Currency and exchange rates

By Professor Gavin McCrone FRSGS. This article first appeared in the spring 2014 edition of the RSGS's magazine, The Geographer.


There are reasons for thinking that a small independent country may sometimes do better economically than if it were a region of a larger country. This applies particularly if it has a very different economic structure or is at a different stage of development. The ability to tailor economic policies closely to its needs can give it a better chance of success than relying on the one-size-fits-all policies of a larger state. This applies particularly to the exchange rate. A country has to pay its way with its trading partners, and movements in the exchange rate are one of the principle ways in which it ensures it is competitive.

A region does not have to do this: its surplus or deficit will be evened out by the larger country of which it is a part. A competitive exchange rate can ensure that there is investment in the economy and low unemployment, but a region has to work with whatever the exchange rate happens to be for the larger economy, whether or not that suits it.

Scotland’s economy, without North Sea oil, is similar to and closely integrated with that of the UK as a whole. Independence would affect that integration and would involve costs. Moreover, because of the substantial but declining income from the North Sea, Scotland could be subject to very different pressures from the rest of the UK. Both its balance of payments and the government’s budget would be subject to volatility.

The Scottish Government’s declared policy is to retain monetary union with the rest of the UK after independence. This is a central issue in the independence debate, but the intervention by the Chancellor in a speech in Edinburgh in February, and the rejection of a currency union by spokesmen for the other two main UK parties, make it most unlikely that a formal union, whereby the Bank of England would act as central bank and lender of last resort for both countries, would be negotiable. There could be advantages in an independent Scotland having its own currency, even if it were pegged to the pound to give it greater stability, because it would mean that the exchange rate could be altered in a major crisis.

But it would also mean that Scotland’s currency would be exposed to many of the pressures of a petro-currency. Moreover, those doing business across the border with the rest of the UK would face transactions costs and at least some degree of exchange risk. This would also apply to those who had mortgages or pensions in sterling. A mortgage with a UK lender would be in sterling, while the asset against which it was provided was in pounds Scots. To avoid the exchange risk, borrowers would need to remortgage with a Scottish lender or a branch of a UK lender able to lend in Scots currency.

This is just one of a number of major uncertainties as Scotland goes into the referendum. Another is whether or how quickly Scotland could become a member of the European Union in its own right, thereby safeguarding its position in the EU single market. Would it have to take its place in a queue of candidate countries seeking membership, with much uncertainty over its position in the meantime? Or would it be possible to retain membership by the quicker and easier process of treaty amendment? Whatever the outcome, it would have to have the agreement of the 28 existing member states, any one of which could exercise a veto.

Scottish Ministers have rightly pointed to Scotland’s wealth of resources, not only in offshore oil and gas but also in renewable energy. But, with the exception of hydro electricity, renewable energy has had to be subsidised by consumers across the whole UK. Onshore wind power is becoming more economic and, if present trends continue, may be competitive later in this decade. But this does not apply to offshore wind or to wave and tidal power, which are still at a very early stage of development. Would consumers in the rest of the UK be prepared to continue subsidising renewable power in Scotland after it became an independent state? This would probably depend on whether they could get the electricity they require from other cheaper sources.

These are just some of the uncertainties as the date of the referendum approaches. It is only realistic to accept that much is likely still to remain unknown as people go to cast their votes.