Scottish Economy Watch

Scotland's Public Sector Net Debt

Yesterday the Scottish Government produced a paper where estimates are provided of Scotland's historical notional share of UK debt interest payments and public sector net debt.

The paper identifies UK public sector net debt at the end of 2011-12 as £1,100 billion, which amounted to 72% of UK GDP. Applying a per capita share to Scotland, produces an estimate for Scottish public sector net debt of £92 billion. This amounts to 62% of Scottish GDP, since with a geographical share of oil Scotland's GDP per capita is estimated to be greater than the UK.

One can accept this estimate provided one does not then conclude that the burden of debt in an independent Scotland is ten percent points lower than the UK. We cannot conclude this because, as I and others have noted, an independent Scotland will be faced with a higher interest rate on its long-term government borrowing than the UK.

More controversially, the Scottish Government's new paper goes on to estimate an illustrative historic share of UK net public debt. The Scottish Government describe this estimate of Scotland's net public debt as being based on:

estimates of public spending and tax receipts in Scotland over the past thirty years, in other words, on the basis of what Scotland has actually contributed to UK tax revenues

On this basis, the Scottish Government estimates Scotland's share of UK net debt to be £56 billion, equivalent to 38 per cent of GDP.

These estimates lead Deputy First Minister, Nicola Sturgeon to conclude that:

Both of the methodologies show that Scotland's estimated share of national debt takes up a smaller proportion of our economy than is the case for the UK - which means that in all circumstances Scotland will be better off with independence.

I have already noted that these estimates ignore the cost of borrowing, which is likely to be higher in an independent Scotland. But a moment's further thought should lead one to question the Scottish Government's illustrative historic calculation.

First, it seems a reasonable logical argument that as part of the United Kingdom Scotland should broadly be expected to share on a per capita basis in UK public spending, taxation and debt. Asking Scotland to take a per capita share of UK debt if Scotland decided to leave the UK union would seem to be reasonable, since everybody in the UK might be said to be in the same boat together.

However, the Scottish Government suggests that a historic calculation may be more appropriate. But in computing their 'historic' estimate they confine the calculation to the cumulated fiscal balance, including a geographic share of oil revenues, since 1980/81. This is then expressed as a ratio of the cumulative UK deficit over the same period (5.1%) and that ratio is taken to be Scotland's notional share of UK public sector net debt (£56 billion).

But if we are to compute Scotland's share of UK debt on an historic basis, shouldn't we also allow for special Scottish factors that directly affected the level of UK public net debt?

One obvious and significant omission is the bailout of the two Scottish banks in 2008-09.

The National Audit Office estimates that the amount of cash - requiring to be borrowed - for the bank bailout was £124 billion. The share of the two Scottish banks amounted to £67 billion. If we assume that a population share of this number is allowed for in the Scottish Government's 'historic' estimate, this leaves a further £57 billion to be added to the £56 billion debt estimated by the Scottish Government. £113 billion of debt amounts to 77% of Scottish GDP including a geographical share of oil value added.

The new estimate is shown along with the Scottish per capita estimate and the UK net public debt share in the following chart

On this basis and adjusting to gross debt figures as the Scottish Government do in their Chart 4, Scottish gross debt on an historic basis would rise from 44% to around 90%. This would raise Scotland in the debt EU-15 debt ranking from the Scottish Government's rank of 14th from 16 (adding Scotland to the EU-15) to 6th from 16.

This, and remembering the point about borrowing costs, certainly doesn't appear to support Nicola Sturgeon's contention "that in all circumstances Scotland will be better off with independence."

 

Scottish Tax and Spend

Today the Scottish Government published a two-page document providing a summary of trends in total Scottish tax receipts since 1980-81. The summary allocates to Scotland a geographical share of North Sea Oil revenues and draws from experimental statistics of Scotland's fiscal balance which are published on the Government Expenditures and Revenues Scotland (GERS) website here.

The data are not new. The fiscal balance estimates were updated for the GERS exercise to include 201-2 fiscal data and published on 5 March. Nevertheless, the Herald thought the information to be of sufficient importance to run the story as its main feature under the headline "New Report: Scots paying more tax than rest of UK" Given prominence in the story was a quote by Finance Secretary John Swinney from the government Press Release accompanying the report:

These figures confirm what we have known all along. Scotland more than pays her way in the UK. They show that the average tax receipt per person in Scotland has been higher in each of the last 30 years than it has been across the UK as a whole.

