Thursday, 12 November 2015

FFA For Dummies Methodology

I'm delighted that more and more people who are avowedly committed to the Yes cause - who believe that Scotland should definitely be independent no matter what the economic implications - are starting to actually engage with what those economic implications might be.

As a result there have been two questions raised about the methodology I used in Full Fiscal Autonomy for Dummies (and more generally when comparing Scottish and rest of UK economic statistics). These are good questions, so I think its worth answering them.

1. The use of per capita comparisons instead of %age GDP comparisons

Quoting figures on a per capita basis (or as Alex Salmond used to delight in saying "for every man, woman and child in Scotland") is common practice  - people can relate to the idea of their own personal contribution, to their own pay-packet.

Oil tax revenues are notoriously volatile (that's kind of the point) and so Scotland's GDP is itself volatile.  If (for example) we look at a time-series of public expenditure as a %age of GDP it is harder to interpret than public spend per capita (e.g. has it gone down as a %age of GDP because it's gone down in total or because GDP has gone up?).

Similarly if we want to disaggregate the contribution of Oil & Gas Tax revenues from other (aka Onshore) Tax revenue, which GDP number do we use as the denominator? We could include Oil & Gas in the GDP in both cases or indeed if we could include it in one but not the other - either way it becomes harder to understand what is causing observed fluctuations.

Finally, the Scottish Government's preferred allocation methodology for nationally shared costs (debt interest, defence expenditure etc.) is on a per capita basis. When the indyref was in full flow there was broad agreement that (were it to happen) debt allocation would take place on a per capita basis. Given that (up until about now) Scottish GDP/Capita has been higher than the UK average for many years, it goes without saying that if you allocated these costs on a GDP share basis Scotland would appear worse off.

So, given my objective was to drill down and explain how the Scottish Economy differed from the rest of the UK, it made sense to use a per capita basis. That the resulting graph (see below) showed such a remarkably stable picture of onshore revenues difference and public expenditure difference per capita kind of proves my point: this is an enlightening way to look at the data.


2. The use of UK or "rest of UK" (rUK) for comparison

I do all of my analysis comparing Scotland to rUK (where rUK is the UK excluding Scotland). As with any good analysis there isn't a right and wrong answer here - it depends what you are using the figures for, how you interpret them.

The Nationalists delight in making the debate about us and them - although  "we contribute more than them" is heard rather more often "we get more spent on us" (and even the former won't be heard now oil has all but disappeared as a tax revenue generator). In that context it makes sense that "us" is Scotland and "them" is rUK, If the debate is about how much we pull our weight (the extent to which we give or receive more) within the UK then it makes sense to compare Scotland versus rUK.

If you're asking "what would the difference be for the Scottish population between Scotland standing alone and remaining fully pooled and shared within the UK" then it makes sense to compare Scotland with total UK (with us in it).

If we're looking at Full Fiscal Autonomy (as the blog post I'm referring to does) then we need to understand what it would take for Scotland not to be dilutive to the UK economy (for the rest of the UK not to be subsidising us indirectly through supporting the shared currency). In this case it's appropriate again to look at Scotland vs rUK.

It depends what you are using the analysis for.

One of the more bizarre suggestions is that I chose this methodology to make Scotland look worse - given that it makes Scotland look better in terms of relative tax contribution (and when we're a net contributor)  that accusation makes no sense at all.


Conclusion

I hope the merit of the Full Fiscal Autonomy for Dummies blog post is that by sticking to a single definition for comparison purposes (per capita and vs rUK) we can walk all the way through the figures understanding them in a way which is consistent with the language of the debate. It provides a clear and easy to follow explanation.

I stand by my position that for Full Fiscal Autonomy analysis it is correct to use Scotland vs rUK and that it is simpler to understand the figures and the debate in terms of per capita figures. I'm very clear about my definitions and the deficit gap I'm identifying is identified on a per capita basis.

I happen to agree that it's better to define the deficit gap on a %age GDP basis, but it's harder to create a consistent numerical narrative if you do the analysis in that way - for the reasons I explain above. What matters of course is what difference would it make?

This is why I'm so pleased that devoted Nationalists are engaging with this question.  If they would rather define the deficit gap on a %age GDP basis then they really should.  It would make a big difference if our GDP/capita was hugely different from the rest of the UK, but it's not. That's why some of the more wild-eyed cybernats have to use illustrations pretending we're like mexico versus the USA or that our population might be boosted by zombies who wouldn't impact our GDP or spending (yes, really).

