It’s a pleasure to be here.
It’s only two months since I last spoke to the SCDI. But it’s fair to say that even in that short time, much has changed for the Scottish, the UK and the global economy.
Today I want to talk about the implications of the Eurozone crisis for the debate about Scotland’s economy in the future, and in particular the currency question.
But first some brief points on the current situation.
Last week, we delivered an Autumn Statement which set out the tough decisions the Coalition Government is taking to protect the UK economy now, and build prosperity for the future.
And of course, it came with a sombre outlook from the Office for Budget Responsibility (OBR).
Growth won’t be as strong as it had forecast. A sharp rise in global commodity prices, and the ongoing uncertainty in the Eurozone continue to act as a drag on our own economy.
More than that, the OBR presented new evidence demonstrating that the boom that preceded the crisis was in fact greater and more unsustainable than first realised.
It means the bust was even deeper than we thought, and the impact on our economy even greater and longer lasting than we hoped.
We remain on course to meet our deficit reduction and debt targets. But it’s a difficult path because of the underlying damage done to our economy and the strong global headwinds we face.
But one thing is clear. We here in Scotland are in a much stronger position to weather those headwinds because of the tough decisions the UK Coalition Government has taken to repair our country’s financial position.
Let’s not forget that when we came into Government, we inherited the country’s largest ever peacetime deficit, borrowing one pound for every four we spent, and S&P had the UK’s triple AAA rating on negative outlook.
Eighteen months later and we are the only major Western country which has seen its credit rating outlook improve.
That means record low bond yields, which feed through into low and stable market interest rates, which help businesses and families right across Scotland.
Even a one percent rise in our lending rates would add £10 billion to mortgage bills every year…
It would increase the cost of business loans by £7 billion…
So, in the face of ongoing Eurozone turmoil it is even more important that we remain resolute, and we will. It is the only way to protect our economy from the economic storm.
That stability is the vital pre-condition for recovery.
It’s the essential platform for sustainable growth, driven by private sector investment, enterprise and export.
And we are doing all we can to promote that recovery across Scotland and the rest of the UK…
Creating the most competitive tax system in the G20, including by cutting corporate tax rates to 23% by 2014.
Making the UK the best place to start and grow a business by cutting red tape, extending broadband, and ensuring access to finance through credit easing measures of up to £21 billion.
And investing £250 billion in our infrastructure and long term competitiveness…including an extra £5 billion of public investment in this Parliament and up to £20 billion of pension fund investment.
Stability. Competitiveness. Investment.
These are commitments that benefit businesses all over Scotland.
Businesses and investors need confidence if they are to take decisions with a long term horizon.
Earlier this week, Mario Draghi, the new President of the European Central Bank said,
Confidence works backwards: if there is an anchor in the long term, it is easier to maintain trust in the short term.
We have provided that long term anchor through the collective strength of the UK economy, supported by our collective willingness to see through the necessary but difficult decisions to put us on the right track.
And we are much stronger in that task pulling together, rather than pulling apart.
For Scotland, being part of the United Kingdom is another long term anchor
However, here in Scotland, we have the uncertainty caused by the Scottish Government campaign to dismantle what is the longest standing and most successful Economic and Monetary alliances in the world.
A campaign that is creating uncertainty for businesses at the very worst time for our economy.
Last month, Citigroup recommended, and I quote,
utilities and other investors should exercise extreme caution in committing further capital to Scotland.
CBI Scotland have already warned of the possible damage that could be done to Scotland by the uncertainties arising from the commitment to, and timing of, a referendum.
And only last week, the Chairman of Scottish Financial Enterprise warned that the consequences of uncertainty over a referendum would be ‘profound.’
And he is right to be concerned.
There are profound questions that are unanswered in this debate. Today, when governments across Europe are contemplating further major integration of their economies, it is a good day to consider one of the most important.
The currency question for Scotland is often skated over, as if there is a simple answer.
But it is far from simple, as the eurozone crisis makes clear.
Today, I want to try to shed some light on this issue.
The Scottish Government say that they would continue to operate within the Sterling currency area, but there’s still the question…
Is it an independent Scotland within the sterling monetary union?
Is it an independent Scotland using sterling without any formal arrangements…something akin to a sterlingization mechanism?
Or is it something else altogether?
And even then there is the long term question for the Scottish Government…is it sterling for good? Or sterling now, Euro later?
My remarks today are the reflections of a proud and patriotic Scot, who is intimately engaged with the British economy and the implications of the Eurozone crisis.