As the chart below shows John Swinney's comment is correct.

However, what was not reported in the Herald, wisely in my view, was John Swinney's further comment in the Press Release:

With the full control of our finances we could have invested this money for the people of Scotland, creating jobs and investing in public services.

The 'new report' does not contain any information on spending. An examination of the spending data on the same per capita basis as the tax data and taken from the GERS website reveals the following:

Yes, spending per person in Scotland has also been higher in each of the last 30 years than it has been across the UK as a whole.

So, broadly, these greater tax receipts were invested for the people of Scotland, creating jobs and investing in public services.

The Scottish people have received a significant dividend from North Sea oil revenues, much more than people in the rest of UK.

Now, it is clear that oil revenues were exceptionally high in real terms in the 1980s - as the tax receipts chart indicates. The Scottish people might legitimately note that the greater spending received in that period was much lower than the tax receipt surplus.

A sense of this can be gained from the final chart, which expresses per capita spending in Scotland and UK as a ratio of per capita tax receipts. This is really another way of expressing the fiscal balance data as I did in this post.

The large scale of oil revenues in the 1980s meant that Scotland would have been in surplus - ratio less than one. But from 1990 the spending to tax ratio has tended to be similar in Scotland as in the UK, in fact a little higher in Scotland at 1.11 compared to 1.10 in the UK.

So, if we are to talk about a country 'paying her way', we need to bring into account spending as well as revenues. Public spending per capita has averaged more than ten per cent (10.86%) higher in Scotland than in the UK since 1990/91, while tax receipts (including a geographic share of oil revenues) have averaged less than ten per cent (9.67%) higher in Scotland than in the UK since 1990/91.

With the independent Office of Budget Responsibility predicting (page 102 of its March Economic and Fiscal Outlook) a sustained decline in future oil revenues from £11.2bn in 2011-12 to £4.3bn in 2017-18, Scottish tax receipts are set to fall relative to the UK.

And of course I have not brought into this discussion the issue that an independent Scotland is likely to have to pay higher borrowing costs than the UK as I noted in this and this post. It is not just the size and relative size of a government deficit that matters.

Funding costs must also be considered.

Nicola: don't forget the day job!

It is inevitable that the media should focus on Nicola Sturgeon's new role responsible for Scottish Government strategy and the constitution. The talented minister will be responsible for leading negotiations with Westminster on the referendum and piloting the referendum bill through Holyrood.

But all of that is in addition to her 'day job' as the new minister for infrastructure, investments and cities.

Alex Neil, whom she replaces, has for many years been a passionate advocate of the need for more investment to raise the long-term rate of growth. I have crossed swords with him in the past because I felt that he did not pay enough attention to the quality of investment. Investment per se is not enough. It needs to be innovative and embody new technologies. But subject to that caveat, investment in both plant and machinery, R&D and infrastructure is crucial, as well as in human capital. There is some debate about the relevant importance of each but that is an issue for another day.

If we look first at gross investment to GDP, we see in the chart below that the SNP minority and then majority government at Holyrood presided over a decline from just under 20 percent of Scottish GDP to just above 15 percent in the first quarter of this year. In the UK the share declined from a peak of just above 18 percent in 2007 to just below 15 percent in the first three months of this year. The Scottish data are drawn from the Scottish National Accounts Project (SNAP) and are experimental, with work continuing to improve the quality of the statistic. Readers - and authors! - should therefore be careful in drawing conclusions from the dataset.

Clearly, the Great Recession and its aftermath appears to be primarily responsible for the fall.

But there are longer-run trends at work.

The UK gross investment share has clearly been on a downward trend since 1998, although that does not seem to have been the case in Scotland. Andrew Smithers of Smithers & Co argues, supported by sophisticated modelling on executive compensation contracts and macro instability from the New York Federal Reserve, that the falling investment share in the US and the UK and lower future growth is a direct consequence of the growth in the corporate bonus culture. This has been particularly prevalent in financial services. One interpretation is that spending on investment reduces profits in the short-term even though it will raise them in the long term. If executive compensation is linked more to bonuses, which in turn are linked to the short-term profit numbers, then there is a built bias in the corporate reward system against investment: a perverse incentive.