If they want to talk about the "independence difference" rather than the "FFA Challenge" (although I still don't think many of them have understood this subtlety) then they should do the analysis versus UK instead or versus rUK.

I keep challenging them to do this with the real numbers (as opposed to some they've made up)

  1. Recreate the graphs below using %GDP and vs UK
  2. Tell us what the resultant onshore deficit gap is on that basis


I've shown the second graph on a %age GDP basis in my blog - see if you think it makes a difference to the narrative



I can guarantee you they've done this and discovered that
  • It's hard to get a clear picture on the first graph because of denominator volatility (so in trying to draw that graph they'll understand why I chose the definitions I did)
  • The resultant onshore deficit gap is a figure they can't (yet) bring themselves to say in public (I'm keen they work this number out for themselves - but they could just look at the IFS analysis and adjust out the oil)

As with my previous blog: I applaud their engagement with the analysis. It's a good thing.



** Addendum **

I have given up waiting for those who challenge the methodology I used to re-run the analysis on a %age GDP and vs Total UK basis so I've done it and decided to post it here. This way people can see why they're so reluctant to do it.

Remember we're looking at the Onshore deficit gap (i.e. the difference between Scottish and UK economies if there was no oil tax revenue) so that we can see what the underlying gap is. This gap has in the past sometimes been filled to over-flowing with oil, but given how bleak the oil outlook is now it would likely need to be filled with tax rises or spending reductions (or - for as long as it would be sustainable - greater borrowing).  The view as to how necessary it would be to close this gap varies depending on your perspective: if we were Fully Fiscally Autonomous the rest of the UK would require us to close the gap to avoid the rest of the UK subsidising us by supporting our shared currency (see Eurozone).  If we were independent we might choose to simply run a higher deficit and build up yet more debt - but by any measure if we don't close the gap we'd be worse off.

So let's plot the deficit gap over time using the two alternative methods. For the per cap / rUK method this is effectively a plot of the gap between the red and green lines in the graph above.




As I've argued throughout - the methodological difference is very small. Hardly surprising given our onshore GDP/Capita is so similar and we represent under 10% of the UK.

For the record, the 15 year average onshore deficit gap in real terms is:

  • Per cap / rUK Basis (Chokkablog Full Fiscal Autonomy For Dummies Method): £9.1bn
  • % GDP / UK method (arguably better for Independence option analysis): £8.6bn

As you can see the lines actually converge in more recent years: the last 5 year averages are £9.0bn and £8.8bn respectively.  I think we can safely say that the Onshore deficit gap is stable at around £8.5 - 9.0bn (I've consistently argued for +/- £0.5bn on these figures anyway).

Let me repeat here for the avoidance of doubt: were we to be independent or fiscally autonomous we would not expect this gap to remain the same.  The gap is a function of being in the UK, sharing a tax system (and currency), generating slightly less onshore tax and having a lot more spent on public services (as UK Pooling & Sharing allows).

What this analysis shows us is: to not be worse off than we are now (at least from a net fiscal balance perspective) we'd need to find £8.5 - 9bn from some combination of N Sea revenues, higher tax rates, higher economic growth and/or public spending cuts.

This analysis is simply a guide to scale, it gives us a clear indication of the size of the challenge we'd face, it tells us broadly what we'd need to believe for separation or Fiscal Autonomy to make economic sense.

To help put this £8.5 - 9bn in perspective:
  • The last time oil was at $99/bbl (in 2014) we generated only £2.6bn of tax revenues - and tax rates and N Sea profitability have declined since then.
  • The total defence budget allocated to Scotland in the most recent figures was £3.0bn
  • Our total  education and training spend in the most recent figures was £7.6bn
I understand why committed separatists would rather talk about theoretical examples involving Snow White and Zombies (yes really) or why they'd rather play with numbers for Mexico and the USA (don't ask me). But the harsh truth is these number represent the best understanding we have of our economic situation and they expose very clearly what many of us were saying all along: oil was never a bonus, it was the bedrock of the economic case for Independence.  Without that oil, there is no economic case for independence.

For absolute Completeness Here's the Fully Audit-Trailed Data Set for vs UK Figures









22 comments:

Sheumais said...

So that's why Sturgeon's so eager to embrace asylum seekers/migrants, increase the headcount and you reduce the debt per head.

Yes, I am joking.

Andrew Morrison said...


