The Squeeze, the Curse, and the Silence of the Economists

"Serious intellectual analysis of Scotland as an oil-rich economy has never taken place"(e-mail from retired Professor of Economics)

(1) The Background

It is not difficult to establish that there is significant interest in the economy of Scotland, and that this interest is long standing and deep. Numerous articles and books have been written on it, government departments and whole academic careers devoted to it. The press is full of articles and analyses on the subject which deals with the subject directly and indirectly.

What is less obvious is how badly biased and distorted the policy agenda (and subsequent debate) on this subject has been. The distortion and bias predates the creation of the new Scottish Parliament in 1999, but it is a distortion that has been maintained, and in some respects increased, by the administration that formed the Scottish Executive in the frst two parliaments, 1999-2007. Unfortunately, the distortion has also been reflected in activity and economic analysis conducted by universities and in the media.

I will discuss this with respect to two phenomena which, while quite different, have potentially serious and damaging implications for the Scottish economy. The first is the Barnett Squeeze which is a consequence of the Barnett Formula, and is a convention for allocating public funds to Scotland which has policy implications. The second is the Resource Curse which is a naturally occurring phenomenon which also has serious policy implications for Scotland. In the case of the Barnett Squeeze (henceforth referred to as the Squeeze), debate has effectively never been conducted on a proper footing in Scotland. In the case of the Resource Curse (henceforth referred to as the Curse) it has only been publicly recognised as a possible issue in the last few months.

While I will take the treatment (or lack of treatment) of the Squeeze and the Curse as illustrative of systematic bias in the policy agenda for the analysis of the Scottish economy, these are regarded here as indicative cases and does not preclude more widespread biases in associated and unrelated areas of economic research as far as Scottish economic policy analysis and formulation is concerned.

A short explanation may help in both cases. For more than two decades, the Barnett Formula has been part of the mechanism for determining the budget of the Scottish Office/Executive. It only applies to parts of the budgets (not, for example, Social Security) and ensures that, where applicable, changes to programmes in England result in equivalent changes in the Scottish allocation calculated on the basis of population shares. The Squeeze occurs because the Scottish budget is increased by the same absolute amount as England (not same percentage amount) per head in cases where it is applicable; and because Scottish public spending per head was traditionally higher than in England (for reasons that included economic, social and geographical factors). It means that the same absolute increase per head in England and Scotland translates as a lower percentage increase per head in Scotland compared to England.

In an article in 1998 I wrote;.

For example, if public spending is increased by 4% in England and Wales, the higher base for Scottish public spending levels means that Barnett translates this into a percentage increase in Scottish spending of about 3%. … there are two problems with this situation. The first is inflation. Typically most public spending increases are to cope with the effects of rising prices. Suppose public spending is increased in England by 4% to deal with an inflation rate of 4%. The increase in public spending down south would just compensate for the effects of rising prices, but Barnett would convert the English settlements into a real decline of 1% in the Scottish Block … The second particular problem is time. The difference between, say, a 3% and a 4% increase may be tolerable as a one-off, but the Barnett formula implies a continuing squeeze on Scots public spending … (The Scottish Parliament and the Barnett formula, in Quarterly Economic Commentary, 24, no 1, 1998, 32-48).

A serious issue worthy of policy consideration? One would think so.

I will return to this in a moment, but first here is a brief explanation of the Resource Curse and why it might be important. I submitted an invited Commentary on the Resource Curse to a January 2007 meeting of the Parliament's Finance Committee (See as part of the enclosed papers here). In it I noted that the "Curse" is the apparent paradox that countries (and also importantly for Scotland, regions and states within countries) with a windfall "blessing" of natural resources tend to grow more slowly than countries (and regions and states) without these natural resources. There is strong empirical support for its existence, and its dangers have been acknowledged by many national governments and pan-national organisations such as the IMF and UN. The Harvard economists Sachs and Warner argue that one possible explanation is that increasing demand for inputs from the natural resource sector can drive up input costs and wages, squeezing profits of (and crowding out) growth-generating traded activities such as manufacturing that compete with the natural resource sector for these same inputs. The crowding out of manufacturing then puts the squeeze on the growth process.