Maybe the bonus culture has not developed as strongly in Scotland. It is certainly true that those parts of the financial service sector where this culture is more in evidence such as hedge funds and the shadow banking sector are less represented in Scotland. But it is certainly something that the new minister should be urging Scottish Financial Enterprise, the CBI, the IOD and other industry bodies to discourage.

The UK's record in investment is clearly not one which neither industry or government can be proud.

In the latest CIA World Factbook the UK ranks 137 out of 150 countries for gross fixed investment as a percentage of GDP. It is true the United States ranks lower at 142 but that perhaps makes Andrew Smither's point!

Net government investment in the UK is also in decline and that decline is forecast to continue due to fiscal consolidation as the chart below shows.

The situation on public sector net investment is likely to be much the same in Scotland as in the UK. Which brings me back to Nicola.

It is too easy to argue that if only Scotland can get out of the UK union everything will in the end be ok on the investment front and the wider growth of the Scottish economy. As I and others have argued, see here and here, an independent Scotland's fiscal position is likely to be no better than under the present arrangements and probably worse. Given that, it is difficult to see an independent Scottish government make a radical switch from current to capital spending. The short-term political cost would be extreme.

So, if Scotland is going to raise radically its investment spending then it is down to the private sector. Inward investment can play a role. But we note that despite recent successes the attraction of inward investment has done little to arrest the slide in the investment GDP ratio.

More demand in the economy would certainly help. But it is really down to Scottish companies being prepared to put investment spending over short-term profit. A challenge for any Infrastructure, Investment and Cities minister no matter how competent.

So, Nicola. Don't forget the day job!

Anti-Austerity Policy: Independence or Devolution?

In this post I argued that

devolution can offer fiscal policy options that are just as credible as the policy mix that would be available under independence. And these options could be available without some of the costs of independence. .... Scotland does not have to accept a Tory-Lib Dem austerity policy. But it doesn't have to leave the UK political union to do so.

However, I wasn't able to offer any numbers. I suggested that

Further academic research is required on the appropriate form and degree of fiscal devolution for effective stabilisation but there is little doubt that stabilisation at the level of nations and regions within the UK is feasible.

Full and detailed research is still required but I am now able to offer some 'ready-reckoner' type estimates that give some idea of the magnitudes involved. They should be viewed as illustrative and not definitive.

The first point to note is that small open economies such as Scotland, whether politically independent or not, tend to have smaller fiscal and other multipliers than larger states. This is because when the propensity to import from a pound/dollar/euro of extra spending is high much of that spending will 'leak out' of the economy. Ray Barrell, Dawn Holland, and Ian Hurst have recently produced this paper for the OECD, which looks at fiscal consolidation in 18 OECD countries. Using the National Institute Global Econometric Model (NiGEM) they provide estimates of first-year multipliers for different types of fiscal intervention. These multipliers are shown to be larger the bigger the country and the lower the degree of import penetration.

The chart below reproduces their data for the relationship between temporary spending reduction multipliers and import penetration:

Using the estimates provided by Barrell et al we can estimate a spending multiplier for Scotland using a measure of import penetration drawn from the 2007 Scottish Input-Output tables - see here. Scotland's share of imports in GDP/GVA is 0.66, which compares with 0.70 for the Netherlands, 0.72 for Ireland, and 0.80 for Belgium. This gives a spending multiplier of -0.17 for Scotland using the average relationship derived from Barrell et al's work. But this value could be too low if Ireland is a close comparator so we also use the value of Ireland's multiplier of -0.33 in the exercise below.

We now assume that the UK government introduces a fiscal spending consolidation equal to 1% of GDP which can be either temporary or permanent. The impact on Scottish GDP is estimated in Table 1 for different constitutional states:

Under the status quo it is assumed that the UK fiscal multipliers apply, from Barrell et al. GDP falls by a temporary 0.74 percent for a 1 percent of GDP reduction in UK public spending. The permanent fall in GDP is less because the NiGEM model allows for UK monetary policy affects as long-term interest rates fall boosting demand and production.

