Saturday, May 04, 2013
Scotland needs to join the Eurozone after leaving British Union...!
Published: 30/01/2013 08:14, British Summer Time
Several times, it has been mentioned that Scotland should keep remaining in British Union especially because of economic (mainly for the macroeconomic aspect) and political reasons in many articles in this blog.
Having observed the current fiscal havoc in both Great Britain since 1997 and the Eurozone, it is ostensible that the separation of the monetary policy from the fiscal policy (The independent monetary policy) results in the notorious misconduct of both the economic policy and the private sectors' economic activities. In particular, under such a stagnated economic climate, the efficient contact between the fiscal and monetary authorities and their cooperative efforts are necessary to effectively stimulate the economic activity level in the macroeconomic scale. Also, this harmonised fiscal and monetary policy is effective to repress the overheated economic activities as well.
The independent monetary policy itself is not a bad policy as long as the following conditions are fulfilled. Firstly, the price inflation has to be controlled. The obvious obstacle for the independent central bank is the instability of the price indices which affect their decision to set the interest rate and the money supply volume (Both are the tuner of balancing the saving&investment volume) adjusted to the situation in the next time period. Secondly, the role of the fiscal policy is kept to be tight (Less proactive). This is one of the key factors to control the inflation, and ease the decision making process of the monetary authority.
In particular, when there are many fiscal authorities existing in one monetary union, this is a very crucial factor. When these fiscal authorities act proactively and independently, the business cycles in this monetary union become disturbed because the monetary authority cannot set the different interest rate for these different regions. This is the main reason why the European Central Bank (ECB) strictly enforce the tight monetary policy and the Eurozone nations put their resilient effort of keeping their fiscal policy very tight into practice.
Another problem is the "credibility". When Scotland becomes independent from British union, Scotland will encourage her own new economic project for Scotland, independent from the United Kingdom. So, it is obvious that the business cycle disturbance mentioned in the previous paragraph will inevitably occur. Some famous economists claim to install Scottish own currency to solve the problem. But, this opinion encounters with the credibility issue. In such a world economic climate, the prospect of the newly independent national economy is uncertain. Leaving from the historically most peaceful and successful union contains a risk for Scotland to depreciate her credibility as well.
In addition, because the subsidies from the Westminster will disappear, Scotland will have to finance herself by increasing her tax revenue, incurring the national dept, and increase her money supply. Incurring Scottish national debts under the newly introduced independent monetary policy will be extremely restricted due to the low credibility (Many developing countries are severely restricted from financing by incurring national debts). Even though Scotland has a big potential to grow after her independence, the volume of this new currency supply will be tremendously higher than rise of this currency's credibility. Sum up, this phenomenon causes both the high inflation and the high tax rates.
Well, if they seriously declare Scottish fiscal independence from the rest of Britain, Scotland had better switch from British Pound Sterling to the Euro due to the macroeconomic policy, the credibility issue, and the trade advantage.
Before explaining the precise details of the advantage for Scotland to join the Eurozone, the business cycle synchronisation of Scotland and the Eurozone has to be shown. In order to join the monetary union, the business cycle of the new entrant country needs to be co-integrated to the business cycle of the already existing monetary union members. The Gross Value Added (GVA) of Scotland (From Scottish Neightbourhood Statistics: Official National Statistics (ONS)) and the Gross Domestic Product (GDP) of the Eurozone (From the IMF) from 1998 to 2011 are used as the variable.
This research assessed the co-integration of these two variables (Dickey Fuller strategy). The p-value is ignored in this time series analysis because these variables are the non-stationary variables (I.e. They have a "Unit-root"). So, the t-value of the coefficients is compared with "t = -2.89".
In order to assess the co-integration, these variables have to be non-stationary variables when it is tested by the Dickey Fuller Strategy.
Unit root test for both variables
By means of the auto-correlation test shown below, these two variables have a unit-root so that they are not stable variable.
Then, the co-integration of these variables are tested as follows:
The condition for the co-integration is that the residuals (The error term of the regression analysis) have to be converge to zero (Because the mean value of the error terms is zero) i.e. this variable is stable.
The result for Scotland on Eurozone:
The result for Eurozone on Scotland:
These t-values are not less than -2.89, but they are reasonably close to -2.89 (The difference with -2,89 is 17% for the first one and 10% for the second one). This can be because Scottish economy is more closely tied with England and the rest of Britain which still share the same monetary policy together. Or, it can be because it is still on the progress to be more integrated with the Eurozone. Statistically speaking, unfortunately, the number of the sample time periods used in this analysis is not enough for assessing the stability and the co-integration. This kind of analysis is the one used in the financial variables with quite a few number of the time periods. With such a limited number of the time series and the variables which are not quite suitable for this kind of the time series analysis, these variables show a pretty much strong trend of the co-integration. Thus, it can be concluded that Scottish business cycle and the Eurozone business cycles are more likely to be co-integrated.
Regarding to the necessary fiscal harmony, the Eurozone has already experienced handling the decentralised fiscal policy institutes under the strict guide line conducted by the ECB. So, Scotland seems to be able to rationally operate her independent fiscal policy within the European Monetary Union (EMU) rather than the British monetary union which is not yet used to the situation that the EMU is experiencing.
Furthermore, after Scotland becomes independent from British Union and joins the Eurozone, the ECB will conduct Scotland, as same as it is currently doing for the entire Eurozone economies, to fundamentally reform her entire economic model. She has to replace the heavy public sector base economy to the self-sustainable private sector base economic model to avoid the business cycle disturbance.
The private sector base economy under the Eurozone membership is also beneficial for Scotland to attract the foreign direct investment. While Scotland joins the European monetary union (EMU), many Europeans will become much easier to travel and invest to Scotland. There are already many tourists and investors from the continental Europe who like Scotland. Their main obstacle for tourism and investment in Scotland is the exchange rate fluctuation which burdens the menu cost on them. After this obstacle is removed, their business performance will be far more improved and flexible to tour and invest in Scotland.
Scotland with the Eurozone membership will attract not only these Europeans but also people from outside Europe. Not all the people traveling to Scotland from their home country bypass through England to go to Scotland: Many people visit Scotland before and after traveling the continental Europe. Moreover, because there will be no longer the menu cost caused by the exchange rate fluctuation, it will be more flexible and costless for multinational corporations to operate logistics between Scotland and the other Eurozone countries.