I have never argued that Scotland cannot become independent. But I very firmly believe that it is not the best option for those Scots who, like me, have economic security and future prosperity as our first aspiration for Scotland.
I will seek to demonstrate that the monetary and fiscal issues are first order questions that advocates of independence need to answer, as well as I believe being first order arguments for maintaining the UK.
I want to take this chance to go into detail about the strengths of Scotland within the UK Fiscal and Monetary Union.
And set out the real issues that the Scottish people have to consider if the Scottish Government ever gets round to calling a referendum on independence.
These are difficult and technical questions.
But they are serious questions, and deserve a serious debate.
We only need to look at events in the Eurozone to understand that.
As you’ll know, discussions are ongoing amongst Europe’s leaders to reach a solution to the crisis.
We’ve consistently said that a resolution to the Eurozone crisis means that the Eurozone has to follow the remorseless logic that leads to closer fiscal integration.
And it’s exactly the same message we’ve heard from France and Germany in the last week.
Their proposals aim to bring a much greater degree of fiscal integration and central enforcement across all Eurozone members than was ever the case before.
The message from the Eurozone is simple: It is extremely challenging to combine monetary union with full fiscal independence.
As in the Eurozone, monetary union between fully fiscal independent countries can appear successful in a period of stability, but can lead to brutal readjustments in times of economic stress and uncertainty.
Over the last 12 years, the Euro single currency served to mask significant differences in the economic fundamentals of the countries within it.
The markets consistently underpriced the risk of debt among periphery countries, perhaps in the belief that there was an implicit guarantee from the bigger and stronger Eurozone countries.
It’s no surprise then that periphery countries chose to borrow more and more, seemingly free from any constraint.
And the result…public debt rising to unsustainable levels in some member countries.
The consequences are plain to see…a brutal re-adjustment. Interest rates rising in countries considered as more risky.
Risks of contagion to interest rates in other member states.
Risks for the stability of the financial system across the union.
Risks born from monetary union without fiscal union.
Of course, theoretically there are ways around those risks.
Explicit “no bail out” clauses.
Mutual rules to promote fiscal discipline, and sanctions where they are breached.
But design is one thing, execution another.
Fiscal rules are complex to design and difficult to enforce among independent countries.
And it can be hard to convince markets that the “no bail out” clause will hold in a crisis, especially when it can have serious consequences for the stability of financial institutions across the Union.
As the architect of the Euro, Jacques Delors, has said this week the currency suffered from the start from “a fault in execution.”
Even if in the future, Scotland chose adopting the Euro… either by joining the Euro or dollarizing with it…the risks are similar to those I’ve already just discussed.
We can learn directly from the experiences of those countries that are already in the Euro, where the risks aren’t hypothetical but an everyday reality with huge ramifications for us all.
But we have to also ask what might be the consequences for Scotland of forfeiting the benefits of monetary and fiscal union by choosing independence and continuing to use sterling.
That is, continuing to use sterling either within the monetary union, or through a ‘sterlingization’ mechanism…using sterling but not formally a part of the monetary union.
In either case it is assumed that Scotland would have fully independent fiscal policy, just like Member States within the Eurozone, only instead of the ECB it would be tied to the monetary decisions taken by the Bank of England.
Firstly, and stating the obvious, independent from the rest of the UK, Scotland would have access to massively less fiscal firepower.
Scotland would be completely reliant on its own fiscal means to withstand an asymmetric shock to its economy.
At the same time, reduced access to the UK’s fiscal firepower would have implications for Scotland’s celebrated role as a home to some of the UK’s largest financial institutions. As we know, the resources needed to recapitalise both RBS and HBOS in 2008 and 2009 dwarfed the entire Scottish budget.
If an independent Scotland had to undertake such huge recapitalisations itself, there is a high risk that the very solvency of the country, let alone its banks, would come under market attack.
It’s not a hypothetical consideration…just look at what happened to Iceland and Ireland. They were two key parts of the ‘arc of prosperity’ after all, though mysteriously airbrushed from the latest propaganda.
A smaller economy and a smaller fiscal base, mean that Scotland has access to much less fiscal firepower than if it decides to remain in the UK.
More than that, it would also be more constrained in its capacity to use deficit funded fiscal policy, since high levels of Government borrowing would increase the risk of default. Exactly as we have seen in some of the smaller and weaker economies in Europe.
As such, a Scottish fiscal base, as opposed to a UK wide base, may be too small to provide an effective buffer against large adverse shocks.
