Scottish Economy Watch

August 2014

Yes, that month will be the centenary of the start of horrible carnage that became known as the First World War.

It is also the month that the Commonwealth Games are being held in Glasgow.

Less auspiciously, it is the month when we expect that GDP in the Scottish economy will have finally attained its pre-recession peak. See our forecast here

Source: Fraser of Allander Institute, Economic Commentary, February 2012, University of Strathclyde

That is, more than 6 long years since the start of the recession. And almost 3 years after the United States attained its pre-recession peak. Scotland's dividend from the UK Government's fiscal austerity policy.

FAI Economic Commentary - February 2012

Our latest Economic Commentary is here. For those that can stand it my podcast is here.

The basic picture continues to be one of weak recovery with a further weakening apparent towards the end of 2011, as the UK economy contracted by 0.2%. Scottish GDP is still -3.3%% below the pre-recession peak nearly four years ago, while the figure for UK GVA is -3.6%. However, while the depth of the recession was greater in the UK, at -7.2%, than in Scotland, -5.9%, the recovery of UK GDP has been slightly faster than in Scotland. The jobs market is depressed with unemployment rising back to that experienced at the trough of recession, and currently at 231,247 or 8.6% and above the UK rate of 8.4%.

There are some indications, though, that growth is beginning to pick up and after a weak first six months growth may pick up towards the end of the year. This for two reasons.

First, the rate of inflation is falling and may give a relative boost to real incomes and so encourage a rise in household demand. But it might not. If the pressing need of households is to pay down debt then a rise in real income could lead to higher savings with little or no impact on household demand.

Secondly, the situation in the Eurozone has eased because of the €130bn second bail-out for Greece, and because of the role the ECB has recently played in acting as de facto lender of last resort. By buying securities from EZ banks the banks have been able to use the increased liquidity to fund some of the debt of the peripheral sovereigns. These developments offer only temporary respite to the EZ balance of payments and debt crisis. But there is still a risk of a disorderly Greek default and exit from the EZ, which will put at risk some of the other sovereigns such as Portugal and Spain. Moreover, the balance of payments financing and adjustment issues have hardly been tackled even if some progress has been made on debt.

Against this background our forecasts are as follows:

Forecasts

• We have revised down our forecast of GDP growth for 2012 to 0.4% from 0.9%.
• But we expect growth to be a little stronger in 2013 at 1.7% instead of 1.6%.
• By 2014 we predict a stronger recovery with growth of 2.6% taking us back to the pre-recession GDP peak by the third quarter. Six years after the start of the recession.
• We expect Scottish growth to continue to be weaker than the UK but growth in the two jurisdictions is now expected to be much closer together, in line with the evidence from the recovery to date.
• For employment, our central forecast is for net jobs to fall by -1.8% in 2011, and by -0.7% in 2012, rising by 1.0% in 2013 and by 1.7% in 2014.
• The number of employee jobs in Scotland is forecast to decline during 2012 by just less than 16,000 jobs. Through 2013 and 2014 we forecast increases in employee jobs in our central forecast, with annual increases of over 23 thousand and 38 thousand respectively.
• There are job increases across all the main sectors.
• However, we forecast a "rebalancing" of employment within the service sectors towards non-public activities as fiscal consolidation continues. Construction employment is forecast to increase in 2013 and 2014 as spending on (private) investment projects returns with renewed confidence in the recovery.
• Unemployment is forecast to continue to rise on both key measures this year.
• On the preferred ILO measure unemployment is predicted to reach 265,250 by the end of this year, or 9.8%. That is a rise of 34 thousand from the level reached at the end of 2011.
• As with our last forecast, we are expecting the unemployment position to improve through 2013, and are now forecasting unemployment at the end of that year of 253,950, 9.3%, falling further to 234,300, 8.8%, by the end of 2014.

Is it the smear not the economics, stupid?

Kenneth Gibson, an SNP MSP, on Good Morning Scotland Thursday 23 February, criticised the recent CPPR report on the SNP's proposed oil fund as "fiddled figures" from "two former Labour Party spin doctors" who "deliberately misled." I find this form of political thuggery difficult to take. It seems to me disgraceful that a balanced piece of work such as this report, by three not two authors, should be treated in this way. The third author not mentioned by Gibson is Professor Richard Harris, who holds the distinguished Cairncross Chair of Applied Economics, as well as being the Director of the Centre for Public Policy for Regions.

