Addressing the Welsh Fiscal Gap

The economic arguments are examined by Rhys David

Could Wales afford independence? Particularly among young people there has been growing interest in the past year or two, and among the wider population of Wales growing numbers are identifying as “indy-curious” – yet to make their minds up but not automatically opposed.

Of course, there are few countries genuinely wanting independent status that could not make it work one way or another, but the key question is whether Welsh people would be better or worse off compared with the status quo. So, could Wales make a go of it? This is one of the questions examined in the report of the Wales Independence Commission published in September 2020.

Analyses by Wales Fiscal Analysis and the ONS shed light on the current fiscal position of Wales under the current constitutional arrangements where Wales is a region that many consider to be subordinated to the interests of London and the south east of England with its strong emphasis on the provision of financial services. In 2018-19 it was estimated that Wales had a deficit of roughly 18 per cent of GDP or £4,300 per person. In total this amounted broadly to a transfer of £13,5bn over and above taxation raised in Wales to meet Welsh needs. It is, therefore, the headline size of the task.

Such a transfer is not unique, however, to Wales. Only three of Britain’s twelve planning regions – London, the South East and East of England – do not require subsidy and are net contributors to the Exchequer. However, the gap between what is raised in revenue in Wales and what is spent on public services is higher than in all but one region. The average is a much more modest £620 per head. So, is our best bet just to plough on and hope we can narrow the gap and reduce this amount over time?

Indeed, do we not need this security to deal with the damaging consequences of the Coronavirus pandemic, the effects of which are likely to be felt strongly in territories such as Wales? Moreover, Wales is deficient in those sectors which have a greater share of the digital and other industries that are likely to  benefit as a result of changes due to the pandemic, and more dependent on others, such as tourism, that will be hardest hit. The consequences and costs of the Coronavirus will unfold over many years to come. Would not Wales be better off in a union with the rest of Britain as it adjusts to harsh new realities across the economy and society?

For all that it has bright spots, the Welsh economy has chronic structural weaknesses that have proved hard to overcome for a long time. They include industry structure, external ownership and management, low productivity, a missing middle of medium-sized companies, vulnerability to take-over, a low export propensity, and educational and skills shortcomings. All have combined with poor road, rail, and telecommunications infrastructure to leave Wales among the poorest UK regions and stymied attempts to raise its relative position.

Better, it might be argued, to take the money and rely on a subsidy that enables Welsh people to enjoy household incomes and living standards broadly the same as those of the rest of the UK. Un-supplemented revenues raised in Wales would be enough to pay for the public services offered in Portugal – a much poorer country. Instead, we have roughly the same services as Ireland, a richer country on most measures. Many will argue this is a trade-off too valuable to lose.

Yet, is this the way we want to go on? Do the present arrangements offer a serious prospect of improving our economic and social well-being and reducing the Welsh fiscal gap over time? Could our dependence even be a consequence of continued reliance on subsidy?

The unvarnished truth is that Wales has been sliding backwards in relation to the richer regions of the United Kingdom, and especially London and the South East, for the past fifty years. All pretence that the gap could be closed or even significantly narrowed has now been buried in suggested new formulations of how prosperity should be measured.

This is too seductive. ‘Wellbeing’ and other similar measurement concepts designed to look at society’s health and wealth, other than through the prism of more recognised gauges of wealth, are important. They should not be put up, however, as a way of avoiding problems of poor economic performance and entrenched poverty across a broad section of the population.

Population growth offers one telling proxy for Wales’s relative decline. After a sharp decrease in the 1920s because of outward migration, numbers stood at 2.59m in 1931 and rose only by 3,000 in the next 20 years. By contrast Scotland’s population grew by 253,415 to 5,095m in 1951, while England recorded an increase of 3.7m to 41,147m. What has happened since, however, is equally interesting. England’s population has risen by 37 per cent to 56.29m, Wales’s by 23 per cent to 3.2m and Scotland’s by an even more modest 7 per cent to 5.46m.

