The Political Economy of Financing Scottish Government

The Political Economy of Financing Scottish Government

Considering a New Constitutional Settlement for Scotland

Studies in Fiscal Federalism and State–local Finance series

C. Paul Hallwood and Ronald MacDonald

Can the UK survive widespread dissatisfaction in both Scotland and England with the financing of public spending by Scotland’s parliament? This timely book explains how fiscal autonomy could raise economic growth and efficiency in Scotland – to the benefit of both Scotland and the rest of the United Kingdom. The authors discuss how other reform proposals – which amount to cutting Scotland’s block grant – would fail as they would not be seen in Scotland as legitimate. They conclude that fiscal autonomy would be accepted as it reduces Scotland’s democratic deficit in public spending, and would go a long way toward reducing vertical and horizontal imbalances in the UK.

Chapter 10: A Separate Currency for Scotland?

C. Paul Hallwood and Ronald MacDonald

Subjects: economics and finance, public finance, regional economics

Extract

A possible reason for the decentralization of fiscal policy in the UK, particularly the macroeconomic stabilization function, is a consequence of the monetary union that exists within the UK. The so-called optimum currency area literature suggests a number of criteria that should be satisfied if a country or region relinquishes control over its monetary policy. If these criteria are not satisfied, or are only partly satisfied, then decentralized fiscal policy can act as a substitute. Of course, if the criteria are not satisfied this begs the question of whether Scotland should in fact be part of the UK monetary union. In this section we consider the implications of the optimum currency area literature for tax devolution, issues of macroeconomic risk sharing within a monetary union and the economic implications of Scotland leaving the UK monetary union. MONETARY UNION, TRADE CREATION AND EXCHANGE RATE BEHAVIOUR The logic of having a common currency between two regions is that by simultaneously reducing transaction costs, currency risk and the opacity of relative prices, it encourages trade. Glick and Rose (2002) estimate the effect of currency union membership on trade integration using a large data set of countries that have left currency unions. They find that trade integration with the remaining members falls by about one-half from the boosted level associated with monetary union in the year or so immediately following exit. Accordingly, if Scotland were to leave the UK monetary union, it might experience a large and rapid fall in its trade with its...

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