Jo Armstrong and John McLaren can well defend themselves. But as far as I understand neither worked as "spin doctors" for the Labour party. Yes, they both worked as Special Advisers for a period to the previous Labour/Lib Dem coalition. But they were employed for their technical skills in economics and finance not to craft and draft a party line, which is what the sub-set of advisers who are spin doctors actually do.

On this basis, would it be fair game for another political party to charge Nobel Prize winners Professors Jim Mirrlees and Joe Stiglitz, both past and present members respectively of the SNP government's Council of Economic Advisers, as "SNP spin doctors"? Or, given that Alex Salmond worked for the Royal Bank of Scotland for some time, would it be fair to brand him as an "RBS spin doctor" whenever he comments on banking in general and RBS in particular?

Of course Gibson, like many a Scottish politician, is quick to cite the distinguished credentials of some noted non-Scot, or ex-pat Scot, if they just happen to say something that supports or confirms the policy of the politician and his or her party. And quick to rubbish, sote voce of course, if the distinguished figure says what they don't want to hear as John Kay recently found out.

Joe Stiglitz is a case in point. Gibson sought to comprehensively rubbish the CPPR report by contrasting their "fiddled figures" with the views of the "Nobel prize winning economist" that setting up an oil fund was "imperative" for Scotland. Now it is true that in his interview on Newsnight Scotland with Gordon Brewer on 24 August 2010, Stiglitz did use the word "imperative" when addressing the question of setting up an oil fund in the UK. But it is clear from listening to the interview that what Stiglitz was saying was that since the UK had consumed not invested its oil revenues so far, it was "imperative" that an oil fund be created if the remaining oil revenues were not be squandered or frittered away. That is world away from Stiglitz saying that Scotland would be able to set up an oil fund with an investment of £1 billion a year for 20 years without public spending having to fall or taxes to rise. It would be helpful if some journalist would pose that specific question to Stiglitz next time he is in Scotland to attend a COE meeting.

But then if the Nobel economist is not saying that £1 billion a year can be found for 20 years without any opportunity cost what about those CPPR "fiddled figures"?

Two sets of figures are involved. The most important is the nature and extent of Scotland's fiscal balance. CPPR use the figures from Government Expenditures and Revenues Scotland (GERS) which is a National Statistics kite marked publication of the Scottish government. The latest data are for 2009-10. New data for 2010-11 are due in 10 days on 7 March. In CPPR's words

Over the period 2005-06 to 2008-09, the 'surplus' that could have been available to invest in an oil fund totalled £2,234 million, well short of what would be needed to fund the deficit that accrued in 2009-10. Furthermore, this net position was during a period of record high oil prices. Over the longer period, covering 2002-03 to 2009-10, the current balance accumulated a far larger total deficit of £12,752 million. Thus over the recent past, the current budget surplus was never at, or above, £1 billion surplus in any year; and in only 3 out of 8 years was there a surplus that could have been available to invest. ....... Given the on-going likely Scottish fiscal balance position, for the Fund to be viable would also require: Either much higher oil prices and/or oil production levels than currently anticipated; And / Or higher taxes or lower expenditures to free up £1 billion to put into such a fund.

I have examined GERS and I completely concur with CPPR. The figures used by CPPR are those in GERS. And remember they are talking about the current balance. If the focus is on the net fiscal balance, which includes capital spending, the deficit is higher with the geographical share of North Sea oil included as with the current balance.

Against this, Gibson asserted on GMS that

Over the last five years the GERS figures show that there was a £7.2 billion surplus over that period.

I am certain that you cannot find a £7.2 billion surplus in GERS over the last five years. What you might be able to construct, however, is a figure that is the outcome of estimating what Scotland's fiscal balance would have been if Scotland had had the UK deficit percentage and then subtract that figure from Scotland's actual fiscal balance. A surplus might emerge on that calculation. If that is what Gibson and the SNP have done then it is a slight of hand. It is not a real figure in the sense that there would be any money from that figure to invest in an oil fund. It is a purely hypothetical comparison with the UK. What funding would be available to invest or not is given in GERS and CPPR state it clearly.

