Scottish Economy Watch

Fraser Economic Commentary - November 2015

 

I           Overview

 In the latest Economic Commentary  we note that Growth in both the Scottish and UK economies is slowing and in the second quarter a gap opened up between Scotland and the UK.

• The chained volume measure of GDP rose by 0.1% in Scotland in the quarter, while UK GDP rose by 0.7%.
• UK GDP (ex oil & gas) stands 6.9% above the pre-recession peak compared to 3.0% in Scotland. UK GDP - ex oil & gas - has had an even stronger recovery from recession than Scottish GDP.
• Scottish GDP has recovered by 8.4% since the trough of recession while UK GDP - ex oil & gas - recovered by 13.8% from its trough by 2015q2, compared to 12.8% when oil and gas output is included. In the latest quarter, UK GDP ex oil and gas rose by 0.5% - less than the 0.7% when oil & gas is included, suggesting a pick up in offshore activity - and by 2.7% over the year – four quarter on four quarter.

 

II          Industries and sectors

 The pattern of growth between Scotland and the UK again differed considerably in the fourth quarter. 

• In Scotland it is the construction sector that is providing the main impetus with public spending on infrastructure underpinning growth.
• In the UK in contrast, the service sector is the main driver with construction weakening.
• In Scotland, weakness in the service sector has been affected by the onshore implications of the fall in the price of oil hitting business services in particular as well as mining and quarrying. 
• Manufacturing growth is weak in both Scotland and the UK, which seems to be a reflection of weakening external demand for UK exports reinforced by the strength of sterling, the current crisis in the UK steel industry being a sad, example.

 

III         The labour market

 The latest labour market data show that the recovery in the labour market is slowing in both Scotland and the UK, while the recovery remains stronger in the UK.

• In the quarter to August 2105 employment fell by -6,000 (-0.6%) to 2,610,000 while unemployment rose again by 18,000 (0.6%) to 170,000 with the rate rising to 6.1%.
• In both the jobs market and in output the recovery has been stronger in the UK than in Scotland. On jobs, employment was 2.2% above the pre-recession peak in Scotland at the end of the second quarter, while UK jobs were 4.4% higher than the peak.

 

IV         Factors influencing the recovery

 (i)             Domestic demand

 Domestic demand in Scotland and the UK continues to be boosted by:

• low inflation;
• net immigration into the UK;
• low interest rates; and some pick up in wages and earnings.

 To be set against these positive influences are actual and potential threats to the growth of domestic demand:

• further planned austerity by the UK Conservative Government exemplified by the planned cuts to tax credits; and
• the continuing high levels of household debt, which for some households paying a variable interest rate will become an increasing burden if rates rise in the near future.

 (ii)           External demand

 External demand for Scottish and UK goods and services is being boosted by:

• the continued resilience of the US economy;
• a gradual pick up in growth in the Eurozone as the risks of deflation appear to recede while the problems of Greece are, for the short term at least, resolved;
• and the world economy is forecast by the IMF to grow by 3.1% this year and by 3.6 % in 2016.

 To be set against these positive influences are actual and potential threats to the growth of external demand:

• the high sterling exchange rate against the Euro, which appears to have been boosted by the short-term market expectation of an imminent increase in UK interest rates;
•  the IMF’s forecast for global growth in 2015 and 2016 represents a slowdown from the 3.4% achieved in 2014;
• China’s transformation from dependency on high domestic investment, forced saving and a disproportionate reliance on external demand to a greater reliance on household consumption and associated structural reforms will lead to slower growth; and
•  the effect of what the IMF calls ‘policy normalisation’ of monetary policy in the United States as interest rates begin to rise is expected to have global repercussions, which will serve to slow growth especially in emerging markets.

 

 V          Forecasts

 (i)             Output

• Our GDP forecast for 2015 is 1.9%, which is revised down from our forecast of 2.5% in June of this year due to the evidence of a slower than expected rate of growth in the second third quarters of 2015.
• For 2016, we have also revised down our forecast to 2.2% from 2.3% in June, in recognition that the slow down in the rate of recovery will continue into 2016 as exporting continues to be difficult due to the high pound sterling and because of the lingering effects on Scottish onshore activity of the low price of oil.
• On our central forecast, we are forecasting a pick up in the rate of growth in 2017 as the economy rides out the challenges of 2016. We have therefore raised our forecast for 2017 to 2.5% from 2.3% in our June forecast.