A few quick comments just now from this wild-eyed cybernat:

1 - Your point that the error on the expenditure side is compensated by making the same error on the income side is valid provided they are of roughly the same size. Once you 'disappear' the oil that no longer holds.

2 - The 2 bar charts might look superficially similar. Look closely and there are important differences - most obvious from 2006 onwards. You can't tell me that these are insignificant.

3 - I'm quite happy to model a more realistic and formal illustration of why GDP per capita is a misleading metric - no zombies. It will take me longer and be harder to grasp intuitively but it will show the same conclusion.

More to come when time allows - especially on the difference between FFA and Independence and Snow White's situation.

Craigie Watson said...

Not strictly an answer to this, more of a side thought.
If the referendum had gone the other way but the oil price had plummeted in the way that it has, would the more suspicious individuals have assumed that rUK had engineered the price drop out of vitriol?
The price drop, as it has gone, is far beyond the ability of one state to manipulate (up or down). But my feeling is that for all the "Britain has had it's day" quotes that we continue to see on social media, under those circumstances the more gullible Yes supporters would have been able to imagine the rUK actually having that ability.

rocoham said...

Seems clear enough to me. I reckon there's a different bone to pick with GERS figures, namely that they put forward a relatively simplistic disaggregation of Scotland's public finances from the UK as a whole. The parts of the overall UK picture which apply wholly or in part to Scotland are ring-fenced and those "become" the picture of public finances for an independent Scotland. So far so "GERS doesn't paint an accurate picture of what an independent Scotland might do (which without question would be better)". Perhaps, but on the other hand, what is missing (and outside GERS' remit really) is any assessment of how these figures are currently valid only *because* Scotland is part of the UK. Absent AFAIK is quantification of latent benefits such as cost of borrowing, absence of borders and tariffs, single currency with largest export market and shared BoLR, unified tax regime, and any of the other pooling and sharing factors which create economies of scale and reduce volatility and exposure. The calculations are well beyond me (I must check if the Cuthberts have anything to say), but I suspect there's quite a sizeable cost mark-up to be applied to the GERS balance sheet if independence happens.

theambler said...

Okay, it is apparent that the %GDP graph paints a less gloomy picture for Scotland. Your critics have a fair point there. The problem is, it is still very gloomy and does not change the substance of your argument.

Kevin Hague said...

Andrew Morrison

1. "Your point that the error on the expenditure side is compensated by making the same error on the income side" - I don't make that point, I've no idea what you're talking about

2. I agree they're different - mainly because of denominator volatility - which is a point you stubbornly refuse to grasp - it means oil affects both the top and the bottom of the equation hence magnifies it's effect.

3. You need to come up with a number: what do you think the onshore deficit gap is? "Onshore" in this context means excluding the effect of North Sea oil & gas tax revenues.

You will note that when the analysis is carried out for 2015/16 it is pretty much inevitable the case that doing the analysis on a %age GDP basis will look worse than on a per capita basis - but the difficulties I've outline above remain viz: explain to the layman how much more spending we receive as a %age of GDP and tell me that figure is anything he can relate to ... tell me why the Yes campaign banged on about the higher tax per capita that Scots have paid over the last 15 years (see my link to Salmond quote search in this blog); surely that's an exaggeration because our tax as %age of GDP wouldn't have been as much higher?).

You're dancing on a pin-head here as you will see if you ever have the courage to produce your onshore deficit gap figure.

Andrew Morrison said...


Firstly, a quick correction to my earlier post - it should of course say that 'deficit per capita' is a misleading metric.

1 - I apologise if you didn't say this. It was my interpretation of the italicized sentence before the conclusion.

2 - Partly because of denominator volatility. Mostly because of denominator size.

3 - What time period did you have in mind?

Incidentally the concept of a fixed 'onshore deficit gap' looks quite different through the prism of creative destruction. Maybe one for another time.

If the use of percentage of GDP to compare deficits becomes unfavourable to the Yes argument, I can assure you that I will still insist that it is the correct measure.

I agree that for communication purposes 'per capita' explanations work better. For analysis purposes, they do not.

Kevin Hague said...

Andrew

As you seem so reluctant to do the analysis I've done it for you (see addendum above) - as I've argued throughout, the methodological
difference is in the noise and the communication advantage of per capita is therefore justified.

I know you hate graphs, but they sometimes illustrate a point rather well, don't you agree?

rocoham said...

