SCOTLAND’S ECONOMIC FUTURE EDITED BY PROFESSOR SIR DONALD MACKAY 2011 First published October 2011 © Reform Scotland 2011 7-9 North St David Street, Edinburgh, EH2 1AW All rights reserved SCOTLAND’S ECONOMIC FUTURE EDITED BY PROFESSOR SIR DONALD MACKAY Published by Reform Scotland Reform Scotland is an independent, non-party think tank that aims to set out a better way to deliver increased economic prosperity and more effective public services based on the traditional Scottish principles of limited government, diversity and personal responsibility. The views expressed in this publication are those of the contributors and not those of Reform Scotland, its managing Trustees, Advisory Board or staff. October 2011 Reform Scotland is a charity registered in Scotland (No SCO39624) and is also a company limited by guarantee (No SC336414) with its Registered Office at 7-9 North St David Street, Edinburgh, EH2 1AW. Cover design and typesetting by Cake Graphic & Digital Printed in Scotland by Allander CONTENTS BIOGRAPHIES V PREFACE by PROFESSOR SIR DONALD MACKay IX CHAPTER 1 by PROFESSOR SIR DONALD MACKay 1 The framework, the authors and Home Rule. CHAPTER 2 by PROFESSOR JOHN Kay 11 Is recent economic history a help? CHAPTER 3 by PROFESSOR DAVID SIMPSON 23 An environment for economic growth: is small still beautiful? CHAPTER 4 by JIM & MARGARET CUTHBERT 35 GERS: where now? CHAPTER 5 by PROFESSOR DREW Scott 45 The Scotland Bill: way forward or cul de sac? CHAPTER 6 by PROFESSOR DAVID BELL 65 The Scottish economy: seeking an advantage? CHAPTER 7 by PROFESSOR ANDREW HUGHES Hallett 83 Optimal monetary arrangements for Scotland: adopt which money and why? CHAPTER 8 by PROFESSOR JOHN Kay 97 What future for Scottish banking? CHAPTER 9 by KEITH SKEOCH 107 The Scottish financial services sector after the global financial crisis: Celtic eagle, sparrow, lion or hare? CHAPTER 10 by PROFESSOR ALEX KEMP 119 The great North Sea oil saga: all done or still unfinished? CHAPTER 11 by BEN THOMSON 135 Is there a need for a Scottish Exchequer? CHAPTER 12 by PROFESSOR SIR DONALD MACKay 149 What does Home Rule mean for economic policy? i LIST OF TABLES AND FIGURES CHAPTER 3 TABLE 1 24 Western European comparisons of GDP CHAPTER 4 FIGURE 1 37 Royalty and tax revenues from Scottish sector of continental shelf, as a percentage of Scotland’s non-oil GVA. TABLE 2 39 Scotland and UK: balance on current budget as percentage of GDP. TABLE 3 39 Scotland and UK: net fiscal balance as percentage of GDP. CHAPTER 6 FIGURE 2 66 Gross Value Added by industry sector, 1989, 1998, and 2008 FIGURE 3 69 Employment in Scottish manufacturing 1950-2008 TABLE 4 71 Change in Scottish manufacturing employment 1995-2008 TABLE 5 72 Employment in Scotland in 1995 and 2008 by sector TABLE 6 75 Changes in employment 2002-2010 FIGURE 4 76 Change in manufacturing employment 2000-2010 TABLE 7 80 Births and deaths of firms: Scotland as a share of UK ii TABLE 8 81 Number of enterprises, human population and enterprises per 1000 population: 2008 CHAPTER 7 TABLE 9 93 Correlation coefficients between business cycle growth rates in Scotland, UK, Eurozone and the G7: 1990-2009. CHAPTER 9 TABLE 10 108 Scottish industries highly dependent on the Scottish financial services industry. Average 1998-2003 TABLE 11 109 Annual increases of output after a £1m shock in the financial services industry occurs. Average of 1998–2003 period. FIGURE 5 110 Scotland and UK annual GDP growth rates and gap, 2001 Q4 to 2010 Q3 FIGURE 6 110 Scotland and small EU countries annual GDP growth rates and gap, 2001Q4 to 2010Q3 FIGURE 7 111 Scottish banks as a percentage of UK banks TABLE 12 113 Economic performance during and after the global financial crisis FIGURE 8 114 Scotland relative to top 3 and regional top 3 financial centres CHAPTER 10 FIGURE 9 129 Hypothetical Scottish royalty and tax revenues from the UKCS (£m. at 2009/10 prices) iii FIGURE 10 133 Potential hydrocarbon production $70/bbl and 40p/therm hurdle: real NPV @ 10% / devex @ 10% > 0.3 FIGURE 11 133 Potential hydrocarbon production $90/bbl and 60p/therm hurdle: real NPV @ 10% / devex @ 10% > 0.5 iv BIOGRAPHIES PROFESSOR SIR DONALD MACKay FRSE, FRSGS Professor Sir Donald MacKay FRSE, FRSGS has held professorial posts at three universities before being a co-founder of an economic and planning consultancy, Pieda, in 1976. His public appointments included membership of the South of Scotland Electricity Board and the Sea Fish Industry Board, chairmanship of Scottish Enterprise and being an Economic Consultant to successive Secretaries of State for almost 30 years. He has acted as an economic adviser to the Scotch Whisky Association and the Society of British Aerospace Companies and has been a board director or Chair of a variety of private sector businesses engaged in financial services, Scotch Whisky, oil and gas exploration, transportation and retailing. For a number of years