Scottish Economy Watch

Scotland's unemployment differential

Yesterday's unemployment figures show a rise in Scotland of 7,000, or just over 3 per cent. In the UK, in contrast, unemployment fell by 50,000, a fall of just under 2 per cent.

What accounts for the difference?

There has been speculation in the media that this is due to an 'Olympic bounce' favouring London and the South East but not Scotland. Others cite the different movements in part-time and full-time employment between Scotland and the UK. Some mentioned weaker Scottish growth. Measurement error was also hinted at. Lags too!

All of these explanations may hold some truth. And, I certainly can't give a definitive explanation either. But what I can do, and what I think the discussion requires, is provide a framework within which to place the factors that generally determine changes in unemployment. I have tried to do this in the following chart:

What the chart suggests is that changes in unemployment reflect movements in both labour demand and labour supply. Taking demand first, we can see that when GDP changes - let's say falls - then jobs will fall proportionately if productivity remains unchanged. The fall in jobs will then translate into an equal rise in unemployment providing there are no changes on the supply side: the numbers active/inactive and new entrants, including individuals deciding to take on more than one job.

Therefore, holding productivity and supply factors constant, a comparable fall in GDP in Scotland and the UK should result in a comparable fall in jobs and a comparable rise in unemployment. There may be lags as employment adjusts to output change and unemployment to job change but for simplicity I'll abstract from those.

So, in principle, yesterday's rise in Scottish unemployment should be explained by differential movements between Scotland and the UK in one or more of the following:

• GDP,
• productivity, and
• labour supply.

Specifically, weaker GDP growth, faster productivity growth, and a faster growth in the supply of labour should, severally, or collectively, account for the relative rise in Scottish unemployment.

Can we go further?

Yes, I think we can. But just a little!

The jobs and unemployment data published yesterday refer to the period June - August. Unfortunately, we don't have GDP data for this period. The latest Scottish GDP data, also published yesterday, cover the second quarter, that is April - June. There is only an overlap of one month. We must await the third quarter data to see if there is evidence of an 'Olympic bounce' because, if it exists, it will be picked up in the GDP figures. So, the strong jobs growth of 0.72 percent in UK employment in the quarter, compared to a fall of 0.06 per cent in Scottish jobs, might be largely the result of a strong output differential due to the Olympics. But we just don't know at the moment.

There is of course the possibility that Scottish productivity rose faster, or fell by less, than in the UK during the quarter, probably because of a bigger shift to part-time employment in the UK than in Scotland. The Scottish TUC, and Stephen Boyd in particular, highlight this factor. And they may be correct.

But we still have to get from jobs to unemployment. And for that we need to allow for changes in labour supply.

The jobs, or employment, rate fell in Scotland by 0.1 per cent while rising by 0.5 per cent in the UK. The activity rate rose by 0.3 per cent as more people offered themselves for work in the UK but it also rose very slightly in Scotland. In the UK, the rise in the activity rate was less than the rise in employment, so unemployment fell. But in Scotland, the rising activity rate meant that a weak fall in employment translated into a bigger rise in unemployment.

We can therefore conclude, tentatively, the following as an explanation of the large rise in unemployment in the most recent quarter in Scotland compared to the UK:

• Output growth was probably weaker here.
• Productivity probably rose faster, or fell by less, here due to a greater shift to part-time employment - with less hours worked - in the UK. And because of this:
• Jobs growth was disproportionately weaker here.
• The supply of labour rose disproportionately in Scotland.

The third quarter GDP data, when it arrives, should throw more light on this important issue.

Jobs and hours

The latest labour market data show jobs in Scotland falling by 1,000, and unemployment rising by 7,000 in the latest quarter. Over the year, jobs were up by 16,000 but unemployment was higher by 10,000.

Unfortunately, as I have noted before - here - the change in the number of jobs provides a less than clear picture of change in the labour market and in employer demand for workers.

An examination of changes in types of employment offers more clarity.

What this chart shows is that total employment is, from today's data, about 3 per cent below the 2007-2008 pre-recession peak. Full-time employment is down by more, just over 7 per cent. In contrast, both part-time employment and self-employment have soared. Part-time employment is now 9 per cent above its pre-recession peak while self employment is 11 per cent higher.

These data suggest that the total jobs figures probably overstate the strength of the Scottish labour market. Part-time employment and self employment may be rising for involuntary reasons. Employers uncertain about the future appear to have been shifting demand away from full-time employment to part-time and temporary jobs. Self employment also may have been rising as a second-best alternative to full-time employment.