 (ii)           Jobs

• The number of total employee jobs is forecast to continue to increase in each year, and at a faster rate than that seen during 2014 (although not as strongly as in 2013).
• Our forecast for the number of jobs added in 2015 has been revised down since June’s forecast, from 51,250 to 49,400. The number of jobs at the end of 2015 is now forecast to be 2,433,400, an increase of 2.1% on 2014 (the same percentage growth forecast in June’s Commentary).
• Our current central forecast is that the Scottish economy will add 45,000 jobs in 2016, down by 4,600 from our June forecast, while we forecast the addition of 54,650 jobs in 2017, an increase of nearly 3,000 on our June forecast.

 (iii)          Unemployment

• On unemployment, the most recent figures show that unemployment rose again by 18,000 (0.6%) to 170,000 with the rate rising to 6.1%. Unemployment in Scotland rose by 19,000 over the year, or 0.7%.
• Despite the recent increases, the improvement in the labour market is forecast to continue with unemployment rates and numbers falling to end 2017.
• Our projection for unemployment on the ILO measure at the end of 2015 is 169,150 (6.2%), falling further to 155,450 (5.7%) by the end of 2016, and 118,400 (4.6%) by end 2017.

 

 

Annex: Fraser of Allander Institute Forecast Tables

 

Table 1: Forecast Scottish GVA Growth, 2015-2017

GVA Growth (% per annum)	2015	2016	2017
Central forecast	1.9	2.2	2.5
June forecast	2.5	2.3	2.3
UK mean independent new forecasts (October)	2.5	2.3
Mean Absolute Error % points	+/- 0.26	+/- 0.80	+/- 1.37

© Fraser of Allander Institute, November 2015

 

Table 2: Forecast Scottish Net Jobs Growth in Three Scenarios, 2015-2017

	2015	2016	2017
Upper	54,950	65,500	88,800
June forecast	62,100	72,650	80,600.
Central	49,400	45,000	54,650
June forecast	51,250	49,600	51,700
Lower	43,800	24,450	20,500
June forecast	40,400	26,550	22,800

© Fraser of Allander Institute, November 2015

 

 

Table 3: Forecasts ILO unemployment 2015-2017

ILO unemployment	2015	2016	2017
Rate (ILO un/TEA 16+) June forecast	6.2% 5.1%	5.7% 4.5%	4.6% 3.9%
Numbers	169,150	155,450	118,400

 © Fraser of Allander Institute, November 2015

 

  (V) Growth

 Analysis by the Institute on the long-term growth performance of the Scotland’s economy leads to the following conclusions:

 

On long-term growth performance, the main conclusions are:

• Scottish ‘trend’ GDP growth over last 50 years is identical to UK growth at 2.3% p.a;
• Scottish ‘trend’ GDP per head growth over last 50 years is 2.2% p.a. faster than UK’s 2% p.a. – due to falling or slower population growth in Scotland.
• We note that there has been a relative weakening of the Scottish economy since 2010.
• It follows, that to secure a sustained increase in the growth rate overall the economy will have to raise its competitiveness.

 

On raising competitiveness, we show that Scottish labour productivity while growing is weaker than in UK.

• We cite recent research evidence from Durham University’s Professor Richard Harris and Dr. John Moffat that Total Factor Productivity (TFP)  - the productivity of all factors: labour, capital and land – is also lower in Scotland than UK.
• They find that on average Scotland has had significantly lower productivity compared to the rest of the UK since the end of the 1990s. Overall, the ‘gap’ was around 11% across all sectors in 2012 (and 22% below the leading UK region).
• There is an academic and policy consensus that we get stronger productivity growth through improvements in: innovation/R&D; exporting (especially in small open economies); skills; investment, and enterprise.
• Scotland is shown to be weak in varying degrees on all of these determinants of competitiveness.
• We look particularly at export performance and find that there has been a long-term decline – since the early 2000’s - in manufacturing exports abroad. This has affected the performance of overall exports to the rest of the world.
• In addition, there is clear evidence of the growing importance of exports to the rest of the UK, which peaked at 68% of total Scottish exports before the recession. Exports to rest of UK are heavily dominated by service sector exports and financial services in particular. That importance dipped during and immediately after the Great Recession to 2012 with the contraction of financial services activity but picked up again after that.
• Another pointer is that exports to the rest of UK track GDP much better than exports to the rest of the world. This in part reflects the scale of rest of the UK exports to both GDP and total Scottish exports

Fraser Economic Commentary - June 2015

 

I           Overview

In the latest Economic Commentary we note that the Scottish and UK economies are continuing to grow and recover from the Great Recession. With growth of 0.6% in the final quarter of last year – the latest data point - the Scottish economy has now enjoyed positive growth for the last 11 quarters (since 2012q1) while in the UK, also with growth of 0.6% in 2014q4, the sustained recovery period has been shorter at 8 quarters. But the recovery continues to be stronger in the UK.

