Annex 6: An Independent Scotland and the Euro
One of the most important choices for an independent nation concerns its choice of currency.
In their first report, which provided a comprehensive analysis of the options for Scotland post-independence, the Fiscal Commission Working Group (FCWG) considered the four potential currency options for an independent Scotland:
- The Euro
- A Scottish currency pegged to Sterling
- A flexible Scottish currency
Following a detailed analysis of the various options the Working Group:
"commends to the Scottish Government retaining Sterling as part of a formal monetary union, and believes that this provides a strong overarching framework for Scotland post-independence."
The Scottish Government is clear that sterling will continue to be the currency of an independent Scotland. This decision is based on an analysis of the potential impact of the alternative currency options on Scottish people and businesses, including the ease with which they can conduct their business with people and companies across the rest of the UK and beyond.
The Scottish Government therefore agrees with the recommendation from the Working Group that retaining Sterling, in a currency union with the rest of the UK, would provide a workable currency from day one of independence as part of a strong overarching framework for Scotland post-independence.
While the Scottish Government understands the political and economic objectives that underpin the decision to establish the Eurozone, it is clear that an independent Scotland will not be in a position to seek, or as is demonstrated below to qualify for, membership of the Eurozone in the foreseeable future. Indeed, as the analysis indicates, under current economic conditions leaving the sterling currency area could damage both Scotland's economic prospects and those of the remainder of the UK. Accordingly, the transition to full EU membership will include specific provisions that ensure Scotland's participation in the sterling currency area does not conflict with its wider obligations under the EU treaties.
Assessing Currency Options: the economic analysis
The First Report of the FCWG was accompanied by a technical paper which provided a detailed assessment of the currency options that would be available to an independent Scotland. In considering potential options for a currency union the report highlights that:
"…countries are believed to be better suited to currency unions when there is a high degree of trade, capital and labour mobility between them, and they share the same broad trends and structures in their macroeconomies."
The criteria used to make such an assessment includes: trade levels (for both intermediate and final goods and services); factor mobility (for example, of labour and capital); alignment of economic structures; wage and price flexibility; productivity; correlation of economic cycles; and, prevalence and scale of asymmetric shocks. Considerable divergence in these criteria would suggest that the countries are less likely to form an optimal currency area. Applying this criteria the FCWG suggests that:
"…the assessment on whether Scotland would form an 'optimal currency area' with the Euro Area is less clear than is the case with Sterling. On many key macroeconomic indicators, Scotland is currently less aligned with the Euro Area than it is with the UK."
Economic Arguments in Support of Retaining Sterling
The FCWG set out a number of economic arguments as to why "…retaining sterling would be a sensible currency choice that would be attractive both to Scotland and the UK."
1. The UK is Scotland's principal trading partner accounting for two thirds of onshore Scottish exports in 2011. Modelled data suggests that imports from the rest of the UK are likely to be at least as large as the figures for Scottish exports.
2. While less than 2% of registered enterprises operating in Scotland are ultimately owned by enterprises from the UK, they account for over 20% of employment and turnover; there is clear evidence of a number of significant pan-UK companies operating in Scotland (and vice versa) with complex cross-border supply chains.
3. There is considerable labour mobility between Scotland and the UK - helped by strong transport links, culture, recognised education qualifications and a common language; and historically the majority of inward migration into Scotland has been from the rest of the UK.
4. On long-term measurements of economic performance, the Scottish and UK economies are broadly aligned - in 2011 productivity (output per hour worked) levels in Scotland were the same as the UK, whilst GVA per head in Scotland was 99% of UK levels.
5. Past evidence of business cycles shows that while there have been periods of temporary divergence, overall there is a relatively high degree of synchronicity between the Scottish and UK economies compared to other closely related economies.
The Eurozone: entry requirements admission procedures
Notwithstanding the clear economic case supporting the retention of sterling as Scotland's currency following independence, critics of independence have claimed that under EU rules an independent Scotland would have no choice but to become a member of the Eurozone and adopt the Euro as its currency following independence.
This assertion is incorrect on two counts.
First, the simple fact that eleven EU Member States do not use the euro as their currency - only two of which formally have an opt-out from the relevant articles in the Treaty - itself demonstrates this is a wholly misleading claim. The Member States that do not use the euro include Sweden, a member since 1995, along with many of the countries acceding to the EU in 2004 and 2007.
Second, as explained in detail below, it ignores both the prerogatives Member States retain in determining whether, and when it is appropriate - in terms of their economic self-interest - to adopt the Euro, and the economic pre-conditions that Member States must satisfy (under EU law) before being allowed to join the Eurozone. It is simply not in the interests of individual Member States or of the Eurozone as a whole to encourage a country to adopt the Euro against its own economic self-interest or the economic interest of the Eurozone as a whole.
As already noted, the decision of the Scottish Government that an independent Scotland will retain sterling is one based on economic considerations and economic evidence. The analysis of the FCWG demonstrates that adopting the Euro immediately following independence would weaken the Scottish economy and, by extension, weaken the wider Eurozone economy.
