Is Wales really too poor to be independent?

John Ball unpicks the economic arguments against Welsh independence

In a click on wales article in June of 2017, Mike Hedges suggested that there were structural and technical issues that need to be addressed before any referendum on independence. In that he was quite correct; any debate on independence must be an informed discussion.  He raised some of the main economic issues which I addressed in a click on wales article in December 2017.

 

The debate has since then moved forward, not least fuelled by the 2016 report by Cardiff University’s Governance Centre which suggested Wales had a serious imbalance between taxation revenue and government spending amounting to some 24% of GDP. This has been blissfully leapt upon by those who delight in maintaining the myth that Wales is too poor ever to consider becoming a sovereign state – penury will exist.

 

In the spirit of informed discussion, it’s time to look very carefully at the figures contained in that report whilst contemporaneously exploring some ways in which taxation revenue could be improved in a sovereign state.

 

The first, perhaps most basic thing to make clear is this – quite simply, no country in the world pays its way, all countries to a greater or lesser extent run a deficit and borrow to balance the books. This requires realism in accepting that there will be in all likelihood a deficit; the aim must be to reduce it to manageable proportions.

 

The budget deficit (the annual difference between government taxes and spending) is itself dynamic and any report – such as that produced by Cardiff University – is at best a snapshot.  This can be illustrated with a look at the UK economy. At the end of 2010, the UK budget deficit was over £160bn representing 8% of GDP, at the beginning of the current financial year the deficit was £46bn with a target of £37bn by year end and whatever the level, the gap is filled by borrowing. Incidentally, the National Debt (that is the total of all borrowing) for the UK currently stands at £1.8trillion, or 100% of GDP. And Wales is poor!

 

The world’s richest nation – the United States – has a current budget deficit of $779bn; its National Debt stands at an eye watering $22trn (twenty two trillion), compared with GDP in 2017 of $19trn, or 116% of GDP. Perhaps America is too poor to be independent …

 

In summary, the Cardiff University report suggests that there is a gap between taxation and spending of £13bn, representing 21% of GDP – part of the report suggests 24%. This latter figure includes capital and although perhaps technically correct, we should be concerned here with current spending, which was the point of that report. When such a bold and easily repeated figure such as “24% of GDP” is bandied about, it must be remembered that when comparing two factors, the first thing is to be clear as to definitions. Since the report choses to compare with GDP, it is important to note that this definition of a country’s economic wealth is in itself deficient. GDP is made up of final goods and services, it follows then that much of Wales’ economic activity is not counted. Steel, tinplate, car engines are not by definition final goods and only appear in a GDP calculation when they become part of final goods – for example as a new car for sale. So this much vaunted gap is not what it seems.

 

The university report is a bold attempt to picture government spending and taxation; it is not an analysis of economic activity or a calculation of Wales GDP. The reality is that any examination of the Welsh economy suffers from a paucity of accurate and reliable data. Almost all economic data which would be of use is actually collected on a UK wide basis; it therefore follows that some form of best estimate is the only way forward. Indeed, this is clearly stated in the Cardiff University report.  

 

Aside from the difficulties of capturing data and the need to use estimates, a careful look at the figures further challenges the poverty argument. Three particular expenditure allocations make interesting reading. A defence cost of £2bn is excessive and some 3% of GDP (more than any other country!), incoming pensioners is a further cost of £2bn (this clearly is a cost to the UK (English) revenue) and there is a £3bn “accounting adjustment” – such a balancing figure is quite normal in such research, but this amount is excessive. This in total amounts to some £7bn, which makes the difference between revenue and expenditure of approximately £6bn, or 10% of GDP, notwithstanding the definitional issues noted above. This deficit is of course still high. Addressing the deficit presents a challenge.

 

Staying with the report that started the current discussion, it is informative to look at differences in taxation; income tax accounts for 25% of revenue in the UK, only 19% in Wales while Corporation Tax accounts for 6% of revenue in the UK but just 4% in Wales – a reflection of the amount of external ownership of businesses active in Wales. The percentage of revenue from National Insurance payments was approximately the same for Wales and the UK.

 

In addressing the deficit the first challenge is to improve the amount of revenue earned from existing taxes. The poor position of income tax relative to the UK is a reflection of low levels of skill and consequent low levels of personal income. National Insurance payments in Wales grew by 12% in the period from 2010. This is interesting since it reflects the concurrent growth in part-time working and low pay. The national insurance threshold is significantly lower than for income tax and means many do not earn enough to reach the latter. Recent research has suggested that anything from 40% to 53% of those in work do not earn enough to pay income tax. This, combined with a less than satisfactory contribution from income and corporation taxes, is a damning indictment of past and present economic policy.

