Summary
The latest Government Expenditure and Revenue in Scotland (GERS) statistics on Scotland’s public finances provide stark evidence on the mismanagement of the economy by the UK Government.
Two-thirds of Scotland’s current account deficit in 2022-23 was due to two aspects of poor UK economic management: the cost of living support that was necessary due to inflation in the UK that was higher than other advanced economies, and the significant increase in the cost of servicing public sector debt. These result from UK policy mistakes including Brexit (and its impact on inflation), greater exposure to global oil and gas prices than other countries and the decision to index-link a much higher proportion of government debt than any other country, increasing the exposure of UK public finances to inflation.
If the Scottish current account deficit for 2022-23 were revised to remove these two examples of UK economic mismanagement, it would fall from 6.4% of GDP to 2.2%, well below the UK current account deficit and well within the 3% that is generally regarded as sustainable.
The substantial contribution of oil and gas revenues to Scotland’s public finances also highlights a significant economic opportunity. Whilst it is possible that the 2022-23 may represent a peak in oil and gas revenues, at £9.4 billion, the forecasts of the Office for Budget Responsibility (OBR) are for an additional £35-40 billion over the next five years.
This provides a huge opportunity for the Scottish economy and Scottish public finances. These revenues are taxes on the profits of the energy sector. The profits retained after tax are set to be invested in the energy transition, which will generate many employment opportunities (for example, in offshore wind farm construction) and provide a basis for increasing the competitiveness of the Scottish economy in the long-term and sustainable public finances.
The GERS Publication
Every year the Scottish Government produces “Government Expenditure and Revenue in Scotland” (GERS), an accredited National Statistics publication that estimates the state of Scotland’s public finances. It analyses the total tax revenues collected from Scotland and the total spending of the UK Government, Scottish Government, local government and other public sector organisations in and on behalf of Scotland.
Whilst the publication of GERS tends to lead to news coverage that focuses on the implications for Scottish independence, GERS is not an analysis of public finances in an independent Scotland, it is an analysis of the situation that currently exists with Scotland as part of the UK.
As one of the founders of The Bottom Line, Professor David Simpson, has previously argued[1], the publication of GERS should be scrapped since it is generally misinterpreted and mis-directs the debate on the Scottish economy. It focuses political debate on the state of Scotland’s public finances as part of the UK, instead of providing the evidence required to explain the performance of the Scottish economy and how it might be improved.
Scotland’s Public Finances in 2022-23
The latest GERS publication [2] for 2022-23 highlighted that increased taxation revenues from the energy sector had improved Scotland’s fiscal position but that Scotland in the UK has a public sector deficit. That is, public spending in Scotland plus an allocation of UK public spending exceeds the taxation revenues collected in Scotland.
GERS estimates that the “net fiscal balance” for Scotland in the UK in 2022-23 was a deficit equivalent to 9.0% of Gross Domestic Product (GDP), compared to a deficit of 5.2% of GDP for the UK as a whole. This calculation includes both capital and revenue.
From a practical perspective, the more useful measure is the “current account balance”, since this excludes the capital investment, which should generate longer term improvements in economic performance, and so improve the state of public finances by generating additional taxation revenues. GERS estimates that “current account balance” for Scotland in the UK in 2022-23 was a deficit equivalent to 6.4% of GDP (£13.6 billion), compared to a deficit of 3.2% of GDP for the UK as a whole.
Evidence of Economic Mismanagement
The latest GERS also provides stark evidence on the mismanagement of the economy by the UK Government. Given Scotland’s huge economic potential and assets, there should not be a public finances deficit.
A previous post from The Bottom Line (https://thebottomline.scot/the-costs-of-dependency-the-tax-gap/) set out the costs of Scotland’s dependency as part of a UK economy that has been underperforming, resulting in a growing economic gap between the UK and other advanced economies, particularly those small advanced economies that an independent Scotland could reasonably aim to emulate. Closing the resulting tax gap would not only eliminate the budget deficit, it would provide the opportunity to increase public spending and / or cut tax rates in an independent Scotland.
However, the latest GERS also shows how it is recent mismanagement of the Scottish and UK economies by the UK Government that accounts for most of the Scottish current account deficit. There are two significant changes in the 2022-23 GERS resulting from policy mistakes in the management of the UK economy. Both have substantial impacts on the current account balance.
