provides much needed labour in California. However Greeks will find it harder to move to Germany because of language and cultural barriers. So what actually happened in Greece has been an economic disaster because they cannot devalue their currency. They have had to cut costs, which means cutting salaries and axing jobs, which has increased unemployment benefits. To prevent an economic meltdown the other Eurozone countries have had to give billions of Euros to Greece to prevent mass starvation and rioting. Unless Greece was given this money it would have not been able to pay its massive debts which would have caused a major banking crisis. Global banks would go bankrupt; savers, investors and businesses would lose all their money and the cost to the German economy would be much more than the cost of the bailout. So they had no choice but to bail Greece out. However, the Germans still resent having to give up their hard earned cash to make up for the economic mismanagement of another country. To remedy this problem the Eurozone is now trying to align the tax and spend policies of its member states, which means individual countries are losing their independence. i.e. their ability to set their own tax and spending levels. For this reason the UK would be very unwise to let an independent Scotland use its currency unless their economies were aligned in their tax and spend policies. The UK would not want to have to bail out Scotland in order to save its own economy. This effectively would mean that Scotland would need to have its budgets approved by the UK parliament, making a mockery of their notion of independence. Likewise, Scotland would be unwise to use the pound because it wouldn’t be able to devalue in the event of a crisis. Of course Scotland would have similar problems if it joined the Euro. This is the very reason it doesn’t want to join the Euro! Having its own new currency would also carry large risks as they would not have a large economy to protect it from wild fluctuations in the currency markets and it may have much higher borrowing costs. For a single currency to work there has to be similar tax and spend polices across the whole currency zone and there must be similar language and culture to allow workers to easily move to where the jobs are. Answer these 5 Questions before voting on Scottish Independence