Scottish Economy Watch

Scottish jobs market weakens further

Today's labour market figures provide further evidence of a weakening economy that is deficient in demand for goods and services and hence for jobs. In August - October unemployment in Scotland was 25,000 higher than the previous quarter - a rise of 12.1% - with the Scottish unemployment rate rising to 8.5%, or in numbers to 229,000. The rate has now gone above the UK rate of 8.3%, where the numbers rose by 128,000 to 2.64 million - a rise of 5.1%. Employment in Scotland contracted by 22,000, while the rate and number inactive remained unchanged.

In the Fraser of Allander Institute we have been forecasting that jobs growth would falter and that unemployment in Scotland would begin to rise again. Sadly, this has come to pass. The main reason is that the growth in demand for goods and services is too weak to lower unemployment.

The jobs market in Scotland is, and has been, weaker than in the UK despite a brief burst of job creation into the recovery which has now ceased. The relative position for employment to the pre-recession peak and to the UK is given in this chart:

However, the raw jobs position fails to provide an accurate indicator of the state of the Scottish labour market because the supply of labour has been growing when demand for workers has been falling. This is revealed by the following chart which expresses jobs as a ratio of working population:

On this basis there has hardly been any recovery in the Scottish labour market at all.

Grim news from the high street

The latest data from the Scottish Retail Consortium (SRC) present a worrying picture of the state of the Scottish high street. In their words:

"Total sales in November were 1.3% down on November 2010, when they had increased 3.4%. This was the worst fall in total sales for any month since the survey began in 1999. Like-for-like sales were 2.1% lower than a year ago, the worst since August and the sixth decline in the past seven months."

This weakening in household spending is in line with our forecasts in November but the rate of contraction comes sooner and is faster than we expected.

To be certain that these data are providing an accurate picture of Scottish retail spending we need to benchmark a seasonally adjusted series against the household spending data published by the Scottish Government's Scottish National Accounts Project (SNAP). However, the SRC do not appear to publish a long run of the data. More data are behind a pay wall. But releasing the aggregate time series data would help analysis and reinforce the public's perception of the value of the survey, without prejudice to the commercial interests of SRC.

Inflation is falling

The latest Consumer Prices Inflation (CPI) data published today show a welcome but small fall in the annual rate of UK inflation from 5% in October to 4.8% in November. The decline in inflation should continue during the next twelve months as the demand in the economy remains weak, commodity prices moderate and one-off changes such as the VAT rise work their way out of the index.

The Bank of England's expectation for inflation is shown in the following chart drawn from its recent Inflation Report

The chart assumes that base rate remains at 0.5% and the amount of quantitative easing is £275 billion. The most probable outcome is that inflation falls back to target (2%) by the second to third quarter of next year. On these expectations inflation is not a problem but weak aggregate demand and weak output growth is.

Scottish Economy Continues to Grow: Just!

The latest data from the Bank of Scotland PMI survey suggests that the private sector in the Scottish economy continued to grow in November, but only just. The good news is that business activity was better than the PMI returns for the rest of the UK where there was an abrupt slow down. However, new business inflows were weaker and the run-down of business outstanding was faster than in the UK. It should be noted that the difference appears small and may not be statistically significant.

Overall, the PMI paints a picture of slowing economy close to stagnation, with growth in Scotland and the UK very weak. The UK and Scotland appear weaker than the global average and the US but stronger than the Eurozone and Japan as the chart from Markit - who undertake the Scottish survey for the Bank Scotland - shows.

It is a pity that the Bank of Scotland does not appear to make a full data series available of the Scottish PMI, so that we can more clearly compare and contrast Scottish performance.

