At a lunchtime meeting, hosted jointly by the Royal Society of Edinburgh and The Royal Bank of Scotland and organized by the Centre for Economic Policy Research, Professor David Begg, Birkbeck College and CEPR, outlines the implications of the birth of EMU for Scottish devolution. He concludes that a separate monetary policy for Scotland should be rejected. He argues that Scotland is in many respects more European in aspect than England and therefore, in the advent of the UK joining EMU, Scotland would benefit (as Ireland as) in terms of inward investment by companies seeking a toehold in Euroland.

Jeremy Peat, Chief Economist at The Royal Bank of Scotland, will co-chair the meeting. He said: "The Royal Bank of Scotland is delighted to co-host this event, both because of Professor Begg’s undoubted expertise and because the economic and business impacts of EMU and devolution are key issues facing Scottish business in 1999. These are complex topics, upon which universal agreement can never be expected. However, high quality contributions to the debate must always be welcomed and encouraged."

Begg addresses four questions:

• Why is EMU happening?
• What will it mean for the countries of Europe, in and out?
• Is EMU an ambush by European fundamentalists, hoping to lure moderates into ever-deeper union?
• What does EMU, and the forces of which it is a symptom, imply for devolution in general and Scotland in particular?

It is no accident that the centralisation of Europe is taking place at the same time as greater devolution. Both are products of the same set of forces that are slowly undermining the sovereignty of nation states. Sovereignty reflects two characteristics, ability to exercise power and willingness for that power to be exercised. The ability of nation states to exert power over their citizens presupposes that there are no easy escape routes across national borders. Dramatic advances in transport and communications undermine this power by increasing the mobility both of tax bases and those potentially entitled to welfare provision. The geographic domain of the nation state no longer corresponds to the area of economic relevance. However, the legitimacy of nation states also depends on a sense of shared identity, community and culture – in short who is willing to pay for whom. European integration has been messy precisely because the technical obsolescence of nation states, especially small ones, has proceeded more quickly than corresponding changes in shared identity. Even that is beginning to change.

EMU will mean permanently fixed exchange rates between member states, and a single interest rate, set by the European Central Bank. The ECB is committed to the use of interest rates to maintain price stability; despite the austerity of the rhetoric, it will of course pay some attention also to the state of the business cycle, as central banks usually do. EMU membership will also entail participation in the Stability Pact, a requirement to avoid excessive deficits. Since Scotland is already a member of the monetary union called the UK, whose government is committed to low inflation and fiscal prudence, it might appear that exchange of the pound for the Euro would make little difference.

This presupposes that Scotland is as integrated with Euroland as it is with the rest of the UK, which presently is not the case. A single monetary policy works well when countries are similar, but creates strains when countries have different structures and differing needs; the latter has of course fuelled some of Scotland’s existing discontent with Westminster.

A country out of kilter with the central monetary policy has essentially two resorts:

• First, it can seek adjustment instead through labour market behaviour. This requires both flexibility and the skill to cope with change, not an easy combination: the competition that promotes flexibility in many cases also undermines incentives to train and invest.
• Second, a country can rely on using its own fiscal policy to counteract its own problems. Many economists remain worried that the Stability Pact will prove too much of a straightjacket to make this easy; nor is Scotland likely to have much fiscal flexibility within the existing framework for devolution. However, EMU membership would at least protect Scotland from gross errors of fiscal judgement, most recently by the Chancellor of the Exchequer, Gordon Brown, whose failure to tighten fiscal policy forced the Bank of England to set interest rates that induced an unrealistic sterling appreciation that in turn crippled exports. Whatever the outcome within Euroland, the fact that for all European countries, including Scotland, trade mainly with one another, would make effects via Europe’s external exchange rate much less significant.

It is sometimes claimed that EMU is an ambush by Euro federalists: an early crisis will spur moves of much deeper fiscal integration in order to reconcile national needs with the single monetary policy. This view is probably mistaken for two reasons:

• First, gains to fiscal federalism are greatest when countries differ: when one is up, the other is down, and sharing provides mutual insurance. Paradoxically, the Maastricht convergence criteria, while good for the single monetary policy, have reduced the gains to fiscal integration.
• Second, EMU is not an act in isolation; it is the consequence of many deeper and ongoing forces of integration within Europe. These forces will not go away, and may in time, perhaps quite soon, foster greater fiscal integration, but that will not be caused by EMU per se.

What lessons for Scotland the brave?

