ࡱ> [\Zܥhc eFZ""""D```ttttt :teְڰWX`IM ``ְ``Jttt````SCOTLAND DEVOLVED AND MONETARY UNION Margaret Cuthbert INTRODUCTION The Treasury assessment of the Five Tests has been completed with a decision of not yet to European Monetary Union (EMU) entry [1]. Essentially, the tests assessed whether the UK (a) could enter EMU without the shocks being too great and (b) could thereafter survive and prosper in it. Convergence and flexibility were regarded as being of prime importance. The five tests provide a framework which can be used to assess any monetary union and are used here to consider the position of Scotland. This paper examines three issues: first, what assessment can be made on Scotlands performance in the current UK monetary union (UKMU); second, is devolved Scotland likely to benefit from entry into EMU; and third, what policies should the devolved Scottish Parliament pursue to assist Scotland to benefit from whichever scenario develops: that is, UK entry or non-entry into EMU. SCOTLANDS PERFORMANCE: IN THE CURRENT UK MONETARY UNION AND IN RELATION TO EMU ENTRY The paper concentrates on the Treasurys key tests: Are business cycles and economic structures convergent? If problems emerge is there sufficient flexibility to deal with them? The Treasury examined cyclical, historical, structural, and endogenous convergence. Each of these is considered here with regard to Scotlands performance in the UKMU and to assess Scotland in relation to EMU entry. With regard to flexibility, the Treasury examined wage and price mechanisms available, and the potential for an enhanced role for fiscal policy. Where possible we use the same variables: GDP growth, output gaps, labour market, housing, trade, foreign direct investment, and structure of industry. In some cases, we have examined movements over a longer time period: we have also added population change is an indicator of the long-term performance of an economy: monetary unions are, after all, expected to last a long time. Convergence The Treasury notes that: The convergence test addresses the issue of whether a single interest rate will be suitable for all euro area members over time UK and euro area business cycles and economic structures must be compatible. Convergence must be settled and sustainable. There must be a past track record of achieving convergence and a high degree of confidence that this performance will be sustained into the future. 1. Cyclical convergence: Is there more cyclical convergence between Scotland, the UK and the eurozone than in the past? GDP growth GDP growth is one measure of the business cycle. Chart 1 shows growth forecasts for Scotland, UK and the eurozone. The performance of the Scottish economy remains much weaker than the UK with manufacturing output, and electronics output in particular being weak. Over the period from 1988 to 1994, the cycle in GDP growth in Scotland and the UK was substantially different from that for the eurozone, with the UK showing much more volatility than Scotland. Thereafter, growth rates have been more convergent, but still with differences. In particular, if Fraser of Allander projections are correct, the Scottish GDP growth cycle is closer to that of the eurozone countries than to the UK. The Output Gap: Shocks may lead to a gap opening up between actual output and long-run potential output: the output gap. This gap is a measure of inflationary pressure in the economy. In estimating the output gap for Scotland, HM Treasury advice was to use the technique which they themselves used, as described in [2]. The results are shown in Chart 2. The Treasury tests are primarily concerned with inflationary pressure rather than with the possibility of deflation. The output gap measure is not particularly appropriate to Scotland. The relative weakness of the Scottish economy compared to England is likely to manifest itself less in an output gap than in long-run generally depressed output, relatively high long term unemployment, and migration out of Scotland: that is, in real factor movements. An analysis of output gaps as a percentage of GDP for the period 1988 to 2002 for Scotland, UK and the eurozone is nevertheless revealing. Before 1997, the series are very divergent: after 1997, they do move somewhat closer together but this is weak evidence to imply that there has been a fundamental improvement in convergence, among any of the areas considered. c. Sectoral Composition of Output Growth The main factor behind stronger growth in the UK economy relative to the euro area in 2001 and 2002 was UK consumption, fuelled by a strong housing market. This aspect for Scotland is discussed under structural convergence. While house prices in the UK increased on average by 30% between 1996 and 2000, the average increase in Scotland was only 15%. [3]. The Treasury also cites increases in the employment rate as fuelling consumption. While the employment rate has increased in Scotland, this has primarily been in part time employment. The inflationary pressures from these sources on the Scottish economy are therefore