Scottish Economy Watch

Recovery or false dawn in Scottish jobs market?

Last week the latest Scottish jobs and unemployment data were published and somewhat lost amidst the media coverage of the Budget.

These labour market numbers were clearly better than they have been for some time. During the quarter to Nov-Jan 2013 employment rose by 19,000, unemployment fell by 4,000 and the numbers inactive also fell, by 11,000. The 16 plus activity rate rose slightly from 62.3% to 62.6%, the unemployment rate fell from 7.6% to 7.4%, and the inactivity rate fell from 37.7% to 37.4%.

All good news.

Moreover, given the fall in the numbers inactive my estimate of 'real' unemployment also dropped relative to the measured number and rate of unemployment - see chart

Clearly, one swallow doesn't make a summer.

The estimate of real unemployment is still 63,000 higher than the ILO unemployment measure for Scotland; that is 2.2% points higher than the official rate of 7.4%.

The jobs numbers also continue to look weak when compared to the pre-recession figures as this chart shows

After nearly 5 years employment remains 68,000 below the pre-recession peak, a short-fall of -2.7%.

Added to this, with the working population rising, the ratio of employment to working population still looks like an economy in recession:

One would like to hope that we are beginning to see the start of a more sustained recovery in the labour market in Scotland. But several more quarters of positive data are required before we can conclude that hope has finally triumphed over experience.

Where have all the new firms gone?

 Personal note: For anyone who might have noticed I haven't blogged much in the last month. This has been largely due to a vicious viral infection, which has laid me low for the past few weeks. I am now back at my desk, if still slightly groggy. Hopefully, I can start to produce more blogs but probably not until after a week away on Mull next week!

While in my bed, new business statistics from the Committee of Scottish Clearing Bankers were published for the fourth quarter 2012. As I noted in earlier posts e.g. here, this series records new business start-ups based in Scotland that have opened accounts with any of the four Scottish Clearing Banks. It is a valuable series because it should be expected that the creation of new firms would move in line with overall economic performance and GDP in particular.

The latest data show a drop again in new business formation between the third and fourth quarters with the number of new starts falling by 375 from 3,091to 2716. But as explained before the CSCB data are not seasonally adjusted, so I have constructed a four-quarter moving average, which smoothes out some of the seasonality and other short-term fluctuations. The updated chart is here

At a time when there is much concern about both lack of demand and weakness in the supply capacity of the UK and Scottish economies, these data are a clear cause for concern.

In the latest data, the number of starts is 47 percent below the (smoothed) pre-recession peak compared to 45 percent in the third quarter. Alternatively, the latest numbers are 35 percent below the average quarterly starts in the period before the recession started, compared to 33 percent in the third quarter.

It is possible that Scottish new starts are creating bank accounts with non-Scottish Clearing Bankers. But that seems unlikely.

It is more likely that the data reflect:

• a continuing lack of demand for goods and services which is discouraging new starts;
• the failure of the banks to lend to new starts because of increased risk aversion on the part of the Scottish banks compared to the period before the recession.

An examination of the industrial pattern of new starts offers more information Between 2011 and 2012 the number of new businesses fell by 881 from 14,737 to 13,856. The industrial distribution of that change between 2011 and 2012 is shown in the chart below.

The chart makes clear that the weakest sectors in terms of new business creation were in property related activities and business services, construction, wholesale and retail activities, and in other financial intermediation. In some ways that maps what has been happening to output across the Scottish economy.

In contrast, it is good to see a pick-up in manufacturing new starts, which again reflects what has been happening to output. There would also appear to be some growth in small businesses serving the public sector and insurance and pensions sectors, which may reflect the evidence of a shift away from full-time employment to self-employment.

Overall, the new business data appear to confirm a picture of an economy still suffering from a lack of demand with a hangover from the property and finance boom and bust that preceded the loss of output and jobs in the Great Recession.

It's not just size that matters.

The spin and hype from the 'yes' and 'no' campaigns after the publication of the Government Expenditure and Revenues Scotland (GERS) was enough to make the eyes water.

In 2011-12 the estimated net fiscal balance (with a geographical share of oil) is -5% of GDP compared to the UK's balance that year of -7.9%.

The 'yes' campaign and supporters of independence argue that GERS demonstrates that Scotland's fiscal position is better than the UK. The 'no' advocates highlight the importance of north-sea oil revenues amounting to £10bn, or 17%, of estimated current revenue. North-sea revenues are volatile and projected by the OBR and others to be in long-term decline. The size of Scotland's net deficit is likely to worsen both absolutely and relative to the UK.