And that raises serious questions for the UK to consider. What would be the knock on effect for our economy, our interest rates, our financial stability?
As we see in the Eurozone, a common currency and a common monetary policy without fiscal integration runs the risk of shocks easily exacerbating, escalating and extending to other economies.
In contrast, the United Kingdom fiscal union provides both Scotland and the rest of the UK with mutual insurance against adverse shocks affecting one member of the alliance.
By being part of a larger fiscal base, by pooling fiscal resources, and by sharing fiscal risks, revenues can be transferred from one area to another, or one country to another, to help cope with the impact of a country specific shock.
And just as Scotland would be unable to share the risks with the rest of the UK, Scotland wouldn’t be able to share the wins too. Sharing is a good value that Scots celebrate - we are always prepared to take the rough with the smooth with our neighbours.
Fiscal and monetary union, provides us all with deeper and more liquid markets which facilitate access to capital markets for governments, and indeed businesses, which helps to reduce borrowing costs, and makes it cheaper to finance production and investment.
Those are huge and vital fiscal benefits that come from being a full part of the United Kingdom.
The value of that fiscal integration is precisely the lesson that EU countries are starting to learn right now.
The United Kingdom monetary and fiscal union underpins the stability that is vital to a prosperous Scottish future.
The Scottish Government has to think carefully before sacrificing that stability through independence.
And not only stability. There are many other benefits that come from being part of one of longest lasting fiscal and monetary unions in the world.
Benefits that are vital to creating a competitive and attractive environment for private sector growth.
Firstly, a single currency over an appropriate area lowers transaction costs in trade.
It improves price comparability but more importantly, eliminates the exchange rate risk and the need to hedge against it.
Secondly, it helps to impose discipline over inflation by limiting the ability to use exchange rate devaluation to compensate for high domestic inflation.
And thirdly, it provides the exchange rate stability that many smaller, open countries yearn for.
If we look across Europe, a number of countries have either a formal or informal link to the Euro.
Denmark and Latvia are members of the Exchange Rate Mechanism, pegged to the euro; Bulgaria maintains a peg.
Even Switzerland is actively managing its bilateral exchange rate against the euro.
Of course the price is the loss of independent monetary policy. But it’s already the case that the Scottish economy is taken into account in to the Bank of England’s monetary policy decision.
And if Scotland chose to use sterling whilst being not part of the monetary union, the sterlingization route, then its influence on Bank of England monetary policy would be zero.
In many ways monetary policy set by the Bank of England is already suited to Scotland given that the United Kingdom and the pound exhibit many of the characteristics of a so-called ‘optimum currency area’.
For one, Scotland and the rest of the UK are very similar in their industrial structure, business cycle and price volatility.
For as long as that high degree of integration continues, it’s likely therefore that monetary policy chosen to accommodate the UK as a whole would also be well adapted to suit Scotland.
For instance, in the third quarter of 2011, the employment rate was 70.2% for the UK on average, and 71.2% in Scotland…a figure closer to the UK average than that of any other region or devolved country.
Furthermore, Scotland and the rest of the UK are highly integrated in terms of labour and product markets, and capital flows.
Each year 50,000 people migrate from the rest of UK to Scotland, and as nearly as many people move in the opposite direction.
About two thirds of Scottish exports go to the rest of the UK compared to around one third to the rest of the world.
And firms registered in Scotland but owned by the rest of the UK employed 20 per cent of all Scottish workers, and contributed to around 25 per cent of total turnover in 2010.
These are strong ties that have been forged over centuries through a common language, geographical proximity, and historical links.
Bonds reinforced through centuries of common and shared fiscal and monetary policy.
And in contrast, unlike Scotland with the rest of the United Kingdom, Scotland and the Euro area have some important differences in their industrial structure, business cycles and price volatility.
Scottish monetary policy as set by the European Central Bank may not always be well adapted to Scotland’s needs as policy set by the Bank of England.
So let me summarise, if Scotland wants to wants to keep the pound, and if Scotland wants to secure, in full, the benefits of keeping the pound, it can only do so by remaining part of the United Kingdom monetary and fiscal union.
To do anything else would put those benefits at risk.
Scotland within the monetary union but fiscally independent, creates similar risks to those we see in the Eurozone.
If that crisis tells us anything, it is that strong control of fiscal policy and borrowing would have to be exercised centrally
Scotland using the pound through a sterlingization mechanism, but fiscally independent creates similar risks.
However in that scenario, it would have no say over its own monetary policy as set by the Bank of England. And in a Scottish crisis, the Bank of England would not be obliged to step in for Scotland.
