Click through to read part one and part two in this series.
We previously looked at two reports considering the economic case for an independent Wales. These are the Government Expenditure and Revenue Wales report of 2019 (GERW) prepared by Cardiff University’s Wales Governance Centre, and another by Professor John Doyle of Dublin City University.
The GERW report significantly underestimated the revenue generated by Wales. This article will look at what revenue is spent on.
Government expenditure
GERW estimated government expenditure in Wales to be just under £40.8bn during the period of reporting. However, that included expenditure in both devolved and non-devolved areas of responsibility. While it’s possible to be accurate in accounting for devolved expenditure in areas such as health and education, that’s not the case for non-devolved areas like defence or social security.
The GERW report simply allocates Wales’s share of UK expenditure as a proportion of its population, that is, 4.7%. This takes no account of where expenditure occurs, nor of relative economic capacity. Costs could be more fairly allocated as a proportion of GDP: 3.3%. Let’s look at the numbers in more detail.
In order of magnitude, GERW identified expenditure for Wales as:
- Social security, excluding pensions – £8.954bn
- Health – £7.263bn
- Pensions – £5.846bn
- Education and training – £4.279bn
- Accounting adjustments – £2.926bn
- Economic affairs – £2.715bn
- Public sector debt interest – £2.123bn
- Defence – £1.833bn
- Public order and safety – £1.450bn
- Public and common services – £776mn
- Recreation, culture, and religion – £743mn
- Housing and community – £714mn
- Environmental protection – £646mn
- International services – £507mn
I’m sure most, if not all, of those categories include opportunities for further reduction. But for the time being I’ll focus on five areas.
Pensions
GERW says Wales is responsible for pension payments of £5.846bn, equivalent to 4.7% of total UK liability. Professor Doyle asserted that the UK should remain responsible for payments, so Wales’s liability should initially be zero. The reality lies somewhere between. There are two components of UK pension liability – the state pension payable to everyone, and public sector pensions for those working in the civil service, the NHS, and so on.
For public sector pensions, liability should remain with the employer. If someone worked for a particular organisation, making pension payments into it, then it remains responsible for meeting future liabilities in the same way as if someone had a private employer.
If someone leaves a public organisation voluntarily or due to redundancy or reorganisation – as might happen upon independence – the original employer’s pension fund must meet future obligations, or make a transfer payment to another fund sufficient to meet them, up to the point of employment ceasing. In this respect Doyle is correct, and public sector pension liabilities would only begin to accrue post-independence.
The situation isn’t as clear with state pensions. UK pensions aren’t paid from a dedicated fund but out of general taxation. The original purpose of National Insurance payments was to cover the costs of social security including pensions, but that link was broken long ago. The UK pension is now run as a glorified Ponzi scheme, with current outgoings funded by current income. An independent Wales should expect to self-fund state pensions on a similar basis.
Our public sector pensions represent around 25% of overall UK liability, so Wales can reduce expenditure on pensions (compared to GERW figures). We cannot eliminate it entirely as Doyle suggested. Nevertheless, this represents a significant reduction in expenditure of around £1.460bn.
Accounting adjustments
I’m suspicious of vague descriptions such as this being attached to a large number like £2.926bn, which can be used to hide all sorts of things. But nor can I challenge the overall figure without further information.
As this relates to accounting and not to people, I suggest that Wales’s costs in this respect should be allocated on a GDP-proportionate basis – 3.3% of the UK total. This would reduce our ‘expenditure’ to £2.054bn, a savings of £865mn.
Public sector debt interest
According to GERW, Wales is responsible for making interest payments on our share of the UK national debt, calculated at £2.123bn per annum, in proportion to population (4.7%). But Doyle held that an independent Wales wouldn’t be liable for any debt. He noted that countries gaining independence through the dissolution of the USSR and Yugoslavia became debt-free.
Again, these positions represent two extremes. The liabilities of an independent Wales would fall somewhere between, subject to negotiation. There’s an established precedent for sharing debt in the UN Vienna Convention of Successor States – effectively an international divorce law.
