Wings Over Scotland

It was reported in the Scotsman on Wednesday that the President of the Czech Republic Vaclav Klaus had raised doubts over whether an independent Scotland could successfully keep using Sterling, because when Czechoslovakia split into the Czech and Slovak Republics in 1993 it took only 38 days for the currency union to split.

His views led to a rush of comments from supporters of the UK union arguing that a currency union is only possible with political union. Then a spokesman from the Treasury asserted that protectionism grew between the Czech Republic and the Slovak Republic after the split.

The evidence cited by the Treasury spokesman was the fall in Slovak exports to the Czech Republic from 42% of all exports to 13% between 1993 and 2003. Conversely, Czech Republic exports to the Slovak Republic fell from 22% of total exports to 8%. He noted ominously that currently 59% of Scottish exports are to the rest of the UK.

While the basic facts cited are correct, the interpretations put on them by Vaclav Klaus and the UK Treasury spokesman are, shall we say, at odds with the truth.

Scotland in 2012 or 2014 is not the Slovakia of 1992 or 1993.

First, Czechoslovakia was a planned economy, part of the Soviet bloc that practised autarky and state direction of production and resources. At the time of the split, the eastern bloc had dissolved and the two new states were seeking to become market economies increasing their trade and other economic links with the wider world.

Slovakia was much the weaker state, heavily dependent on resource transfers from Czech, with GDP per head at 76% of the Czech figure (having risen with the help of a state policy promoting convergence), while labour productivity stood at around 89% of the Czech figure, as this table shows:

Note also from the table that wages were much closer, at 97% of the Czech average monthly wage. Hence, Slovaks were consuming much more than they were producing. This leads on to the second key fact about the relationship between the two nations.

Prior to the split, the extent of resource transfer from Czech land to the Slovak lands was about 11% of Slovak GDP and about 4% of Czech GDP – see this very informative research paper by R?žena Vintrová in 2009 from which the above table is taken. The transfer of resources was outstripping the Czech rate of growth and this is one reason why many Czechs wanted rid of Slovakia.

Now, while there is a sizable transfer of resources to Scotland from rest of UK, this is only the case if you do not allocate to Scotland a geographical share of oil revenues. And the average size of Scotland’s fiscal deficit since 1990, even if a population share rather than geographical share of oil revenues is assigned, is 6.5%. With a geographical share there is still a deficit of 3.6% since 1990, but this is much less than 11% – see my blog post here.

So, the reason why the Slovak Republic chose a 10% one-off devaluation thereby breaking the currency link to the Czech Republic was because as an independent country it was consuming beyond its means, running a large current account trading deficit and a large effective fiscal deficit. Given its low productivity the devaluation was necessary to reduce domestic real wages and get unit labour costs down to more competitive levels.

Further depreciation against the Czech koruna occurred in later years. Slovak wages started to fall relative to wages in the Czech Republic. From almost parity in 1993 at 3% below to 30% below in 2007. This policy was largely successful as the Slovak economy began to diversify away from heavy industry and armament production to new forms of competitive advantage such as motor vehicle production. A diversification based on trade, low wages and imported foreign technologies.

The result of these adjustments was a rapidly growing economy, more diversified and trading with many countries, especially Germany, compared to the pre-split centrally planned days. Hence trade with the Czech Republic fell for growth and market reasons mainly and had little do with a rise in protectionism. This was further facilitated by entry to the EU in 2004.

So, Scotland is not Slovakia. With a geographical share of oil revenues Scotland is close to paying its way, labour productivity levels are almost identical to the UK – see here – although total factor productivity growth could be somewhat lower. Moreover, Scotland is a well developed market economy trading with many nations not a centrally planned, autarkic state.

For these reasons it makes sense for Scotland, if independent, to stick with sterling. A rise in protectionism between an independent Scotland and a rest of the UK state is possible in subtle ways that might circumvent the EU single market. But my judgement is that it would not be great. It would be insufficient to undermine the rest of UK as Scotland’s major trading partner and its integrated UK labour market and hence the justification for retaining sterling.

But as the oil revenues begin to run out an independent Scotland will need to raise its performance in manufacturing and tradable services. If productivity growth is insufficient to achieve this then that might be the time for the link with sterling to be broken. While if Scotland remains within the UK, the burden of such adjustment will be borne by the whole of the UK.

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Brian Ashcroft is Emeritus Professor of Economics at the University of Strathclyde, and writes the Scottish Economy Watch blog. He is married to former Scottish Labour leader Wendy Alexander.