An English Patient and a Scottish Project

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by Michael Liebig


Compared with the continuing problems on the “continent,” as the British say, Britain seems to be in good shape. Britain doesn’t belong to the eurozone and doesn’t care much about the next rounds of stressful EU summits in Brussels. Instead, the British prospect is the great spectacle on the occasion of the 60th Jubilee of Queen Elizabeth II in June. Worldwide, TV audience will follow colorful uniforms and royal coaches in central London and a splendid boat parade on the Thames. Then, July 27 till August 11, the Olympic Games will take place in London. Here again, Britain will show its best side. However, the merry appearance of “Cool Britain” is misleading.

In reality, we have a “sick man at the Thames”. Britain not only has enormous economic and financial problems, but faces an unprecedented political-constitutional crisis. It is even conceivable that within a few years, the United Kingdom might not exist any longer in its present form. Why? Scotland may declare its independence – if not juridically, then practically. At the last “diamond” Jubilee – Queen Victoria in 1897 – the British Empire was the undisputed No. 1 world power. Then, Britain was the leading industrial and financial power, had the largest colonial possessions and the biggest fleet. 17 years later came World War I. The British leaders first thought that their continental European rivals – Germany, France and Russia – would once again slaughter each other as they had in the previous centuries. This did indeed happen, but unlike before Britain was not the laughing third party. World War I made the United States the strongest financial and economic power in the world. In 1914, the USA were Britain’s debtor, in 1918 its creditor. World War II consolidated America’s superpower status, while the nominal (co-)winner Britain was relegated to a middle power status – politically, economically and militarily.

Deindustrialization & Finanical Deregulation

In the 1970s, the British elites made a fatal decision – whether they made it on purpose or let it happen, is debatable. Britain was rather rapidly de-industrialized: the shipyards, the car industry, mechanical and electrical engineering, aerospace etc. were phased out – not modernized and innovated. Industry was substituted by the „financial industry“ and the „service industry“. In 2011, merely 2.5 million people – 8% of the British workforce – were employed in industry, while the financial sector employed 1.2 million people. That is to say: For every two engineers and skilled workers, there is a banker!

However, every society has to reproduce itself materially: all that is consumed must be designed, developed and produced at first. The French economist Jacques Rueff has compared money with a wine bottle. Yes, the empty bottle matters too, but what really matters is its content: the wine. The “financial industry” can provide the “bottles,” but only manufacturing can produce the “wine”. Translating Rueff’s metaphor into the real-life economy means: If there is not enough wine in the bottle and if the wine is of poor quality, you get inflation and debt. Here lies the core problem of the British economy: A gap between the expanding financial/services sectors and a shrinking, non-competitive real economy.

Now the question arises, why was the British economy apparently thriving from the 1980s until the financial crisis of 2008/09? Under the Thatcher and Blair governments all seemed well in the British economy, which was extolled as model of macroeconomic efficiency. During this period of time, the gap between the real economy and financial sector could be bridged by three factors: 1) the North Sea oil, 2) the deregulation of the financial sector, and 3) a gigantic real estate bubble.

1) Over the past 30 years, the revenue from North Sea oil has compensated, at least in part, the economic loss caused by industrial degradation. Britain was able to export oil and gas and needed no energy imports. This was helped by the fact that two of the world’s largest energy companies are British: BP and Shell. Now, however, the the oil and gas extraction in the North Sea has peaked and the buffer effect for the British economy is declining. Also, one should take note of the fact that the oil and gas reserves in the North Sea are located off the Scottish coast – and the Scots claim it for themselves.

2) Financial market deregulation. The financial sector is the more profitable and “competitive”, the less it is regulated. This seemingly plausible principle was effectuated by the Thatcher government with its “Big Bang” deregulation of October 1986.

Until 1986, Britain’s financial markets were regulated in traditional manners that sought to contain speculation and excessive risks. The “Big Bang” deregulation explicitly encouraged speculation and risk-taking: proprietary trading, derivatives, hedge funds, mergers & acquisitions, etc. The City of London’s new “market philosophy” came down a rather simple equation: little regulation + sophisticated speculation + high risks = maximum revenues. The equation worked splendidly – for two decades. The financial sector delivered 25% of Britain’s GDP. But in 2008 the party was over.

Amazingly enough, the deregulation policy for British financial markets was not reversed even after the financial crisis of 2008/09. Whenever there has been an effort to re-regulate financial markets in Europe, the City of London and the British government have tried to block or obstruct. The refusal of the British government to agree to a European-wide financial transaction tax is only the most recent example.

There is another dimension of the British deregulation policy. The most effective “regulation” of the financial sector is its rooting in the real economy. The profits from the production of real goods and related services are always relatively moderate, because there are “hard” production costs: machinery, R & D, wages, raw materials. When banks do business with the real economy, their revenues are determined by these constraints and they cannot expect double-digit revenues. In the financial sphere itself, however, there are no such „physical“ boundaries. This second type of basic “regulation” has been absent in Britain, because its financial sector is not centered on the real economy.