When oil and gas production is removed – to compare like with like, since offshore activity is included in the UK but not the Scottish GDP data - we find that the gap in the strength of the recovery widens further in the UK’s favour. UK GDP stands 5.1% above the pre-recession peak compared to only 2.3% in Scotland. We speculate that the relatively stronger UK recovery under the new accounting system ESA 2010, under which the latest data were generated, could be due to the recovery in R&D activity being stronger in the rest of the UK after the recession than in Scotland and, if so, may not augur well for Scotland’s growth performance in the longer term. However, there may simply be a technical rather than an economic cause due, for example, to different sub-sectoral weights between Scotland and the UK.

 

II          Industries and sectors

When we examine the performance across different industries and sectors, we see that the pattern of growth between Scotland and the UK differed considerably in the fourth quarter.  In the UK, the service sector was by far the main driver of growth, while in Scotland the sector made no contribution to growth. In contrast, the principal driver of growth in Scotland was the construction sector while the sector in the UK was a drag on growth. In addition, the production sector contributed about a third of the growth in Scotland but made no contribution to growth in the UK. Within production, manufacturing in both Scotland and the UK made no contribution to growth, while in Scotland it was mining & quarrying and electricity & gas that provided the contribution to growth.

 

III         The labour market

The latest labour market data show that jobs continue to be created at a fairly fast pace, indeed in the latest February – April 2015 quarter at a faster rate in Scotland than the UK both in the quarter and over the year. However, the picture differs on unemployment with the numbers seeking work rising slightly in the latest quarter and the reduction over the year, while sizeable  is proportionately less than in the UK. By the end of the fourth quarter, Scottish jobs as reported in the LFS household surveys were 2.6% above the pre-recession peak, while UK jobs were 4.6% higher than the peak. So, the latest data show the recovery in the labour market to be continuing but there is now some evidence that the rate of recovery is slowing in Scotland and despite recent stronger Scottish jobs growth overall the recovery remains stronger in the UK.

 

IV         Progress of the recovery

Our conclusion on capacity utilisation is that despite the recovery the Scottish economy still has spare capacity available, most notably in the labour market where the number of total weekly hours worked in Scotland was close to but still -0.4% below the pre-recession peak. Moreover, by January - March 2015, the ratio of employment to working population stood at -2.4% below the pre-recession peak, a worsening of the position in the final quarter of last year, compared to -6.7% at the trough of the recession. In the UK as a whole, in contrast, the ratio is only -0.6% below its pre-recession peak but still below a peak that was attained 7 years ago.

 

(i)        Positive influences on the recovery

We note that there are clear positive influences boosting the demand for Scottish goods and services:

• Domestic demand is still growing strongly boosted by investment (see below);
•  Domestic inflation is close to zero, below nominal earnings/income growth and so boosting real income; and
•  External demand remains reasonably strong, with growth in the euro area beginning to strengthen while US growth having faltered earlier in the year looks set to pick up again.

 

 Yet, there are continuing threats to the further recovery of demand which policy should seek to minimise.

 

(ii)       Threats to the recovery

 

•  First, growth remains unbalanced with household spending the key driver fuelled largely by rising household debt, which we fear may soon become unsustainable. The growth of imports continues strongly outstripping the relatively weak growth of exports and so net trade acts as a drag on growth. Policy must seek ways of boosting exporting performance because it is becoming clearer that a more competitive price through a lower sterling exchange rate is insufficient to boost export demand. Issues of product quality and marketing would appear to be at the root of this Scottish and UK problem. One bright spot in this picture of unbalanced growth of demand is the performance of capital investment, which is now contributing significantly to demand and the growth of output in Scotland. Infrastructure spending is playing a big role in Scotland – think the new Forth Road Bridge – but also foreign direct investment where Scotland again enjoyed a successful year in 2014 with over 80 inward investment projects attracted.

• Secondly, the victory of the Conservatives with a small majority in the May UK General Election appears likely to lead to a continuation and perhaps a tightening of the previous Conservative / Liberal Democrat Coalition austerity plans. We shall find out more in the Chancellor’s forthcoming Budget. With more austerity households can expect a further reduction in their incomes, on average. What that means is that household spending will also be reduced and the fall is likely to be greater the more quickly the Chancellor seeks to bring the UK government’s budget into balance. Austerity will continue to be a major drag on capacity utilisation and economic recovery in Scotland and the UK.

