Without taking into account the geographic shares of oil and gas the Scottish economy comes across as extremely weak. But once we include the geographic share of oil the Scottish economy comes across as one of the strongest in Europe.
Yesterday the Scottish government released an experimental data series estimating the amount of oil and gas exports and imports coming out of and into the country. By combining this new dataset with other datasets that have been published -- namely, the quarterly national accounts and the estimates of public sector revenues -- we can form a relatively complete picture of the Scottish macroeconomy.
The best way to see the overall macroeconomy is through the lens of the sectoral balances approach as pioneered by the great British economists Lord Nicholas Kaldor and Wynne Godley. The sectoral balances show what each sector is contributing to the economy at large. It is a basic accounting identity that shows how one sector's surplus is another sector's deficit and vice versa (a more thorough breakdown of the framework can be found here while a less technical discussion can be found here).
The simple intuition lying behind the sectoral balances framework is that if one sector is net spending another sector is receiving income and net saving. This framework can tell us a lot about the structure of the macroeconomy. For example, prior to the 2008 financial crisis many countries had large private sector deficits. This led to instability in these economies as the debts accumulated by firms and households became too large.
Likewise, in the wake of the crisis many countries today have very large public sector deficits. These allow the private sector, by accounting identity, to net save, deleverage and draw down debt.
Here we will lay out two different sectoral balances for Scotland. One will show the sectoral balances for Scotland if the geographical oil and gas exports are included. The other will show the sectoral balances for Scotland if the geographical oil and gas exports are excluded. What we see when we examine these is two very different macroeconomic pictures. Here are the graphs.
As we can see, in the first chart -- the one which includes the geographic share of oil and gas exports -- we see a very robust economic picture. The private sector in Scotland is in a healthy position of large net savings -- implying very strong balance sheets and a low level of net private sector debt. Meanwhile the government does not have very large deficits -- an unusual situation in a world where, since 2008, public sector deficits of upwards of 8-10% have become the norm.
The reason for this healthy economic picture is the large amount of oil and gas exports. These ensure healthy trade surpluses which provide an inflow of income into the country and buttress Scottish saving.
When we take the geographic share of oil and gas out, however, we get a very different picture. In the second graph it is clear that Scotland is, apart from oil and gas, a country with a very large trade deficit -- this deficit is about twice the size of the otherwise large British and American trade deficits. In addition to this, when you remove the revenue generated from oil and gas the public sector also tends to run enormous deficits.
The net result is that private sector balances sheets look far more precarious. The private sector basically relies on enormous public sector deficits for its rather meager net saving position. It is easy to imagine how, if a Scottish government denied of its oil and gas revenues (which, by the way, are extremely volatile due to price and quantity fluctuations) ever tried to engage in austerity to reduce the size of its public sector deficits the economic contraction would be enormous.
We can also see from the above graph that if Scotland ever issued its own currency and did not have access to its geographic share of oil and gas the currency would likely collapse under the weight of enormous public sector deficits and trade deficits.
There are a lot of lessons contained in the above two charts and we have only begun to hint at them here. But the easiest takeaway from these graphs is that there are indeed two Scotlands. One Scotland, the Scotland with its geographic share of oil and gas, is rich and stable with high savings rates. The other Scotland, the Scotland with no oil and gas, is poor and would be prone to macroeconomic instability due to its large public sector deficits and trade deficits.
If Scotland does decide to shoot for independence come September of this year it had better have access to its geographic share of oil and gas. And even in such a circumstance the country will require a robust and flexible macroeconomic framework in place to ensure stability when volatility is inevitably encountered in the oil and gas market.
Update 14/02/2014: There have been some questions regarding just how Scotland's macroeconomy might respond to oil and gas fluctuations. In a post today we lay out the relevant statistics.
Note on sources: Despite enormous and valiant efforts on the part of the Scottish government and its statisticians, Scottish economic statistics are only in their most primitive phase. While the data seems so far robust it is presently only available for limited periods and for limited sectors. For this reason the above private sector balances are derived from the published trade and public sector statistics as they do not currently have an independent existence.