By George Kerevan
There was much fuss regarding a recent story in the pro-independence Sunday Herald. This revealed a confidential government paper from the 1970s by Professor Gavin McCrone, then Chief Economic Advisor at the Scottish Office. This draft green paper, dated 1976, recommended the creation of what we would now call a sovereign wealth fund, created by investing some of the oil revenues.
As we all know, the Treasury put the kibosh on the idea of a wealth fund. So what did happen to those oil revenues?
In the years between 1980-81 and 1989-90, the Thatcher government received a staggering windfall of £166bn (in 2011 prices). If just 10 per cent of UK tax receipts from the North Sea had been put into an oil fund starting in 1980 and continuing until 2008, and if the nominal return had been 3 per cent, the value of the fund would be £24bn per annum. (By the way, I’m quoting figures from the academic Jim Gallagher, an advisor to the Better Together campaign.)
Twenty per cent of oil revenues on a return of 5 per cent would have created a sovereign wealth pot of £66bn per annum. (And before anyone carps, I know share prices went down during the crisis of 2009, but they’ve shot back up again.) That aggregates to £1.8 trillion.
The annual interest on that sum would pay for 17 per cent of all UK public spending this year. That’s the equivalent of nearly two thirds of the pensions bill, or the total education and defence budgets combined.
Instead, governments – starting with Margaret Thatcher’s – decided to spend the money as they went along instead of saving some of it for a rainy day, as Gavin McCrone advised all those decades ago.
Journalist and writer David Torrance, whom I debated recently at Waterstones in Edinburgh, argues:
“But the idea that oil wealth was, as The Sunday Herald splash puts it, poured ‘down the drain’ is risible: it went on public spending”.
Did the oil revenues in fact go in extra public spending? Quite the opposite. During Margaret Thatcher’s era, overall public spending in cash terms was held roughly static but the state’s overall share of GDP diminished dramatically.
Public spending fell from 44.6 per cent of GDP in 1979-80, to 39.4 per cent of GDP in 1990-91, a 5.2 percentage point decline. Put another way, that’s a bigger cut than George Osborne has managed.
The true magnitude of Mrs Thatcher’s spending cuts is masked by the recession of the start of the 1980s. Rising unemployment caused public spending to peak temporarily at 48.2 per cent of GDP in 1982-83, funded by a huge hike in VAT. After that, the Thatcher administration really started hacking at the state. The peak to trough reduction in public spending was a stunning 8.8 per cent of GDP – austerity on the grand scale.
Another theory says that the new oil revenues were spent on public investment, thereby creating capital assets that added to economic productivity. In other words, according to this argument, the oil cash was saved for a rainy day by being put into housing, roads and schools.
Er…wrong again. The Thatcher decade hides a dramatic cut in real capital investment. Net public capital investment (i.e. new investment assets as opposed to depreciation) fell from 2 per cent of GDP in 1979 to a pathetic 0.2 per cent a decade later. Gross public investment fell from 6 per cent of GDP to under 3 per cent.
Mrs Thatcher did increase some elements of capital spending – in defence and public order. Public investment in these areas rose by the equivalent of 1 percentage point of GDP – hardly a gain for productivity.
A third explanation is that the oil revenues funded significant tax cuts, and that these cuts in turn funded a significant boost to private sector investment, thereby increasing productivity. If so, North Sea oil revenues were ‘saved’, but in the form of a modernisation of Britain’s industrial base.
In fact, Mrs Thatcher was not a great tax-cutter. She raised taxes significantly when she came to office (that VAT rise) with the result that the burden of taxation as a percentage of GDP was only a few points below that of the previous Labour government, when she demitted office in 1990. Income tax rates were cut, but this was largely offset by the rise in consumption taxes paid by the poor.
Neither is there evidence of any sudden flowering of industrial investment during the Thatcher years. Capital investment as a proportion of GDP fell in the period 1980-89, from 19.9 per cent to 18.4 per cent. UK investment was actually the lowest of all the major industrial economies.
So where did the oil money flow to during the Thatcher era?
First, much of it was swallowed up in the gigantic 1980 recession. It took 18 quarters for GDP to recover its pre-recession peak and unemployment was still nearly 12 per cent in 1984. As a result, non-oil revenues declined while welfare spending increased. North Sea oil income filled the gap. Between 1980 and 1984, the Thatcher government received £96bn in oil revenues (in 2011 money). Essentially, this funded the recession without borrowing becoming unsustainable.
In the latter half of Mrs Thatcher’s time in office, the oil income went towards actually reducing public borrowing. When the Conservatives came to power in 1979, gross National Debt stood at 44 per cent of GDP. Fiscal tightening transformed this situation. In the four years from 1987 to 1991, the government actually ran a budget surplus, paying back debt. When Mrs T. was booted out, National Debt stood at a mere 27.7 per cent of GDP.
Unfortunately, the results proved perverse. A too-cocky Chancellor Nigel Lawson felt able to hold down interest rates to shadow the D-mark, while cut income tax too fast. The result was a house price bubble and rampant inflation, followed by another deep recession (and huge public deficit). But by this time, global oil prices had collapsed and the tax bonanza was a thing of the past.