Why has Edinburgh not suffered from the banking crisis?

Edinburgh may be one of the epicentres of the greatest financial crisis in modern history, but you’d be hard pressed to tell. You might have expected a city flat on its back, with dazed ex-bankers wandering around the aisles at Lidl and TK Maxx. You might think that the council would be pushing through emergency cutbacks and bracing itself for a collapse in property taxes. But if you’re looking for austerity, it isn’t here.

There is no shortage of new cars on Edinburgh’s roads, even before the government’s scrappage scheme has started. House prices have taken a knock, but only by about 10% - and the market remains pretty healthy by comparison with London. Seriously expensive flats are still being built in developments like the Quartermile on the site of the old Royal Infirmary of Edinburgh. A half billion pound tram system is being laid between Edinburgh airport and projected luxury developments at Granton.

This doesn’t seem to make a lot of sense. Edinburgh’s banks - RBS and HBOS - may have collapsed into insolvency and been bailed out by the state, but Edinburgh hasn't turned into Reykjavik or Dublin. Why not? Well, the answer is that while Edinburgh was big on banking, it has been bigger, much bigger on public spending It’s not bankers who are keeping he wine bars buzzing in the New Town, but civil servants, council officials, teachers and NGOs.

Edinburgh is a big administrative centre of Scotland, and home to many of Scotland’s 40,000 highly paid civil servants. The city’s 20,000 council staff have had a 5.5% pay hike this year. They brush shoulders in Starbucks with Edinburgh’s 50,000 students, many of them from overseas and paying hefty fees at Edinburgh’s three universities.

According to he Centre for Economic and Business Research, Scotland’s public sector wage bill has risen by 55% since 1999 to £12 billion, with nearly one in four Scots working for the state. The annual public sector pension bill alone amounts to $2.3 billion. For a country with only 5 million people, these are big numbers.

But is the party over following the unveiling of the Scottish Government's austerity budget? Well, not without a fight. The Scottish Government is furiously opposing what it claims is a £500m cut next year in Scottish public sending. It will lead, says the finance secretary, John Swinney, to 9,000 public sector job losses. Labour dispute the figures, but accept that some belt-tightening is inevitable.

And worse could be on the way. The Centre for Public Policy for Regions (CPPR) at Glasgow University estimates that a total £6bn will be lost from the Scottish budget by 2013-14. It suggests that high spending policies like the council tax freeze, abolition of bridge tolls and even free personal care might have to be revisited. The alternative would be many job losses in the public sector which is considered politically unacceptable in an economy so dependent on the state.

Mind you, private sector workers - those still in work - look enviously at the legions of bureaucrats in Edinburgh living in a different world, of secure employment, annual wage rises, and final salary pensions. There’s a feeling that someone has to call a halt to this, but no one is sure how. The SNP government wants economies, of course, but doesn’t want to be blamed for massive job losses. The SNP First Minister, Alex Salmond, is determined to blame London for cuts that, he says, will prevent economic recovery north of the border. But he also wants to use the shrinkage of the state to argue the case for fiscal autonomy in Scotland.

He may get it sooner than they think. There is a very strong case now, if Scotland wants to avoid these cuts, that it should be required raise revenue to pay the cost of preventing them. It seems inconceivable that Scotland will be excluded from the financial constraints on public spending that have been set in train by the treasury. Any way you look at it, the years when public spending rose in real terms year on year are over. The Scottish Executive budget has doubled since 1999. There is only one way that this can continue: if Scotland given the means to tax and borrow its way out of recession.

All the parties in Holyrood now favour a new range of tax raising powers for Holyrood. The Labour-led Calman Commission on the constitution is expected to argue later this year for the Scottish government also to be given borrowing powers. The present arrangements, under which Scotland receives a block grant from London, may have worked in the years of plenty, but not any more. The only people who haven’t been consulted on this are the Scottish people themselves. We don’t know whether Scotland is prepared to shoulder a greater tax burden than England - no party has proposed using the parliament's existing powers to raise the basic rate of tax by 3p. But we may be about to find out.