 

The percentage of VAT in Wales is a little more than the UK, which seems a little odd, but this figure should really be treated with caution for two reasons. The first is the University report, although a reasonable estimate, it followed the approach of other research and was not actually based on businesses but on other proxies, such as population. The second is that with the current amount of external business ownership, it is difficult to estimate the amount of VAT actually collected in Wales but which for tax purposes is allocated to the business headquarters outside Wales. This is particularly important because VAT is a substantial source of tax revenue.

 

There are other possible sources of taxation that could be open to a Welsh Treasury. A detailed discussion is outside the context of this article; suffice to say that there are other possible sources of taxation. Take a few examples; for many years the potential revenue from water was at best a guess, now there is hard evidence – in its last annual accounts, Severn Trent reported revenue of £1.5bn. Tourism is apparently worth £2bn to the economy and yet Wales must be the only country in the world with an active tourist industry but no tourist tax. A land value tax is perhaps the most interesting and exciting; some estimates suggest that such a tax might raise some £6bn – this amount may be optimistic and some would accrue to local government, but provides an indication of how much such a tax might yield. Interestingly, the new First Minister appears to be keen on such a tax.

 

In addition to raising funds through taxation, governments also raise revenue through borrowing. Finance is raised by selling Government Bonds that carry an annual interest, a redemption rate and can be denominated in a currency other than the domestic currency. There would certainly be a market for Welsh Government Bonds; bonds of all types and all countries are sought after and seen as safe investments because of their relative security, backed by sovereign countries.

 

In conclusion, a word of caution. Without accurate data any analysis of the Welsh economy must be treated with a degree of uncertainty, although the picture painted by the Cardiff University report of a country in penury is quite clearly overstated.  

 

Nevertheless, in all honesty and when compared to other countries, especially the small nations of Europe, Wales is relatively poor and this needs to be addressed. Wales being a relatively poor country now in such a wealthy part of the world is one of the core arguments for independence.

 

Therein lies the challenge; it doesn’t have to be like this!

 

All articles published on Click on Wales are subject to IWA’s disclaimer.

Dr John Ball is a former lecturer in economics at the School of Management, Swansea University

8 thoughts on “Is Wales really too poor to be independent?

  1. John, what’s your view on Wales becoming a currency-user if it uses the euro, but not a currency-issuer now with the pound, and its effect on its ability to spend on infrastructure/services/etc.?

  2. In reply to Tim Jefferson, below is an extract from the Click on wales article published in December 2017. I hope it is of interest.
    The first is currency. There may well be some longing for the pound sterling or a desire (Brexit notwithstanding) for the Euro or the US dollar; or indeed for a new, separate Welsh currency. Whilst in might be fun to indulge in what name such a new currency would carry, this may be impractical, certainly in the short term. The reality is that there is no reason why, in an independent state, the pound (or for that matter the Euro), could not continue to be used. It is a fallacy to suggest that this is not possible.
    The countries of the British Isles could form a currency union based on the pound. Despite the doubtful arguments of the Better Together campaign during the Scottish referendum, to a great extent such a currency union already exists. The Scottish and Northern Ireland pound, the Isle of Man, the three Channel Islands and British Overseas Territories all of whom to a greater or larger extent issue their own bank notes. The downside – if downside it is – the Bank of England would remain as the Central Bank and thus lender of last resort. In terms of economic stability this would be the best, current option, certainly until any turbulence following independence settles.
    The use of a non-domestic currency is not unusual. Six countries outside the Eurozone use the Euro, nine countries the US dollar and seven countries share the East Caribbean Dollar. If you think about it, the 19 countries using the Euro by definition do not have a domestic currency and ultimately rely on a “foreign” bank (ECB) as lender of last resort.
    There are of course other options. In the absence of a currency union so-called sterlingisation would be an alternative, certainly in the short term. In this scenario the pound would remain the currency but used without the consent of the Bank of England. The major weakness would be no Central Bank to act as lender of last resort and no control over interest rates – although the latter would still apply with a currency union. Interestingly, there is an argument that such an arrangement would work over the longer term, as is the case with some Latin American countries that use the US Dollar. Since there is no lender of last resort, such a system requires discipline from the banks, which need to be more prudent and far less likely to indulge in the reckless activities that led to the crash of 2007/08.
    There is in addition the use of seigniorage, essentially a system where the pound continues to be used on the basis of a “fee” to the Bank of England. Interestingly, the Bank of England’s latest accounts show a seigniorage income for the year of £432million.
    There is of course the option of a new, separate currency. This is not as fanciful as it may seem. Wales would be fully responsible for its own future, policy priorities and choices. Such a system would allow control of both fiscal and monetary policy (instruments fundamental to driving economic growth and heaven knows we need that!), macroeconomic policy, control of inflation and address current deflationary pressures. Many small countries that have emerged over the past century – and for that matter only since the end of empire and the Soviet Union – developed and use their own currencies. In his contribution earlier this year, Mike Hedges pointed to the relative ease with which the former two nations of Czechoslovakia launched their own, separate currencies.
    There will be a need for a new central bank. Since the end of the second world war no fewer than 25 new central banks have been established, many in Europe. The role of a central bank – inter alia – is to set the interest rate and act as a lender of last resort. This latter responsibility of course requires that such a fund be available. Estimating the amount such a fund should hold is not easy; as an example at the time of the Scottish referendum the Governor of the Bank of England suggested that a new, Scottish Central Bank would require an initial fund equivalent to approximately one quarter of Scotland’s GDP. How this figure was arrived at is at best unclear (as indeed were his comments during that campaign). However an equivalent figure for a Welsh Central Bank would be approximately £22 billion.
    Whilst there will be the need for such a fund, it will not of course be required from day one. The existing clearing banks – all of which are required to hold their own reserves – would be required to register as separate, Welsh businesses probably within a Wales Stock Exchange. As subsidiaries of larger banks, these would in any event have the “protection” of the parent bank. This is what happens in other European states.