Can we say more about the state of labour demand in Scotland?

My colleague at the Fraser of Allander Institute Cliff Lockyer suggested I look at total hours worked. The chart is produced here

Since peak employment, the millions of hours worked in Scotland have dropped by over 5 million, or -6.2%. Moreover, there is hardly any evidence of a recovery. The demand for labour seems to have dropped markedly and has been stagnating since mid 2010.

And, again, I think we know why that is the case!

(More detailed analysis of Scottish GDP, the labour market and future prospects will be provided in the Fraser of Allander Institute, Economic Commentary, which will be published on 7th November.)

 

Little joy in latest GDP data

Today the Scottish government published GDP data for the second quarter and the ONS published jobs and unemployment data for quarter June - August.

On any criteria, the new data do not make encouraging reading, with output falling, the number of jobs contracting and unemployment rising.

In this post, I shall focus on GDP and output, leaving a discussion of the labour market to a later post.

GDP in constant prices fell by 0.4% in Scotland during the quarter, the same loss of output as in the UK. We currently have available only the rounded data but on that basis we get the following chart

Both the Scottish and UK economies have contracted for the last three quarters. This is clear evidence of a recession, although thankfully not as steep as 2008-09. We wouldn't expect it to be as steep of course. Because what we are experiencing is effectively an aftershock of that Great Recession.

Over the year, the Scottish economy has experienced zero growth compared to slight growth of 0.4 per cent in the UK. It seems unlikely that there will be much improvement in that annual growth by the time we reach the end of the year, unless there is a mini-boom in output in the second half of the year. However, all the indications are, from surveys and casual empiricism, that that will not happen.

One issue that stands out from the latest Scottish data is the weakness of the production sector here. Output fell by 3.8 per cent compared to a fall of 0.7 per cent in the UK. The key reason for this was that the performance of Scottish manufacturing weakened considerably in the quarter and that was mainly due to a fall in production in the engineering sector, specifically Electronics (-5.5%), Textiles, Leather & Clothing (-3.8%), Other Manufacturing Industries including Repair (-3.1%), and Refined Petroleum, Chemical & Pharmaceutical Products (-2.4%).

The service sector did a little better here (+0.2% against -0.1% in UK) and construction bounced back (+2.0% against -3.0%) from the large fall experienced over the year. But, on an annual basis both services and construction have performed less strongly here than in the UK as a whole.

A final point on output is that the Scottish recovery is flattered by the statistical quirk that the UK figures include all of oil production whereas the Scottish data do not. With oil production weak this has affected the Scottish-UK GDP relative as John McLaren at CPPR pointed out as I reported here. As the chart excluding oil and gas production, and incorporating the latest data, shows, the Scottish recovery from the Great Recession has been weaker than the UK.

We are still a little over 4 per cent below the pre-recession peak in early 2008 with the UK still 3 per cent below.

On the latest evidence it will be many quarters yet before we return to that peak. And readers of this blog know why!

(More detailed analysis of Scottish GDP, the labour market and future prospects will be provided in the Fraser of Allander Institute, Economic Commentary, which will be published on 7th November.)

 

Scotland is thriving

The latest version of Regional economic performance indicators (REPI) published on 21 September by the Department of Business Innovation and Skills (BIS) is a fascinating source of data on the economies of UK countries and regions.

If we ignore the implied insult that brands Scotland as a 'region' there is much in the database to inform our understanding of the absolute and relative performance of the Scottish economy. I shall be returning to some of these data in later blogs.

For this first blog using these data, I want to contribute to the debate that has emerged between myself, George Kerevan and Tom Miers on the absolute and relative overall performance of the Scottish economy. I plan to provide a more detailed response to Kerevan's piece in a later post. But today I want to focus on the Scottish economy's performance and the income of Scottish households in the noughties, the devolution years.

George Kerevan argues that

the relative underperformance of Scotland grew worse in recent years. Between 1998 and 2006, the UK economy grew at 2.7 per cent while the Scottish economy grew at only 2 per cent, a gap of 35 per cent.

I don't think this is accurate in itself and it certainly is at variance with the evidence on the performance of the Scottish economy in the period of devolution.

The Scottish economy performed more strongly in the period of devolution from 1999 to 2007 when the Great Recession started. Over this period GVA in the Scottish economy grew at 2.6 per cent while the UK economy grew at 2.7 per cent.

Moreover, when one looks at GVA per head, which allows for population change, the Scottish economy improved its relative GVA position as this chart shows

So, I'm afraid Tom Miers can't cleverly use the Scottish GVA performance data under devolution to argue against both devolution and independence!