So another potentially serious issue worthy of policy consideration? Again, one would think so.

Now we have the Barnett Formula potentially squeezing Scottish funds for public spending, and the Resource Curse potentially squeezing Scottish growth. Call me old fashioned, but I would feel anyone responsible for Scottish economic policy would at least feel they also had a responsibility to be interested in (and concerned about) these two phenomena.

In the next section I will briefly summarise what has happened to the public debate (or non-debate) on both of these issues.

But first, consider some possible implications for policy arising from the Squeeze and the Curse.

As far as the Squeeze is concerned, it would tend to give the lie to claims that the Barnett Formula is protecting Scottish public spending (irrespective of the legitimate but separate debate as to whether or not you believe current levels are necessary or desirable). Over time, the formula should drive Scottish public spending per head in the areas to which it applies towards convergence with English levels, with no considerations of any specific needs or special circumstances relating to the Scottish case. Clearly, this could have serious implications for Scottish economic policy and raises the issue that the Scottish Executive has no direct control over the convention (the Barnett Formula) that is driving the Squeeze.

As far as the Curse is concerned, while it also could have serious implications for Scottish economic policy, the good news is that there are well established policy tools for dealing with it (such as taxing the natural resource to produce a fund for future generations once the resource has been exhausted). The bad news is that such policy tools generally require powers that are reserved to Westminster. This again raises the issue that the Scottish Executive has little or no power to formulate policies to counter any adverse effects in this area.

In short, any public debate or analysis on either the Squeeze and the Curse would effectively highlight the weakness of the Scottish Executive as far as dealing with their potentially adverse consequences is concerned. It is in this context that we look at how these issues have been treated for public policy purposes in Scotland.

(2) The Debates - or the Lack of Them

I will look at both issues in turn

The Non-Debate on the Barnett Squeeze

I have been wrongly credited in the past (most recently in the January 2007 Finance Committee meeting referred to above) as having invented the phrase "Barnett Squeeze" in my 1998 Fraser Commentary paper (also referred to above). In fact, as far as I know, it was first used by Jim Cuthbert (former Chief Statistician in the Scotttish Office) in an SNP publication "The implications of the Barnett formula". Saltire Paper No. 1, J. Cuthbert (1998). Jim Cuthbert and his wife Margaret have continued to be a remarkable source of expertise analysing the Scottish economy both before and after the creation of the new Scottish parliament. Over the years they have produced more important insights and detailed criticisms than might be expected from a team of experts. However, there is little evidence that the previous Executive recognised the real contributions they could make in this context - though in the light of the analysis below, perhaps they did, which makes the relative neglect of their work more explicable but even more unforgivable.

I had presumed that once the facts about the Barnett Squeeze had been laid out in public, it would lead to a constructive public debate on the issues. I could not have been more wrong. Arthur Midwinter, a former professor of political science then argued in the press I was mistaken and that the Barnett Squeeze simply did not exist.

I found this point of view difficult to give any credit to. There were special features that could lead (and had led) to the formula being overridden in the past, but these days were largely gone. The Barnett Squeeze was a real issue with serious implications for economic policy.

I knew that there were many economists in university departments around Scotland who should be aware of the implications of the Barnett Formula (and the implied Squeeze) and I contacted all or most of them. Without exception, they agreed I was right and Arthur Midwinter was wrong (in fact, I could not find any economist to agree with him). But not one would go into print to say so.

To its credit, the economics research community in Scotland has looked at the possibility of the Barnett Squeeze and its implications in recent year. Amongst others, there is important work by David Bell (who demonstrated significant effects from the Squeeze) and economists linked to the Fraser of Allander (who predicted a significant contractionary effect on the Scottish economy attributable to the effects of the Formula). And Professor Brian Ashcroft noted at the January meeting of the Finance Committee referred to above that "what is happening to the spend on health and education is an indication of what Neil Kay and others have called the Barnett squeeze. Clearly, Barnett is biting on the spend in those areas and we can make the comparisons" (at this point, in the context of the discussion below, it is important to acknowledge the important job that Brian Ashcroft has played down the years - often in a very difficult political environment - in making sure that the Fraser Commentary continues to be a source of balanced and diverse economic analysis).