  3. John Ball’s article discussing whether Wales is too poor to be independent is a mixture of fair points and nonsense.

    He mis-states the concept of GDP. It is not a summation of final goods production but of value added in the production of all goods and services including intermediate ones. The only exceptions are imports and exports which are gross production quantities, including material content.

    There is no great field of economic activity in Wales excluded from national accounting. The main unrecorded activities are criminal: the production and distribution of illegal drugs and prostitution. No doubt welfare would be enhanced if these were legalized, regulated and taxed but doing so would not come near closing the budget deficit.

    Note that estimates of Welsh GVA are made purely on the income side and do include a certain amount of imputation; there are no expenditure estimates of GVA. That means we don’t even know how much of our GVA is exports to England. We certainly do need better statistics but we would have to pay for them. The ONS would leave Newport and we would have to re-staff a Welsh service. Other scale economies in governance would be lost too. We would have to set up departments to raise taxes and administer all surviving forms of social security.

    Defence: we wouldn’t need a standing army but we would require a coastguard and some sort of civil defence provision. I don’t know how much change out of £2b that would leave – some for sure. We would have to pay for our own police but that is included in the deficit figures.

    JB is a rather insouciant about borrowing. The divorce settlement with the U.K. would involve our taking a share of existing UK debt. Servicing that is also in the £13 billion figure but it means we would not start with a clean debt/GDP slate.

    His thoughts on tax, however, are uniformly misleading. Water is a hopeless tax base. What sort of tax rate could you levy – 1 or 2 per cent? On £1.5 billion that’s £30 million, rounding error in a budget of £30 billion. We could tax water exports at a higher rate but very much higher would be regarded as blackmail. England could retaliate in numerous ways: electricity grid, road links to Europe etc. Not a good fight to pick.

    Land tax: this base is already exploited via council tax and business rates – both highly unpopular. The £6 billion, JB mentions involves I believe a land tax at 3 per cent. Council tax averages about 1 per cent of property values. Do the maths and imagine the outcry. Would farmers pay too? Most would be bust. That tax is politically infeasible. Rhys ap Gwilym has proposed it as a replacement for other taxes and accompanied by a reduction in income tax. I think Rhys’ idea goes in the right direction but then goes much too far. But at least he doesn’t argue the tax would produce much additional revenue to the taxes it replaces. Generally, English taxes would put an effective ceiling on what we could levy given how open is our border.

    I am sympathetic to the argument that Wales’ poverty is partly a consequence of colonial status and reverse-agglomeration. The history of the Irish Republic demonstrates what independence can do. There is no question it would give Wales a massive kick up the backside but it would require the initial curtailment of welfare payments and services. The trouble is that independence requires people to want it and to accept those sacrifices. Not much sign of that. After they have experienced the consequences of Brexit they will be even less inclined to political adventures.

    The only potential route towards greater autonomy for Wales is for the devolved government to achieve conspicuous success so making the case for getting more and more powers. So far it has lacked ambition and capacity to build the case for greater autonomy.