Inequality and Austerity

As austerity programmes begin to bite across the developed world, it is quite natural that the issue of fairness should become more prominent. Sovereign debt is high - although not by historical standards, which is another story - largely because of the need for the state to compensate for the debt excess in the private sector. The financial sector grew rich on the back of this debt explosion. The Scottish banks were no exception. Originate and distribute models of lending, and mortgage lending in particular, meant that appropriate due diligence was often absent on the part of the lender. Ethical issues such as whether the lending, pension, or care bond, was appropriate to the circumstances of the individual were often swept under the carpet. Yet, when the bubble burst while many of the workers in the financial and property service sectors lost their jobs , the senior executives and key traders continued to receive high and rising salaries and bonuses. At the same time government's had to borrow to bailout the banks thus raising the present and future tax burden right across society.

It is, therefore, not unreasonable that the Occupy Wall Street movement and its offshoots across the world appear to have struck a chord with many people. But the OWS is about more than banking excess. It points to the rising inequality across western societies. A warning that was given firm empirical support on Monday (5 December) with the publication by the OECD of its Divided We Stand: Why Inequality Keeps Rising report.

The report finds that

"Income inequality among working-age persons has risen faster in the United Kingdom than in any other OECD country since 1975. From a peak in 2000 and subsequent fall, it has been rising again since 2005 and is now well above the OECD average." (See Figure 1)

I see no reason to doubt that the position in Scotland would be much different from the UK.

Figure 1

The report finds that technological progress has led to higher wage differentials benefitting workers with high skill levels. Hence, the importance of education a rising supply of skilled workers in limiting the rise of inequality. Globalisation is found not to play much of a generic role in widening wage inequality but the pressure from globalisation precipitated domestic policy and institutional reforms, which did widen the distribution of wages. But a key reason for widening income inequality in the UK is that taxes and transfers became less redistributive.

The report notes:

"Between the late 1970s and mid 1980s, the tax-benefit system in the UK offset more than 50% of the rise in market income inequality. This effect has fallen in the subsequent decades."

Against this background it is strange to read the following by Bill Jamieson writing in the Scotsman on 1st December:

"But addressing inequality by further taxes on the rich may prove a road with little mileage. The top 1 per cent of taxpayers in the UK are already providing 25 per cent of tax revenue. Back in the 1970s when we last faced economic misery, the top 1 per cent accounted for just 11 per cent of tax revenue."

What this comment fails to appreciate is that the reason for the top 1% paying a greater share of tax revenue is not that they are being taxed more heavily. Rather, because they are appropriating an ever greater share of income. Again as the OECD report notes the income share of the top 1% doubled in the UK between 1970 and 2005 rising from 7.1% to 14.3%. This occurred during a period when the top marginal rate of income tax fell from 60% in the 1980s to 40% in the 2000's before its recent rise to 50%. But what the report does not say is that this growth in the income share of the top 1% and, indeed, the top 0.1% is due to the explosion in CEO and senior corporate executive pay and bonuses not simply in banking but right across the corporate sector of the UK and the US. This growth cannot be justified rising performance - value of the marginal product - of the executives in question. It is largely down to a power relationships and corporate politics and represents a weakening in the power and control of shareholders over corporate executives.

It is for these reasons, coupled with rising austerity, that I expect that the campaigning of the OWS movement and its growing offshoots will become more central to US, UK and Scottish politics.

Eurozone: balance of payments crisis not public profligacy

Martin Wolf in today's Financial Times is completely correct when he describes the current Eurozone crisis as, at root, a balance of payments problem not a government deficit, sovereign debt problem.

Take a look at the average fiscal deficits of 12 significant (or at least revealing) eurozone members from 1999 to 2007, inclusive. Every country, except Greece, fell below the famous 3 per cent of gross domestic product limit. Focusing on this criterion would have missed all today's crisis-hit members, except Greece. Moreover, the four worst exemplars, after Greece, were Italy and then France, Germany and Austria. Meanwhile, Ireland, Estonia, Spain and Belgium had good performances over these years. After the crisis, the picture changed, with huge (and unexpected) deteriorations in the fiscal positions of Ireland, Portugal and Spain (though not Italy). In all, however, fiscal deficits were useless as indicators of looming crises.

