In our latest Economic Commentary we recognize that the situation in the Eurozone complicates the forecasting picture considerably. We assume in our central forecast that for the medium term there is an essential "muddling through" process, with further support given first to peripheral country banking systems and then to their sovereigns if necessary. Through this process confidence remains low and growth is weak as austerity policies are not, or are insufficiently, relaxed. Moreover, complete steps to full fiscal union with Eurobonds and sizable fiscal transfers between countries, which would finally resolve the crisis, seem unlikely.
But there remains the risk of a Greek default and even exit from the Euro in the near term and the break-up of the Euro in the medium term. We have therefore considered these two outcomes as possible scenarios to assess their likely impact on the Scottish economy. We draw on this research produced by ING in December of last year.
The analysis is not a forecast but a 'what-if' impact study, with the impact on the Scottish economy assessed at the end of three years after each event occurs.
The impact of both a Greek default and euro exit and a complete break-up of the Euro would impact upon the Scottish economy through several different channels:
The figure suggests that the transmission mechanism embraces five main channels, through which GDP and jobs in the Scottish economy would be affected: country GDP, consumer confidence, business confidence, bank lending, foreign direct investment.
Changes in the GDP of Eurozone countries and other major economies in the wider global economy such as the US and the UK would affect Scottish GDP and jobs through a reduction in Scottish exports to such countries.
Reduced consumer confidence would bear directly on household consumption in Scotland.
Reduced business confidence would affect the willingness to export and invest.
Reductions in lending from Scottish and UK banks as they sought to rebuild their balance sheets would be likely to affect all three sources of demand: exports, consumption and investment.
A reduction in FDI flows from the Eurozone but also the US and elsewhere as their economies contract would clearly affect investment but also exports.
Finally, as GDP and jobs began to fall directly as a result of these Euro events multiplier effects would kick in leading to further secondary falls in domestic Scottish consumption and investment and hence GDP and jobs.
The results of this modelling exercise are presented first for GDP and then for jobs in the charts below:
It should again be stressed that these estimates are the result of a "what if" simulation with estimated impact after 3 years with all other things held equal. One countervailing force could be any monetary and fiscal policy responses introduced by the Bank of England and the UK Government.
If that caveat is kept in mind we can draw the following conclusions.
First, a Greek exit leads to a drop in GDP in Scotland of -1.2% and a loss of just under fifty thousand jobs. This is not trivial but small compared to the other events shown.
Secondly, the consequences of the breakup of the Euro would be a major economic event for Scotland even though we are not in the Euro. With an estimated drop in GDP of -5.3% and loss of -144,200 jobs the effect would be comparable in scale to the effects of the recent Great Recession and worse than our simulation estimate of the effect of fiscal consolidation. Such an event only a few years after two major exogenous shocks to the Scottish economy - Great Recession and Fiscal Consolidation - is something that we must hope can be avoided. Because if it does occur, the damage to the Scottish economy will be felt for many years to come.