Raphael De Santos looks at the implications of high inflation, rising interest rates and a contracting economy for Scotland after independence.
Nine months ago, I wrote in Scottish Left Review (September/October 2021) prior to the full impact of Covid-19 being known, outlining the challenges facing a Scottish economy under independence. Since then, we have seen that Covid-19 has brought inflationary pressures into the world economy. On one side, supply chains were broken and, on the other side, there was a pent-up demand as well as a further stimulus from government rescue packages. This saw the price of commodities and goods rise with the price of oil going from $60 a barrel a year ago to around $90 a barrel at the start of 2022. This inflation started to eat into people’s spending power with the UK economy seeing zero growth in February 2022. Then in late February 2022, the invasion of Ukraine happened and the oil price has now risen to around $120 a barrel. The world is heavily dependent on Russian oil, gas, coal and fertilizers as well as wheat from Ukraine. This has had a major impact on inflation which is now approaching 10% in Britain, Europe and the USA.
Central banks have reacted in the classical way to dealing with inflation by raising interest rates. Some have carried it out more gradually like the Bank of England, a 0.25% rise over many months. Others like the US central bank have been playing catch up with a blunt hammer, raising interest rates by 1.25% over two months. They both have the same outlook in fighting inflation; they will do what it takes to quell inflation even if it means pushing economies into recession as people and companies face higher costs from their mortgages, credit cards and loans. The period we are entering has been compared to the stagflation of the 1970s and early 1980s. Stagflation was a bit of a misnomer as over a ten-year period there were two recessions lasting a combined total of nearly five years and a 6% contraction in the world economy with inflation at over 11% on average in that period. Inflation was only finally killed off when the US central bank raised interest rates to 20% in the early 1980s!
Inflation in the 1970s was like inflation now, caused by a war. In 1970s, it was a 1973 war between Israel and the Arab countries which lasted 19 days. The Arab oil producers put an embargo on selling oil to those countries supporting Israel in this war which was primarily the USA. The oil price tripled in price from around $20 a barrel to $60 a barrel and stayed at that level till the end of the 1970s. There was another upward price move in 1979/1982 with the Iranian revolution and the Iran/Iraq war.
This time, we have a war in the Ukraine which has lasted over four months and there is no end in sight. Partial sanctions have been applied to Russia but the aim is to completely replace Russia as an oil and gas supplier by the end of 2022. Taking Venezuela out of the equation, Russia is the seventh largest oil producer in the world just below the United Arab Emirates. Taking them out of the supply side while the demand side remains unchanged would mean oil and gas prices will remain elevated for some time. This means inflation will be at these high levels for years and central banks will keep raising interest rates further. A recession globally is certain – the UK economy has already contracted in March and April and the USA economy shrank in the first three months of 2022.
In 1973, unsold goods built up in warehouse as people’s spending power was reduced by rising inflation. Companies cut production and services laying off workers. Unemployment in the major economies averaged 9% during the 17 months of the 1973-75 global recession. We are already starting to see the same pattern being repeated now. Global trade in 2021 was at staggering $28.3tn, up 13% on the pre-pandemic 2019. These goods are building up in warehouses worldwide as consumer demand wanes.
What does this mean for the prospects and nature of Scottish independence? A planned referendum in 2023 will be held in the middle of this black economic winter with actual independence, if achieved, taking place in this ‘New Normal’ economy as well. This amplifies the problems around dealing with the deficit, the currency and how we engage with Europe.
In my Scottish Left Review (September/October 2021) article, I discounted the contribution of oil to an independent Scottish economy. The price of oil was not much above its cost of production which for North Sea oil is around $44 dollars a barrel. I advocated running production down and moving to renewable energy, owned and controlled by the Scottish people. The ‘New Normal’ has changed all that. We can expect oil to trade at over $100 a barrel for several years. Scotland literally has been landed a golden egg. We have enough oil to last seven years and produce over a million barrels a day. At a conservative price of $100 a barrel this would mean oil profits of £18.5bn a year. Even at the 30% current tax rate that would mean revenues to an independent Scottish government of £5.6bn. This would put a dent in our pre-Covid-19 deficit of £15bn pounds. It would still leave us with an annual deficit of 6% which is well outside what is required for EU membership as well making it difficult to borrow on the international markets. In this economic climate, growing the economy would not be plausible. The other options are cuts in public finances and tax rises which are favoured by the SNP. But in this economic downturn tax revenues would be falling making the deficit larger.
There is a bolder approach: A super tax on oil revenues while we run the oil reserves down. A tax of 75% would produce revenues of £14bn a year for seven years. This would allow us to shrink the deficit while allocating money to build a national renewable energy company; invest in a green public transport system; and build sustainable affordable housing. All these projects would create jobs to more than replace those lost in the oil industry as well as providing much needed services and infrastructure.
These projects need engineering experts in all the relevant fields employed to oversee them. In addition, the projects must be fully costed by economists and accountants. Regular audits and report backs on these projects on how they are making progress in construction and financial targets must be made available and the whole process must be transparent to the Parliament and public. We cannot allow a repeat of the recent ferry and rail fiascos.
The oil super tax would also take away the need to raise taxes or cut public finances. It would help shield the Scottish people from the worst economic effects of the ‘New Normal’. This would give us some space in the decisions around what our currency should be and how we engage with the European Union. It would give us instant stability around our economy rather than have a longer transition period were we gradually reduce our deficit and prove our financial competence.
Initially, as I have shown previously, because we carry out so much trade with the rest of Britain and our loans and mortgages are all in pounds, it would be sensible to initially retain the pound as our currency. This would be especially so with our larger dependence on oil using the super tax. A Scottish currency introduced immediately would become a so-called petrocurrency. It would be highly volatile and rise and fall with price of oil making any planning of the economy difficult.
It would allow us, post-independence as a country, to debate how we interact with the European Union (EU). Should we go for full EU membership or take the route Norway has pursued and become members of the European Free Trade Association (EFTA) and European Economic Area (EEA) or take the current approach of the UK government of being fully independent with no manifest ties to Europe. There is no need to attach our colour to one mast as part of the campaign for independence. I set out the various arguments of how we engage with Europe in Scottish Left Review (November/December 2021).
Decisions about the currency and our interaction with Europe can be taken after independence with a full debate and a referendum on the issues. This is how you can obtain buy in from the whole population, instead of handing down decisions from above prior to a future independence referendum. If the Yes campaign puts forward a clear strategy of how independence will proceed, it can win over a majority of voters including from the poorer sections of society who have previously not fully participated in the referendums. In summary, this would comprise: i) A super tax on oil profits to improve our finances and fund; ii) Renewable energy, transport and housing projects; iii) No tax rises or cuts in public spending; iv) Use the pound initially; and v) After independence a full debate and vote on our currency and EU membership.
A failure to have such a bold and clear approach in the midst of this coming economic storm plays right into the hands of the ‘No’ campaign. They will exploit all the contradictions and any fuzziness of the ‘Yes’ campaign’s approach. They would argue Scotland needs to shelter under the wing of the UK to survive this storm. Our chance for independence could be gone for decades. This ‘New Normal’ provides a once in a life time opportunity to build a fair and sustainable country. Let’s not pass it up.
Raphael De Santos has been active in left politics since the late 1970s. He was a supporter of devolution and now independence. He has worked in the financial sector for over 30 years, leading teams in research and strategy advising governments and central banks. References for all the statistics are available on request.