likely to be far weaker than they are in the UK as a whole, and position Scotland closer to the eurozone than the UK as a whole is. d. Labour Market Conditions The Treasury uses the unemployment gap as an indicator of the degree of spare capacity in the labour market. Both UK and eurozone unemployment rates are estimated as being close to their long run underlying trend. Chart 3 compares Scotlands unemployment gap with that for the UK and shows that like the eurozone and the UK, Scotlands unemployment rate is close to the long run underlying trend. However, this possibly temporary position gives little comfort. During the early part of the period considered, both the UK and Scotland experienced considerable fluctuations around trend. Since 1994, the UK has shown less volatility than Scotland, with Scotland experiencing positive cyclical unemployment over much of the period since 1996, before its improvement against trend in 2001. e. The Treasury also considered: official short-term interest rates, real short-term interest rates, long-term interest rates and inflation expectations, and the exchange rate. As Scotland is part of the UKMU, there is only UK data on these variables Historical convergence: Time series evidence is important for establishing the long-term record of convergence between countries. For the UK, the Treasurys conclusion is On past performance, UK business cycles have been much less compatible with the euro area average than has been the case in other countries such as Germany and France Over the last five years, the UK output gap cycle has been more highly correlated with the German cycle than that in the US, although the UK has fluctuated around a higher growth trend However, the UKs history of divergence remains a risk factor. This section examines time series evidence for Scotland relative to the UK and the eurozone. a. The Output Gap: Chart 4 shows the output gap business cycles for Scotland and the UK, 1951 to 1999, and that for the eurozone 1975 to 1999. Percentage point values greater than zero indicate where the economy is performing above its long-term trend. Output gaps in Scotland and the UK do move fairly well together, indicating that the Treasury findings of UK greater volatility than those for major Eurozone countries also hold for Scotland. In addition, considerable differences between Scotland and the UK from 1984 onwards suggest non-convergence within the UKMU. However caution has to be exercised over GDP performance in Scotland in the 1990s and ONS has expressed doubt over the reliability of their figures which are under revision. For this reason, no further work is presented here on correlations between cycles and between shocks. b. Output Gap Deviations: Analysis of absolute output gap deviations provides a measure of the amplitude of the cycle. Regional output gaps calculated by the Treasury [1] show that, over the 1990s, the absolute deviation between Scotlands output gap and the output gap for the UK has been higher at 1.45% of GDP than the UKs deviation from the eurozone (0.8% of GDP), which is itself higher than that of France and Germany, and Italy. In other words, based on the Treasurys own findings, UK business cycles have been much less compatible with the euro area average, and there is lack of convergence between Scotland and the UK average. Structural convergence Differences in structures between countries in a monetary union can make one country more vulnerable to shocks that do not affect the others; further, one country could react differently to changes in economic circumstances that affect the whole of the monetary union. Which differences in structures are important? The Treasury considered sectoral composition, trade patterns, investment linkages and financial structures, and housing markets. Sectoral share of output Table 1 summarises the composition of output in Scotland, UK, Germany, France and Italy. In the UK, 73.6% of output is accounted for by the services sector, higher than Germany, Italy and France. Scotlands service sector is smaller but its public sector share is much larger. The share of manufacturing in output in Scotland is on a par with Germany and higher than that of the other countries shown. At a sub-heading level, Scotland and the UK have important oil, gas, and financial services sectors. The Treasury conclude that in terms of industrial specialisation the UK is quite similar at the aggregate level to other large EU countries. Experience within the UKMU indicates that the differences which do exist in manufacturing share are important. A rise in interest rates to manage inflation in the South East where financial services are more important can have a relatively greater dampening effect in Scotland where manufacturing is important. Table 1: Sectoral share of output, 2002 Percent of Total OutputScotlandUKGermanyFranceItalyAgriculture, etc.2.70.91.12.82.6Manufacturing, mining, utilities24.619.924.220.122.4Construction6.05.54.44.74.9Distribution, etc2322.918.619.323.7Finance, etc.2227.930.130.126.8Public admin & other