As the recent Reform Scotland policy brief “Investing for Recovery” put it succinctly regarding the economic shock caused by Covid-19, “if [this]is not a catalyst [for]bold, radical interventions that will transform Scotland’s economy, then nothing ever will be.” This is both true, and sadly, not just a Scottish problem.
Lulled into the false sense of security generated by the actions of central banks to stem the 2008 crisis, policy incrementalism is steeped into the DNA of governments these days. Rather than the problem being just a lack of fresh ideas, the deeper issue seems to be a lack of political courage to try anything new. Even self-proclaimed populists fall back on tired old solutions such as tax cuts and tariffs in the face of these new challenges. We must do better.
In their paper, rather than arguing for more taxes as being the only game in town or a reducing debt to free up fiscal space, Alan McFarlane and Andrew Wilson focus on the asset side of the state’s ledger, something that has been badly neglected for 40 years.
States used to have public capital in the form of stakes in companies, and the ownership of assets such as public housing or utilities. The great privatisation spree of 1980-2000 passed most of that public wealth into private ownership. While the effects of this shift on inequality are well noted, the effects on the state’s balance sheet are not.
Public assets generate public income. Without such income, deficits become inevitable, stretching budgets, especially in an environment of tax cuts and rising inequality. So rebuilding public assets seems a good place to start. Some smaller governments similar to Scotland (except that they have greater degrees of monetary autonomy) such as New Zealand and Ireland recognise that rebuilding the public housing stock is necessary. “Investing for Recovery” takes another angle on this question, one that we share.
Governments everywhere have, despite Covid-19, received a windfall in the form of structurally low interest rates and a distinct lack of inflationary pressures. The reasons behind this shift are multiple, ranging from changing demography to the effects of QE, but the fact of this environment for funding is not. Most ‘A rated’ sovereigns can at this point issue debt over a 10-15 year horizon at a negative real rate, which means investors are paying the sovereign. Given the general level of uncertainty facing investors, there is no shortage of demand for such “safe assets” despite the negative payoff. As such, even discounting Covid’s effects, there has never been a better time to undertake long-term public investments.
In our new book Angrynomics, and in a recent IPPR paper ‘Beyond Bailouts,’ we take this insight further and argue for the establishment of a Citizen’s Wealth Fund (CWF). Modeled after the sovereign wealth funds of smaller states such as Singapore and Norway, we argue that a CWF can be a new and important tool to combat inequality. Buying a broad swathe of equities in moments of crisis when the government’s cost of capital goes negative as investors dump equities and buy bonds, a CWF can hold these assets for the long term on behalf of the public, picking up the equity premium and banking those equities as publicly-held wealth. These returns can then be redistributed to the bottom 80 percent of society and/or used for transformative investments such as decarbonisation.
We were happy to note that the Reform Scotland piece referenced our work in their call for the creation of two entities, Scottish Government Investments (SGI) and Equiscot, that have broadly the same remit as our CWF proposal. In what follows we discuss these proposals and suggest how to strengthen them, while noting some of the limitations of attempting to build such institutions in an environment of devolution and monetary non-sovereignty.
Scottish Government Investments (SGI)
Scotland, it seems, has a multiplicity of public and quasi-public asset managers ranging from Public Corporations, investments by a variety of government bodies, impact investments of various kinds and infrastructure assets. “Investing for Recovery” views this moment as an opportunity to rationalise these holdings, while taking a longer view of the portfolio of assets as a whole. That is, how can one part of the portfolio – for example, investment in a public utility – offset the costs of a socially necessary connective enterprise, such as island ferries.
To get there “Investing for Recovery” envisages SGI as a dedicated public investment fund that actively manages these assets with a view to cross subsidise and grow the overall portfolio.
The first question that arises is ‘should the government do this?’
Our answer is that the government is already doing this, but doing it with less strategic vision and no core strategy. We can do better.
An analogy can usefully be made with private equity (PE). Whereas a PE firm would set up funding pools to buy these assets, add the cost of the purchase to the balance sheets of these assets, and then run high revenues through them with a view to selling them on the public markets, a public equity fund, which is what SGI really is, can take a different approach.
Already owning the assets, such a public fund could use the income streams in place to strengthen the overall portfolio and its returns. This would help rebuild Scotland’s much-diminished public assets while giving a positive income stream to the Scottish Government (SG). It would also supply, over time, high quality ESG-compliant assets that the SG could choose to sell to the private sector, in whole or in part, but only with a view to refreshing the overall portfolio of assets. Such a fund would thereby provide an incubator for future potentially high-growth investments in new technological areas. A kind of ‘angel investor’ scheme that is self-financing.