Wales is now down to 4.9 per cent of Britain’s population, from 5.3 per cent after the war. Scotland has fallen from 10.4 per cent to 8.4 per cent. Meanwhile, England is three percentage points higher at 87 per cent. If the population of Wales had climbed at the same rate as that of England there would now be 3.56m people living in the country – half a million more. Each of these missing individuals represents a loss, or a potential loss, of employees, output, and creativity.

Would a break with the status quo make sense, therefore, and could it set Wales on a new trajectory that does not presage, as our present does, continued marginalisation within these isles? Could the cold turkey of coming off subsidy be a stimulus to the creation of a new Wales, one confidently able, albeit after a period of adjustment, to join the comity of nations? Other nations with similar numbers prosper, Indeed, a population of 5m, or roughly half as much again as Wales, seems a near optimum – as in Denmark, Ireland, and New Zealand.

As the Coronavirus crisis has shown, these countries may not have the means to develop new vaccines, though Denmark and Ireland do have internationally important pharmaceutical industries. Yet in terms of managing the spread of the virus they have done better than such scientific powerhouses as Britain and the United States. In this crisis, strong and consistent political leadership, and good on the ground public health systems, have been as important in managing the outbreak as world-leading epidemiologists, virologists, medical researchers, statisticians, and disease modellers. Possibly more so.

In other areas, too, small nations can be nimble, and can try different approaches. In an age when territorial aggrandisement is no longer the threat it once was, the defence advantages of being part of a bigger unit are less important. Indeed, the costs of trying to stay at the top table of military powers can be crippling, as the old Soviet Union found.

Trade, too, is now largely under multinational rules, making it more difficult for small nations to be bullied by their bigger neighbours when disputes occur. As the economist John Kay has pointed out:

“…there are few economies of scale in statehood. Size is as much a disadvantage as an advantage when it comes to carrying out the principal functions of modern government: justice, health, education, internal security.”[1]

Yet a hard question for proponents of independence to counter is that in the past twenty years, Wales has had more control than ever previously over its economy, transport, health and education systems and has hardly made a good fist of it. Would a step further into the unknown be sensible? Where will the capacity to make the transformational improvements come from?

Yet, it can be argued that it is precisely because we are trapped within an economy overwhelmingly shaped in the interests of the City of London that Wales has failed to make economic progress. Fiscal analyses of the position of Wales as a region of the UK, it is argued, reflects importantly the result of its past and current status within the British state: a ‘region’ subject to economic policies formulated to serve the interests of the City of London and the South East of England. If nine of the twelve countries and regions of the UK are persistently in deficit, is the fiscal and economic model perhaps broken? It has not, and does not, deliver prosperity to Wales, and offers no expectation of doing so in the future.

A better model

During the past twenty years the Labour Welsh Government’s frequently updated plans for boosting the economy have failed to produce the step changes needed in performance. Initiative weariness is being manifested. Leading economists and others have started to ask the independence question: might a new constitutional settlement with the rest of Great Britain deliver the desired results?

In an article in early 2020 Professor Mark Barry of Cardiff University rejected the idea that Wales might be too poor or too small to be independent. If it were true, he said, Wales would be unique globally, the only place where an independent country of 3m people could not exist. The question was could our economy and wellbeing be best served by Westminster/Whitehall or by something more radical and more common across the world.[2]

Yet, how the economy of a successful, independent Wales might function remains hard to delineate. Some clues might be taken from the report of the Sustainable Growth Commission chaired by former member of the Scottish Parliament, Andrew Wilson, which reported to the SNP Government in Edinburgh in 2018. It argued that Scotland has an economic potential that far outstrips its current longer-term performance, and that the ambition for the country should be to perform to the level of the best of the small advanced economies.

The report argues that a centralised ‘big country’ model which concentrates too much economic activity in London and the south-east region is holding Scotland and the other regions and nations of the UK below their potential. A similar point is made in a separate report by the UK2070 Commission under the chairmanship of Lord Kerslake, a former head of the Civil Service. It observed that 50 years of effort trying to rebalance the UK economy and create a fairer and stronger nation had failed, leaving Britain one of the most unequal and divided countries in Europe. It urged: “We need to adopt a strategy that allows London to sustain its global role whilst at the same time targeting some systematic firepower at raising the economic performance of regional Britain.”[3] And it pressed for a change to Treasury rules that made it harder to justify expenditure in less populous areas, thereby favouring London and the South East.