• Finally, there is Greece. At the time of writing we do not know the outcome of the negotiations between the Greek government and its creditors. The risks of Greece both defaulting on its debt and leaving the euro have increased since we last reported. This issue is again fast becoming a major threat to the recovery not simply in the eurozone but perhaps, with the possibility of contagion, in the rest of the world, including Scotland.

 

It is against this background that we have prepared our latest forecasts.

 

V          Forecasts

 (i)        Output

Our GDP forecast for 2015 is 2.5%, which is revised down slightly from our forecast of 2.6% in March of this year due to the evidence of a slowing of the rate of growth through the first half of the year. For 2016, we have also revised down our forecast to 2.3% from 2.4% in March, in recognition that while the recovery is continuing the growth of demand is now anticipated to be slightly weaker than previously thought. We also are prepared to acknowledge that the negative effects of the oil price fall on the oil production and services, may be a little greater than we anticipated in March. We are forecasting 2017 for the first time and the underlying determinants suggest that growth will be little different from 2016 and so we retain the forecast of 2.3% for 2017.

 

(ii)       Jobs

The number of total employee jobs is forecast to continue to increase in each year of the forecast horizon 2015 to 2017, and at a faster rate than that seen during 2014 (although not as strongly as in 2013). Our forecast for the number of jobs added in 2015 has been revised down marginally since March’s forecast, from 51,350 to 51,250. The number of jobs at the end of 2015 is now forecast to be 2,444,250, an increase of 2.1% in 2014. Our current forecast is that the Scottish economy will add 49,600 jobs in 2016, down by 8,000 from our March forecast, while we forecast the addition of 51,700 jobs in 2017.

 

 (iii)     Unemployment

Given the small revisions to the growth in employee jobs over the next two years in our latest forecasts, there are only small revisions to the levels and rates of unemployment from our earlier forecasts. The improvement in the labour market is forecast to continue with unemployment rates and numbers falling to end 2017. Our projection for unemployment on the ILO measure at the end of 2015 is 138,200 (5.1%), falling further to 122,364 (4.5%) by the end of 2016, and 108,150 (3.9%) by end 2017. It is worth noting that our unemployment forecast for 2017 means that the unemployment rate finally falls to where it stood when the Great Recession started in 2008, nine long years ago.

Government economists and the Scottish Government

More on the Scotland on Sunday news story and my article, which is also included in my last post.

My paper criticises recent work by Scottish Government economists in the Office of the Chief Economic Adviser (OCEA), which purports to show that increased productivity, investment and exports will raise the growth of the Scottish economy and generate more tax revenues.

That is unexceptional.  

However, the March 3^rd paper, which accompanied the Government’s new Economic Strategy, has the implicit sub text that the new strategy will raise the rate of growth of productivity etc. The March 3^rd paper is careful to say that it is ‘illustrative’ but nowhere does the paper mention the difficulties of getting an effective growth policy, something that has eluded governments for years.

It is the March 9^th paper, which I find most troubling. This is essentially the March 3^rd paper with anther scenario added to the analysis contained in that paper which is branded the first scenario and called the Smith Commission Scenario. The second scenario is branded the Full Revenue Retention Scenario.

What I find particularly troubling with both scenarios is that they ignore the partial or complete loss of Barnett that would have to occur before either scenario could be implemented. The second scenario is simply full fiscal autonomy (FFA) in different words and so would only follow after the loss of Barnett.

In the Scotland on Sunday news story the Scottish Government responds with:

“Going forward, these figures illustrate once again the need for the Scottish Government to have full control of job-creating powers.”

I suspect what they mean with the phrase "Going forward" is that from an initial equilibrium state increased growth would generate more tax revenues for Scotland if Scotland had FFA.

But this is the wrong counterfactual.

The correct counterfactual must be taken into account, which is that in each period future public spending will be lower in Scotland because of the loss of Barnett. The counterfactual used in the OCEA model and in the quote above is that baseline public spending is unchanged. This would only be the correct counterfactual after FFA had been implemented and after the loss of Barnett.

However, given that we currently benefit from Barnett, to undertake an analysis which does not acknowledge this loss is partial at best and dishonest at worst.

I fear that this is a further example of the politicisation of the Scottish civil service. One would have expected in the past that the OCEA would have resisted pressure, had it occurred, to produce such a partial analysis.

This is an issue that clearly needs further discussion and debate.