services24.122.821.623.119.6Services total69.173.670.272.470.1Note: Output measured by gross value added. French data for 2001. Source: Treasury, Scottish Economic Statistics Any differences in the structure of the Scottish, UK and euro area economies could result in divergence with the euro area in the future. One significant difference in structure lies in the relative importance of the public sector to the Scottish economy, accounting for 21.6% of GDP compared with Englands 18.3%. The potential for growth in the Scottish economy will be more limited than that in England if in meeting primary objectives attention is not also paid to how innovation and enterprise opportunities in Scotland might be fostered. Second, wage rate parity systems across the UK public sector mean that a buoyant labour market in England can push up public sector wages in England and result in increases in pay rates in Scotland, even if overall labour demand in Scotland is far less buoyant. Other differences are in oil and gas production, and in the financial services sector. Both oil and financial services can be subject to large shocks and have the potential to affect the whole economy, despite their relatively small share of total output. b. Trade: As with the UK, Scotlands relative patterns of trade and the degree of openness to trade have an important role in determining how global shocks might affect Scotland relative to the eurozone. Most of Scotlands trade is carried out with the rest of the UK. This section considers only exUK trade. UK and Scotland have less EU trade integration than other EU countries. The Treasury notes that UK trade in goods and services (exports plus imports) with the EU is equal to nearly 30 per cent of UK GDP. This is in line with Italy but slightly lower than in Germany and France. Comparable data is not available for Scotland. Using Scottish Council Development and Industry estimates of exports to EU, and ONS estimates of Scottish GDP in 1999, it is estimated that Scottish exports to the EU were around 18% of GDP. Customs & Excise regional data suggest imports from exEU are greater than those from EU and total imports are less than exports. On this basis, it is reasonable to assume that Scottish trade with the EU is also close to 30% of GDP: Scotland is more likely to be exposed to trade shocks from exEU than is the eurozone as a whole. ECB interest rate management is primarily geared to managing inflation rather than exchange rate movements. UK entry to EMU could put Scotland into a vulnerable position unless it was able to change its trade patterns towards Europe and away from other overseas countries. But doing this would involve a radical change as it would involve Scotland abandoning its current entrepot role: that is importing materials and parts from outwith the eurozone, adding value, and exporting the more finished products to the eurozone. Further, relative to the rest of the UK, Scotland is more peripheral to main markets in Europe. Transport costs from Scotland are inevitably higher, and this is exacerbated by UK fuel cost policies and relatively poor transport links to main markets. This peripherality would not be so important if it were not that the domestic market in Scotland is itself small: this places reliance on supplying to markets outside of Scotland. c. The housing market: One of the principal factors stalling the Treasury in recommending immediate entry into the eurozone is the state of the housing market and how it fuels domestic demand. The Croner Reward Regional Price Comparisons series [3], as shown in Chart 5, shows that while house prices in the UK as a whole, led by the south east and London, have increased more than threefold since 1982, those in Scotland have increase 2 times. The housing market in Scotland is less buoyant than that in the south of England and might be badly affected by efforts to damp down the market throughout the UK. Thus, the Treasury conclusion for the UK that incompatibility of housing structures (between the UK and the eurozone) means that the housing market is a high risk factor to the achievement of settled and sustainable convergence may be less true with respect to Scotland and the eurozone.. d. The Treasury also examined differences in investment linkages and financial structures. A separate exercise was not possible for Scotland. 