he was a contributor to The Scotsman. PROFESSOR JOHN Kay John Kay is a visiting Professor of Economics at the London School of Economics, a Fellow of St John’s College, Oxford. He is a Fellow of the British Academy, a Fellow of the Royal Society of Edinburgh and a member of the Scottish Government’s Council of Economic Advisers. He is a director of several public companies and contributes a weekly column to the Financial Times. He is the author of many books, including The Truth about Markets (2003) and The Long and the Short of It: finance and investment for normally intelligent people who are not in the industry (2009) and his latest book, Obliquity, was published by Profile Books in March 2010. PROFESSOR DAVID SIMPSON David Simpson graduated in Economics from Edinburgh University. He received his Ph.D. from Harvard, where he was research assistant to Wassily Leontief. After a spell in the Statistical Office of the United Nations in v New York, he was a Research Fellow at The Economic Research Institute in Dublin. In 1975 he founded the Fraser of Allander Institute at Strathclyde University and was Professor of Economics there until 1988. He then joined Standard Life as their Economic Adviser, an appointment he held until his retirement in 2001. He is currently Deputy Chairman of the Water Industry Commission for Scotland. David Simpson is the author of several books, and has published numerous articles in periodicals ranging from Econometrica and Scientific American to The Financial Times and The Spectator. PROFESSOR DREW Scott Drew Scott is Professor of European Union Studies and Co-Director of the Europa Institute at the University of Edinburgh. He is an economist by training and prior to joining Edinburgh University in 1993 was Lecturer in the Department of Economics at Heriot-Watt University. He has published on a range of economic aspects of the Scottish economy and recently co-authored a major paper on the economics of fiscal autonomy. He has been adviser to the European Commission, the Statistical Office of the European Union, and has worked with a number of national and sub-central governments addressing issues pertaining to fiscal decentralization. PROFESSOR DAVID BELL David Bell has a First Class Honours degree in Economics and Statistics from the University of Aberdeen, an MSc in Econometrics and Mathematical Economics from the London School of Economics and received his Ph.D from the University of Strathclyde. He has served as a Professor of Economics at the University of Stirling since 1990, having previously held positions at the University of St Andrews, University of Strathclyde, University of Warwick and Glasgow University. David Bell has also acted as an adviser and consultant to a range of organisations including the Finance Committee of the Scottish Parliament, The Cabinet Office, World Bank, Royal Bank of Scotland and Scottish Enterprise. David Bell has written a large number of articles for a range of journals and newspapers and is a regular contributor to The Scotsman. JIM & MARGARET CUTHBERT After lecturing in statistics at Glasgow University, Jim Cuthbert joined the United Kingdom civil service in 1974 and worked in statistics in the Scottish Office and the Treasury. He was latterly Scottish Office Chief Statistician. vi After leaving the civil service in 1997, he has pursued a number of interests, including research and consultancy. His research is particularly in the areas of Scotland’s public finances and the Scottish economy and in certain aspects of purchasing power parities. Particular interests have been in the analysis of government expenditure and revenues in Scotland (GERS), the performance of PFI schemes and developing alternatives to current models for utility charging. Margaret Cuthbert has lectured in economics at several Scottish universities, but spent most of her career as an economics and business consultant. Her major area of research has been public expenditure in Scotland. She edited and contributed to “Public Expenditure in Scotland”, one of the few economics texts on Scotland written in the period after the first devolution referendum. Specific interests include GERS, and the improvement of the GERS data and analysis: critiques of the private finance initiative: the analysis of devolved and reserved spending: and research into the basis of the costings of the policy of free care for the elderly. PROFESSOR ANDREW HUGHES Hallett Andrew Hughes Hallett holds joint appointments as Professor of Economics at George Mason University’s School of Public Policy in the US and at the University of St Andrews. His interests lie in macroeconomics and policy. He is ranked in the top 1% of economists world-wide, has held appointments at Princeton, Rome, Berlin and Paris Universities, is consulted by the European Central Bank, IMF, World Bank, and sits on the Scottish Government’s Council of Economic Advisors.