 

Home rule fiscal autonomy ‘doesn’t add up’

The news story in Scotland on Sunday about my article is here. The article itself does not appear to be on the Scotland on Sunday website yet,  so here it is:

 

On March 9th the Scottish Government published a news release "Greater gains from more fiscal control" The release claimed that

" ... new Scottish Government analysis will demonstrate that if Scotland was able to retain and reinvest all the proceeds of improved economic performance, through holding greater economic powers, the overall positive impact on GDP, employment and tax revenue would be significantly increased."

This analysis presumably by government economists in the Office of the Chief Economic Adviser (OCEA) was first released on March 3rd as a simulation exercise demonstrating how improvements in Scottish total factor productivity, investment and export performance could boost GDP employment and tax revenue. The March 9th version includes additional analysis. It first rebrands the original March 3rd analysis as a 'first scenario' which

" ... reflects the situation under the Smith Commission powers where the majority of additional tax revenue generated by increased economic activity are retained by the UK Government and cannot be directly reinvested back into the Scottish economy."

The March 9th paper adds a 'second scenario' where

" .... all additional tax revenue generated by the expansion in the economy are assumed to be retained in Scotland and reinvested back into Scotland’s public finances and public services. This scenario is referred to in the paper as ‘Full Revenue Retention’”.

No technical paper has been released by the OCEA to explain the nature of the modelling underlying the analysis. So we are forced to guess. 

In the absence of official information I suspect that the analysis has been produced by a Computer General Equilibrium (CGE) Model, which was originally developed by my colleagues in the Fraser of Allander Institute at the University of Strathclyde. The model was used in November 2011 to simulate the impact of a reduction in the corporation tax rate in Scotland. The model allows system-wide, or economy-wide, impacts of economic shocks/changes to be modelled and identified.

The OCEA and the Scottish Government should be applauded for using rigorous modelling to assess the impact of economic shocks such as policy changes. However, in this case the model has been used inappropriately to suggest political-economy outcomes that are fanciful and are lacking in economic rigour.

Let me explain.

What we can say is that the OCEA economists have brought together a general economic modelling approach with a very partial political-economy analysis.

First, in the March 3rd paper reference is made to the new Scottish Government Economic Strategy, which has the objectives of "achieving a productive, cohesive and fairer Scotland." It seeks to achieve this through desiring to boost investment, innovation, internationalisation, and inclusive growth. 

Now since this is merely a wish-list the March 3rd paper simply offers an illustration of the consequences for Scottish GDP, employment and tax revenues of arbitrarily assumed small increases in total factor productivity, investment and exports. It is true that these increases relate in some sense to Scottish Government targets but as everyone knows you can have any target you like, the issue is how realistic is the target and the underlying policies adopted to achieve the targets. Not surprisingly the OCEA papers are silent on that. What must be understood at this stage is that simply having a target is obviously no guarantee of success. 

Secondly, in the March 9th paper, the March 3rd analysis has become what the situation would be under Smith Commission powers as stated in the second quote above. It is not at all made clear how in the modelling the Smith Commission powers lead to an increase in productivity by 0.1% per annum over 10 years, a narrowing in the gap in investment between Scotland and its international peers, and boosting exports by 50%. This is simply assumed. There is no rigorous analysis of how policy gets productivity, investment and exports to rise. It is fanciful. It is surely not the job of the Government Economic Service in Scotland to simply and unquestioningly affirm the dreams of Government politicians.

Thirdly, and in many respects more damningly, the second scenario generates greater GDP, jobs and tax revenues because of the so-called ‘Full Revenue Retention’ concept, as all the tax revenues generated by growth are re-spent in Scotland, in contrast to the Smith Commission powers. Full Revenue Retention" presumably means what it says - that the Scottish government would retain all the revenue from Scottish taxation and use it to pay for the public services that Scotland receives. This is just another phrase for the idea of Full Fiscal Autonomy, which is now the policy of Ministers. It is wholly unrealistic to imagine a policy in which in addition to the Barnett formula the Scottish government also received any increases in Scottish tax yield. 

So, the Scottish Government economists are in their second scenario effectively assuming full fiscal autonomy (FFA) plus Barnett. Yet, elementary political economy tells us that with FFA Barnett would be abolished and there would be no risk pooling or sharing of revenues between rest of the UK and Scotland.

I noted in my post this week on GERS 2013-14 that nearly £4 billion would be withdrawn, through higher taxes and lower public spending from the Scottish economy if Scotland had had FFA in 2013-14 and had run the same deficit as the UK. Why doesn't the OCEA include that in its analysis, or the even larger withdrawal of £6.6 billion estimated by the IFS for 2014-15 by the IFS? It is not as if it is rocket science.

On the Scottish Government website it states that one of the key aims of OCEA is to

" ... provide high-quality analytical support for Ministers and colleagues across the Government on all aspects of the Scottish economy and public finances."