Of course, this is the levelling up process to which the Conservative Prime Minister Boris Johnson is committed. So far it amounts to not much more than increased spending on roads, rail, schools, hospitals, and housing. There is little evidence of deep thinking on how the industrial and employment structure of regions outside London might be reshaped to reduce dependence on low-skilled and often impermanent jobs.

The Scots know what they would like to do differently, with all the powers of an independent state at their disposal. In most respects this represents a programme that a Welsh state would probably also want to follow, though the starting point would be further back in terms of existing economic strengths and institutional structures.

If the Sustainable Growth Commission’s findings were implemented, the Scots would work up a model that used the three similarly sized economies of Denmark, Finland, and New Zealand. This, they note, is based on quality of governance, long term cross partisan strategy, a focus on innovation, competitiveness for international investment, exploitation of the country’s resource endowment, export-orientation, immigration friendliness, maintenance of a highly skilled workforce and the use of the taxation system as a tool for economic development. For Wales, read Scotland.

The Welsh balance-sheet

Even so, it remains hard not to be brought back down to earth by the short, medium- or even long-term cost implications of opting for independence. Or, by the realisation that greater divergence rather than convergence with the rest of the UK economy may also be the result of maintaining the status quo, despite the Government’s promised commitment to regional re-balancing.

Fortunately, reliable information is now available on the Welsh balance sheet through a report in early 2020 by the Wales Fiscal Analysis team at Cardiff University.[4]As a result the options can be considered more realistically than was the case previously. The UK Government’s Office for Budget Responsibility has also this year produced its first Welsh taxes forecast. As such, we now have for the first-time detail on Welsh revenue and expenditure and the direction of travel. The stark truth: revenue raised in Wales is not set to show greater buoyancy but is set to decline further as a proportion of the total UK tax take.

However, before going further it is necessary to point out that calculations in these reports are pre-Covid. All predictions regarding the economy of Wales, Britain, Europe, and the rest of the world are guesswork. We can only surmise what shape recovery will take or what industries and regions will suffer most or least, or what the tax take and revenue spending of the UK or Wales, and the consequent fiscal gaps or surpluses will be.

Nonetheless, in March 2020 it was possible for the Cardiff report to state that at £13.5bn in 2018-19, the deficit between revenues raised in Wales and public spending in Wales was the second highest in the twelve UK planning regions after Northern Ireland. Public expenditure levels (outside certain areas such as infrastructure) are not, however, out of kilter with other regions. The Welsh deficit is primarily due to the lower tax revenues. In this respect Wales differs from Scotland where higher public spending accounts for the tax to spending deficit.

This lower Welsh tax take is mainly the consequence of lower wages. The UK income tax system is highly progressive, with by far the biggest share being contributed by higher income earners. Indeed, of the 440,000 additional tax rate payers in the UK, 300,000 are in London and southeast England, compared with only 6,000 in Wales. Analysis by the Office of Budget Responsibility reveals that only 44 per cent of the Welsh population paid any income tax in 2016-17, compared with 47 per cent of the UK population (a bigger proportion of whom will have been paying higher rates).

With just under 5 per cent of the UK population Wales has only 1.4 per cent of additional rate taxpayers earning more than £150,000 a year. Low wage levels also exclude large numbers in Wales from paying national insurance contributions. Welsh residents pay only 2.7 per cent of UK income tax revenues. If tax and national insurance contributions in Wales matched the UK per person average an additional £5.3bn would be raised.

Yet, although high levels of Government spending in Wales on social protection are maintaining living standards roughly equivalent to the rest of the UK, they are not contributing to the extent required to the rebuilding of the Welsh economic base. Infrastructure spending, essential to increasing the productivity and profitability of Welsh businesses, falls well short of spending in London and the South East where it is directed under current Treasury rules, because of the greater returns it will bring.

Thus, transport spending per head in Wales is less than half that in London, which has seen a succession of multi-billion pound rail projects over recent decades. This contrasts strongly with the struggle Wales has had to secure the funding for a potentially game-changing revamping of rail services into Cardiff. The current approach is to reward success in the south east of England rather than remedy under-performance elsewhere, a point also made in the UK2070 report.