But under independence Scotland will have its own tax and spend regime and we assume that direct fiscal consolidation applies only in the rest of UK.

However, Scotland is not unaffected.

Around two thirds of Scottish exports go to the rest of UK, representing a 34 percent share of Scottish GDP. So, even under independence with no fiscal austerity from the Scottish Government GDP falls - by 0.25 percent. The permanent impact is lower too under Scottish independence, because we assume that an independent Scotland remains in sterling and therefore interest rates in Scotland move in line with the UK.

What about the impact under devolution?

Under Devo-Max, or full-fiscal autonomy, the GDP effect is assumed to be the same as under independence.

But under Devo-Plus, where we assume the Scottish Government has responsibility for tax and spend equal to 50 percent of its revenues and expenditures, the fall in GDP is greater than under independence but less than the status quo for both temporary and permanent fiscal consolidations.

If a Scottish Government seeks to defend against the fiscal austerity practised by the UK Government, what would be a fiscally neutralising response?

Table 2 illustrates.

Table 2 shows what a Scottish Government would be required to do if it wished to neutralise the impact of a 1 percent UK fiscal austerity on its GDP. Under Independence and Devo Max it would need to raise spending by 0.77 percent to 1.43 percent of GDP. The lower figure is based on Ireland fiscal multiplier of 0.33, the larger figure is based on the 0.17 multiplier derived from feeding Scotland's import share into the relationship estimated from Barrell et al's paper.

What is interesting about these estimates is that size of the neutralising spending increase required under Devo Plus: from 1.5 per cent to nearly 3 percent of GDP. The present UK Government's fiscal consolidation programme is seeking effectively to remove 6 per cent from GDP. So, this would be exceptionally difficult to fully neutralise, if not impractical, under Devo Plus. It would also be a tall order under Independence or Devo Max.

But let no one rush off and seek to argue that this analysis supports the view that Independence is the only constitutional state that would allow Scotland to defend against UK fiscal austerity.

In order to raise public spending to defend against UK fiscal austerity, the Scottish Government would need to increase its budget deficit. To do so it would have to borrow - sell bonds. It is likely that an independent Scottish Government would face long-term borrowing rates that are higher than the UK - see my post here and here. It would also, if using sterling, have to operate under fiscal rules on deficit to GDP and debt to GDP set by the Bank of England. Two issues follow.

First, if deficit and debt levels are already high then an independent Scottish Government's room for manoeuvre to offset UK Government austerity, even partially, may be limited, if not precluded all together by financial market constraints.

Secondly, it is a moot point whether an independent Scotland would be faced with a higher long-term borrowing rate than a devolved Scottish Government borrowing with UK Treasury backing.

In sum, a Scottish Government of whatever constitutional ilk would be severely constrained in defending against a large UK fiscal austerity programme. This is because the Scottish economy is highly integrated through trade and labour market links such as migration with the rest of UK. Political independence would not change this much.

Public Sector Jobs and Fiscal Austerity

Yesterday saw the publication of the public sector jobs data for both Scotland and the UK. I examined in this earlier post what could be deduced about the impact on public sector jobs of fiscal austerity when data for the fourth quarter 2011 were published back in March.

The new data show fiscal consolidation continuing with more jobs being shed. And Scotland still seems to be leading the way as this chart shows:

However, the 8.9% fall in public sector jobs in Scotland includes the banking employment in HBOS and RBS, which were included in the data from the fourth quarter 2008 after the UK government took a majority stake in each. Transferring those jobs to the private sector reduces the fall in public sector jobs to -7.6%. This makes the job loss broadly the same as England.

There is some evidence that the part-time jobs have initially been more vulnerable than full-time jobs. But recalculating the job loss in terms of FTEs leads to an estimated fall of -7.3%, not much different from the percentage fall in the ex banks headcount. But the FTE numbers are smaller.

Overall, some 57,000 public sector jobs have been cut if the banks are included, 44,000 if the banks are excluded, which translates into about 37,000 FTEs. This is still a sizable job loss whichever way you look at it.