Might I suggest that, on this occasion at least, that aim has not been met.

What GERS 2013-14 tells us

The latest Government Expenditure and Revenue Scotland (GERS) published today with data for 2013-14 is hardly a revelation. Scotland is shown to have a net fiscal deficit of -8.1% of GDP - when a geographical share of oil revenues is assigned to Scotland - while the UK deficit is -5.6%.

It is true that the data show that Scotland pays £400 more per head in tax revenues than the UK as a whole but it also enjoys greater public spending of £1,200 per head than the UK as a whole.

The absolute size of Scotland's estimated net fiscal deficit in 2013-14, at a time when oil prices - the principal driver of oil revenues - were almost twice as high as they are now, was £12.4 billion. This means that if Scotland had 'enjoyed' full-fiscal autonomy (FFA) in 2013-14 the Scottish Government would have had to fund that deficit by a mix of borrowing, higher taxes and lower public spending.

If we assume that under FFA Scotland could have been able to borrow to fund a deficit the equivalent of the UK's 5.6% - which would have been a tall order for a sub-state government, or an independent Scotland, at the same borrowing rate as the UK -  then a further £3.8 billion would have had to be funded by higher taxes and lower public spending.

Now we need to be clear about the significance of that.

£3.8 billion amounts to:

• half the cost of the Education & Training budget;
  
• one third of the Scottish Government health budget;
• one sixth of the £22 billion Social Protection Budget in Scotland;
• is 25% greater than the Scottish Government's Transport Budget;
• is 135% more than the Scottish Government's Housing and community amenities budget; and
• is 262% greater than the Scottish Government's Enterprise and Economic Development Budget.

So, it is not a trivial sum, to say the least.

And this greater Scottish deficit in 2013-14 is not a one-off phenomenon. The tables that can be downloaded from the Scottish Government's website to accompany the GERS publication provide runs of data back to 1998-99. The reason for doing this is that a new system of economic and government accounting has been adopted in the UK first and now in Scotland. This system, known as ESA 2010, along with some other revisions, have resulted in, quoting GERS 2013-14

"public revenue, expenditure, and GDP are higher than previously estimated. This has led to revisions to Scotland‟s fiscal aggregates in all years."

The graph below charts the new estimates of net fiscal balance from GERS from 1998-99 to 2013-14.

What is evident from the chart is that in only 4 of the 16 years was the net fiscal balance in Scotland better than in the UK. (I have included data labels only for the largest deficit, Scotland or UK in each of the years.)

What that means is that in 12 of the 16 years if Scotland had 'enjoyed' FFA it would have had to have higher taxes, lower public spending or both than the UK, assuming it was able to borrow to fund the same scale of deficit as the UK - a big ask as noted above.

Of course, the situation will almost certainly deteriorate further in the next fiscal year due to the halving of oil prices in 2014 and the possibility that oil prices may stay considerably lower than the Scottish Government's expected price of $110 per barrel for some time. 

Add declining oil production into the mix and we can reasonably ask: What price fiscal autonomy and what price independence?

 

 

Why we should be concerned about further planned austerity

In the latest Fraser Economic Commentary we discuss the threat to the Scottish and UK economies of the UK Coalition's current plans to increase the pace and scale of austerity  over the next 4 years.

The Institute for Fiscal Studies in their IFS Green Budget 2015 highlight the scale of the UK government’s recent and planned fiscal consolidation programme. The IFS analysis shows that by 2014 £110bn of fiscal tightening measures had been implemented. A further £92bn of fiscal tightening is currently planned. So, on this measure 55% of planned fiscal consolidation has been completed with 45% still to come.

Of the further planned fiscal tightening, a comparison of IMF forecasts for structural borrowing in 32 advanced economies shows that the UK has the largest planned fiscal consolidation between 2015 and 2019 and the 18th largest (or 15th smallest) planned structural deficit in 2019. Some £200 billion of fiscal tightening is nearly 13% of GDP.

If we assume a multiplier of 1.5 – not unreasonable when interest rates are close to zero and there is no scope for countervailing monetary policy - the policy would have served to have reduced GDP by 10% up to 2014 and by a further 9% by 2019.

This doesn’t mean that GDP will fall by 9% between now and 2019 but does imply that private sector output must rise by a substantial amount if GDP growth is to remain in positive territory. Specifically, if the economy is to grow at around 2.5% per annum then the underlying growth rate of the private sector in the face of such anticipated fiscal consolidation would need to be of the order of 4% per annum: a big challenge for the private sector.