In a sense both sides of the campaign are correct, although for the Scottish Finance Secretary John Swinney to say that the figures showed that Scotland was better off to the tune of £824 per person is stretching it a bit. We didn't have a bigger surplus but a smaller deficit, courtesy of oil revenues, of £7.6bn, or 5%.

The 'no' campaign also need to be reminded that there will be policy options open to an independent Scottish government to help reduce spending, raise taxes and lower the deficit e.g. less defence spending, policies to stimulate migration that will mitigate Scotland's developing demographic problem etc. GERS offers a static picture with the finances likely to evolve after independence.

Yet, a deficit will still have to be funded. And what is important is not just the size of the deficit but the cost of funding it i.e. the cost of borrowing.

As I noted in this detailed post a newly independent Scotland is likely to have higher borrowing costs than the UK for three reasons.

First, a recently independent Scottish government, with no previous experience of and reputation for fiscal management will have a credibility problem. That problem is likely to be worsened by both the high levels of debt that will be inherited by the new Scottish state and the fears of a continuing structural deficit, which will have to be financed.

Secondly, Scotland is much smaller relative to the UK and its finances are likely to be more volatile because of its size. According to OECD evidence small countries tend to pay a risk premium on their borrowing simply because of their size. Moreover, Scotland's dependency on oil revenues is an additional factor increasing the risk of volatile tax revenues and hence the demand for a risk premium by purchasers of Scottish government bonds.

Finally, an independent Scottish government that chooses sterling, for the very good reasons noted above, will effectively be borrowing in a foreign currency. The implication of this is that the financial markets will perceive Scotland to be a greater default risk compared to a state that can meet its obligations by printing its own currency.

So, we cannot simply judge the health of an independent Scotland's public finances by the scale of its likely deficit, the cost of borrowing is as important.

It's not just size that matters.

 

Latest FAI Economic Commentary

The latest Fraser of Allander Institute Economic Commentary, sponsored by PricewaterhouseCoopers LLP is available here.

There is much in the Commentary including signed pieces by researchers outside the Commentary team e.g. Iain Inglis, and Kenny Richmond from Scottish Enterprise on The technology company development journey – from concept to commercialisation, and David N.F. Bell, University of Stirling Alasdair G. Rutherford, University of Stirling,Robert E. Wright University of Strathclyde on Free Personal Care for Older People: A Wider Perspective on Its Costs.

A brief summary of the Outlook and Appraisal and forecasts follows:

The Institute notes that there was evidence of some genuine growth in the Scottish economy in the third quarter of last year. Also the new GDP methodology and revisions have meant the fit with the UK economy during recession and recovery is closer. The recovery has been a little stronger than the earlier data suggested but still a little weaker than the UK as a whole. But survey evidence suggests a weakening in the final quarter of 2012 and uncertain prospects for 2013.

It is quite clear the main components of aggregate demand in the Scottish economy remain weak.

Household demand growth is weak, due to

• Falling real incomes as inflation above earnings growth of 2%.
• Employment is falling again and number of hours worked is very low.
• The housing market is flat with no growth in house prices offering no boost to household wealth and increased spending.
• The Scottish household saving rate is high and rising; at 11.1% it is 3.4 percentage points higher than in the UK.

Investment spending is falling both absolutely and relative to GDP - see chart below drawing on latest (28 February publication) Scottish National Accounts Project (SNAP) data

After improving during the recession our relative export performance has deteriorated since 2011 with negative contribution to growth - see next chart drawing on SNAP data

The prospects for a growth in the contribution of net trade depend in the short term:

• On the recovery of demand and output in the eurozone from the current recession and wider growth of world trade.
• Huge uncertainties exist over eurozone prospects.
• The main beacon of hope is recovery in the US economy but this is not without its uncertainties.
• But also price issues as well as demand:
  • The effect of sterling devaluation
  • The intrinsic competitiveness of Scottish companies – more significant for long-term growth

Government fiscal consolidation is set to increase as the UK Government strives to meets its target of balance in its structural (cyclically adjusted) current budget in five years. Most of the future adjustments concern spending rather than taxation with 68% of planned benefit cuts and 78% of current departmental spending cuts still to come after April this year. These cuts will depress household demand as well as reducing government spending directly.

The labour market in Scotland shows falling measured unemployment but from the middle of last year employment is falling and the number inactive continues to rise. The 'real' level of unemployment is clearly higher and that will contribute to weak household spending on goods and services.