The second set of figures concern the return on Norway's oil fund, the Norwegian Government Pension Fund. CPPR state that the real net rate of return for the fund since 1998 lies between 2.2% to 2.9%. Gibson on GMS said he didn't accept those figures, and asserted that the rate of return on the Norwegian fund was 4.2%. Gibson gave no source for his figure but CPPR do. First, from the latest - February 2012 - OECD Survey of Norway we find on page 6 the following

For the first decade or so, it achieved almost a 4% real return, but after stock market declines since the crisis and up to September 2011, the average return since the inception of the fund has been only 2.2%.

Then, from the Norwegian government's summary of its 2012 Budget, we find on page 17 this statement about the performance of the Government Pension Fund

Average annual net return since 1998 was 4.9 pct. and, adjusted for inflation, 2.9 pct.

So, are we to conclude that the OECD, and the Norwegian government itself have colluded with CPPR to produce "fiddled figures" in an attempt to thwart Gibson and his SNP colleagues in creating an oil fund?

I leave it to the reader to judge.

Music for the weekend: Madison Violet - The Ransom

I really like this duo. Relaxing after finishing the latest Fraser Economic Commentary. It is published this Wednesday, 29 February. Look out for it. More blogging to come!

 

The benefits of true fiscal union (not the Euro kind)

In the financial crisis that came with the credit crunch and which led to the Great Recession, the two principal Scottish banks, the Royal Bank of Scotland (RBS) and Halifax Bank of Scotland (HBOS), got into severe financial difficulties. The subsequent bailout by the UK government led to the government taking a stake overall of 82% in RBS and 43% of a new entity formed from the government encouraged merger of Lloyds bank and HBOS.

The scale of the assets of RBS and HBOS to Scottish GDP - which does not include oil - in 2008 is shown here and compared to Iceland and Ireland.

The story of Iceland and Ireland is well known. That of Scotland is less so because of Scotland's place in the wider UK monetary and fiscal union.

The subsequent GDP performance of Scotland compared to Ireland, Iceland and the UK is shown in the chart below.

Scotland broadly tracked the UK during the recession and in fact did a little better. Its performance compared to Iceland and Ireland, the former a completely independent country with its own currency and the latter a member of the Eurozone, speaks for itself. (Ireland does even worse on GNP but we don't have GNP data for Scotland, itself home to several multinationals.)

Is there any better example of the benefits of a true fiscal union?

Scotland needs an OBR plus

Bill Howat's call for a Scottish public spending watchdog to be set up along the lines of the Office for Budget Responsibility (OBR) in the UK, is worthy of serious consideration. But we should go further. A case can be made both for a stronger internal challenge function within the Scottish government and an independent external body such as the OBR to monitor government fiscal plans.

Fiscal Councils are becoming popular in several sovereign states as a complement to, and even a substitute for, fiscal rules. The UK macro-economist Simon Wren Lewis has been an advocate of fiscal councils for some time and has written extensively about the concept individually and with collaborators see here and here. As Simon says on his fiscal council's web page

The term Fiscal Council is generally used to describe an institution, funded by but independent of government, which provides public advice on fiscal issues ..... these same institutions may or may not also provide detailed microeconomic costing of the budgetary impact of particular projects or proposals (as is the case of the CBO in the US, for example.)

Wren Lewis and Calmfors point out that the limited statistical evidence on their impact is mixed. But they highlight several theoretical reasons why fiscal councils can be a valuable aid to prudent fiscal management. First, a council can help correct the deficiencies of information that produce a 'deficit bias' in government fiscal behaviour. Better forecasts of the public accounts and a reminder to the public of the need for government debt to be backed by expected future cash flows i.e. future taxation (technically: government's inter-temporal budget constraint). Moreover, a council can help provide the co-ordination to overcome 'common pool' problems where, for example, many spending ministers may be involved in setting budgets, but who may fail to internalise the overall costs of higher spending and debt.

The need for such an institutional innovation would appear to be high in Scotland given where we are currently in the devolution process and in view of what may lie ahead if there is a 'yes' vote to independence in the forthcoming referendum.