So one would expect that the Barnett Squeeze would have entered centre stage into public debate and its dangers well recognised? Well, hardly.

In 2000, the Scottish Parliament produced a Research Note on the Barnett Formula which is still on its website today. In my view it is an extremely poor and inadequate briefing note on such an important issue, with the debate over the Barnett Squeeze largely reduced to the level of a disagreement between Midwinter and me, with the former producing straw men which were not, and should not be, any part of a wider economic policy debate. The reality, even by then, amongst economists who had looked at the issues seriously, was that there was general - I would even say universal - agreement that the Barnett Squeeze was a real phenomenon which posed serious public policy issues for Scotland.

What makes the inadequacy of the briefing given by the Research Note on the Holyrood website even more striking is that its Westminster counterpart in 2001 published its own Research note on the formula which not only treated the Barnett Squeeze seriously, but showed how it could impact, basing its analysis on work by Professor David Bell (though the discussion on the long time span to eventual convergence in that document is a bit of a red herring in that the major effects of the Squeeze would be felt in a much more immediate time horizon).

During the first session of the new Parliament, Arthur Midwinter was appointed its adviser to the Finance committee. This had several significant effects.

First, it put him in an important gatekeeper role. If your adviser says in parliament; "you will forgive my scepticism over the Barnett squeeze, which I regard as theoretical, not real" , then it is difficult to ignore him.

Second, it gave an important platform to assure the press what most of them were inclined to hear - there was no such thing as the Barnett Squeeze.

Third, it gave him a platform from which to dismiss economics and economists. In February this year, he commented, "I am not an economist, and have no wish to be described as one. Economics has too much abstract theorising for my taste". But if the Finance Committee is anything, it is an economics committee. To be an adviser to a governmental Finance Committee you should acknowledge the relevance of economics to the matters you will be dealing with, for example the Barnett Squeeze involves such economic issues as inflation, growth, public sector spending etc. For a finance adviser to dismiss economics in this context it is a bit like a medical adviser dismissing biology. One would hardly expect to hear an adviser to Gordon Brown (who has been the UK's Finance Minister over the past ten years) comment that "economics is too abstract for my taste". He/she (or Gordon Brown) would be laughed out of court. It is reflection of how impoverished the debate has become in Scotland in recent years that Midwinter's insults passed virtually without comment.

His dismissal of economics in general also typically extended to economists who disagreed with him on the Barnett Squeeze (which, as I have noted, basically means just about any economist who has looked at the issue). You can read how Midwinter pours scorn on respected economists who point out the implications of the Barnett squeeze here describing their arguments as "unrealistic...misleading ... irrelevant", and insulting five economists (including two senior professors) who are conducting serious ESRC-funded research which had already been subjected to significant peer review and comment (unlike his own criticisms). In response to Professor David Bell's warnings about the seriousness of the Barnett Squeeze, he dismisses such arguments as "extremely silly". And not long after my own submission to the Finance Committee of Parliament this year he said "(Neil Kay's) regular interventions in letter columns on this topic are clearly driven by his politics, not his professional interests", a contemptible remark given all my arguments in this context were based on solid economic arguments and evidence.

I am not questioning Arthur Midwinter's sincerity in his ridiculing of the existence of a Barnett Squeeze, or his competence in his chosen area of expertise. Nor can I query his consistency. He has not wavered in his contention that the Barnett Squeeze is not a real phenomenon. Nor do I award him more importance than he deserves in this context. Of course one single person could never have such an effect by himself. He could only have such influence if it suited the purpose of those who were promoting his position and ideas - which largely meant the then Executive, aided by the press.