Most importantly, that Convention recognises that both debt and assets are shared. If Wales is responsible for 4.7% of UK national debt, it’s also due a 4.7% share of assets. It would own 4.7% of the UK’s tangible assets including the armed forces; treasury assets including gold, bonds, and gilts; and UK and overseas real estate. It would also own 4.7% of intangible (non-physical) assets, including international treaty rights like the UK seat on the UN Security Council.
Ownership of all physical assets within the new country would automatically transfer to it. For Wales this would include Ministry of Defence land, Crown Estate assets, government buildings, and NHS infrastructure. Any debt directly attributable to assets would also transfer. This applies equally to the residual country, the remaining UK (RUK). Assuming the RUK took full ownership of the UK Trident fleet, for example, it would take on all associated debt liability.
So while an independent Wales wouldn’t incur 4.7% of UK debt, nor would it assume no debt. The amount would be subject to protracted negotiations, but I’d expect a realistic outcome of around 1.0%, equivalent to debt repayment of £450mn, a reduction of £1.673bn.
Defence
GERW reported that Wales ‘spends’ £1.833bn on defence. This isn’t actually expenditure, but a proportional allocation of 4.7% of UK defence spending, based on population. Wales’s GDP per capita being lower than the UK results in that being equivalent to 2.6% of GDP. This makes Wales seem one of the most militarised nations in Europe, far in excess of the NATO target of 2% (albeit a target ignored by almost all European NATO countries, let alone non-NATO countries).
What do we get for that ‘expenditure’? Unionist politicians note that RAF Valley air base significantly boosts local employment on Ynys Môn. Not only military personnel, but also private contractors and support staff, all spending locally in shops, pubs, and services. This is true of all large military bases, and Wales should expect a fair share of UK military expenditure.
With around 180,000 military personnel based in the UK, Wales could expect around 9,000 to be based there, equivalent to two or three medium-sized bases similar to RAF Valley, supporting local economies. Yet we have around one-third of that – most military is based in South East England. Wales contains training areas at Eppynt and Castlemartin but they have few fixed personnel, offering little to local economies.
So not only is Wales overpaying for defence, it’s short-changed on the benefits expenditure can bring.
A defence budget for an independent Wales should be based on a credible threat assessment. It doesn’t need submarines and aircraft carriers, or squadrons of tanks or bombers. It needs an armed coast guard and mobile homeland defence force, and should be prepared to contribute to European/NATO peacekeeping forces.
This would cost around 1% of GDP, comparable to Ireland’s 0.6%, around £750mn. It’s sufficient to develop armed forces for an independent Wales – the bulk being spent there, providing direct economic benefits – with a cost reduction of £1.083bn.
International services
This relates to international aid. Wales couldn’t initially afford that, and should wait until it has stabilised its finances. This results in savings of £505mn.
Balancing our books
Taking the above into account, a revised estimate of government expenditure in an independent Wales is no more than £35.190bn, a reduction of at least £5.586bn on the GERW data. It’s likely that further reductions are possible, but I’ve ignored them for the time being.
As noted in a previous article, Wales Government revenue for the same period was estimated at £28.75bn, resulting in a revised fiscal deficit of around £6.44bn, equivalent to around 8.5% of GDP. While this is much less than the claimed GERW shortfall of £13.7bn, it’s considerably more than Doyle’s £2.6bn.
So, while Wales is clearly big enough and rich enough to support independence, there’s still some work to do to ensure it can balance expenditure and revenue. Part of this is simply to grow the economy. Cardiff is projected to have the fastest growing economy in the UK outside of London this year, so we’re moving in the right direction.
Most modern economies operate at a budget deficit and make up the shortfall through borrowing. The UK itself currently runs a deficit of 4.2%, yet nobody suggests the UK cannot be independent. However, Wales should limit borrowing to funding capital expenditure only – currently around £3bn – and should plan to balance current expenditure against revenue.
This means reducing expenditure and/or increasing income. Potential sources of additional income related to water and energy can be tapped, and probably further reductions can be found.
An independent Wales will need to make tough decisions in its early years to ensure a sustainable economy. It would be unrealistic to believe otherwise. But this is an insufficient basis for arguing convincingly against independence itself.
