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From Slovakia to the UK – with love

11 Feb 2014

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Slovak Marek Zemanik, policy officer at the Scottish Conservatives, settled in Scotland after studying for his Masters here and then falling in love with a local girl. Here he describes why he’s backing the United Kingdom in the referendum, and how the break up of Czechoslovakia shines a light on the SNP’s attempt to keep the pound in the event of independence.

 


I have tried, more or less successfully, to stay away from the passion and emotion of the independence debate in Scotland. After all, it is my job to deal with facts and figures, not target people’s sense of belonging or identity. I am in no doubt that the battle over the coming months will be one of head and heart of equal measure, but I will only be fighting on one front.

I have also tried to stay away for a more prosaic reason – while I have called Scotland home for almost 10 years now, I am and will remain a foreigner. However, my background does give me a unique perspective. I have personally seen my own country break up before. Born in Czechoslovakia, I am now a citizen of only half of it.

Coming from Slovakia to Scotland in search of better higher education, like a character in a clichéd romcom I unexpectedly fell in love with a local girl, eventually got married and never left. I always felt a certain closeness to the United Kingdom. After all, my bilingual alma mater was set up with the considerable help and guidance of the British Council. However, I never expected this closeness would evolve into working to save the country itself.

I am wary of any analogies that are made in relation to Czechoslovakia and the future of the United Kingdom. The romantically labelled Velvet Divorce was nothing but a politically expedient decision that was unpopular (albeit more so in the Czech part), taken hastily without a referendum (which would certainly have failed) and one that many of us regret to this day. Some of the parallels made are outright bizarre. I recall someone using the post-split economic fortunes of the Czech and Slovak Republic as an argument for independence, which I have always found amusing. Any economic boom came about as a result of the dismantling of the totalitarian communist behemoth that a country with tremendous potential was shackled by for decades.

There is one area, however, where Czechoslovakia can give us some pointers for the debate in Scotland – the success, or indeed failure, of a currency union. This topic has become one of the key referendum issues and for good reason. Any (potential) changes to the money in people’s pockets and the disruption with it will inevitably be discouraging.

The Scottish Government asserts that the pound will remain in an independent Scotland and that a currency union will be created. Putting aside that this depends on agreement from both sides and, more importantly, would likely require a ceding of some fiscal (not just monetary) sovereignty from both sides and would constitutionally lead Scotland closer to Devo Max than independence, what can we learn from the short-lived Czech-Slovak currency union?

CZE-SVK

Academic literature on the reasons for the failure of the currency union, which was planned for a minimum of 6 months, but broke down after 38 days, is surprisingly scarce. There seems to be more interest in the secretive operation that preceded the immediate collapse of the currency and, frankly, it is fascinating. Nonetheless, applying political and economic theory to the Czech-Slovak example highlights numerous factors that led to the collapse of the currency union.

One of the main contributing (political) factors was the lack of political commitment in both countries. Private capital flight is the biggest risk in currency unions, especially asymmetric ones. If investors perceive any danger of a drop in currency value, capital will flow to stronger economies (in scale). Political commitment to make a currency union work is therefore paramount. Indeed, it has been argued the only reason the Euro still exists is strong (German?) political commitment.

The Czech-Slovak currency union was created for an initial 6 months, with set conditions that would trigger dissolution and it was to be reviewed regularly. This weak arrangement was not enough to prevent capital flight from Slovakia to her western neighbour and spelled the beginning of the end of the Czechoslovak koruna. I will not speculate on the political commitment from either side of the debate in the UK. It is worth pointing out though that the Scottish Government’s White Paper already acknowledges the possibility of a different currency arrangement for Scotland in the future and virtually all statements from Westminster politicians have been non-committal.

Significant policy divergence between the two parts of the Czech-Slovak currency union was also a contributory factor. Following the fall of communism the Slovak National Council resisted the speed of market-oriented reforms initiated by the federal government and it became increasingly clear that an independent Slovakia wanted to go a different way. (It turned that way led through corrupt nationalist authoritarianism for half a decade, but that is not for this piece to explore.) This policy divergence put significant pressure on the currency union right from the start. While nowhere near the same scale, the path the Scottish Government seems to want to pursue is deliberately a very different one from the UK Government. Should this lead to significantly varying economic fortunes of the two countries, the currency union would come under strain – certainly without any stabilisers, but more on that below.

Macroeconomic theory on currency unions emphasises the effect of economic integration and similarity between constituent countries. The more integrated and similar they are, the more stable (optimal) the currency union should be. Problems arise when currency unions are subject to asymmetric economic shocks, for example unforeseen events that lead to a big fall in GDP in one part of the union. In fact, even the very possibility of an asymmetric shock can put pressure on a currency union. Here Czechoslovakia serves as a good example – the two country economies were surprisingly varied despite sharing the same state for 70-odd years.

When Mark Carney made his speech in Edinburgh a few weeks ago he spoke about the “similarity of industrial structure” between Scotland and what would become rUK. On a geographical allocation of oil revenues the two economies are comparatively (to other currency unions) diverse. An independent Scotland’s economy would depend on the energy sector a lot more than the UK’s, that’s undisputable. It follows that in the event of, for example, a major drop in oil prices the economic shock would asymmetrically affect Scotland in the currency union.

It would, however, be unfair to conclude that divergent economic structures themselves make a currency union unstable. Indeed, both Carney and other studies stress the importance of absorption mechanisms in currency unions – most importantly labour mobility and fiscal transfers. Labour mobility, where following an asymmetric shock the unemployed relocate, across Czechoslovakia (and her two successors) was surprisingly low, even though no barriers were in place. Interestingly, evidence suggests the same across the UK, although Carney suggests that overall positive economic conditions never put that theory to the test.

Fiscal transfers, on the other hand, are much more complicated between two sovereign states. Within the UK, automatic fiscal stabilisers exist (welfare payments and tax receipts are in a direct relationship) which can mitigate regional GDP fluctuations, but these would clearly cede upon independence. Other fiscal transfer or control arrangements would have to be negotiated, taking into account relative positions and future prospects of the economies of Scotland and rUK. I will let the reader conclude which of the two would have the stronger hand.

Political or economic reasons on their own do not go far enough to explain what happened to the Czech-Slovak currency union – it is the combination of both that paints a fuller picture. Drawing on the Czechoslovak example, this piece tried to outline, albeit simplistically, some of the major challenges that would need to be overcome in pursuit of an agreement between an independent Scotland and the rest of the UK.

None of the evidence here or elsewhere, however, can refute a few simple facts: the pound has been good for Scotland and, unsurprisingly, most Scots want to keep it. Most importantly though, Scotland already is, just like Slovakia was, part of a successful currency union. This year, I will be campaigning for a currency union, for a political union and for a social union – I will be campaigning for the United Kingdom.

 

Marek Zemanik
@marek_zemanik