The outcome will also be dependent on the result of the General Election in May 2015 because the Labour and Liberal Democrat parties are planning a slower pace of fiscal consolidation and a Conservative or indeed an unspecified Coalition government might alter the scale and pace of current plans or bias any consolidation more towards tax rises than via spending cuts, which could have a different impact on growth.

Why the fall in the price of oil could benefit the Scottish economy.

The underlying basis for the estimate in Fraser of Allander Institute's latest Economic Commentary that the fall in the price of oil could raise Scottish GDP growth is given in the box below:

Fraser Economic Commentary - March 2015

Our latest Economic Commentary, which was published today can be accessed here.

A summary of our findings and forecasts is provide below:

Overview

•  The Scottish and UK economies are now recovering at a reasonable rate from the greatest economic shock since the 1930s. This recovery, slowed by the UK Coalition Government’s austerity programme, has taken longer than from the 1930s Depression or any of the three other recessions experienced since the 1970s.
• But while growth is continuing, the pace of growth seemed to have slowed a little towards the end of 2014.
• The jobs market and unemployment have recovered more strongly than output, resulting in falling labour productivity and hence little improvement in real wages and real household incomes.
• Unemployment now stands at 5.4% in Scotland and 5.7% in UK.
• Despite the better headline unemployment figures in Scotland, there is still more ‘slack’ in the Scottish labour market than in the UK and so despite jobs growth there is little upward pressure on wages.

 

We ask: will the recovery continue? We identify several positive and negative influences that will impact on the pace of the recovery. We examine them under four headings: growth in markets; oil prices, inflation and deflation; UK fiscal and monetary policy; and Greece and the Eurozone.

 

Growth in markets

The key points here are:

• Despite the steady growth in world trade the latest IMF and OECD forecasts suggest a slowing in key countries and Scotland’s key export markets.
• The composition of Scottish and UK growth also continues to be unbalanced with household spending driving growth, and fixed investment making a variable contribution. 
• As we have stressed in recent Commentaries, household spending is being fuelled by rising debt, which is almost certainly unsustainable.
• If the economy is to rely on continued growth in household spending it requires a sustained rise in the real wages and incomes of households. However, this is unlikely to occur unless labour productivity improves, which has been badly hit as a consequence of the Great recession.

 

Oil prices, inflation and deflation

• Inflation is falling right across the global economy. There is a clearly a risk of deflation – a sustained falling price level, leading to expectations of further price falls, postponed spending and reduced spending as the real value of household and corporate debt rises.
• However, while the risk is there for the UK and the US, at this stage it is more apparent than real. Core inflation is around 1.6% in the US and close to 2% in the UK.
• The fall in oil prices has been large, around 50% at the time of writing, and the potential for a sizable boost to spending is significant with some respected analysts forecasting a 0.5% boost to UK GDP in 2015.
• I’ll discuss our estimates of the impact of this fall after Grant has spoken about some of the related issues

 

UK fiscal and monetary policy

• The base rate set by the Bank of England’s Monetary Policy Committee (MPC) is likely to remain at 0.5% for the remainder of this year. So monetary policy should remain accommodating to growth for the foreseeable future.
• The same cannot be said for fiscal policy in the UK.  
• The UK Coalition plans a further £92 billion of fiscal tightening by 2019 if they win the election - more than £200bn in total or a direct reduction in GDP of 13%.
• We estimate, that if the economy is to grow at around 2.5% per annum then the underlying growth rate in the face of such anticipated fiscal consolidation – which might change after the UK General Election in May - would need to be about 4% per annum: a big challenge for the private sector.

 

Greece and the Eurozone

• The new Greek Government led by the Syriza party came to power with a mandate to renegotiate the terms of the 2012 bailout, which most analysts agree is imposing a severe burden on the Greek economy and society.
• GDP has fallen by 25% since 2007 and unemployment is currently over 25%, with youth unemployment 50%! No other democratic country has endured austerity of such size and pace.
• If by June 2015 there is not agreement on a reduction in the pace of austerity, then there is a real risk of ‘Grexit’, that is a Greek exit from the Eurozone.
• This would have significant economic and political consequences for the Eurozone itself and for the global economy, including the Scottish economy.
• When the threat of Grexit was last posed in 2012, the Fraser of Allander Institute undertook a modelling exercise which estimated that a Greek exit would lower Scottish GDP by -1.2% and reduce employment by 49,000 and this is before estimating the potentially greater impact of a wider contagion of bank runs and possible further withdrawals of other peripheral countries from the Eurozone.