It is also worth noting that at the Fraser of Allander Institute, in a CGE model simulation published in the Economic Commentary in June 2012, we estimated that the public sector job loss from departmental spending cuts would likely be in the range 78,000 to 90,000. It would appear, sadly, that we are well on the way to attaining that range of job loss.

The overall public and private jobs position since the start of the Great Recession is given in this chart:

What is again clear from this chart - I have smoothed the data in the absence of seasonal adjustment - is that the recovery of private sector jobs has not in any significant way compensated for the public job loss.

So much for the UK government view that there would be a crowding in of private jobs as the public sector contracted.

Benefits: Ground Control to Sir Tom

Sir Tom Hunter is reported today as believing that Scotland has become far too reliant on the state and that benefits have corrupted the nation's work ethic. He is quoted in the Sunday Times as saying:

The fact is the welfare state has simply enabled us to become pampered, dependent people who expect what others strive and grasp for... For those most vulnerable, most in need in our society, (the welfare state) is sacrosanct. ... However the pendulum, in my view, has swung too far and we expect too much from our state when in many respects we have not earned that expectation.

The basis for Sir Tom's comments is data from the UK Department of Work and Pensions, which reveals that Bridgeton in the east end of Glasgow has 85 per cent of working age adults in receipt of benefit. Further, seven of the ten areas with highest receipt of benefits per working age adult are in Scotland and four of them are in Glasgow.

No one doubts Sir Tom's sincerity. I personally stand in awe of his philanthropy and his magnificent contribution to the promotion of entrepreneurship in Scotland and the good of economy generally. But on this issue I fear he has not been well advised. Indeed, it might be said that he has inadvertently played into the hands of the present DWP and its benefit cutting agenda.

No one doubts that Scotland has too many people locked into a cycle of extreme deprivation and disadvantage. Many of them are located in the Glasgow area. It is a tragedy that more is not being done to break the cycle and assist them to attain a state where they no longer need to rely on benefits.

But is Scotland much out of line with the rest of the UK? Indeed is Glasgow?

The chart below shows benefit expenditure per voter - electorate - in England, Wales, and Scotland:

Yes, benefit spending - data exclude housing benefit and council tax benefit - per voter is higher in Scotland than England by 9 percent. But spending in Wales is higher than in Scotland also by 9%. Hence Scotland is not dramatically out of line with the rest of Britain.

So, what is going on?

What Sir Tom, and I think also the DWP, may not properly understand is that the interaction of the jobs market and the housing market leads to the spatial concentration of different social groups within a city. So, if I do well at my work and get promotion I might be able to buy a house in the West End or over in the South side. But, if I lose my job and can't keep up my mortgage payments I may lose my house and eventually move into social housing in Bridgeton or Rutherglen.

What we see from that stylised example is that the unemployed and benefit dependent families tend over time to concentrate in certain areas. On the other hand, the better-off, upwardly mobile, go to the West End, South side, or just outside Glasgow to places such as Bearsden. Hence, the high proportion of benefit recipients in Bridgeton. (On housing market segmentation see inter alia Christine Whitehead here.)

Don't believe me?

Well look at this chart

Benefit Spending per voter in Scottish Westminster Constituencies 2010-11

The chart may be difficult to read but it shows the benefit spending per voter in each UK Parliamentary constituency in Scotland. The spend in the median constituency is £2,813 a little lower than the mean of £2,832. At the lowest extreme stands the West Aberdeenshire and Kincardine constituency with a spend of £2,016 per voter, while at the top of the spending range stand 3 Glasgow constituencies. The one with the highest spend of £3,756 per voter is Glasgow North East, closely followed by Glasgow East at £3, 724.

But note: there are 3 Glasgow constituencies with a benefit spend below the Scottish median and mean: Glasgow South (£2,782), Glasgow Central (£2,666) and Glasgow North (£2,382). Indeed, Glasgow North has the sixth lowest spend in Scotland and is below the average for England.

Scotland clearly has problems of multiple deprivation leading to higher levels of benefit spending than in England. But less than in Wales. The incidence of this deprivation and need for benefits is clearly in Glasgow. Yet, within cities poor deprived people tend to live in certain areas while the better off live in other different places.

It is also probable that concentration of large numbers of deprived individuals and families in one area may make it harder for many to escape the stigma of deprivation see this book especially Ch 4 by Alan McGregor. And some of these may become dependent people.