Given the way that serious academic work and serious academics have been treated here, it is no wonder I found it impossible to get public support for my argument that Midwinter was wrong on the Barnett Squeeze all these years ago. Academic work is difficult enough without also exposing yourself needlessly to the risk of public humiliation, especially when it is unjustified. If the type of criticism that Midwinter has made of several of my colleagues - and me - were taken seriously by peers, university heads, and those who sit on grant awarding bodies, they would be career-damaging. Is it any wonder in those circumstances that most economists chose to remain silent on the issues?

It is ironic that it is often argued that economists advice can be ignored because they disagree. Here is a case where they are ignored despite (or perhaps because) they all agree.

The conclusion on the Barnett Squeeze? It is a major policy issue for Scotland, and economists are generally agreed it is a serious issue. And as far as the Executive and the press are concerned? Either it does not exist, or the jury is still out on it. A master class in how to bury bad news and a shameful distortion of what is one of the key public policy issues facing Scotland in the future.

The Non-Debate on the Resource Curse

The Resource Curse raises parallel issues of potential distortion of the economic agenda as it relates to public policy. In November 2006, I was phoned by an SNP parliamentarian to ask if I would give evidence to Finance Committee on GERS (Government Expenditure and Revenue in Scotland statistical series). I agreed and started by looking at the trends and found that tax from Scottish sources as a percentage of UK had dramatically fallen in recent years. It was not immediately obvious why that should be the case, but one possible culprit was the low growth of the Scottish economy. But this raised the further issue that Scotland was an oil-rich economy, so why should it be suffering low growth at all?

Up to now I had always relied on secondary sources for analysis of the determinants of Scottish growth, but when I started looking as the issue myself, I very quickly came up against a striking and well documented phenomenon - the Resource Curse..

Try this at home;

First Google "Resource Curse" and you will find that the number of web pages found explodes with about 139,000 recorded (7th June 2007). As I noted in my Finance Committee submission, the Resource Curse has been a source of real concern in many countries and regions across the world.

Now Google "Resource Curse" +Scotland

Only 639 web pages found, the top three to my own work on this, and after that the fact that "Scotland" appears in the documents brought up by the search typically has no direct relation to the Resource Curse issue. The Resource Curse may have been a source of real concern in many countries and regions across the world - but not in Scotland.

I prepared my submission to Finance Committee and submitted it both written and orally to the committee in January.

However, after I gave my presentation, one issue began to worry me. It had not been difficult for me to find the evidence and arguments on the Resource Curse. Indeed, any well trained economist provided with access to a library or the Internet and asking the same questions as me would quickly have come up a similar analysis. As I noted in my submission, "An economist from Mars, knowing all about the Resource Curse but nothing about Scotland, would not be surprised by news of the poor performance of the Scottish economy and its contingent tax revenues following the windfall of North Sea oil".

So why had no-one else pointed this out before I did? I could not believe that I was the first to make the Resource Curse connection in the context of Scotland.

Economic colleagues who read my Note on the Resource Curse generally agreed here was something important that should be studied further. One colleague passed it on to a mutual friend who was also a retired professor of economics who had been involved in research in the Scottish economy.

He e-mailed (correctly) that one reason for the neglect of the Resource Curse in the Scottish context was that it had at first been thought of as primarily or solely a macroeconomic phenomenon, impinging mainly at UK and not disproportionately at regional level. Then he commented;

"....In Scotland specifically, the (Resource Curse) agenda quickly became embroiled in political debates about "Scotland's Oil" etc. Academics felt it was not very fruitful, and could even be career-damaging, to become involved in all this. This was and is unfortunate, since it means serious intellectual analysis of Scotland as an oil-rich economy has never taken place"

What an indictment. Years of wasted opportunities and a legacy of distorted economic analysis. Indeed, since much economic research is grant-funded, it is not surprising that even those who would be aware of the potential significance of the Resource Curse stayed silent. Even if they were prepared to do the (potentially career-damaging) research, they would know that research applications to find evidence for these effects would have a high chance of rejection from the then Scottish Executive, so why waste time and ink trying? And of course subsequently, in the absence of research on the issue, critics could says there was no evidence on the issue......