4. Endogenous convergence: The Treasury considers: How strong are endogenous convergence effects likely to be and how rapidly could they occur? Their study is in its nature hypothetical since, as at present, the UK has not joined the EMU. However, it is possible for Scotland to add to the debate on endogenous convergence since it has been in a loose UK monetary union for around 300 years, and more particularly has been in a tighter one since the Bank Charter Act of 1845. Where the Treasury study has properly examined deviations from trend rather than trends in its examination of historical, cyclical and structural convergence, underlying trends are of importance in studying endogenous convergence. In considering the value of a monetary union to it, a country is concerned about how it will fare in the long run. In examining the endogenous convergence of Scotland and the rest of the UK, we have the advantage of fairly long time series in a number of important economic variables: these are considered below. a. GDP growth trends confirm that, as part of UKMU, Scotland has not converged with the rest of the UK within the UKMU. Using Scottish Executive GDP data [4], from 1964 to 1998, the average annual growth rate of output in Scotland was 2.1%; the overall UK rate was 2.4% at constant basic prices. Going even further back to 1951, Scottish GDP has grown by around 285%, UK GDP has grown by 319%.[5]. The relatively large public sector has ensured that Scotland has not experienced the depth of recessions of the UK as a whole. The Treasury estimates that entry into EMU has the potential to add between 5% and 9% to UK GDP over 30 years, arising from lower transaction costs, lower exchange rate volatility, greater cross border trade, and an integrated European capital market.[1] Compared with the difference in growth rates between Scotland and the UK, this potential gain is small. It is not enough to look at output gaps: we need to understand what has been happening to long-term trends in the economy. Chart 6 shows the derived underlying trend in the Scottish and UK economies, 1951 onwards, estimated from [2]. From the early 1980s the long run trend for Scotland is depressed relative to that for the UK as a whole and differences are increasing: again suggesting that the two economies are not converging but following different output paths. b. Labour market conditions Unemployment statistics give some idea of the spare capacity in an economy. Scottish unemployment rates have been consistently above UK average rates. During the 1980s they averaged around 4 percentage points higher than UK rates. Chart 7 shows that although there was some relative improvement in the early 1990s, the divergence increased as the UK economy recovered. With regard to employment, the Annual Business Survey shows that between 1991 and 2000, employment in GB as a whole rose by 16.5% while that in Scotland rose by 11.2%. The improvement in overall employment figures in Scotland is primarily due to increases in part time employment: the growth in full time employment in GB was 10%, compared to 3.3% in Scotland; for part-timers, the growth in GB and Scotland was similar at 35%. This would indicate continuing divergences between Scotland and the rest of Britain. c. Is There Evidence that Scotland is functioning at the Wrong Interest Rate: The Taylor Rule: In its assessment of convergence, the Treasury cites the Taylor rule as providing a simple rule of thumb for estimating the appropriate short-term nominal interest rate for the prevailing output and inflation conditions at a given point in time. The basic form of the original Taylor rule is given by: i = r + * + 1/2 ( *) + 1/2 (y y*). where i is the nominal interest rate, r is the neutral (equilibrium) real interest rate, * is the inflation target, ( *) is the deviation of actual inflation from target and (y y*) is the deviation of actual output from trend (the output gap). The Treasury assume an equilibrium real interest rate of 2 % and the inflation target is assumed to be 2%. In words, this means that the interest rate, i, should differ from its notional equilibrium value, (r+ *), by amounts which reflect both the deviation of actual inflation from target, and the output gap. Using this formula for Scotland and the UK, and assuming as shown on Croners Reward series, that inflation is roughly the same in Scotland as in the UK as a whole, then any differences in interest rates between Scotland and the UK are a function of differences in the output gaps. In recent years, from 1989 onwards, the data suggest that the actual short term interest rate in Scotland should have differed from that in the rest of the UK in a range varying from as much as 1.9 percentage points below in 1990 to 1.5 percentage points above in 1996. It would be wrong to interpret these figures as implying Scotlands interest rate has at times been too low over the recent past. Taylors theorem in itself does not apply to Scotland, since it fails to take account of the depressed trend line of Scottish growth. However, the point of applying even this inadequate version of Taylors theorem to Scotland is to illustrate how it gives significantly different results than for the UK as a whole, suggesting that the one size fits all monetary policy of the UK has not been not in Scotlands best interests. Summary: The above indicators would suggest that the Scottish economy is not converging with the rest of the UK within the UKMU. Entry into the eurozone would not change the relationship between Scotland and its largest trading partner, England. Further, there are clear risks associated with entry into the EMU at the present time. Flexibility The Treasury identifies flexibility as a key test along with convergence: sufficient flexibility ensures that shocks do not have long-lasting effects and that high levels of output and employment are maintained. Flexibility is the ability to respond to economic change efficiently Inside EMU, loss of national monetary policy and the nominal sterling-euro exchange rate means that other adjustment mechanisms would have to work harder. Wage and price adjustment are the most effective adjustment mechanisms available, but there is also a potentially enhanced role for fiscal policy. National monetary unions, including the UK, have been successful without high internal mobility. These statements raise a number of issues which will be discussed in this section: first, while flexibility is important as a short-term response to shocks, in the long-run, what really matters to be successful in a monetary union, is to have productivity growth at or above the average in the union. Flexibility and productivity are examined here. Second, there is an acknowledgement in the Treasury documents that fiscal policy may be an important tool in ensuring flexible responses to shocks within a monetary union: however, the Chancellor, as a general principle, defends the unitary fiscal policy within the UKMU. And thirdly, the statement that the UKMU has been successful without high internal mobility has to be assessed. Without a variable exchange rate, flexibility within the EMU will have to rely on wage adjustment, re-skilling, labour mobility and changes in fiscal policy. The Treasury believes that neither the UK nor the eurozone exhibits sufficient flexibility in the labour market for UK entry to be prudent at the present time. Wages: The Treasurys findings are that UK real wages have tended to be rigid when there are high levels of unemployment but have grown strongly when unemployment has fallen: more recently there has been an improvement in real wage flexibility. We would argue that in Scotland, a relatively large public sector and UK national wage bargaining are likely to have helped make wages sticky downwards, while also fuelling wage increases when the Scottish economy itself is not experiencing demand pressures. Earnings in Scotland have been lower than in the UK as a whole, but potentially could be lower. b. Prices: Government statistics on price indices for different parts of the UK are not produced, however the Croners Reward group have produced UK regional price comparisons since the early 1970s. The broad trend for Scotland is similar to that for the UK, although slightly below. The differential in prices is of a much lower order of magnitude than the differential in employment, unemployment, or GDP growth. The strong effect of a single UK market and single currency is likely to severely limit the possibility of prices being relatively flexible. c. Skilling: By improving skill levels, a country can effect a decrease in real wages. This policy is and has been one of the major planks of government economic policy for Scotland. This policy can be successful if there are sufficient openings in employment and sufficient entrepreneurial potential to absorb or attract large numbers of graduates and skilled people. Without such openings, an improvement in skills and education can increase the mobility of labour out of the country. Anecdotal evidence from Scottish HEIs suggests that a high proportion of the best science, engineering and technical graduates leave Scotland to find employment elsewhere. d. Fiscal Policy: Under present devolution arrangements, the option of competitive fiscal policy, or of using fiscal policy to manage demand in the Scottish economy is not available. Further, if the UK begins to use fiscal policy more actively, for example to lower demand pressures, then on past economic performance this is likely to be in response to high demand pressure in London and the South East. It is therefore possible that the effect of such policies will be to dampen the Scottish economy, even if there is no evidence of inflationary pressure in Scotland. Failure of any of the above four mechanisms to produce sufficient flexibility for an economy to respond to change is likely to mean that real factors, labour and capital, will have to move. Contrary to the claims by the Treasury that the UKMU has been successful without high internal mobility, we suggest that Scotland has experienced high labour and capital outflows, including the loss of many head offices, and that the dynamics of the monetary union work against the general development of enterprise in the country. e. Population migration: Out-migration is the classical adjustment mechanism to an imbalance in economic performance among states in an economic union, if wages and prices are sticky downwards: and so it is with Scotland. Net emigration has averaged roughly one quarter of a million per decade, in the past century. [5] Scotlands population has fallen from 12.5% of the UK population in 1861 to 8.6% in 2001. The issue of population decline in Scotland and its ageing has almost become accepted, as if this was just another