Paying our way

How to increase Wales’s ability to pay its way, whether inside or outside GB is the challenge. If GDP per person in Wales were to increase from its present level of 74 per cent of the UK average to 80 per cent by 2029-30 the deficit would, the authors of Wales’ Fiscal Future estimated, halve to around 9.4 per cent of GDP. Substantial growth in Welsh output, spurred by rapid productivity improvements, must occur for this to happen, but progress on this scale and beyond has proved elusive to date.

Militating against this too is the larger than average share of the Welsh population of people over 65 and therefore not economically active, and a smaller under-16 cohort entering the labour market. Emigration from rural areas and to universities in England never to return and earn the higher wages – and pay higher taxes that their degree would facilitate – add to the problem.

Various reports have suggested that to catch up Wales – irrespective of independence considerations – must adopt radical new policies and adopt a researched strategic approach. This must involve investing heavily in education, research and development, and infrastructure. Rebuilding would place a greater emphasis on local sourcing, the attraction of inward investment from growing sectors, and the maintenance and development of a stronger cadre of Welsh-owned and managed businesses. The attraction of entrepreneurial individuals and the retention or return of Welsh students whose skills are currently lost after graduation in English universities would also be required.

The hope that lies behind the case for status quo – union in a continuing United Kingdom with, or without Scotland – is that the policies outlined in the most recent iteration of Welsh Government economic policies – Prosperity for All, An Economic Action Plan – will work in combination with UK-sponsored ‘levelling up’. Government funding will switch away from the South East, and road, rail and broadband infrastructure spending will be concentrated not just in the north of England and other English regions but will be made available to Wales, too.

In this scenario Britain will have other eggs than financial services in its basket and will be making more of the products on which it depends in basic fields from foodstuffs to new areas in high technology and artificial intelligence. Many of the pioneering companies in these fields will decide to build in Wales (and similarly deprived English regions). Matching these developments Welsh schools will perform high up in the OECD Pisa league tables, and Welsh students will be trained in Welsh colleges and universities in the skills that successful economies of the future will depend on. Britain will have acquired once again the much more balanced economy that existed until several decades on after World War Two.

For all the good intentions of recent decades and the recent rhetoric of the UK Government, just how likely is this? The authors of Wales Fiscal Future are sceptical. As they say:

“A key challenge for those who want Wales to remain a part of the UK revolves around the likelihood of Wales’s current economic, fiscal and social problems being alleviated under current constitutional arrangements. Given the relative trends in the Welsh economy since 1999, there is room for doubt whether such a relative improvement in Wales’s economic performance is possible, let alone likely.”[5]

It would mean reversing more than 40 years of a largely laissez-fair approach to regional policy that has seen financial services become the dominant sector supporting the UK economy and allowing other sectors to grow more quickly in future. Moreover, it would be necessary to imagine a Cardiff Bay Government being able to exert considerable leverage on Westminster to secure the transformational expenditure and diversion of resources to Wales that will be needed.

A different sort of union

It is for this reason that independence has been advocated as a breakthrough option. Our Fiscal Future makes clear that wide-ranging changes to both taxation and spending would be required from day one. Without fiscal transfers there would be a big bill to be paid in Wales for social security spending if current levels of service were to be maintained.

These costs will increase significantly over the next decade as a result of the damaging consequences for employment and society generally of the Covid-19 crisis.

Wales would at the same time have to negotiate with the rest of the UK, in effect the Westminster Government, a settlement of the expenditure that would continue to be incurred to service Wales’s proportion of inherited UK debt. Other costs, for example on border protection, for belonging to international institutions, paying for overseas healthcare or for culture and recreation services, including the BBC, are attributed proportionately to Wales at present and would either have to continue to be provided centrally and paid for, or replaced with separate Welsh-funded services, depending on the choices made.

The arrangements made with the rest of Britain for defence – whether a continuation of the present system of unified armed services or establishing a separate Welsh force – would also have to be determined and costed. Because many of these items of expenditure would have to be maintained, the savings from leaving the UK might not make much of a dent in the deficit.