The Euro was adopted as the EU single currency in 1999, with Euro notes and coins being introduced into circulation and replacing the national currencies of the participating countries on 1st January 2002. The legal base for the introduction of the Euro, and the rules governing Member States' eligibility to adopt the Euro as national currency, was set out in the Treaty on European Union (TEU) which entered into force in 1993. Both the UK and Denmark secured an "opt-out" from the Treaty provisions relating to the Euro, and neither are under an obligation to participate in the single currency arrangement. Both countries can, however, "opt-in" to Euro membership if they wish, assuming they meet the strict pre-requisites for membership.
Since 1993 successive UK Governments have maintained the position that while membership of the Eurozone is not entirely ruled out, this would only be contemplated if a number of economic "tests" demonstrated this was in the UK's best economic interests and providing the majority of the public endorsed adopting the Euro as the UK currency in a referendum. In 2003 the Treasury published results of the five economic "tests" deemed appropriate to determining if Eurozone entry was economically desirable, and found these tests were not satisfied. Since then, and particularly against the backdrop of the financial and economic crisis, official and public opinion in the UK has significantly hardened against Eurozone membership under any circumstances.
Under Article 140 of the Treaty on the Functioning of the European Union (TFEU) makes clear, an EU Member State is only permitted to join the Eurozone and adopt the Euro as its currency when four economic tests have been met. These are generally referred to as the "convergence criteria" and are designed to ensure a new Eurozone member will avoid any significant domestic economic disturbance upon entry. The four tests are:
- Inflation rate: the applicant country inflation rate to be no more than 1.5 percentage points higher than the three lowest inflation Members States of the EU;
- Government finance: the applicant country ratio of annual deficit to GDP to be less than 3% and ratio of gross debt to GDP to be less than 60%;
- Exchange Rate: applicant countries must have been a member of the Exchange Rate Mechanism II (ERM II) for two consecutive years and should not have devalued its currency during that period; and
- Long-term interest rates: the applicant country's nominal long-term interest rate must not be more than two percentage points higher than in the three lowest inflation Member States.
Under the TFEU a Member State that fails any of these four tests will not be permitted to join the Eurozone.
There are important points to note about these conditions of Eurozone entry. First, the decision as to when, or if, to include a currency in the ERM II - a pre-condition for Eurozone membership - rests entirely with individual EU Member States. That the exchange rate strategy adopted by a "new" Member State is the prerogative of the national government has been confirmed numerous times both by the European Commission and the European Central Bank. And if a national government decides not to join the ERM of the EU, as it is entitled to do, then by definition it cannot become eligible for membership of the Eurozone. For instance despite being an EU member since 1995, the Swedish krona is not in the ERM II. And a number of the countries that joined the EU in 2004 and 2007 continue to keep their currencies outside the ERM II.
Secondly, it is worth stressing that neither the European Commission nor the EU Council has ever sought to remove the derogation that in strict legal terms permits the non-Eurozone countries (except the UK and Denmark) to remain outside the arrangement. In effect a derogation from the relevant single currency Treaty articles must be granted to all "new" EU Member States. This is because, self-evidently, a "new" Member State cannot possibly meet the pre-requisites to join the Eurozone immediately on accession to the EU - if only because it cannot join the ERM II until it is a Member State. At the very least a derogation must be granted to cover the first two years of EU membership.
However, in the event the EU authorities have never sought to remove a derogation from Eurozone membership from any Member State. There would be little point doing so. As already argued the EU lacks any legal means of forcing Member States to comply with the pre-conditions that have to be satisfied before Eurozone membership is possible. Moreover, individual governments also lack the legal authority to ensure some of these pre-requisites are satisfied. Accordingly, it is difficult to envisage any circumstances in which the EU authorities - in particular, the European Commission - would wish to launch legal procedures against any Member State on the basis of non-compliance with the TFEU provisions on membership of the Eurozone. Not only has the European Commission never pursued such a course of action, it has never inferred it had any interest in so doing.
Scotland and the Euro
It is very clear that there are simply no conceivable circumstances in which an independent Scotland would be "forced to join" the Eurozone. The Scottish Government has repeatedly stated that its primary objective in the negotiations it will have with the EU Member States and institutions following a positive vote for independence in the 2014 referendum will be to ensure "continuity of effect" in the terms and conditions of Scotland's independent EU membership.
As the FCWG have highlighted, a newly independent Scotland would not in any event meet the criteria required for joining the Euro, even if a future Scottish Government intended to recommend such a course of action to the people of Scotland. This is not from the perspective of the relative strength of the Scottish economy but simply due to the current system being incompatible with the pre-requisites for membership of the Euro.
In addition, an initial analysis of a range of criteria that could be used as a starting point for assessing whether Scotland formed an 'optimal currency area' with the UK or the Euro Area suggests that Scotland is currently less aligned with the Euro Area than it is with the UK.
The Scottish Government therefore agrees with the Fiscal Commission Working Group's recommendation that it makes sense to retain Sterling, in a currency union with the rest of the UK, and that it is essential to use the vital tax and other economic powers of independence to create jobs, grow the economy and build a fairer country.
Given the compelling economic case for an independent Scotland retaining sterling as its currency, the Scottish Government considers this would most appropriately be accommodated in Scotland's case by providing for an opt-out from the TFEU obligations that maintains the status quo ante.