  4. Like many other contributors to Click on Wales on whatever the topic relevant to life in Wales, my contributions have been within the spirit of informed discussion and debate – whether readers agree or not. However, for Mr Holtham to resort to insults in describing my article as “nonsense” and “misleading” simply belittles his argument.
    In my article I noted that “ (the deficit)… has been blissfully leapt upon by those who delight in maintaining the myth that Wales is too poor ever to consider becoming a sovereign state – a state of penury will exist.” Q.E.D.
    It is not my intention to use this reply as a crash course on economics, although Mr Holtham might benefit from such a course.
    Turning to the specific points made. GDP is made up of final goods and services, this prevents double counting (for example the steel produced at Port Talbot would be counted first as steel as then as a car); and while it’s deficiencies are well known it is the chosen measure for almost all economies and was the measure used in the Cardiff University report.
    To suggest that “There is no great deal of economic activity in Wales excluded from national accounts” is of course correct and a neat piece of double speak – they are included in the UK accounts as a whole and not separately. Indeed, in more than one section the Cardiff report specifically points to the problem of separate accounts
    “Some taxes (are) relatively straightforward but for others it is quite complex as revenues are not necessarily reported where they are generated and there may be different interpretations on what the underlying activity or how to capture it might be. For example, disaggregated HMRC administrative data is readily available for Capital Gains Tax but arriving at VAT estimates is more complicated as different sources are used for the four sectors that make up VAT receipts. These figures do not represent the distribution of revenue by the location of the tax collecting office.“
    Quite why the ONS would leave Newport is a mystery – like other government departments these would pass to the Welsh government and provide services to England and elsewhere – see my Click on Wales article December 2017. Furthermore, I am at a loss as to why there would be a need to “set up” government departments – they already exist!
    Clearly there are issues with tax and borrowing. Any divorce settlement might well include taking a share of current UK borrowing, but how much would be a matter for settlement at the time; although I for one (and I suspect , many more) question why we should contribute (albeit retrospectively) to nuclear armaments and other England glory spending.
    My thoughts on tax are not “misleading” – insults again! What I have suggested is that, recognising the need to raise taxes in addition to those already collected, that there are innovative sources that should be explored. Quite why we should not tax water exported escapes me; retaliation by England. Really??
    Land tax is worth exploring and can take many forms, not just as a tax on vacant land – depending on the width of the tax it might also include vacant buildings (an idea used successfully in America) or different and potentially more equitable local authority funding . The idea should not simply be dismissed. It could provide an opportunity both to raise taxes (as in a number of other countries) whilst contemporaneously having the added advantage of improving the environment. Quite why “English taxes would put an effective ceiling on (this tax)…” escapes me; it’s the absurd open border argument again.
    There is no question that there are challenges and I’m more than a aware of that. What I have tried to do is to stimulate debate and suggest ideas and potential ways forward.
    Sadly, yet correctly, in the final paragraph Holtham has identified the fundamental weakness – Wales is a colony, and in the words of the late Professor Phil Williams, the challenge is to replace a colonial economy with a national economy. Holtham’s negative approach has simply served to reinforce colonialism.

  5. Nothing is more likely to set back the cause of greater Welsh autonomy than the sort of advocacy that invites disbelief. A realistic view of the difficulties is a precondition for dealing with them and so garnering support . I think Dr Balls and I agree that greater Welsh autonomy would be a good thing. I see the way to achieve it as the hard slog of building the economy and tax base under the present dispensation. He seems to believe we can just raise more taxes to pay for independence.

    “Misleading” was my attempt to be polite in describing Dr Ball’s tax proposals. Taxing water exports to England might provide some psychic satisfaction but it can’t provide significant sums of money. At any reasonable tax rate it cannot provide more than a few tens of millions of pounds. It is misleading to cite that as even a partial solution to a deficit of some £12-13 billion. Land is already taxed in Wales, indirectly, and the taxes are not popular. Much of the land has only low commercial value so this is not an area where a great deal more revenue can be extracted. And as for taxes on moveable or footloose items, of course they are constrained by the level of English taxes. As a peripheral economy, Wales does not have a future as a high-tax economy next to a larger one with lower taxes.

    Perhaps I have misunderstood what Professor Balls means by independent. He seems confident that England would be content to leave government departments or agencies outside the country in another independent state. I believe it would be content for ONS or DVLA etc to remain in Wales under a federal system but I don’t think you can assume that under formal independence.

    I leave it to readers to decide whether the tone of my original comment was appropriate and whether that of Dr Balls’ reply is an improvement.

  6. I am grateful for Mr Holtham’s further comments.
    Strangely enough there seems to be agreement here, in some ways at least.
    He is correct in his assertion that hard slog is needed in building the economy and tax base in the present circumstances. Indeed, in fairness in his original response he does make reference to the lack of ambition by the present administration; it is a telling indictment that after two decades of devolution, Wales is one of the poorest nations in Europe.
    However, I think a re-emphasis is required. I have suggested that which might be possible in an independent state. What started this current debate is the Click on Wales article by Mike Hedges that rightly called for a full understanding of the issues and possibilities before any referendum.
    I am under no illusions, it will not be easy, yet when I look at the small nations of Europe I am envious and angry. Why not us?
    The late Senator Bobby Kennedy sums up my approach and should be perhaps the watchword for those who are excited by the prospect of an independent state, whatever the challenges.
    “Some men dream of things that have been and say why, I dream of things that have never been, and say why not?”

Comments are closed.

Also within Politics and Policy