The economics of an independent Wales pt.1

This is a response to Mike Hedges’ article in September 2019, which called for Welsh independence to be negotiated before being put to a referendum. This is the first of a two-part response and the second article can be read here.

 

In an interesting article in Click on Wales in September last year, Mike Hedges not for the first time, suggested the need – as he put it – to clarify the details involved in independence.

 

Encouragingly, he began with an acceptance that Wales is “neither too small nor too poor” to be independent. Without any evidence and contradicting this earlier remark, he then repeats the mantra that Wales will be poorer, with high taxes and poorer public services – that sounds to me like Wales today. 

 

He reminds us that the Welsh economy, as measured by GVA is one of the poorest in Europe. “I did not stand for election,” he states “to make my constituents poorer.”  Perhaps he should be reminded that the Welsh economy has been in decline ever since the establishment of the Assembly, and on his party’s watch.

 

Amongst a number of disconnected issues, he points to two fundamental questions; currency and tax receipts. The first is currency. The reality is that there is no reason why, in an independent state, the pound could not continue to be used. It is a fallacy to suggest that this is not possible.

 

During the Scottish referendum debate the Governor of the Bank of England played two hands, one saying that a currency union would be needed for Scotland to use the pound and then, strangely, saying that it could not use the pound at all.

 

The pound could continue to be used within a currency union, despite the doubtful arguments of the Better Together campaign and the Bank of England Governor, a currency union already exists. The Scottish and Northern Ireland pound, the Isle of Man, the three Channel Islands, British Overseas Territories, St Helena and Ascension Island all of whom to a greater or larger extent issue their own bank notes and by definition form a currency union.

 

In the absence of a currency union so-called sterlingisation would be an alternative, certainly in the short term. In this scenario the pound would remain the currency but used without the consent of the Bank of England. The major weakness would be no Central Bank to act as lender of last resort and no control over interest rates – although with interest rates likely to remain at or close to zero probably for the remainder of the 2020s, this is a minor issue.

 

Interestingly, there is an argument that such an arrangement would work over the longer term, as is the case with some Latin American countries that use the US Dollar. Since there is no lender of last resort, such a system requires discipline from the banks, which need to be more prudent and far less likely to indulge in the reckless activities that led to the crash of 2007/08. In terms of economic stability this would be the best, current option, certainly until any turbulence following independence settles.

 

Support for sterlingisation (in Scotland, but applies equally to Wales) has come from two totally different sources. Lord Mervyn King, former Governor of the Bank of England has pointed out that there is no reason why Scotland could not continue to use the pound within such a scheme. The Adam Smith Institute – a much respected think tank – has suggested what it calls an “adaptive sterlingisation” which not only allows continued use of the pound but an approach that would strengthen the economy. 

 

The use of a non-domestic currency is not unusual. Six countries outside the Eurozone use the Euro, eleven countries the US dollar, seven countries share the East Caribbean Dollar, nine the West African Franc and five the Central African Franc.

 

If you think about it, the 19 countries using the Euro by definition do not have a domestic currency and ultimately rely on a “foreign” bank (ECB) as lender of last resort. Interestingly, the five fastest growing economies in Europe (the three Baltic States, Slovenia and Slovakia) use the Euro which by definition is not their “domestic” currency.

 

There is in addition the use of seigniorage, essentially a system where the pound continues to be used on the basis of a “fee” to the Bank of England. The upshot is that, yes, we can continue to use the pound, if we wish.

 

There is the option of a new, separate currency; in this scenario Wales would be fully responsible for its own policy priorities, control of fiscal policy (although this would apply whatever currency option is chosen), monetary policy (far less important in a world of very low interest rates) and the macro economy.

 

A new central bank would be established; since the end of the second world war no fewer than 25 new central banks have been established, many in Europe. Its role as a central bank – as with all central banks – is to set monetary policy (in cooperation with government) set interest rates and act as a lender of last resort.

 

Interestingly, currency unions such as the UK pound, the Euro and countries using non domestic currencies are actually in the minority. Domestic currencies provide control and of course, status, it hasn’t gone unnoticed that economists and some politicians in Europe still hanker after their own, currently lost, currencies.

 

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