These are the questions that need answers…
Using sterling outside the monetary union, who would act as the Scottish Lender of Last Resort?
Outside the monetary union, would Scotland have the fiscal power to support its financial system?
With independent fiscal control, would Scotland have the power to respond to shocks to its economy without racking up unsustainable debt?
Or as a part of the Euro, will Scotland accept greater European fiscal integration and control on its fiscal power?
But nor are these matters that can simply be determined by the Scottish government.
In the event of Scotland seeking independence, the monetary and fiscal arrangements will have a direct effect on the rest of the UK, and so of course would have to be agreed.
It is those risks and those complex considerations that mean the question of currency has to be at the centre of any debate and any referendum on independence.
It’s a question that goes to the very heart of Scotland’s monetary, fiscal and indeed political future.
Part of Sterling, and fiscally locked to UK?
Part of the Euro, and fiscally locked to the EU?
Or standing alone, independent of both, and open to the turmoil that undermines all our economies?
If Scotland does choose the separatist route, the currency question is a major issue.
There are no easy options - all are fraught with economic dangers.
All are less optimal for Scotland than the current arrangements.
I firmly believe that it is in Scotland’s interests to stay a part of one of the most successful, complete and stable fiscal and monetary unions in the world.
We cannot afford to recklessly discard the bonds that tie our two economies so closely together.
But it’s right that we adapt in the modern age to ensure that we have a system that delivers for all its citizens, both north and south of the border.
It was right that the UK devolved powers in 1997. And it’s right that we take further major steps towards Home Rule through the current Scotland Bill - steps that bring major new powers to Scotland without jeopardising the success and stability of the United Kingdom.
That’s why the Scotland Bill grants greater flexibility and control of taxation policy, and for the first time, gives Scottish Ministers powers to borrow, within strict limits, for capital infrastructure projects.
And following representations by the Scottish Parliament we have also amended the Bill to allow the power to issue bonds to be introduced in the future without primary legislation.
We will begin full consultation on Scottish bond issuance in the coming months.
Together these reforms are the most fundamental shift of financial responsibility within the United Kingdom for 300 years.
But they are reforms that strike the right balance to ensure that we both continue to benefit from risk pooling, economies of scale, and economic efficiencies within the UK monetary and fiscal union, whilst also ensuring that Scotland benefits from greater powers and financial accountability.
It cements the sharing of risk across the UK as well as sharing the wins.
That said, it is vital that the Scottish Government uses the powers it already has to boost the recovery in Scotland.
The priority has to be to support a private sector recovery, ensure sustainable growth, and capitalise on the opportunities for growth that come from working together in a United Kingdom.
We face unprecedented economic challenges at the moment, and it is vital that we focus on working together at Holyrood and at Westminster to restore growth across the UK.
Uncertainty over Scotland’s political, economic and monetary future can only hold our economy back until they are resolved.
The sooner they are resolved the better for Scotland.
But as it stands, these economic and monetary issues are matters on which the Scottish Government has been uncharacteristically silent.
Yet it is one of the most central issues that need to be understood and debated. That silience is not only deafening, but deeply damaging.
Uncertainty on this subject is heightened by even the most basic questions not being answered.
I’ve set out the key questions to which all Scots are entitled to hear the answers from the advocates of independence.
The need to address these issues is heightened by the crisis in the Eurozone, where we see countries in a common currency trying to resolve a crisis caused by their independent fiscal policies.
What is happening in the European Union profoundly affects the debate about the future of our Union.
As the Eurozone seeks rightly to tighten its economic and fiscal bonds in response to the crisis, Scots should ask very searching questions of those who seek to weaken those bonds on our island.
It’s a case that I and the Coalition Government will continue to make, but we also need to hear the voice of business.
All of you here are critical to providing the jobs that Scottish families need through these tough times.
It is up to you to make your voices heard in the Scottish debate, in Scottish media, among Scottish people, to spell out how you see it.
This isn’t just politics…it’s a great deal more important than that.
Having the voice of business, the facts as you see them, will be particularly important.
Politicians on both sides of this argument should welcome all contributions from business, and ensure an atmosphere of debate that you feel comfortable in.
So let me be clear, the UK Government will respect business voices that support Independence, and we will not personalise our response to such voices.
There will be no adverse consequences - public or private - for business people who speak out on that side of the debate.
I look forward to working with you in the weeks and years to come to secure our recovery, and secure the prosperity for Scotland that lasts and as part of a stable and secure United Kingdom.