But Sir Tom, there is no evidence of pampering. Nor is there evidence that Scotland has become far too reliant on the state, or that benefits have corrupted the nation's work ethic.

Scotland and Glasgow's problems of deprivation and benefit dependency are far more complicated than that.

Scotland's fiscal position

Yesterday (18 April) the Scottish Government published along with its latest quarterly GDP figure a long-run series for Scottish and UK GDP in current terms going back to financial year 1980/81. The novelty of the series is that the GDP estimates for Scotland include a population and geographic share, respectively of North Sea oil production (technically a share of extra-regio activities). These data can be combined with the data on Scotland's and the UK's net fiscal balance going back to 1980-81, which were published on 7 March of this year. It is worth noting that the data are classified as 'experimental' as part of the Scottish National Accounts Project (SNAP) and so do not carry the Office of National Statistics (ONS) 'kitemark'.

With these new data it is now possible to compute an estimate of Scotland's fiscal balance since 1980-81 and compare with the UK. I have done this for the case where Scotland is allocated a population share of oil production and revenues and for the case where Scotland is allocated a geographic share of oil production and revenues. The estimates of the geographic share are based on the methodology and modelling of Kemp and Stephen (2008). For a sample of their earlier work on North Sea oil see their 2001 and 2005 papers.

The charts for the two cases are below

There is something in these figures for both proponents of Scottish independence and those who advocate staying in the UK union.

The table below tries to draw some conclusions on the fiscal balance by first taking averages for the whole period up to the start of the Great Recession in 2007-08. The period after 2007-08 is excluded because I assume that it is untypical. It is clear that with a geographic share the Scottish position is far superior to the UK. Both are above or better than the 3% deficit which is the limit set out in the EU Stability Pact. This is the figure that would probably be demanded of Scotland as the limit of its deficit within a sterling union. But Scotland's favourable position is seen to depend on oil revenues. When Scotland is allocated a population share of these revenues the fiscal deficit deteriorates to -5.3%, clearly above 3%.

The second set of estimates is based on the period 1990 to 2007. This excludes the initial rush of oil production as the North Sea boomed and oil revenues were exceptionally high in real terms. On this basis, even with a geographic share, the Scottish fiscal deficit is averaging slightly above 3% and above 6% if only a population share of revenues is allocated. The UK remains under 3% in both cases.

Fiscal balance as % GDP		Sco average 1980 to 2007		UK average 1980 to 2007	Sco average 1990 to 2007	UK average 1990 to 2007
Geographic share oil revenues		1.5		-2.4	-3.6	-2.6
Population share oil revenues		-5.3		-2.4	-6.5	-2.6

Of course, production of oil and gas in the North Sea is set to decline. There is a question mark about the rate of decline because it depends on oil prices and the extent of new discoveries. The best estimate is provided by Kemp and Stephen 2011 and is based on a real oil price of $70 per barrel and a gas price of 40p per therm - the oil price will be higher than $70 in nominal terms because of inflation. This scenario has for them the greater probability than a $90 and 60p combination.

The time profile of hydrocarbon production is shown below

Of course, we don't know what this implies for oil revenues because it also depends on the tax rate, as well as the price of oil and gas, and levels of production.

The main conclusion would appear to be that an independent Scottish government cannot rely indefinitely on oil revenues to ensure that it remains below the 3% deficit benchmark over a sustained period. But it can probably do so for a reasonable period. In the longer term, other sources of tax revenue will need to be found and/or public spending shares reduced.

Amazon and the Scottish Government

Amazon has avoided paying corporation tax over three years on UK sales of more than £7.6bn. The company has been rightly criticised for this. But the Scottish Government has also come under criticism for paying Regional Selective Assistance grants and other public support amounting to £10.6 million. The support has been given to Amazon's fulfilment and distribution centres in Dunfermline, Gourock and also a customer call centre in Edinburgh.

You can see the vulnerability of the Scottish Government's position when one of its economic arguments for an independent Scotland is the opportunity it would be given to lower the rate of corporation tax to attract new inward investment and so, it hopes, promote the growth of the Scottish economy.

