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GEORGE KEREVAN says oil is back in the headlines.

At the weekend, there was much fuss regarding a story in the pro-independence Sunday Herald.  This revealed yet another confidential government paper from the 1970s by Professor Gavin McCrone, then Chief Economic Advisor at the Scottish Office.

This latest 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…

“If we allow this precious asset [North Sea oil] to be used without leaving something in its place for the future we shall be rightly condemned in the eyes of succeeding generations.”

As we all know, the Treasury put the kibosh on the idea of a wealth fund. 1976 saw the IMF crisis and massive public spending cuts – saving for the future was considered a political luxury. This fiscal emergency proved a storm in a teacup and the UK economy rapidly righted itself, even running a budget surplus. But by 1979, Margaret Thatcher was in Downing Street just in time to receive the wall of cash delivered from the North Sea.

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.

But is this criticism defective? Surely, everything depends on what happened to the oil revenues instead. Journalist and writer David Torrance, whom I debated last week 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.

The major axe came in local authority capital spending. Local government gross capital formation was 3.8 per cent of GDP in 1974, at the start of the second Wilson administration. By 1982 it was a mere 0.8 per cent. The number of new dwellings completed by local authorities declined to barely 20,000 in 1990. (NB: Private housing completions rose under Mrs T. but did not compensate for the decline in local authority building).

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.

So where did the oil money flow to during the Thatcher era?

First, much of it was swallowed up in the gigantic 1980 recession, caused by Thatcher’s attempt to squeeze inflation out of the economy – a fiscal tightening that was over-done because Chancellor Geoffrey Howe misread the monetary growth statistics. 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, along with extra VAT. 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.

There you have it: the big oil revenues were largely frittered on boom and bust. True, the forced de-manning of British industry in the early 1980s raised productivity at a stroke. But it did so at the expense of downsizing the entire manufacturing sector, and giving us a permanent trade deficit in goods.

As a result, Britain became a debt-fuelled, consumer-driven economy prone to endless bubbles.