• First, any notion of a separate monetary policy for Scotland should quickly be rejected. In today’s global financial markets, this would simply introduce a new and unnecessary source of currency speculation.
• Second, in many respects Scotland is much more truly European than its Sassenach neighbour, being more committed to education, thrift, investment, infrastructure and community. Paradoxically, Scotland to date has probably been hampered by English ambivalence, allowing the Irish tiger to benefit from English-speaking inward investment in search of a stepping stone to Europe. EMU entry, whether by the UK or by Scotland alone, would draw more effectively on some of Scotland’s strengths.
• Third, Scotland’s peripheral geographic disadvantage, hitherto exacerbated by poor English infrastructure, will gradually diminish in importance as telecommunications develop further; and Scotland’s environmental assets may become significant not merely in tourism but in the attraction and retention of workers in other industries.
• Finally, the mobility of goods, capital and even people makes true fiscal sovereignty an increasingly unrealistic aspiration for any small open economy within Europe.

Successful devolution must therefore be wise enough to pursue the transfer only of those fiscal powers over which sovereignty is feasible; this will typically be in activities where cross country mobility is lowest.

CEPR is a network of over 450 Research Fellows based throughout Europe, who collaborate through the Centre in research and its dissemination. CEPR helps its Research Fellows to develop projects, obtain their funding, administer them and disseminate their results. The Centre’s research ranges from open economy macroeconomics to trade policy, from the economic transformation of Central and Eastern Europe to regionalism in the world economy. For further information about CEPR, please contact Rita Gilbert, External Relations Officer, Tel: 44 20 7878 2917 or email: rgilbert@cepr.org

Professor Begg has written extensively on the monetary integration of Europe, in academic journals and the media. He has also acted as a consultant for the European Commission. He is a co-author of a number of CEPR reports that have proved highly influential, most notably The Making of Monetary Union (1991), which forecast the EMS crisis of 1992; EMU: Getting the End-game Right (1997), which highlighted flaws in the official EU strategy for conversion rates to the Euro and was subsequently adopted as EU policy; and The ECB: Safe at any Speed? (1998) which received wide media coverage for its analysis of remaining and urgent tasks for the European Central Bank to complete before the end of 1998.

The meeting was hosted by the Royal Society of Edinburgh and The Royal Bank of Scotland. We are extremely grateful for their support.

The Royal Bank of Scotland, founded in 1727, is one of the UK’s top 50 companies, and, with assets of £80 billion, is Scotland’s largest bank. It has 650 branches throughout Great Britain, around half of which are in Scotland. It operates internationally, with offices in North America, the Far East, the Channel Islands and the Isle of Man, Greece and the Bahamas. The main business areas of The Royal Bank of Scotland Group include the UK Bank, serving retail, business, corporate and institutional customers; Direct Line Group, which is the UK’s largest private motor insurer; and Citizen’s Financial group, a retail and corporate bank operating in New England, USA.

Since its inception in 1783, the Royal Society of Edinburgh’s role has been to promote academic excellence. As Scotland’s National Academy, it is ideally placed to build bridges in Scotland: between the industrial and the academic sectors; between academic disciplines themselves; between policy-makers and the public; and between generations. The Society is unique in Great Britain in that its elected Fellowship represents excellence across the spectrum of academic, professional, technical, industrial and commercial interest. The Society’s activities range as widely as the interests of its Fellowship and its Charter’s aim of ‘advancing learning and useful knowledge’ enables it to bring the spirit of the Enlightenment to the modern world.

The ECB: Safe at Any Speed?
Monitoring the European Central Bank Vol. 1
David Begg, Francesco Giavazzi, Paul De Grauwe, Harald Uhlig and Charles Wyplosz

ISBN 1 898128 39 1 – £20/$30/30 €uros

EMU: Getting the End-game Right
Monitoring European Integration No. 7
David Begg, Francesco Giavazzi, Jürgen von Hagen and Charles Wyplosz

ISBN 1 8981 28 26 X – £10/$14.95/15 €uros

Making Sense of Subsidiarity: How Much Centralization for Europe?
Monitoring European Integration No. 4
David Begg, Jacques Crémer, Jean-Pierre Danthine, Jeremy Edwards, Vittorio Grilli, Damien Neven, Paul Seabright, Hans Werner-Sinn, Anthony Venables and Charles Wyplosz

ISBN 1 898128 03 0 – £10/$14.95/15 €uros

‘Pegging Out Lessons: Lessons from the Czech Exchange Rate Crisis’
David Begg

CEPR, 90–98 Goswell Road, London EC1V 7RR, UK
Tel: (+ 44 20) 7878 2900 Fax: (+ 44 20) 7878 2999 Email: orders@cepr.org

In North America from:
The Brookings Institution, Dept. 029, Washington DC 20042-0029, USA
Tel: (+ 1 800) 275 1447 Fax: (+1 202) 797 6004

SNS Förlag, Box 5629, S–114 86 Stockholm, Sweden,
Tel: (+ 468) 453 99 50 Fax: (+ 468) 20 62 06