One important element in the current deficit may, however, no longer apply. Pension spending represents by far the largest part of UK government spending for Wales and the future financing of state pensions would need to be resolved before state separation. Currently the UK government pays the pension of British citizens who have fulfilled their requirements to receive a state pension, regardless of whether they choose to retire within the UK.

This would be the subject of negotiation between both governments but a continuation of the current practice making payments an obligation of the UK state could initially reduce Wales’s deficit by £6 billion a year or around 8 per cent of GDP, although this would gradually taper off as new Welsh pensioners started claiming from the Welsh state.

Borrowing to replace the transfers now financing current account spending on benefits and other social protection would be an option. Because of the current world economic crisis, funds could indeed be obtained cheaply. Interest rates would still likely be higher than the UK is expected to pay, as lenders would factor in the default risks attached to lending to a new and potentially less creditworthy state.

In practice, a new Welsh Government would almost certainly need to put in place fiscal consolidation measures – tax increases and/or spending cuts – with the aim of bringing down debt as a proportion of Gross Domestic Product. The authors of Wales’ Fiscal Future argue that closure of the deficit by 1.5 per cent a year would result in the debt to GDP ratio peaking at 73 per cent in 2030-2031. A 3 per cent a year improvement would see the ratio reach 44 per cent by 2026-2027.

The shock to the system could be alleviated if Westminster could be persuaded to continue to make transfer payments tapering down over a period of say 20-25 years. The argument would be that an independent Wales capable of standing on its own feet would emerge, lifting a burden from the rest of Britain, and thus in its interests. Other regions of the UK would, however, have to be convinced and it could be a hard sell.

Whether or not this could be negotiated, what are the prospects of revenues raised internally, matching over time existing subventions from the centre? Wales’ Fiscal Future points to some areas where possible additional Welsh tax revenue might be raised, including from water and electricity supplies to other parts of the UK. However, given the competitive nature of the markets in which these utilities operate, it concludes the amounts would not be material. Desalination, in the case of water, and inter-connector supplies from France in the case of electricity would put a ceiling on the price Wales could demand.

A reformed tax system might offer amore promising approach.. An independent Wales would reconfigure the tax system to reflect the needs of the country. Some variations are already in place. Temporary changes made in the light of Covid-19 to the devolved Land Transaction Tax (LTT) raised the threshold in Wales from £180,000 to £250,000, and second homes were not granted this relaxation of the rules.

In England, the equivalent Stamp Duty Land Tax (SDLT) threshold was increased from £125,000 to £500,000 and this applied to all homes including second homes. The resulting change in LTT in Wales applies to ~90 per cent of all transactions but will not stimulate further the second home market. In England it has been estimated that the average saving from the SDLT change will be £646 in north east England, versus £15,000 in London. Once again, a tax policy, in this case for England only, formulated on a ‘one size fits all’ basis, skewed heavily in favour of London and south east England and in favour of purchasers of second homes.

As matters stand, the composition of the tax take in Wales differs in important ways from UK. Britain’s income tax system is highly progressive. The highest earners make the biggest contribution, and this is even more marked in Wales where 46 per cent of the population pays no income tax, five percentage points higher than the equivalent proportion in UK. Higher rate tax is paid by 4.9 per cent of Welsh taxpayers, compared with 8.7 per cent in UK.

National Insurance revenues, another form of income tax levied on employees, are in line with the rest of the country but receipts from corporation tax are lower. Value Added Tax at 22.9 per cent of the total has, recently become the principal revenue raiser in Wales, overtaking income tax, the biggest UK source of revenues accounting for 23.7 per cent of the total.

Higher taxes on high earners could, however, lead to their leakage across the border to England. Higher VAT rates would target spending not income but would affect consumption and in practice add to the tax burden on poorer people not currently paying income tax. Higher tax rates on corporates could cause capital flight. Lower taxes, while potentially reducing revenue, could, however, lead to the attraction of companies (as Ireland has successfully demonstrated).