Despite the difficulties and obvious barriers, I felt it important to get the Resource Curse into the public domain, beyond the rather limited confines of a background paper for a parliamentary committee. This was as I expected, not just difficult but almost impossible. Indeed, I could not even raise the courtesy of a response or even an acknowledgment from the deputy editor of the Herald, whose brief suggested he should be at least interested in these matters, despite several e-mails and telephone messages to him.

Then towards the end of March the Scotsman carried an article by Peter Jones reporting my analysis on the Resource Curse, though he rather neutralised its impact by stating he "didn't think that it demands new policies, rather the "resource curse" seems to reinforce the argument for policies which so far have only been patchily implemented by the Labour-Liberal Democrat Executive"

That certainly was not my conclusion, nor I think it is fair to say would it be the conclusion justified by looking at actual policies implemented or advocated with respect to the Resource Curse by governments around the world. I did get a short piece under my on name in the Scotsman soon after, but as for the rest, just silence.

Indeed, silence was the main point of a letter which I wrote around that time, just before the Holyrood election and in which I concluded; "...The silence of the economists is one of the most under-reported yet most serious deficiencies in what could be the most important debate on Scotland's future in years".

(3) In Summary - the Non-Debates

The Squeeze and the Curse are quite different phenomena, but they share similar characteristics. They both follow from features that are likely to have been affecting Scotland for many years. Economists who have looked at both cases generally agree there are serious issues here. The Squeeze and the Curse both raise the prospect of serious long term issues for the formulation of economic policy in Scotland. Dealing with both issues generally involves policies (and possibly changing policies) that are reserved to Whitehall. And as far as the administration that formed the Scottish Executive 1999-2007 was concerned, there was simply no recognition of there being a problem in either case.

There is a further characteristic that joins both issues together. They first were brought into the public domain by actions taken by the SNP - the publication of Jim Cuthberts Saltire paper in the case of the Barnet Formula in 1998, and the invitation to me from the SNP parliamentarian in 2006 to submit evidence to the Finance Committee. This might be seen to be the credit of the SNP, and I have no doubt it is. But it raises a much deeper question. Why should it have been left to an opposition party, with limited resources, to have been the catalyst for the subsequent airing of the potential importance of these two issues for the Scottish economy?

That question is the one that will hang in the air after all the substantive arguments about the Squeeze and the Curse have been aired. We have had an economic research and policy agenda that has been constrained and distorted over the past several years, by an administration content to accept these biases in order to avoid awkward questions that might ultimately raise further questions about the devolution settlement and possible inherent weaknesses in it. In turn, these constraints and biases were subjected to little scrutiny by an (in this context) compliant press, while academics who were not coaxed or cowed into compliance were made vulnerable to insults and ridicule. An exaggeration? Then perhaps it is worth reading this blog a second time.

It is in this context that the new Executive will have to change economic policy making in Scotland. It will not be easy. Whole generations of politicians, civil servants, journalists and academics have been trained to avoid, reject or suppress whole issues of real and crucial significance to the future of the Scottish economy. Even those who had no particular vested interest will have been affected by this climate and the surrounding belief system, albeit unconsciously. And as I noted at the beginning here, the Curse and the Squeeze are regarded here as indicative cases and this does not preclude more widespread biases in associated and unrelated areas of economic research as far as Scottish economic policy analysis and formulation is concerned.

Changing the agenda will be the easy bit. Changing attitudes, prejudices and beliefs that have built up over many years (especially among civil servants) is going to be much harder. But as might also be said about the Squeeze and the Curse, in order to solve a problem, you first have to recognise that it exists. It is clear from statements members of the SNP made in opposition that the new Executive certainly recognises many of the problems I mention here. Dealing with these problems is going to be much harder.

Neil Kay, 8th June 2007