On November 12th, we published our latest Fraser of Allander Institute Economic Commentary, - sponsored by PWC. On the same day, the Scottish Government published its quarterly accounts for the second quarter under the Scottish National Accounts Project (SNAP). The Commentary, therefore, could only analyse the drivers of Scotland's economic recovery up to and including the first quarter of this year, drawing on the previous SNAP publication in August.
The latest SNAP data allow us to extend the analysis to the second quarter and take account of revisions to GDP and its spending components in previous quarters. We include below a chart that updates Figure 18 on page 20 of the latest Commentary.
In the Commentary we concluded that elements of a balanced recovery were starting to fall into place, investment was picking up, reinforcing the continuing growth of household spending, while the balance between exports and imports – net trade – continued to be a drag on the economy.
The latest data reinforce that conclusion.
In the second quarter, nominal GDP grew by 1.3%. The main driver of growth was Gross Capital Formation or more loosely investment, contributing 1.95% points to growth, followed by household spending, contributing 0.68% points, and general government spending, contributing 0.28% points. Superficially, if imports had been balanced by exports nominal GDP growth would have been the sum of those three components, or 2.91%. Unfortunately, net trade (exports minus imports) was strongly negative, contributing -1.64% to growth.
Looking back over the previous 4 quarters it is quite clear from the chart that investment has played a stronger role in driving growth than the earlier data implied. Some of this clearly reflects construction spending on major projects such as the second Forth road crossing and it remains to be seen whether companies right across the economy are raising their investment spending. The positive contribution to growth of household spending is evident for 4 of the 5 quarters, although the contribution to growth is a little less on the revised data.
None of this diminishes our warning in the latest Commentary that the economy needs more investment and that government should play a key role by undertaking major infrastructure projects funded if necessary by debt rather than cuts in public spending in other areas. The weakness of Scotland's international trade position in fact reinforces the case for more investment both in the short and long run.
In the short-run there is still the need for strong investment growth to boost demand. Firstly, to offset the drag on the economy as the growth of imports continues to run ahead of the growth of exports, and secondly, to offset the expected slowdown in the growth of household demand as household debt rises and household incomes stagnate with little or no growth in real wages.
However, it is in the long run that the need for strong investment in the economy is even more pressing to improve competitiveness and overcome our weak international trade position. There is little doubt that Scotland's net trade position – excluding North Sea oil – is weak. From the latest SNAP data we can chart net trade as a percentage of GDP going back to 1998 and this is presented in the chart below:
Over the period the trade deficit has averaged just over 7% of GDP. As part of the UK union Scotland has received compensating fiscal flows with the fiscal deficit roughly mirroring the trade deficit, although a proper accounting balance would require the inclusion of net income from abroad to complete the balance of payments picture. An independent Scotland, in contrast, would have oil sales added to its trade account and these probably roughly balance the non-oil fiscal deficit.
The problem for Scotland in the future is that oil sales and oil tax revenues are declining. An independent Scotland would find it unsustainable to borrow to meet the loss of oil revenues and so would either have to cut public spending significantly or find new sources of tax revenue. Probably, the best solution would be to seek ways to raise the rate of growth of the economy generating tax revenues in this way. However, given the openness of the Scottish economy probably the only sustainable way to do this is to boost export performance significantly. Boosting domestic consumption and demand would almost certainly lead to imports being sucked in that would stall the growth process replicating the traditional UK experience of "stop-go".
The problem does not, however, go away if Scotland continues as part of the UK union. Under the new devolution arrangements that are coming into place while Scotland will not be assigned oil revenues, the decline of oil will have indirect effects on Scottish incomes, which will lower income tax yields here. And as I have argued above, higher and sustainable future income tax revenues are probably best achieved through increased growth that is export led. Moreover, from a political standpoint given that the Barnett formula remains in place for the residual portion of Scottish government revenues that are not raised locally, the pressure from Westminster to abolish Barnett and encourage greater Scottish fiscal autonomy seems likely to increase as oil revenues diminish.
So Scotland needs to boost its export performance. The Scottish Government's Programme for Scotland 2014-15 One Scotland recognizes the need for the Scottish economy to internationalise in Para 113:
Encouraging a greater international focus among Scottish businesses is a fundamental part of rebalancing of the Scottish economy, and delivering sustainable economic growth over the longer term. With this in mind, the Scottish Government has set an ambitious target for export growth, to increase the value of international non- oil and gas exports by 50 per cent by 2017.
This is an ambitious target. One might go further and suggest that without a systematic strategy to rebuild Scotland's non-oil export base there is little if any likelihood of policy raising the real value of exports in ten years never mind in two and a half years by 2017.
There is little in One Scotland to suggest that the Scottish Government has such as strategy; a subject that I shall return to in later posts.