manifestation of what is by now a standard Western phenomenon: that all industrialised countries are experiencing such difficulties and that Scotland is no different. This is far from the case: while Scotlands population rose by only 13.2% between 1901 and 2001, the population in England rose by 64%. Projections indicate that, Scotlands population is set to fall while that for England will rise. f. New Firm Formation: Scotland is third-bottom in the list of UK regions in terms of new business start-ups, as measured by VAT registrations per head, and has been so, on average, for more than ten years. Scotlands start up rate per head is around 85% of the UK average. This is one indicator of the lack of opportunity and entrepreneurialism in Scotland. Note too that figures from 1881 onwards show Scotlands employment growth rate to be lower than the UK average [6]. In the long-run, to be successful in a monetary union, productivity growth is vital. One method is to improve the education and skills of the labour force and capture the benefits of those improvements for the home country. This however requires employment opportunities and an environment conducive to entrepreneurship. We have suggested in (c) and (f) in this section, that Scotland within the UKMU has not been sufficiently successful in capturing these benefits. We consider here two further measures which have been used in Scotland to increase productivity: both involve innovation and technology transfer. Inward Investment: Scotland has been successful for many years in attracting foreign direct investment, however this has not proved to increase innovation and productivity in home-grown firms. For example, in 2001, 22% of all employees in manufacturing in Scotland were in overseas owned firms: their gross value added per worker was 67,300 compared to 35,400 for UK owned firms in Scotland. [7] This suggests that some more refined policy instrument needs to be applied to improve regional competitiveness and remove regional imbalances. Innovation and Knowledge Based Industries: The encouragement of knowledge-based industries is seen as a major tool in improving competitiveness. A study by Cardiff University [8] assessed areas within the UK in terms of proportion of knowledge-based businesses and of economic competitiveness. The study found that, in general, competitiveness was highly correlated with the proportion of knowledge-based businesses in an area, and that Scotland fared poorly on both rankings. Index of Regional Competitiveness UK =100 Region / CountryIndexKnowledge Business RankingOverall Competitiveness RankingLondon146.711South East130.322South West124.333East107.644North West83.658East Midlands78.465West Midlands76.476Yorkshire & Humberside76810Scotland73.397Northern Ireland72.61012Wales64.51111 Source: Cardiff University Scotland also performs poorly in business research and development: (0.53% of GDP compared with an EU average of 1.06%). A series of initiatives to encourage a knowledge based economy, including DTI LINK programmes, Farady, European Framework Programmes, COST and EUREKA show extremely poor participation by Scottish based businesses.[9,10,11] This must cast some doubt on the ability of Scottish businesses to increase their productivity through a knowledge economy base. IS A DEVOLVED SCOTLAND LIKELY TO BENEFIT FROM EMU ENTRY The evidence considered in this paper suggests that Scotland has not converged with the rest of the UK within the present UKMU, nor is it in a convergent position with the eurozone. The omens of it benefiting from entry are therefore not good. There are arguments that entry would alter the situation: for example that the lower eurozone interest rate would benefit Scotland. However, if a lower rate is right for Scotland then on the evidence presented here it is likely to be too low for England. There would then be a danger that the English economy would overheat and it would be reined back with fiscal measures. As fiscal policy is the same throughout the UK, this would affect Scotland and dampen demand. Second, it has been suggested that there would be high benefits to the UK from entry and that the Scottish economy would float up in the general benefit. The Treasury Five Tests assessment has disposed of this likelihood with its suggestion that the likely gain is between 5% and 9% of GDP over thirty years. For a devolved Scotland, therefore, entry to the EMU does not hold out any promise of doing any better than it is currently doing. Indeed, entry to the EMU could make matters worse: monetary policy will be tailored for the eurozone and will be less tailored to the UK. Further, the papers presented by JR Cuthbert and A Hughes Hallett and A Scott in this volume suggest that the euro is likely to be a volatile currency, and the latter paper also suggests that there are limits to the extent of endogenous convergence that can be anticipated. HOW MIGHT THE DEVOLVED PARLIAMENT ASSIST To survive and prosper in a monetary union, a country has to have productivity growth at least equal to the average. The