Other Issues

• Quite clear that austerity has reduced growth.
• Weak UK export performance is also a factor in a failure to recover strongly.
• Lack of bank lending is still constraining, especially for small businesses.
• Loss of AAA credit rating will make no difference to UK borrowing costs and ability to borrow.
• Little threat from inflation, indeed inflation will be allowed to go higher and sterling lower to help recovery.

Forecasts

• GDP growth is now forecast to be 0.9% in 2013 and 1.7% in 2014, a lowering of the Institute's forecast in November, rising further to 1.9% in 2015.
• Projected net job creation is 9,400 this year, rising to 19,150 in 2014 and 31,800 in 2015.
• Unemployment is now forecast to be 218,300 by the end of 2013 and 228,500 in 2014. By the end of 2015 unemployment is forecast to have fallen back to 204,100 as the economy recovers more strongly.

 

A Developing Taste for Scottish Goods?

Today's manufactured export figures are welcome. They show a rise in volumes of 0.8% in July - September last year over the second quarter performance. Over the year to the third quarter real exports nevertheless fell by -0.8%.

I was, therefore, a little surprised to read these comments from Finance Secretary John Swinney on the latest figures

" ... it is clear that many counties have developed a taste for Scottish goods ... Our excellent natural larder guarantees some of the best produce in the world and this reputation for quality is paying dividends."

The chart below shows just where Scottish manufactured exports are.

This statement from the Release is formally correct:

The index of manufactured exports fell more than 13 per cent during the recession in 2008/9. Since then the trend in the results shows a recovery in export volumes, although the quarterly growth rates have been relatively volatile. The latest results show that export volumes remain around 10 per cent below their pre-recession level.

But the statement does not tell the full story.

Manufactured export volumes were falling before the GDP recession began - from 2007Q2. They then fell by 16.5% and began to pick up a quarter before the end of the GDP recession. With the latest data, export volumes, now stand at 13% below the 2007 peak. Yes, there has been a recovery but it has been weak and appeared to have run out of steam from 2011Q2.

Moreover, it can be seen that the present situation is worse than the position in the early 2000s after the shock to Scotland's manufacturing exports of the collapse of the electronics industry. Although, in mitigation the downturn then was structural affecting mainly one sector, whereas today the malaise is more general.

We do need to be grateful to the export performance of the food and drinks industry and whisky in particular. The data show that without growth of 5.9% in food and drink during the quarter, manufacturing exports would have contracted by nearly 1%. The position is a little better over the year with engineering making a small positive contribution along with food and drink. But the weak performance of the other sectors resulted in negative growth over all.

Some recovery; some dividend!

Our Recovery Just Got Better!

The latest Scottish GDP data for the third quarter of last year, which were published this morning, provide interesting reading.

The data are interesting for much more than what they tell us about the performance of the Scottish economy in the latest quarter. Improvements to the underlying statistical methodology and source data have changed the whole profile of Scotland's recovery from the Great Recession both absolutely and relative to the UK.

First, the release shows that the Scottish economy grew by 0.6% in the third quarter, compared to growth of 0.9% in the UK. This is a commendable Scottish performance. It is commendable because the so-called 'Olympic bounce' was expected, is likely to have been, much weaker here than in the UK. So, you might say that the 0.6% figure represents genuine growth in Scotland whereas the 0.9% UK figure has a good element of 'flash in the pan'.

Beneath the aggregate figures the Scottish data showed that manufacturing turned in a strong performance with growth of 3% in the quarter and 0.6% over the year. This can be compared with the performance of UK manufacturing which grew by only 0.7% in the quarter and contracted by -1.5% over the year. Similarly, construction also performed better here, in so far as the sector contracted by less here! Scottish construction GVA fell by -0.4% in the quarter and -7.1% over the year - a scary number. But UK construction contracted by -2.5% in the quarter and -11.2% over the year - even more scary!

However, the important services sector, which accounts for 72% of Scottish GDP and 77% of UK GDP, was weaker in Scotland in the third quarter. Scottish service GVA grew by 0.3% here compared to growth of 1.2% in the UK. But over the year the service sector in Scotland grew by 1.3%, identical to UK service sector growth.

The performance of Government services still looks anomalous in the UK with GVA continuing to expand by 1.6% in the quarter and 2.8% over the year. Government and other services in Scotland, more realistically, contracted by -0.1% in the quarter and rose by 0.1% over the year.

But what is perhaps more interesting than the third quarter results is the effect of methodology and data source revision on the nature and profile of Scotland's recovery from recession.