The current settlement provides a form of hard budget constraint through the changes in the block grant assigned to Scotland via the Barnet Formula. However, the availability of borrowing powers in the present Scotland Bill and the high probability of something close to full fiscal autonomy post independence referendum, increases the risk of both 'deficit bias' and 'common pool' problems. Moreover, the 'deficit bias' issue is likely to be worsened by a situation where a future Scottish government is dependent on volatile oil revenues for around 12 percent of its revenues.

The UK Treasury and the Bank of England are likely to insist on Scotland adhering to a set of fiscal rules if Scotland remains within the union but secures a high degree of fiscal autonomy. The Scottish government would also have to observe similar rules if it became independent but chose sterling as its currency - see this earlier post. A Scottish Fiscal council monitoring inter alia adherence to the fiscal rules would smooth relations with the Bank of England and the wider financial markets.

So, we should applaud Bill Howat's call and urge its further consideration. But in my opinion we need not simply a forecasting and monitoring body like the OBR but an organisation like the US Congressional Budget Office (CBO) or the Central Planning Bureau in the Netherlands. These two bodies also undertake detailed costing and appraisal of alternative policies. That is something that the OBR cannot do.

Finally, the discussion of the role of fiscal councils tends to assume that within government there is a separate finance ministry that provides an internal challenge function to spending departments. The UK Treasury offers a good example. In Scotland, in contrast, we do not have a finance department equivalent to the UK Treasury. It is true to say that the status and significance of the finance function has increased under John Swinney and the SNP government. Yet, the Finance and Sustainable Growth department is both a spending department (transport, local government, Scottish Enterprise etc) as well as performing a treasury function. The two roles do not seem compatible. And while that continues, the case for a Scottish Fiscal Council would appear to be even stronger.

Music for the weekend - Feist: The Bad in Each Other

Feist - I can't get enough of her music at the moment. Remember she is appearing at the Royal Concert Hall Glasgow on March 27th. I'll be there!

Scottish growth in the UK union

In the Scotsman today George Kerevan responds to the assertion yesterday by the Prime Minister, David Cameron, that Scotland is richer for being part of the UK. Kerevan's article focuses on two issues Scotland's growth rate in the UK union and the rationale for and procedures to create a sovereign wealth fund (SWF) using oil revenues. I plan to return to the SWF and oil revenues issue in another post. In this post I want to examine Kerevan's analysis of Scotland's growth in the UK union.

Kerevan focuses on the period 1976 to 2006 where UK GDP growth averaged 2.3% per annum, whereas Scottish GDP growth averaged 1.8% per annum. Why 1976 to 2006? He suggests that 2006 is just before the downturn and that seems to be his reason for terminating in that year. But he offers no reason for starting in 1976. The reason is that starting earlier doesn't help his argument.

The available data series for Scottish GDP comparable with UK GDP data begins in 1963 not 1976. So what is the position when we start the analysis from that year? The chart below provides the information

Over the period 1963 to 2009, UK growth is still more rapid than Scottish growth but the difference is much smaller: 2.2% per annum for the UK and 2% for Scotland. So, over the period for which we have data, Scottish growth was less than a tenth lower not a fifth lower as in Kerevan's partial selection of the data. (It's true I need to redo the numbers to include 2010 and I will do that for a later post but it won't make much difference with Scottish growth of 1.2% and UK growth of 1.5% in that year.)

The UK economy growing at an average 2.2% per annum would have doubled its income in roughly 33 years, that is by 1996. The Scottish economy growing at 2% per annum would have doubled its income three years later by 1999.

Is that 3 year gap sufficient reason for breaking the union?

In posing that rhetorical question, I am implicitly conceding that Scotland's slightly slower rate of GDP growth was the result of Scotland's membership of the UK union, when there is no solid evidence and argument either way. Scotland may have grown more slowly as an independent state, that might be the appropriate counterfactual. On the other hand, Scotland might have grown more quickly. Nobody will ever know for certain.

I plan to look at Scotland's growth potential in and out of the union, within the context of growth models in a later post - see this post in David Comerford's new blog for a start on this. But Kerevan's argument's laying the blame for Scotland's minimally slower growth at the door of the union are weak to be polite.