Thanks for the addendum Kevin. Unless Andrew comes up with some substantially different workings (tbc) it makes the case that however one chooses to play the numbers, an independent Scotland would be starting life with a thumping great year-on-year deficit to manage. As you say, there are only so many ways to address that deficit and most of them involve tough political decisions like raising taxes or/and cutting public expenditure, which so far the SNP have been trying not to talk (or probably even think) about. Let's hope their feet get held to the fire sooner rather than later, because this is the basis on which an honest conversation should take place about what "independence at any cost" really involves. Anything less is just treating the people of Scotland like dupes.

Anonymous said...

Kevin,

I suspect I am being extra thick here, but I am really struggling to see how your statement that "I happen to agree that it's better to define the deficit gap on a %GDP basis" (c.f. Per capita) would be true. (I am excluding the excuse - which you show is minimal anyway - that it is a "useful" debating point for a partisan case).

It seems to me that - as an citizen - it's always the case that it's per capita GDP(1), debt or expenditure that counts. Unless that is you do the "look at the size of the economy, never mind that it has to be spread around a huge population" al la China thing.

(1) ignoring arguments about whether GDP is the right measure anyway - it's probably "good enough".

Chris (A lurker who prefers to remain anon - but many thanks for your time and efforts)

Anonymous said...

@rocoham

"Perhaps, but on the other hand, what is missing (and outside GERS' remit really) is any assessment of how these figures are currently valid only *because* Scotland is part of the UK"

This is an extremely valid point which a lot of Indy supporters fail to comprehend.

If there were ten crows on a fence and a farmer shot one, how many would remain?

The answer is not 9, which is exactly the conclusion that most Yes voters would conclude.

Economies are fragile - they take decades to build and merely months to collapse. All it takes is one action.

To assume the fiscal and economic stability of Scotland could only but improve after leaving the UK would be the definition of ignorance.

rocoham said...

Chris, I'd say that since a %GDP calculation scales any number against the overall size of the economy, it better represents that number's true economic significance, and potential impact. For example it is, if I remember correctly, the denominator used by the EU to assess a member nation's fiscal responsibility. So in strict economic terms it is a more useful measure. However, apart from your argument, plus Kevin's about GDP volatility, and a general consensus that per capita is the common language, it is also useful in highlighting the greater level of public expenditure *per capita* that Scotland's more thinly spread population incurs, given that this, rather than the revenue side, is where the disparity between Scotland and rUK largely resides.

Unknown said...

I've withdrawn from the habitual mud slinging on twitter, but still look in on your blog from time to time. Your cogent analysis cuts the weak fiscal arguments of the opposition to pieces. Peer reviewed, openly citing sources and calculation methodology, these are fine examples of economic examination and provide a forensic detail lacking in their counter-arguments. Thank you from an exiled Scot. No, not him, another one. :-)

Berkshire jock said...

Yet another forensic analysis, demonstrating good principles of reporting; clear language, citing source material and inviting peer review. That your opponents fail in these respects and resort to mud slinging, exposes the inherent fragility of their economic arguments. Keep up the excellent blogging Kevin, from an exiled Scot who appreciates your work.

Jock Tamsons Bairn said...

Looks like reality is starting to surface at last ?

"“The fact is a gap exists - Scotland does not earn enough to pay for its current level of spending. Once you accept that, you acknowledge that the SNP’s model is broken.”Scotland would have to tax or cut to bridge the gap, pay the substantial independence transition costs and meet its additional anti-austerity spending pledges, he said.

Mr Bell said the bumpy transition to independence would be like the over-stretched and over-budget Police Scotland merger “multiplied by a hundred”.

He suggested Scotland’s long-serving Finance Secretary John Swinney would be “unfit for the job” if he does not understand these obstacles “so we must assume these bright people know that the old model, once optimistic, is now dead”.

Read more: http://www.scotsman.com/news/politics/case-for-independence-dead-former-snp-policy-chief-1-3949549#ixzz3rrqhT1rk
Follow us: @TheScotsman on Twitter | TheScotsmanNewspaper on Facebook

rocoham said...

Yes, the Alex Bell piece has certainly startled the sheep. However, a sizeable proportion of SNP supporters appear either unable to understand what he's saying, or are going to elaborate lengths to shoot the messenger rather than deal with the substance of what he said. Which was not, btw, that independence is dead, but the model of it sold by the SNP most certainly is (and very obviously right now, there is no other model on the table). So, as far as I can judge from most comments online, those who were sheep are apparently very happy to stay sheep. After all, "we" know GERS is rubbish, or an evil plot, so can't be trusted - and no, we can't see the irony here. Anyone who says different must be blind, bad or stupid, certainly isn't a patriotic Scot, so needn't be listened to - and no, we can't see any irony here either.