Now consider public debt. Relying on that criterion would have picked up Greece, Italy, Belgium and Portugal. But Estonia, Ireland and Spain had vastly better public debt positions than Germany. Indeed, on the basis of its deficit and debt performance, pre-crisis Germany even looked vulnerable. Again, after the crisis, the picture transformed swiftly. Ireland's story is amazing: in just five years it will suffer a 93 percentage point jump in the ratio of its net public debt to GDP.

Now consider average current account deficits over 1999-2007. On this measure, the most vulnerable countries were Estonia, Portugal, Greece, Spain, Ireland and Italy. So we have a useful indicator, at last. This, then, is a balance of payments crisis.

 

So, the proposals currently being crafted on deficit and debt limits by Merkel and Sarkozy are not relevant and will not deal with the problem.

The problems of the Eurozone are largely 'systemic' although the behaviour of some governments and private sector agents in individual countries such as Greece has not helped. Kash Mansori demonstrates that the creation of the Eurozone made it more attractive for investors in the rest of Europe to buy assets in the peripheral countries, where there were, on the face of it, significant investment opportunities. Governments in the periphery were able to borrow at near German rates because the financial markets believed, and were implicitly led to believe by the ECB and Germany and France, that peripheral country sovereign bonds had the backing of the Eurozone authorities. This led to significant borrowing largely by the private sector but also sovereign borrowing resulting in major flows of capital from the centre - especially German and French banks - to the periphery. A crisis was precipitated when these flows suddenly stopped, due in part to the wider consequences of the credit crunch and many of the investments went bad e.g. commercial property and housing investments in Spain and Ireland. This led to a rapid rise in public debt as some of the periphery countries bailed out their banks, and spent more and taxed less in the recession mainly through indirect 'automatic stabiliser' effects - e.g. increased unemployment benefit payments .The analogue of these flows in the national accounts was current account deficits in the periphery and a massive rise in Germany's current account surplus. See chart:

Source: Paul Krugman, 5 December 2011

These capitals flows worsened an already weak and worsening current account trading position in the periphery because of the high exchange value of the Euro driven by continuing improvements in German competitiveness. Several of the periphery countries such as Greece, Portugal and Spain had, and still have, real efficiency and competitiveness problems, which make it difficult for them in a monetary union led by Germany that has high levels of productivity growth. One saving grace might have been if these investment flows had facilitated an economic adjustment in the periphery sufficient to raise their productivity and competitiveness towards German levels. But they did not, even though the evidence shows (Mansori again) that the capital flows were associated with investment spending rising in the periphery countries (with the exception of Portugal) relative to consumption. However, the capital flows in addition tended to fuel rising domestic prices in the periphery, hence a rising real exchange rate and deteriorating competitiveness, which improved little relative to Germany.

So, the Eurozone must first deal with its current sovereign debt financing problem and then deal with the root problem, which is a required adjustment in the relative competiveness - real exchange rates of the periphery relative to Germany.

On financing, the only real solution is for the ECB to take on the true role of a central bank, which is not simply aiming for price stability but also acting as lender of last resort. If ECB acted as a lender of last resort it would start to buy individual sovereign bonds where there was a market shortfall. This is what the Bank of England would do in the UK or the Fed in the US. However, to fulfil this function would require the ECB to print Euros and hence increase the money stock. Given German sensitivities over inflation this is unlikely to happen and so the Eurozone financing crisis will continue. But there is some hope from hints by the ECB that a more solid commitment to fiscal union would result in the ECB playing a more active role in the Eurozone sovereign debt market and therefore move some way towards a lender of last resort position. But this piecemeal approach is unlikely to satisfy the financial markets other than in the very short term.