The Release states that

This publication incorporates a number of updates to methodology and source data. This is the first Scottish GDP publication fully based on the Standard Industrial Classification (SIC) 2007, which is a major revision to the previous SIC 2003. As part of this process, annual GVA weights since 1998 for each industry have been updated following their estimation in a SIC 2007 based Supply-Use framework. The most recent annual GVA weights now relate to 2009, updated from 2007 in the previous publication. This update means that the latest estimates better reflect the current structure of the Scottish economy.

It also means that there is a more accurate like-for-like comparison with the UK.

The effect on Scotland's recovery from recession is marked.

The last quarter data looked like this

But in today's data for the 3rd quarter, after revisions and adoption of the latest industry weights to be directly comparable with the UK, we get this chart

The three quarters of negative growth to the second quarter evident in the previous release have now reduced to two. The scale of the Great Recession is slightly reduced to a drop of -5.6% rather than-5.8%. And now Scotland stands with the UK in being just under 3% below the pre-recession peak, whereas in the previous quarter Scotland was more adrift from the UK.

The Scottish recovery is still slightly weaker than the UK but not by much.

Hey, our recovery just got better!

(A more detailed analysis of the Scottish GDP data and the wider context will be provided in the Fraser of Allander Institute's Economic Commentary to be published in early March.)

Personal Debt, Spending and Recovery

It is difficult to know what to make of the latest data on household debt (financial liabilities, excluding mortgages) which were published by the ONS this week.

Media reporting of these data took some comfort, e.g. here, in the evidence that at £2,500 Scotland had, in 2008/10, the second lowest median of personal financial debt in the UK. Wales at £2,000 had the lowest, while the South East at £4,200 had the highest. Scotland, Wales, West Midlands and London were below the GB average of £3,200 - see chart below.

Why is it an apparent good thing that Scottish household debt is lower than the GB average and several other regions?

The answer is that high levels of household debt are considered to be a major factor in damaging consumer confidence and lowering household spending after the financial crisis and recession of 2008/09.

There is Bank of England survey evidence that concern about high levels of debt leads households to desire to cut spending. And the recent ONS data show that the percentage of individuals reporting financial debt as a burden has increased between the two waves of the survey i.e. 2006/08 and 2008/10. In 2006/08, 47.5% of individuals living in households in financial debt reported their debt as either a heavy burden or somewhat of a burden, compared with 49.4% of individuals in 2008/10; an increase of 1.9 percentage points.

So, can we conclude that because of the lower level of debt Scottish household spending while continuing to be restrained, should be less restrained than in Britain as a whole and in most other GB regions?

Possibly but not certainly!

Economists who believe the "Financial Instability Hypothesis", which was developed by the American economist Hyman Minsky, emphasise the rate of growth of debt as well as its level. Steve Keen, for example, suggests that

"the ratio of debt to GDP — and the rate of change of that ratio — as the key determinant of the state of the economy .."

Superficially, the argument is that the greater the acceleration the more heavily the brakes are likely to be applied. In the debt context, the faster the growth of debt the more rapidly spending will be cut back once the 'Minsky moment' is reached.

If the growth of debt is important, and we are talking hypotheses here, then what do the data show for Scotland in the recent ONS release? The chart is here

The growth in Scottish non-mortgage median household debt (19%) was faster than the average in Britain (14%) but less than some UK regions.

I'm not sure how significant this statistic is. But my main point is that we should not draw too much comfort from the evidence that the level of Scottish household debt is lower than GB and most other UK regions.

Should Scotland be in EU if rUK out?

In a speech to the British Irish Chamber of Commerce in Dublin last week Nicola Sturgeon, Deputy First Minister is reported to have said:

"It is no longer fanciful to consider as real the possibility the UK is heading out of the EU. Let me state emphatically this is not a journey the Scottish Government wishes Scotland to be a part of, nor one I believe would be supported across the Scottish business community or wider civic society."

I have no sympathy with what Prime Minister Cameron is seeking to do re a referendum in the UK on EU membership. But if, hypothetically, the UK did leave the EU is Nicola Sturgeon correct in arguing that it is in Scotland's interests to stay in the EU?

I do not think the issue is as clear-cut as she pretends.

Take trade for example. The following chart, constructed from the recently published Scotland Global Connections 2011 highlights the importance of trade with rest of UK compared to EU trade.

Scottish exports to rest of UK are four times bigger than exports to the EU (ex UK). Moreover, the importance of rest of UK exports to Scotland is rising while the share of exports to the EU has fallen over the period. And that is after a 15 percent increase in the nominal value of exports to the EU between 2010 and 2011, taking the share from a low of 15 per cent to 16 per cent.

Given these data it would appear to be exceptionally foolhardy of any Scottish government to risk trade, investment and migration links to the rest of UK by staying in the EU if the UK left.

