LABOUR ministers were repeatedly advised in the 1970s to set up an oil fund to secure a legacy from the North Sea but failed to do so, newly unearthed archive papers have revealed.

Instead, amid a UK economic crisis, Jim Callaghan's government chose to spend the tax revenues from oil immediately, a pattern that continues to this day, leaving the UK and Iraq as the only oil-producing nations in the world without some form of savings fund.

Norway's oil fund is now worth £500 billion.

The files' discovery follows an appearance by former government economist Professor Gavin McCrone at Holyrood's Finance Committee.

In 1974, McCrone wrote a now-famous report for ministers predicting Scotland would become "as rich as Switzerland" if it controlled North Sea oil - a prediction that was kept from voters.

Last week, he told MSPs he had also written a second paper, in 1976, arguing for an oil fund, sparking a frantic paper chase inside the Scottish Government to track it down.

However, the Sunday Herald found it first.

Marked "Secret", the paper recommends a North Sea Oil investment fund for the whole UK, but giving "especial priority to Scotland".

In it McCrone told Scottish Secretary Bruce Millan: "Given the expectations aroused in Scotland, not only by the SNP but by other parties as well, and the considerable dangers of a move towards independence, it is essential that some tangible benefits should be provided.

"The task will not be easy since to many Scots it may seem that oil revenues are to be used in a hopeless attempt to stave off the day of reckoning for the UK and that in 10 years' time the condition of the economy and of Scotland in particular will be as bad as ever."

McCrone said an oil fund should make "regional development" a priority, and that if a Scottish Assembly was established, it should have some control over oil income "to help in tackling the worst problems of the Scottish scene, particularly the dereliction and urban deprivation of West Central Scotland".

Fixing problems which give rise to "a major source of economic grievance in Scotland and have done as much as anything to fuel the separatist movement" would "minimise the chances of a constitutional crisis", he said.

In its archive trawl to find the 1976 report, the SNP Government also found a draft green paper written by McCrone in 1977 which set out possible Labour government thinking on North Sea Oil, and also included the suggestion of an oil fund.

"If we allow this precious asset to be used without leaving something in its place for the future we shall be rightly condemned in the eyes of succeeding generations," it said.

Although both Millan and energy secretary Tony Benn argued for a fund in Cabinet, the idea was rejected as the UK economy was so bad the government needed to spend the oil revenue immediately, and so saved nothing.

First Minister Alex Salmond said: "These are yet more damning revelations which lay bare the extent to which Westminster has mismanaged Scotland's oil wealth.

"The costs of that mismanagement are now clear.

"Norway discovered oil at the same time as Scotland and now has the biggest oil savings in the world at more than £500bn, while Scotland's fund stands at zero, thanks to Westminster.

"In an independent Scotland we will establish just such a fund - something which only a Yes vote in September will ensure."

McCrone said Labour had little option but to spend the oil money in the 1970s, as the UK was in crisis, but the Tory governments of the 1980s had a real choice.

He said: "It [an oil fund] should have been done in the 1980s when the North Sea oil revenues were colossal. I think the Government could have done it then, but did not."