Scotland - No Detriment, No Danger: the Inter-Regional Impact of a Balanced Budget Regional Fiscal Expansion

In the Scottish Independence Referendum, the Scottish electorate voted to remain within the UK. However, this did not mean that the institutional arrangements in Scotland would remain unchanged. Legislation already enacted under the 2012 Scotland Act plus the recommendations of the Smith Commission report will give Scotland extensive fiscal powers in the future. However, although there will be a highly devolved structure for taxation and public expenditure, the Scottish economy is closely integrated with the rest of the UK and issues of policy co-ordination and misaligned incentives will almost inevitably arise. The paper develops an extremely simple two-region demand-driven analytical model, which is used to illustrate the nature of inter-regional interaction that would occur as a result of devolved policy initiatives. Our particular focus is the question of balanced budget fiscal expansions. We construct a set of two-region (Scotland/RUK) Industry by Industry Input Output accounts for 2010. These accounts are taken as the data on which Input-Output and Social Accounting Matrix (as well as Computable General Equilibrium) models can be built to calculate the impact of decentralised and devolved policies. The simulation results highlight the potential significance of inter-regional effects and the requirement for accuracy in the size of inter-regional trade flows and critically the need for a more highly developed policy framework to measure such inter-regional spillover impacts.