Since the 1980s, house prices have been rising in Britain. Between 1999 and 2007, the representative Halifax Housing Index rose by 141%! A housing bubble is a self-feeding process which usually starts with strong demand and favorable mortgage conditions. As real estate prices surge, the price rise itself becomes the prime motivation to invest in real estate which in turn accelerates the price rise. In Britain, home ownership is predominant. Consequently, the majority of Britons felt more „wealthy“ as house prices increased steadily. It didn’t matter if the family’s home mortgage was far from being paid off, what counted was „higher value“ of the house.

Against the background of apparent financial „safety“ due to the real estate price bubble, the debt of Britain’s private households surged in an unprecedented way. Consumer goods, cars, education costs of children etc. became increasingly financed by credit – the ever “more valuable” home serving as collateral. The average British household now is burdened with debts, which are 150% of its annual income! Thus, one can better understand why the British was thriving for two decades: debt-financed consumption driven by the real estate bubble.

The total British debt – state, businesses and private households – currently stands at 500% of GDP! That’s a negative record for the OECD – well ahead of the United States. The national debt of Britain as a share of GDP is comparable to that of Germany or France: around 80%. But there is one crucial difference. The Bank of England pursues a „quantitative easing“ policy on grand scale. „Quantitative easing“ means that the central bank buys up its own government’s state bonds. Between March 2009 and February 2012, the Bank of England has bought British state bonds – ”gilts” – in the amount of 325 billion Pound Sterling. It’s the central bank that keeps the British government liquid.

The low competitiveness of Britain’s small manufacturing sector is shown by the fact that the index of industrial production today is still only slightly above what it was at the very depth of the crisis in the summer of 2009. British industry has been unable to benefit from economic growth in China, India, Brazil and other emerging economies. A near-term improvement is not in sight.

The Scottish Independence Drive

End of February, I spoke with a former senior diplomat who has observed British politics for decades. He said that London had marginalized itself economically and politically. Britain is isolated in Europe and also the Americans have downgraded the „special relationship“ with Britain in view of the rising strategic importance of Asia. To my amazement, this very sober analyst added that he expects that Scotland will separate from England within a decade.

Scotland splitting from the United Kingdom? Sounds somewhat ludicrous.

The idea of an independent Scotland is not new, after all, the Scots were independent before the forced merger with England into the United Kingdom in 1707. In mentality, tradition, and in institutional terms, there are significant differences between England and Scotland. But until 1970s, the Scottish Nationalist Party (SNP) was only a marginal factor, which was not taken seriously by the London governments. Outside Scotland, the SNP was only known because “James Bond” actor Sean Connery has supported it politically and financially.

Over the past two decades, however, the SNP has gained steadily in strength. A key factor for its success is the fact that the SNP combines its nationalist stance with left-liberal and ecological positions. The leader of the SNP is Alex Salmond. Since 2007, he has been the „First Minister“ of the Scottish (regional) government. Today, Salmond is the dominating figure of Scottish politics.

In 1999, the Blair government had to grant Scotland a regional parliament and a regional government. In the elections for the Scottish Parliament in May 2011, the Conservative Party of British Prime Minister David Cameron received merely 12% of the vote, the Labour Party 27%, but the SNP got more votes than these two parties combined: 44%, which meant the absolute majority in the Scottish parliament and an all-SNP Scottish government.

Salmond’s central issue in the 2011 elections was holding a referendum on Scotland’s independence. Up to the 2011 elections, the political establishment in London felt sure there would be no majority among the five million Scots for a withdrawal from the United Kingdom. Since, London is not so sure anymore. Prime Minister Cameron has therefore launched a counter-offensive: He wants to hold a referendum as soon as possible, in which there must be only one question: Separation of Scotland from the United Kingdom, yes or no. Cameron has understood that the issue of Scottish independence is a race against time for London. He obviously intends to stake everything on one card hoping that he can mobilize fears over a separation in the Scottish population, particularly the older generation. As long as Queen Elizabeth II is Britain’s head of state, London can count on loyalties in Scotland which likely won’t be there for her successor.

I pursuing his strategic goal – Scotland’s national independence – , Salmond is a shrewd tactician. He is no hurry because he knows that time is working for him: the younger Scots are, the lower are their emotional ties to the United Kingdom. Also, the economic prospects of Scotland look better than England’s: the North Sea oil, the near-term self-sufficiency in electricity from wind energy, the better education system, the better and more modern economic structure, notably small and medium-sized enterprises, and a greater affinity to continental Europe.

As of now, the Scottish referendum will take place in the Autumn of 2014. And probably the referendum will not contain only one question, as demanded by Cameron, but two questions: a) complete national independence. b) “maximum autonomy” (acronym: ”devo max”), limiting the constitutional connection with the United Kingdom to the monarchy, foreign and defense policy, and a monetary union.

If the referendum should yield no majority for Scotland’s full independence, a solid majority for “maximum autonomy” seems certain. Whatever result, after the 2014 referendum the United Kingdom will never be same.

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