The first is cost of living support scheme to households and businesses, including the Energy Price Guarantee, the Energy Bill Support Scheme, the Energy Bill Relief Scheme and Cost of Living Payments. The total cost of these schemes in Scotland was £4.5 billion in 2022-23. Whilst that spending will have been welcomed by the households and businesses that benefitted, it should not have been necessary. In March 2023 [3], UK inflation was 8.8%, the highest of the G7 countries (Graph 7). Inflation will have numerous causes including increased costs of trade and shortages of employees in the labour market, both of which have been associated with Brexit. UK energy policy has also resulted in the UK being more exposed than other advanced economies to increases in global gas prices.
Graph 1: Inflation in Large Economies, March 2023 [4]
Source: International Monetary Fund (IMF), Macroeconomic and Financial Data: Cross-Country Indexes, Year-over-Year Change
The second significant change in the 2022-23 GERS is the increased cost of debt interest. The share of debt interest payments allocated to Scotland in 2022-23 increased by 68% compared with the previous year, an increase of £4.4 billion.
The cost of servicing UK debt has increased substantially relative to other countries, due to UK policy decisions, which left the UK finances exposed to the risks of inflation. Borrowing requirements are met by issuing government bonds or gilts. Interest is paid on these and there two main types: one has fixed interest rates and the other is index-linked, meaning that the interest paid increases with inflation. In the UK, index-linked gilts make up 25% of the total gilt portfolio, which is the highest among G7 countries and more than double that of Italy, the country with the next highest share [5]. Index-linked gilts have their role in any financial system, protecting those on fixed incomes but the proportion of UK gilts that are index-linked is out of line with every other country.
Impact of Economic Mismanagement on Deficit
The combined impact of the cost of living schemes and the increased debt interest costs in 2022-23 was £8.9 billion, accounting for two-thirds of the Scottish current account deficit. If the current account deficit were revised to remove these two examples of UK economic mismanagement, it would fall from 6.4% of GDP to 2.2%, well below the UK current account deficit and well within the 3% that is generally regarded as sustainable [6].
Graph 2: UK and Scottish Current Account Balances (as % of GDP), 2022-23
Source: Scottish Government (August 2023), Government Expenditure and Revenue in Scotland 2022-23
What About the Oil and Gas Revenues?
The latest GERS report also highlights the contribution of oil and gas revenues to Scotland’s public finances. The £9.4 billion in 2022-23 represented 11% of all taxation revenues collected in Scotland. Given the higher oil and gas prices in 2022-23 and the long term trend of reducing production, it is possible that the 2022-23 may represent a peak in oil and gas revenues.
However, the forecasts of the Office for Budget Responsibility (OBR) [7] are for an additional £40 billion over the next five years, of which more than £35 billion would be expected to be from the Scottish sector. This provides a huge opportunity for the Scottish economy and Scottish public finances.
Energy companies are already investing profits they are earning from high energy prices in renewable resources like offshore wind. Scotland’s natural capital, particularly the weather, means that it has a huge competitive advantage in renewable energy. Scotland is, therefore, in a position to capture a very large share of this investment, perhaps the biggest opportunity to transform the Scottish economy since the industrial revolution.
The investment in the energy transition will generate employment opportunities directly from the transition itself, for example, in offshore wind farm construction. It will also provide a basis for increasing the competitiveness and growth rate of the Scottish economy in the long-term, improving the sustainability of public finances.
References
[1] The National (22 January 2022), GERS figures ‘should not be published’, top economist David Simpson says https://www.thenational.scot/news/19868101.gers-figures-should-not-published-top-economist-david-simpson-says/
[2] Scottish Government (August 2023), Government Expenditure and Revenue in Scotland 2022-23 https://www.gov.scot/publications/government-expenditure-revenue-scotland-2022-23/
[3] Figures for March 2023 have been used here since they show how prices in the UK had increased at the end of the 2022-23 financial year (the same year as covered by the August 2023 GERS report), compared with one year earlier.
[4] Large advanced economies (LAEs): there are 9 countries in this group, excluding the UK: Australia, Canada, France, Germany, Italy, Japan, Spain, South Korea, USA
[5] National Audit Office (July 2023), Managing Government Borrowing
[6] For example, the European Union’s Stability and Growth Pact, includes a requirement to maintain a budget deficit of up to 3% or less.
[7] Office for Budget Responsibility (March 2023), Economic and Fiscal Outlook