 

Forecasts

• Notwithstanding the developments above, we are forecasting growth of 2.8% in 2014, 2.6% in 2015, and 2.4% in 2016, an upward revision to our November 2014 forecasts.  These reflect our view that household spending and investment are stronger than we projected in November.
• We have also raised our forecasts for employee job creation compared to our November forecasts. On the central forecast, we are now forecasting that net jobs will increase by 53,850 in 2014, 51,350 in 2015 and 57,600 in 2016. Our unemployment forecasts have been revised down further again from November, reflecting higher economic activity.
• Our projection for unemployment on the ILO measure at the end of 2015 is 136,600 (5.0%), falling further to 125,250 (4.6%) by the end of 2016.

 

Are the new jobs as good as the old?

The latest labour market data for Scotland, which were the subject of yesterday's post allow us to examine the type of jobs that are on offer, or are being taken up, in current conditions.

The chart below shows where we are.

 

In general terms, what we see is a shift since the recession away from full-time, permanent, employees, towards, part-time, temporary, and self-employment.

By the middle of last year total employment was back to its pre-recession peak, yet the shift appears to be enduring. That is not wholly accurate, though, since it is clear that full-time employment is recovering. But we cannot be certain it will automatically move back to pre-recession levels.

The growth in temporary and self-employment is large in percentage terms but small in absolute numbers: an increase of 19,000 and 33,000 respectively since the start of the recession. While some might argue that the growth in self-employment is an indication of greater entrepreneurship in Scotland, I doubt it. Many of these self-employed jobs appear likely to be more 'needs must' for people who have lost full-time jobs. The growth of temporary jobs suggest high levels of certainty exist amongst employers but it may also be something of a reflection of a developing 'zero hours' culture.

So. all of this begs the question: are the new jobs as good as the old?

Jobs and unemployment in Scotland and the UK

Following the release yesterday (18 February) of the latest labour market statistics the Deputy First Minister and Cabinet Secretary for Finance, John Swinney, is reported as claiming that:

"Scotland is outperforming the UK on all three headline labour market indicators with employment continuing to increase and unemployment down …."

While this is true if you simply focus on recent levels and changes in employment and unemployment, it is not true for the Scottish labour market if one takes the period from the Great Recession in 2008 and subsequent recovery.

The latest labour market data published on Wednesday provide information up to the end of last year: October – December to be specific.

Chart 1 shows that by Oct-Dec Scottish jobs as reported in the LFS household surveys were 2.4% above the pre-recession peak, but UK jobs were 4.0% higher than the peak. So, despite the good recent performance of the labour market in Scotland overall jobs performance in the recovery continues to be worse than the UK and as noted below, there appears to be more 'slack' in the labour market in Scotland compared with the UK.

An indication that there is still a deficiency of demand in the Scottish labour market in relation to the situation before the recession is provided by data on the number of weekly hours worked. Chart 2 graphs this statistic from 2007 for the total weekly hours worked compared to the pre-recession peak for Scotland and the UK.

By the period October 2013 – September 2014, the number of total weekly hours worked in Scotland was still -1.0% below the pre-recession peak. So despite the number of jobs being higher than before the recession, the demand for labour as measured by hours worked is still lower.

Finally, not only is the demand for labour in Scotland still lower than pre-recession but demand - measured in terms of jobs - is still considerably deficient when compared to the supply of labour. Chart 3 shows the employment to population (aged 16 and over) ratio relative to pre-recession peak for Scotland and the UK to October - December 2014.

By October - December 2014, the ratio stood at -2.1% below the pre-recession peak, compared to -6.7% at the trough of the recession. In the UK as a whole, in contrast, the ratio is only +0.7% above its pre-recession peak.

All of this suggests that while the jobs market has recovered substantially, the recovery has been weaker in Scotland both in relation to the situation before the recession and in relation to the growth of labour supply. In the UK, in contrast, a strong jobs recovery is evident compared to the situation before the recession and the recovery has just managed to keep pace with the growth of the labour supply. We might venture to suggest from the data in Chart 3 that sustained pressures on wages to rise should be starting to occur in the UK, but not so in Scotland.

This conclusion is also echoed in the unemployment rate data as shown in Chart 4.

While the unemployment rate is currently lower in Scotland, at 5.4% compared to 5.7% in the UK, the UK rate is approaching its pre-recession rate of 5.4%, whereas there is still some 1.2% points to go before that situation is reached in Scotland.

So, let us cheer the good news that jobs are being created and unemployment is falling but let us not fall into the trap of ignoring the particular problems of rapid job loss, unemployment increase and a recovery biased towards part-time, adult employment that befell the Scottish labour market over the earlier period of recession and recovery.