On the other hand, foreign investment and skilled labour immigration to Scotland from the EU and other countries could be damaged if Scotland left the EU. And, the impact of Scotland in-rUK out on Scottish trade might be softened if a free trade arrangement was negotiated by rUK with the EU.

So, it is not at all clear that in such circumstances staying in the EU would be in the best interests of the Scottish people. It would be by no means an easy decision for a Scottish government - if independent - and it is rather remiss of Nicola Sturgeon to present it as such.

Jobs Market Weakens Again

The latest jobs market data provided further evidence that the labour market in Scotland continues to weaken. The positive element in the latest figures was a strong fall in unemployment of 14,000 or -6.4%. In the UK, unemployment also fell by 37,000, a much weaker fall of -1.5%.

Yet, the jobs market was much weaker in Scotland. Employment fell by 24,000, or -1%, in Scotland. But in the UK net new jobs were created. Employment rose by 90.000 in the UK. An increase of 0.3%.

So, falling unemployment in Scotland provides an illusory view of the absolute and relative state of the Scottish labour market.

It is also incorrect for the media to report the latest statistics as yet another fall in unemployment in Scotland as the BBC did here. In the data published last month a fall of 19,000 was reported. Now there is a fall of 14,000. But we are dealing with quarterly data not monthly data. The latest quarterly data published today compares the quarter September to November with the previous June to August quarter. Last month's data compared August to October with the previous quarter. Hence in the quarterly data published this month and last month, two of the three months are the same: September and October! The latest figures add November and exclude August.

So, while unemployment fell this quarter, it rose by 7,000 in the previous quarter after falling successively by 3,000 and 13,000 in the two quarters before that.

However, as I noted in earlier posts on the Scottish labour market - here and here - one reason for the apparently stronger unemployment performance in Scotland has been the rising number of inactive workers. In the latest quarter the numbers inactive in Scotland rose by 42,000 or 2.7%. In the UK in contrast the inactive number rose by absolutely less, 39,000, an increase of only 0.2%.

My hypothesis is that the rising inactive numbers in Scotland is a consequence of disproportionate weakness in the Scottish jobs market. Workers are discouraged by the lack of available jobs to cease looking for work and leave the labour market.

If, as before, I assume that the labour market was in equilibrium at the start of the recession then we can compute a 'real' level and rate of unemployment by adding back in this 'discouraged worker' effect. This is done in the chart below.

The hypothesised 'real' level of unemployment is some 80,000 higher than the official rate and on a rising trend.

It is what is happening in the jobs market that, I think, explains this rising trend in 'real' unemployment.

The latest fall in employment is included in the chart below which shows Scottish employment since the start of the recession.

With the latest data, Scottish employment is 96,000 or -3.7% below its pre-recession peak. It currently is only 23,000 above the trough of the 2008-2010 recession. Any recovery that there was in Scottish jobs faltered after the March - May 2011 quarter and has essentially stagnated ever since.

However, that is not the end of the story because it gets worse!

The working population is rising in Scotland so if you express employment over the total number of workers economically active and inactive we get the next chart.

The situation is now worse than at the worst of the recession with employment- working population ratio now -5.7% below its pre-recession peak compared to -5.6% in the trough of the recession.

I know that we must not put too much store by one month's or one quarter's figures. I know also that the Labour Force Survey has a fairly small sample and so is subject to sampling errors which are large.

Yet, my judgement leads me to believe that what we are dealing with here is not measurement error but a real problem in the Scottish jobs market.

 

Hope from the Scottish Housing Market?

I don’t purport to be an expert on the Scottish housing market. But I did notice an interesting piece of evidence when perusing the latest House Price Index data from ONS published on 18 December last year.

The chart below shows the mix-adjusted housing prices monthly from 2002 for the UK countries relative to the UK. The data are not seasonally adjusted, which should be ok if seasonality is similar across countries in UK.

The chart highlights one or two interesting facts.

First, there is the significant absolute and relative boom and collapse in Northern Ireland house prices. Moreover, the recession in the Northern Ireland housing market appears to be continuing.

Secondly, the position of the Scottish housing market is better. Absolutely and relatively compared to Wales and Northern Ireland; and relative to England.

There is not a lot to shout about here. But if house prices are relevant to the household spending then this is one factor that appears to have been more favourable in Scotland than in the other countries of the UK over the last few years.

The good news appears to run out, though, after July 2011 when there was some subsequent slight deterioration in relative Scottish house prices.

So, I don’t expect much of a relative boost to Scottish household demand on this account over the next few months.