On the issue of adjustment, the overriding goal of the ECB and the core countries of the Eurozone, especially Germany, is that the burden of adjustment must be borne by the current account deficit countries in the periphery. But to secure adjustment in the absence of individual national currencies requires internal devaluation: price and wage reductions relative to the core. This is almost impossible to secure. Countries such as Ireland and Latvia which might be described as the poster boys of internal devaluation have hardly achieved any real internal reduction in wages and prices. It can be said with some certainty that Germany and the ECB need to accept that current account surplus countries within the Eurozone are part of the problem. They must adjust too. They can adjust by allowing an expansion of domestic demand sufficient to promote a rise in domestic inflation to 3% to 4%. If that happens then it will be easier for the periphery to adjust through a much less stringent internal devaluation, but if that doesn't occur there is little hope for the survival of the Eurozone as presently constituted.

ITEM: Just the ticket!

Yesterday, the Ernst & Young Scottish ITEM Club published its latest forecasts for the Scottish economy. These forecasts echo our own published last month. GDP growth is forecast to be 0.6% this year and 1.1% in 2012. The Fraser of Allander forecasts were 0.4% for this year and 0.9% for next. Both bodies have made significant downward revisions to their forecasts in the light of the weakening recovery. Both also assume that the Eurozone muddles through its present crisis and acknowledge that a sovereign default by either Italy or Spain would push Europe and the UK back into recession or worse. The Scottish recovery is noted again by both bodies to be weaker than the recovery in the UK, with the performance of manufacturing, transport and communication & business services relatively weak here. The weakness of Scottish manufacturing exports is particularly evident. ITEM rightly note that Scottish GDP in mid-2011 was no higher than in 2006, when on past trend growth performance one would have expected GDP to have been ten percent higher over five years. They suggest that this supports the notion that we may be facing a 'lost decade' of output and income growth.

The ITEM report also makes the point that the current economic malaise may be affecting our long-term growth potential. This echoes the recent Office of Budget Responsibility Economic and Fiscal Outlook report, which concluded that the gap between actual and potential output in the UK in the third quarter of this year was 2.5%, smaller than appeared to be the case a year ago. A smaller output gap means that there is less room for real expansion through, say, a fiscal and/or monetary stimulus. That also means that the government's structural deficit may be bigger than previously thought. So, the Coalition Government has concluded that more fiscal austerity is necessary.

But the policy decision to tighten further is built on slender foundations. The OBR's statistical work may suggest that the output gap is smaller but they can offer no clear reason why this is so. Instead they cite an IMF report which they claim

suggests that an impaired financial sector can lead to low productivity growth and that downturns associated with significant disruption to the financial sector are often characterised by large and persistent output losses. (Page 54).

But as Paul Krugman points out, the OBR fails to acknowledge that the same research report also effectively says that short-run fiscal and monetary policy stimuli tend to limit the damage to long-run growth potential of such crises. Added to this is the clear risk that the present fiscal consolidation and the new measures announced in the Autumn Statement will depress aggregate demand further. Hence tax revenues will fall and expenditures on transfer payments will rise, so that attainment of the deficit target moves further into the future, requiring, in the government's view, further fiscal austerity .....

Such is the basis for UK macro-policy these days.

Why this blog?

I have for some time felt the need to comment more frequently on developments in the Scottish economy. I write the Outlook & Appraisal for the Fraser of Allander Institute's Economic Commentary, which appears every four months. I write an occasional article for the Scotsman and other Scottish newspapers, make one or two appearances on Newsnight Scotland and other news related programmes and give many comments and quotes to journalists. All of this I enjoy and I hope it continues. However, I feel the need to make more frequent and occasionally more in-depth comments than is possible either on television or in quotes to journalists. We are in momentous times. The recent Great Recession and weak recovery, the Eurozone crisis, the movement towards further devolution in Scotland and the ensuing policy debates and policy conflicts means that there is much to comment on. These issues are well covered in the Scottish media. However, I believe that I can make a positive contribution to these debates by offering the perspective of an informed, independent economist. Hence this blog.

Watch this space!