There have been the usual "independence was never about the economy" dismissals of Bell's article, an argument which entirely muddles means and ends, as well as ignoring the bountiful promises of "better off" prosperity made in the whiter-than-white paper. One can seek independence for many good reasons (ends), but in order to work all of them will still need a sound economic foundation (means), otherwise very little can be achieved beyond a gesture. And I have yet to see any of these critics set out even a most basic hypothetical not-about-the-economy framework around which a sustainable independent Scotland might be created.

I thought Alex Bell's piece was intelligent, brave and honest, and honesty is a quality that has been sorely lacking in many Yes advocates before and after the referendum. A reluctance to look objectively at, let alone look for, anything which runs counter to their preconceived narrative; a willingness to denigrate anyone holding a different view; a readiness to accept uncritically any half-truth or even downright falsehood as long as it keeps the dream alive - all this and more have meant that reasoned, respectful, informed debate has been all but extinguished. No wonder there's a large silent majority. Sad to think that this was all being heralded as exemplary evidence of vibrant popular democracy in action.

Anonymous said...

Re "Rocoham said"
Your comments are all true, the bottom line is that if Scots still want to be "Independent" they need to understand they will have a personally lower standard of living as other people in RUK because there will have to be Scottish Government spending cuts or personal Tax rises of various sorts. Therefore we will be poorer overall than our RUK neighbours...if there is another Indy Vote do you think the SNP have the spine to tell people that fact or will they just continue to lie about it and produce confusing data to spin the issue yet again and try to win it on nothing but deceitful propaganda yet again.

The SNP seniors have shown they cannot and will not ever be truthful, therefore cannot be ever be trusted to run any campaign on Honest data. Its about time Scots woke up to that fact. The SNP are a party of morally flawed deceivers.

The biggest lie SNP followers ever propagated was that if your a "real" Scot or true Patriot you could only really ever vote for the SNP. This is the most morally flawed propaganda ever and ranks alongside Joseph Goebbel's best efforts.

SNP = Best for Scotland is the biggest of all lies.

Chris Davies said...

If I were trying to build an economic case responding to your analysis, I'd say "We'll tax a bit more, we'll save a bit here and there, i.e. overall, and we'd borrow the rest to get Scotland's economy booming, like, well, Singapore or Switzerland...". What's the quick answer to why "we'll borrow it..." is a no-no?

Chris Davies said...

If I were trying to build an economic case responding to your analysis, I'd say "We'll tax a bit more, we'll save a bit here and there, i.e. overall, and we'd borrow the rest to get Scotland's economy booming, like, well, Singapore or Switzerland...". What's the quick answer to why "we'll borrow it..." is a no-no?

Kevin Hague said...

Chris

It's really all about what one considers to be a sustainable deficit level - EU use a 3% target, FFA we'd be running at >8% ... if we were sharing a currency (as per Euro example, arguably even tougher if £) that would not be tolerated ... if we were creating a currency likewise unsustainable if we wanted manageable borrowing rates

Kevin Hague said...

Chris (2) ... so I guess the point is it's a a lot more than "a bit here and there" that would be required - the Yes camp were simply lying when they tried to suggest otherwise

rocoham said...

Chris (3)... Where would the increase in taxes fall? Can't really be on business (corporation tax) or commerce (VAT) because that would likely depress the economy, not grow it. Indeed all the SG talk has been about cutting taxes such as Air Passenger Duty, not raising them, in order to get the economy moving. Increasing tax on companies is also likely to risk business flight across the border to a lower-tax rUK. The oil companies are already claiming they are taxed too heavily. So it looks like it's personal income, a tax the rich strategy, which has relatively limited scope and could see a lot of personal wealth moving smartly out of Scotland, or tax the middle classes, which could prove extremely unpopular. Not saying that can't be done, but someone needs to be up-front about the intent.

And the savings? From where will they come? As has been pointed out here on many occasions Scotland is an inherently expensive country to service because its population is widely dispersed over a large area. So beyond the usual (but not simple) suspect of defence, savings are likely to have to come from public service provision. Is that how you see things working out? Because again, it' not at all how independence has been sold so far.