Treasury has outlined the five key drivers that it believes are essential to raising productivity: investment, innovation and enterprise, education and skills, competition and regulation, and public sector productivity. Under devolution, the Scottish Parliament is limited in its ability to operate these key drivers, as a number of them are reserved matters to the UK government. Nevertheless, the following could make a difference: a) A reappraisal of the Barnett formula: to consider what expenditure is required in Scotland to compensate for any nationally determined fiscal and monetary policies likely to be inappropriate to Scotland. b) A radical new look is required to raise productivity and competitiveness in the public sector. In Scotland, the public sector is large and diverse: different parts respond to different objectives: for example, health provision is in response to domestic demand; core research at Scottish universities is funded in accordance with research assessment exercise ratings, where the more research of an international standard that is carried out, the greater the funding. Clearly these objectives are important, but they do not in themselves lead to positive outcomes for the Scottish economy. More effort is required to marry in Scottish economy objectives where possible, and in some cases, such as research, to consider a partial re-focusing of objectives, funding, and effort. c) Improved co-ordination between the Scotland Office and the Scottish Executive to ensure that Scotland benefits from its share of public expenditure on reserved matters, such as science and technology, and that it co-ordinates such spend with its own expenditure on innovation and enterprise. The Parliament might even revisit the matters that are reserved and seek for them to be devolved if their being reserved results in inefficiency in the Scottish economy. [see, for example 9, 10] d) Supply side factors could be improved: for example, assistance targeted to exporting industries; assistance targeted to start-ups in knowledge based industries; more encouragement to research and development; information networks improved in exporting and research development; encouragement of local supply chains; address the export opportunities trapped in the public sector; improve the skills base in technical subjects. Most importantly, co-ordination is needed. Increased provision in higher education, for example, should be accompanied with greater opportunities in the job market. CONCLUSION Overall, it is suggested that Scotlands experience in its monetary union with the rest of the UK is not positive at the present time nor has been for much of the last century. Scotland is in an exchange rate with the rest of the UK that looks too high; wages and prices have been relatively sticky downwards; and Scotland has continued to lose population. Moving into a larger monetary union, while remaining in too high an exchange rate with the rest of the UK, will not cure this fundamental problem. What is needed is a radical change in the management and direction of the Scottish economy. Policies must be prioritised to take into consideration productivity and competitiveness. Scotland needs policies that will encourage further expansion of markets, increasing the diversity of the products and services exported, and increasing the numbers of firms engaged in exporting. REFERENCES HM Treasury, (June 2003), Assessment of Five Tests Morten O. Ravn, University of Southampton, Universitat Pompeu Fabra, CEPR, and Center for Non-Linear Modelling in Economics; and Harald Uhlig CentER, Tilburg University and CEPR, (1997), On Adjusting the HP-Filter for the Frequency of Observations. Croner Reward, bi-annual, UK Regional Comparisons Report Scottish Executive, Scottish Economic Report, 2001 D Simpson et al., (1999), Report on the Economic Aspects of Political Independence, the David Hume Institute, No.56, Ashcroft, B. (1997), Scotlands Economic Problem: Too Few entrepreneurs, Too Little Enterprise?, Strathclyde Papers in Economics Scottish Executive, Scottish Economic Statistics, 2001 Edmonds, T.(2000) Regional Competitiveness and the Role of the Knowledge Economy, Research Paper 00/73, London, House of Commons Library. Cuthbert, M., (2001), Developing a Knowledge Economy in Scotland: Fraser of Allander Quarterly Economic Commentary Cuthbert and Cuthbert, (2002), The Treasury Funding Statement as a Tool in Monitoring the Devolution Settlement, Fraser of Allander Quarterly Economic Commentary Cuthbert and Cuthbert, (2003), The Fifth European Framework Programme: A Comparison of Scotland and Ireland Involvement, Fraser of Allander Quarterly Economic Commentary  Data for the UK and the eurozone are as given in the Treasurys Assessment of the Five Tests. GDP forecasts for Scotland are taken from the Fraser of Allander Quarterly Economic Commentary.  As measured using the Hodrick Prescott Filter Technique, (=100.  From Treasury Convergence chapter.  Labour Force Survey, ILO Statistics.  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