However, lower taxes might still require the acquiescence of the Treasury in England if retaliatory action was to be avoided. Modest Welsh demands for powers to levy Air Passenger Duty to help Cardiff Airport have been firmly resisted on the grounds that it might harm Bristol, even though its passenger numbers are four times bigger, and has big expansion plans.

Some critics see the projections in Wales’ Fiscal Future as too pessimistic. Swansea economist Dr John Ball argues that the corporation tax take attributed to Wales is too low. He also disputes the size of the expenditure allocations, which include, he argues, a share of funding for some schemes that benefit only England.[6]

While inevitable negotiations on tax variance with the rest of the UK would be tough, care would also be needed to ensure at least in the short to medium term that UK-facing public sector offices – the DVLA in Swansea, HMRC and Companies House in Cardiff and the Office for National Statistics in Newport  for example – were not stripped away, as English regions might demand. Westminster might be persuaded to allow such agencies to operate outside English borders but only if the services they offered were competitive with rival bidders, and perhaps only if broadly similar systems and services applied in Wales.

Welsh taxes

These dilemmas have led to suggestions of other novel forms of taxation. Wales is a transit route for many of the goods travelling between Britain and Ireland yet provides the roads and other infrastructure for this service at no cost in tax to the user in the case of foreign vehicles. An independent Wales could replace fuel duty with a road pricing scheme. Electronically gathered, like the Dartford Crossing fee and the London congestion tax, this would harvest rent from trucks and other vehicles making regular usage of Welsh roads, including visitors to tourist destinations and vehicles travelling along the A55 and M4/A40 to and from Ireland to England and the Continent. Such a levy would have to be set at a level that did not divert goods traffic to Liverpool and other ports and holidaymakers to other destinations.

A modest tourist tax could also be levied for use locally as happens in many US states and elsewhere. A pipeline tax on gas crossing from Milford Haven and a pylon tax on electricity leaving Wales are other possibilities though neither of these would raise substantial revenue.

Plaid Cymru’s leader, Adam Price, has suggested more purposeful use of existing Welsh-managed taxes might be implemented. One suggestion, a Land Value Tax would usefully target a non-mobile asset that, unlike individuals and their businesses, could not up sticks in protest. This could, he argues, generate £6bn on current values at a 3 per cent rate, making possible reductions or replacement of devolved taxes such as business rates and council taxes, and of income taxes (where the Welsh Government already has some limited variation powers).

A study into such a tax has indeed been prepared for the Welsh Government. Reporting early in 2020, it estimated that the total value of residential land in Wales was £113.4 billion, and the total value of land underlying properties which currently pay non-domestic rates was £27.6 billion. A uniform national LVT rate of 1.41 per cent on residential land would be sufficient to raise the same revenues as are currently raised by council tax. A uniform national LVT rate of 3.9 per cent charged on the properties that currently pay non-domestic rates would be sufficient to replace that tax. Higher or lower rates, adjusted to local circumstances, could bring in extra resources or reduce the burden where deemed appropriate.

A UK Common Market

Other issues facing the Scots, and extensively rehearsed during the Scottish referendum campaign in 2014, would be replicated in any new referendum north of the border, and in Wales, which in any case is unlikely to progress towards independence or even a ballot before the Scots. Arguments over currency, trade barriers, monetary policy, and historic debt featured strongly then and would do so again if the SNP Government in Edinburgh were to win a second referendum during the next decade.

In a post-Brexit world the degree of integration of the two countries into the UK economy – the most important export market being England – suggests both (and Wales especially) would find it impossible not to be part of a UK Single Market, rather than standing alone. (Whether or not it would be a Britain and Northern Ireland market will depend on the constitutional and/or trading status of Northern Ireland remaining the same as relations between the UK and the EU bed down post-Brexit.)

Within such a market an independent Wales would not be able to enter separate trade deals with other blocs or nations, and would any way lack the capacity to do so, possibly for many years. It would instead have to adopt arrangements negotiated for the whole market. Wales would be expected to demand representation within negotiating parties but might in practice be in no stronger a position to influence outcomes than it is now.