Whatever one might think about this argument for an independent Scotland is it right that the Scottish government should be criticised because Amazon has avoided paying corporation tax?

I think the answer to this question is an emphatic no!

The payment or non-payment of tax is a separate issue from the contribution of Amazon activities to the Scottish economy. Clearly, HMRC should do everything in its power to ensure that Amazon cannot indulge in sophisticated transfer pricing arrangements to avoid paying UK tax. But whether Amazon should have invested in Scottish activities with Scottish Government support depends on the estimate of the net contribution of activities to the Scottish economy.

It appears that with the investment last year Amazon will have around 1000 jobs in Scotland. To criticise Amazon's business model and the quality of the jobs provided as some have done is again a red herring. The critical question is what would the counterfactual have been to the investments? In non jargon: what would have happened if the Scottish government had not paid the £10.6 million to Amazon in grants?

First, if Amazon would have come to Scotland anyway then there would have been no additionality and the Government support would have been a mistake. But the project will have gone through a significant appraisal process by Scottish Government economists and civil servants. They must have concluded that there was a high probability that the investments would have gone to another jurisdiction, probably Ireland. Nobody appears to have criticised the support as lacking additionality. And if the project is additional then there would be secondary multiplier effects creating further jobs from the spending from the incomes earned in the newly created jobs and from any local purchases made by Amazon's Scottish investments.

Secondly, would the £10.6 million have been better used by Scottish companies? Nobody knows for certain. But I doubt it. There is no evidence of competing Scottish owned investments complaining because they could not get grants. Indeed, given Scotland's weak business birth rate this is one key reason why the Scottish government needs to hunt for inward investment. There is currently no domestic Scottish alternative.

Thirdly, would Amazon's Scottish investments have led to the displacement of other Scottish activity? This would also have formed part of the Scottish Government's ex ante appraisal of its support for the investments. Displacement could occur through the jobs market if the incoming investment bids up local wages. This again seems unlikely when unemployment is so high. I doubt no Scottish employer had to shed jobs due to higher wages following Amazon's creation of 1,000 jobs. Displacement can also occur through the goods market. That is Scottish produced goods and services may be displaced as Scottish consumers switch away to buy the Scottish Amazon product. Is this likely? Again I think the answer is no. To argue as some have done on Twitter that the demise of Waterstones and other booksellers based in Scotland is due to Amazon's Scottish investments is risible. Yes, their demise may be due to Amazon but not to their Scottish investments. That would have happened wherever they located.

So, we should welcome Amazon to Scotland, while criticising strongly their apparent tax avoidance. And on this occasion, we should give the Scottish Government a break.

Public procurement: the bottom line

The report by the Cuthbert's for the Jimmy Reid Foundation into the public procurement system in Scotland finds

that the overall process of public procurement in Scotland is not working satisfactorily from an economic and social development perspective. In many cases, contracts have been made very large and there are significant barriers to participation by small and medium sized enterprises. Procuring bodies also find it difficult to reflect social and economic requirements in their procuring decisions. This reflects, to a large extent, the big business friendly/low burden approach .... This unsatisfactory outcome, however, is not inevitable. Evidence from elsewhere in the EU indicates that much more can be done within the scope of the EU Directive, for example to assist the involvement of small to medium sized enterprises.

The report provides a thought provoking critique of the present system and makes a strong case for greater involvement by Scottish small to medium sized firms in public procurement. This could have job creation and economic development advantages.

What the report does not, however, say clearly enough is that in the final analysis the interests of the Scottish tax payer and consumer of public services must be paramount. The Scottish government must purchase from suppliers that offer the best quality, reliable delivery and at the lowest cost. There may be an industrial policy argument for subsidising through the procurement process certain 'infant' companies or industries. But there has to be a strong expectation that these supplier firms and industries would become the best quality, lowest-cost suppliers in the future.

The adoption of a mercantilist policy in the end benefits neither the Scottish tax payer nor small and medium sized firms in Scotland

Fiscal austerity, expenditure and UK GDP growth

I have been thinking further about the prospects in 2012 and beyond for both Scotland and the rest of the UK economies. The latest outturn and survey data suggest that growth weakened further in the final quarter of last year. Consumer price inflation (CPI) is now clearly reducing as predicted. Today's CPI figures for the year to December indicate a rate of 4.2%, a sharp fall on the 4.8% increase to November. Christmas discounting in clothing stores and supermarkets plus the softening of fuel prices played a big role. But whether directly or indirectly, the slowing of inflation reflects a weakening of demand in the domestic and global economies.