The Scottish National Investment Bank (SNIB)
A second set of questions arising is ‘OK, if the government does this, and gets the right people to manage it, and the politicians are kept away from it, it might just work. But surely there will be pressure to buy distressed assets and politically important firms? Do we really want a new form of nationalsation a la the 1970s, even if it’s done through passive equity ownership?”
Our answer is that there is such a risk, but it can be obviated, and it can’t be avoided.
Covid-19 creates a massive problem for capital re-allocation across all economies. We simply do not know how the experience of this pandemic will impact sectors over the long term. Will we trust public transport and air travel again? What about soft-touch services? For example, what happens to ‘intimate’ restaurants and traditional Scottish bar culture? So in one way, Scotland cannot avoid the problem of how to cushion the structural changes that Covid-19 will force upon its economy.
This is where the least developed part of the proposal, for a Scottish National Investment Bank (SNIB), becomes important. Such a Bank, by definition, will have two roles.
First, to pick, if not winners, then survivors. What are the key sectors of the Scottish economy that Scotland needs to succeed post-Covid? How can a public Bank take equity stakes in such ventures to ensure that temporary (albeit long-term by recent standards) liquidity problems do not become long-term solvency problems? To gain from the upside of such liquidity provision, the “price” for assistance should come in the form of five-year warrants that grant the government the right to buy equity in the supported businesses, up to an additional 10 per cent, at the same price at which it has injected the equity, at any point in the next five years.
Its second role is to triage the losers. To act as a “bad bank” to ensure the liquidation and reallocation of Covid-impaired assets is done with a view to minimising displacements. SNIB could in that regard work with a partner institution that focuses on the labor market displacement (perhaps called Scotworks?) to ensure that labour is retrained and reallocated to Covid-resilient sectors. Some entity has to make these calls, which seem different in kind from the mission of SGI. SNIB seems to be that institution.
This division of labor would then free up the proposed portfolio company modelled on Temasek (Singapore’s sovereign weath fund) called Equiscot. “Investing for Recovery” argues that Equiscot should be “free to invest for value and returns anywhere, but in ways that could also enhance existing capabilities [as]an effective asset-manager arm of the SNIB.
We again agree, but would go further. Implicit in “Investing for Recovery” is a temporal dimension. Covid is the immediate shock. Short-term SGI centralises, rationalises, and focuses on growing the public asset stock in response. Medium term, the SNIB performs both triage and liquidity functions for critical firms and sectors.
Then, longer-term, Equiscot comes into its own. First, as the fully independent asset management company focused on long term growth of the type of CWF we argue for in Angrynomics. The borrowing environment makes this an almost free option, and the capital base for it could come from local authority pension schemes and similar, as “Investing for Recovery” recognises.
Second, Equiscot and SNIB could work together to provide the bridging capital needed for the private sector to aggressively move forward with investments in decarbonisation at scale. It seems to be the case that small states with good governance and higher levels of public trust are the only ones that can move forward aggressively with decarbonisation – Denmark, New Zealand and Sweden spring to mind.
Given that global financial markets are waking up to the shortage of ESG assets, the need for “green” financing, and the real possibility of massive losses on so-called ‘stranded’ carbon assets, small states investing at the frontier of such areas – in hydrolysers, in water sequestration and export (as the south of England dries out the new Scottish oil may well be Scottish water), and in exportable wind power – will reap high returns.
The problem with all of this is of course how to fund it. While we are not Modern Monetary Theorists, it is undeniable that having one’s own currency matters. After all, the Scottish government cannot issue its own sovereign debt, nor can it settle accounts in its own currency. As such, our preferred funding vehicle – to issue debt when the government’s cost of capital goes negative – is not possible in the Scottish context. Nor is the environment for greater fiscal independence likely to expand over the course of the current parliament. But perhaps there are work arounds?
Scotland could, by setting up these institutions, act as a “pilot program” for the feasibility of such institutions for the UK as a whole. If cooperation with the Bank of England and the Treasury was foregrounded with such ambition, then the funds needed to get them up and running could be forthcoming. There are more “off balance sheet” ways of proceeding, such as setting these entities up as special investment vehicles and the like. But such opaque moves are likely to be reasonably opposed.
As such, we think that the next part of this conversation should focus on how to fund these entities under the existing devolution settlement. If Scotland can get them to work it will be value added, not just for Scotland, but for the wider world.
Mark Blyth and Eric Lonergan are the authors of Angrynomics (https://www.amazon.co.uk/Angrynomics-Eric-Lonergan/dp/1788212797). Lonergan is a macro hedge-fund manager in London. Blyth is the William R. Rhodes ’57 Professor of International Economics at Brown University, Rhode Island.