It is possible to consider the notion of Wales leaving the rest of the UK common trading area and joining the European Union (as the current Scottish Government wishes to do) at some point in the future. However, this could only occur many decades ahead after Wales had engineered a transformation in its trading profile, replacing its closely interwoven trade links with England with similar close links with Benelux, Germany, France, and other EU countries.

Wales has a slightly bigger share of exports heading for the EU than the UK generally, but probably a similar import profile. However, the bulk of these exports are concentrated in a few products and sectors, notably aircraft wings and other aviation components, vehicle engines and refined oil products. Most Welsh businesses are not engaged in exporting. It would be unrealistic, therefore, to suggest Wales, as Scotland envisages, might seek entry to the EU post-independence, if England chose not to do so.

An export growth strategy designed to increase the value of exports, and diversify sources of export income, as the Irish have done, is one of the main recommendations in the Scottish report and would be even more necessary in the case of Wales – which does not have the huge export-orientated whisky sector or even a declining oil asset as a foundation stone of its overseas sales – to reduce dependence on the English market.

There is a parallel here with Ireland, which, as its economy stood at the time, could only follow the lead of the UK when the decision to join the EU was taken by the Conservative government in Britain in 1974. Such was Ireland’s dependence on the UK at that stage it would have been impossible for it to join separately, or stay outside once Britain had decided to enter. Over the past 40 years this situation has changed considerably. Ireland has built up an enviable export trade with the EU and the rest of the world in food, pharmaceuticals, industrial equipment, computers, mineral ores, and other products, and can regard Britain’s departure from the bloc with equanimity and comfortably remain a member independently.

The long drawn out negotiations over the land border between the Irish Republic and Northern Ireland, resulting in a very unclear arrangement which may not long survive implementation, offer a further caution. The arrangements for trade between Wales in the EU and England outside would be equally if not more difficult to formalise.

Again, links with England make it more difficult to argue the case for a separate Welsh currency. Though countries as small or even smaller than Wales have proved capable of managing a currency of their own, a Welsh currency would impose transaction costs on businesses that would make Welsh operations less competitive than those on the other side of the border with England. However, there are advantages in having a separate currency, not least the ability to revalue as appropriate to reflect changes in competitiveness, but these longer-term benefits would have to be forsaken if immediate damage to Welsh firms was to be avoided.

There are similarities here, too, with Ireland. Before both countries entered the European Communities (as it then was) Ireland was part of the sterling area with the same coins and notes but bearing Irish symbols.

On Irish entry into the Exchange Rate Mechanism in 1979, the Irish punt decoupled from the £ sterling and a separate central bank was created. This allowed the punt to move up and down against sterling, sometimes being more valuable and sometimes less, reflecting the month-by-month competitiveness of the Irish economy vis à vis the UK. (The punt ceased to exist when Ireland joined the Euro.)

These limitations expose a further problem. If a post-independence Wales were to share a common currency with the remainder of the UK it would have to negotiate the right to share in decisions on monetary and interest rate policy. Leverage, however, would rest very heavily with rest of the UK.

So, while independence can be promoted as a way out of Wales’s chronic weaknesses economically and socially, there are limitations on the extent of that status. Links with England, in what would remain a union to a lesser or greater extent, would need to be factored in.

A middle way

In the immediate future a two-stage process might be the way ahead. Rebuilding the economy has been a Sisyphean task for the past four generations. It must continue to be a priority of the Welsh Government which should insist it stands at the heart of the UK Government agenda.

Once recovery from the Covid-19 pandemic has taken place and other issues can be brought forward, UK Government must be held to its promises to level up the UK economy in a meaningful way. Even more importantly, the current Welsh Government, and its successor in 2021, needs to ensure that its voice is heard as loudly as that of the Midlands and North of England, now under the leadership of increasingly vocal mayors.

Against Treasury restrictions, the Welsh Government must endeavour to increase its capacity to borrow for capital spending. It must also have more leeway to shape Welsh business to meet domestic needs without any impact on the Treasury block grant Wales receives. These measures will add to the Welsh deficit and to Government debt. However, they will have the effect of reversing rather than ameliorating current economic weaknesses, as the present funding arrangements seek to do. In other words an ambitious investment programme to ‘pump prime’ the Welsh economy is required: an approach which was abandoned by UK governments when the UK joined the EU.