The November 2011 forecast from the Office of Budget Responsibility (OBR) predicts weak growth of 0.9% this year followed by a bounce back to 2.1% in 2013, almost to trend. Forecast growth strengthens thereafter to 2.7% in 2014 and 3% in both 2015 and 2016.

What is more interesting than the aggregate forecast is the contribution to GDP change of the key expenditure components - see first chart.

So which components contribute the most to recent growth and to forecast growth?

The bounce in inventories in 2010 was a temporary influence on growth. Further adjustments might be expected if companies' expectations of demand are not met. But the OBR is not expecting much impact on forecast growth.

Between 2010 and 2011 there are two key narratives.

First, there was a switch from domestic demand to external demand as the main driver of growth. Private consumption went from 0.7% growth to a contraction by the same percentage. Business investment similarly went from 0.1% growth to a fall of -0.1%.

Secondly, government consumption and investment expenditures contributed positively to growth in both years by 0.4% points and 0.3% respectively. "Hang on!" I hear you say. "I thought the economy was suffering from the effects of fiscal consolidation. What is going on?"

A good question.

It is important to be clear about what is happening. Even amongst people who should know better there is a tendency to present the slowdown in the recovery as being unrelated to the government's fiscal austerity programme. So in their recent analysis in the FT Chris Giles and Andrew Bounds suggest that

A core problem has been deficient growth, which has persistently fallen short of expectations and kept unemployment well above the levels of most of the 1990s and 2000s. ..... Most economists see the fierce political arguments as of little relevance to the question of why the economy has disappointed expectations so greatly. The Office for Budget Responsibility, the independent body charged with advising on the public finances, explains its forecast downgrades not with reference to spending cuts or tax increases but by "higher than expected inflation squeezing household incomes and consumption".

It would be easy to read this and conclude that fiscal austerity is not slowing the economy and that the slowdown is due to a reduction in real personal disposable incomes due to higher inflation than expected.

Of course Giles and Bounds are not talking about the slowdown in the recovery per se. They are actually discussing why the OBR got its forecasts for 2011 badly wrong. This is a different issue. The following chart, again from the OBR, shows the outturn and OBR's forecast for the contribution of government spending to UK GDP growth in subsequent forecasting rounds.

What is clear from this is that government spending in 2010 made half the contribution to growth as in 2009. In 2011, which contains a forecast for the fourth quarter and outturn for the first 3 quarters, government spending again made a positive contribution to growth, all be it somewhat less than in 2010. The reduced contribution of government spending to growth represents the direct effect of the fiscal spending consolidation so far.

It seems probable that the positive contribution to growth in 2011, when the OBR had previously been forecasting a negative government spending contribution, is the result of the effect of automatic stabilisers on spending. The effect of automatic stabilisers is usually considered in terms of transfer payments such as unemployment benefit and tax receipts but there is academic research evidence that current spending on goods and services by government also has a counter-cyclical element.

The other side of this coin is the OBR's failure to forecast accurately the contribution of household demand or private consumption to GDP growth in 2011 as this chart shows:

The large negative contribution of private consumption to growth in 2011 may have been heavily influenced by "higher than expected inflation squeezing household incomes and consumption." But the drop in household spending may also have been due to the net effect of tax rises, such as the VAT increase, on real incomes.

The OBR's forecasts for 2012 to 2016 envisage a recovery mainly in private consumption, business and dwellings investment, with net trade contributing weakly to growth over the period. The switch from domestic demand to external demand appears temporary - see first chart. The direct effect of fiscal austerity on spending is forecast to bite from this year and gets progressively worse to 2015 and 2016. But the forecast deploys assumptions about private consumption, which, even with inflation falling back to a target 2%, seem 'heroic'.

I expect that the radical difference between the OBR's forecast and the outturn for private consumption seen in 2011 may be seen again over this forecast horizon if the present fiscal policy stance persists.