Scotland's stronger growth than the UK in the 1960s was the result of three factors: UK regional policy which led Scotland to attract much inward investment; the rapid growth of banking and financial services and the development of North Sea oil. But rather than recognise the economic success of that period, Kerevan bemoans the outcome as one that created branch plant economy and discouraged local enterprise.

In fact he has it completely the wrong way round here. Scotland's need for inward investment was because of a previous failure of local enterprise, the limitations caused by the small size of the Scottish market and its peripheral geographical position. See the discussion in my chapter in this book which discusses Scotland's failure in the 1930s to generate and attract the 'new' consumer-based industries and services such as motor vehicles, electrical engineering, chemicals, cycles, and furniture and upholstery.

The Scottish economy has weaknesses which have and do affect its competitiveness. More technically despite comparable labour productivity and wages it appears that total factor productivity is on average lower here than, say, in the South East of England. But to say this is the fault of the UK union is mere assertion without evidence. In the academic work on Scotland's low business birth rate, low R&D and low innovation rate it is factors such as weakness in entrepreneurship, high levels of social housing, weak management skills, slow population growth, low investment, small numbers of SMEs, a poorly developed innovation system and so on, that appear to matter not Scotland's constitutional position.

But, there again, evidence is not something that George Kerevan will allow to ruin a good argument.

 

Scotland's fiscal balance: forgotten costs

The Centre for Economics and Business Research (CEBR) suggests in an analysis of the scale of subsidy between different regions/countries in the UK that Scotland receives no net subsidy. The table showing estimated receipts and expenditures is here

CEBR provide no indication of the sources of their data, or their method of estimation. However, their estimate for Scotland appears to be close to the Government Expenditure and Revenues for Scotland (GERS) figures for the net fiscal balance when Scotland is given a geographical share of oil revenues. The table below shows it was -10.6% in 2009-10.

Since the UK had a deficit in 2009-10 of 11.1% of GDP the conclusion drawn by CEBR appears, on the face of it, to be correct.

But wait. If independent, Scotland would have to pay interest payments on its debt at a rate which will almost certainly be above the yield on UK Treasury's, see my posts here and here. The GERS publication shows Scotland bearing interest payments on its population share of UK debt of £2.635 billion. This relates to UK debt payments at an average interest rate of 3%, given earlier more costly borrowing than the current 2% yield and the different maturities comprising the debt portfolio. If we make the assumption that Scotland would have to pay a yield on its borrowings that average 4%, then the Scottish government outlays would rise by about £1 billion - specifically £931 million. If the yield had to be 5%, outlays would rise by £1.8 billion. If 6%, unlikely, then the additional expenditure would amount to £2.7 billion.

So, even a modest premium above UK Treasuries, equivalent to the current yield on New Zealand 10 year bonds, would cost approximately an extra £1billion a year compared with present estimated Scottish government spending in GERS.

Bang goes that £1 billion surplus of oil revenues that Alex Salmond believes he could put each year into an oil fund!

Scottish jobs market weakens as UK outlook brightens

There was little comfort for the Scottish economy in today's labour market data. However, the picture for the UK labour market was a little more encouraging.

Unemployment (on the preferred ILO measure) rose during the quarter by 16,000 to 231,247 or 8.6%, higher than the UK rate of 8.4%. We are now nearly back to the recession peak of unemployment as the figure below indicates

Employment fell by 20,000 to take the Scottish jobs market to a position 3.9% below its pre-recession employment peak. This is not that much different from the trough of the recession after employment had fallen by -4.8%. The position in the UK on the jobs front is better, however. Net jobs were created during Oct-Dec, by 60,000 even though unemployment rose by 48,000. The inactivity rate also fell quite markedly in the UK whereas in Scotland there was only a slight fall.

All this suggests that with more encouraging data on the output front, the UK labour market might be beginning to turn round although unemployment may rise for a little while yet.

The same cannot be said for Scotland. When allowance is made for the growth of working population we see that the amount of jobs on offer compared to the available labour supply is now identical to the trough of the recession, as this chart shows

Unemployment will continue to rise in Scotland for some time yet. Moreover, our position compared to the other regions of the UK, which has also been weakening, may continue to worsen.