The key demand must be that additional finance is deployed through borrowing and more importantly through the proposed UK Shared Prosperity Fund. This will need to go beyond the EU funding that is being lost, so that Wales and other regions can protect against climate change and develop the industries needed for this purpose. Wales will want to improve its transport and technological infrastructure, strengthen its local economies, and participate fully in modern business sectors.

Wales must become less dependent on FDI, and branch factories. The needs of its population dictate the necessity of more technologically advanced businesses, more locally owned businesses, more headquarters businesses, better education for work in business, and more effectively trained managers. It wants to be making greater use of its natural resources to develop a strong food and agriculture sector, its creative industries, its financial and professional services, its biosciences, tourism, and leisure activities. More research into the business needs of the Welsh economy is a priority.

In short, Wales needs an economy that is much more like Denmark or Ireland to make independence seem a realistic prospect for the people of Wales. The challenge is to demonstrate the kind of economy and society that Wales would seek to create and ensure it is one that Welsh people would be comfortable to opt for. A significant strengthening of the economy in the short and medium term will improve the lot of Welsh people and, further ahead, put Wales in a position where an independence option can be put forward that would seem less of a risky leap of faith.

Sceptics will still have a field day and in fairness the record to date is not encouraging. Yet, there is a simple question that can be posed. If Ireland had not decided 100 years ago to break with Britain, would it now be among the richest parts of these isles, up there with London and the south East? Or would it be poor old Ireland, down there with Wales as one of the weakest of the twelve UK economic planning regions?

Recommendations

  1. The role of the Welsh civil service should be re-examined to separate economic policymaking and implementation.
  • A new agency or agencies should be established to promote small business growth, medium size business development, inward investment, productivity, and export activity.
  • A new inward investment focus is needed on businesses capable of offering high quality jobs, even if initially in small numbers, in technology, health and sophisticated consumer-facing products. Potential investors in new technology nations need to be cultivated and contact deepened with alumni of Welsh universities overseas.
  • The export propensity of Welsh firms needs to be encouraged and stimulated to increase revenues and help increase the productivity and scale of Welsh business. Wales should search for businesses that might be relocated back in Britain for strategic security, environmental or other reasons
  • The role of the Welsh Development Bank should be expanded to ensure that state support for key sectors can take the form of direct Welsh Government stakes.
  • Greater involvement with the venture capital industry should be sought and a Welsh venture capital trust investing in Welsh start-ups established.
  • The foundation economy should be put at the centre of policymaking and incentives and penalties to secure greater public sector purchasing put in place. A wholesaler type body should be created to aggregate private sector provision and support tendering, together with a facility through which companies could make their offering more widely known.
  • In the aftermath of the Covid-19 crisis a window for a much greater emphasis on local production and procurement will open and this must be seized. Support should be given to businesses seeking to re-shore products currently made elsewhere, and further efforts made to ensure Welsh food producers contribute a bigger share of the nation’s food purchases.
  • An incoming Government should review the entire Welsh higher education sector to ensure its priority is meeting the needs of the Welsh economy and society. It should set in motion measures to ensure more Welsh students stay in Wales for their degrees and their subsequent careers and that those going elsewhere are encouraged to return.
  • Policymakers need to be equipped with better business intelligence on the needs of the Welsh economy. Welsh Government and business should back the creation of a new university centre for the study of Welsh business and business needs.

Rhys David was a member of the Independence Commission 2020

October 22nd, 2020


[1] John Kay, ‘Size isn’t all that matters for global economies’, Financial Times, 26 November 2003.

[2] Mark Barry, ‘What sort of Wales do we want?’, Nation.Cymru, 8 March 2020.

[3] UK2070 Commission, Fairer and Stronger. Rebalancing the UK Economy, May 2019.

[4] Guto Ifan, Cian Sion, and Ed Poole, Wales’ Fiscal Future: A Path to Sustainability? Wales Governance Centre, Cardiff University, March 2020.

[5] Wales’ Fiscal Future, op.cit, p. 35.

[6] John Ball, The Economics of an Independent Wales’, ClickonWales, 23 January 2020.

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