What these data show is that the gap between Scotland and the UK almost closed over the devolution years. In contrast, in both Northern Ireland and Wales their relative GVA per head position deteriorated and in Northern Ireland markedly so. The disproportionate impact of the Great Recession may account for the recent deterioration in Northern Ireland's GVA performance and perhaps even for the recent improve in the Scotland-UK relative. It will be remembered that the depth of the recession was a little less here.

Also for technical reasons, the inclusion of total north sea oil GVA in UK data but not in Scottish data can distort the Scottish UK relative. This seems to have happened recently to flatter relative Scottish performance because of the weakness of North Sea oil production - see my post here.

So we need to look at the income of Scottish households relative to the UK. The REPI data from BIS allow us to plot what happened to household disposable income (GHDI) over the period. The chart is here

The chart is interesting because it shows that when we look at household incomes, the improvement in the Scottish relative is still clearly present. But now Wales and Northern Ireland are seen to have improved their relative position, all be it marginally.

Why should this be?

The answer, in part, is because of the UK union. In the union, Scotland, Wales and Northern Ireland can draw on, and contribute to, the risk pooling arrangements that exist through UK government transfer payments. These affect household incomes, that is GDHI.

These data might be interpreted as offering some support for the UK union, especially for Northern Ireland and Wales. The data also show that Scotland is thriving.

And it is thriving under devolution.

"It means war, son; a nuclear war"

(Non-economics post)

Reading for the weekend: my article in the Scotsman today on being a teenage member of a rock band caught up in the Cuban Missile Crisis.

The fiftieth anniversary of the start of the crisis is tomorrow.

We were playing at the US Army General Depot, Nancy close to the German border. Here is a map:

And, another photo of me (on the right) with rhythm guitarist Johnny Maunder playing at a US base at Vassincourt, near Bar-Le-Duc, two months before the crisis.

Top Economics Site

A little bit of personal hubris!

This blog has been selected as one of the "Top One Hundred Sites for Enlightened Economists" by economicsdegree.net

The sites chosen were selected because they

are 100 of the best sites in the field. Listed in no specific order, these sites are a must-see for anyone who wants to be considered a quality, "enlightened" economist. Sites were selected based on a variety of factors including readership size, update frequency, information quality, and other awards received.

The above badge and hyperlink will run at the side of this blog, allowing direct access to the other 99 sites.

I am grateful for the recognition.

It's the borrowing costs not the flip-flop

The Scottish media has expressed some concern that Alex Salmond is "flip-flopping" over the issue of whether Scotland would have to sign up to a fiscal stability pact if an independent Scotland adopted sterling: here and here. In March he said we would, then in Chicago last week he said we wouldn't.

Let me set aside what this says about the clarity of the SNP Government's thinking on the economics of Scottish independence and the choice of currency in particular.

What is at issue here is not macho politics but what is in the best interests of the Scottish - and rest of the UK - people. There is no doubt in my mind that if an independent Scotland adopts sterling then it should enter into a formal monetary union arrangement with the rest of UK government and agree/accept a fiscal stability pact.

Let me explain why.

If an independent Scotland adopts another currency rather than creating its own this is technically known as dollarization. Dollarization offers several benefits to a small, newly independent country. It eliminates the risk of exchange rate fluctuations and reduces the risk of inflation.

The risk of exchange rate fluctuation is high for a small country vulnerable to large speculative international capital flows. The more so in a Scotland with an economy subject to the vagaries of variations in oil prices and revenues.

The risk of inflation comes from having one's own central bank and a discretionary monetary policy, including currency devaluation. Scotland would have no need for a central bank and monetary policy if it adopted sterling - effectively a foreign currency. The theory is supported by empirical evidence that inflation is significantly lower in dollarized states compared to non-dollarized ones.

It also makes good sense for an independent Scotland to adopt sterling because the process of developing the union since 1707 has led to the Scottish economy becoming significantly integrated with the rest of the UK economy. The majority of our trade is with the rest of the UK, the labour and capital market is highly integrated with the rest of the UK and there are large fiscal flows between the two. But the latter would clearly cease if Scotland left the union.

So, if that is the case for keeping sterling, why a fiscal stability pact?

The reason is that a fiscal stability pact would deliver lower borrowing costs to the newly independent Scottish government using sterling than without the pact. And those costs in turn are likely to be lower than if Scotland was completely independent with its own currency, at least in the first decade or more of independence.

This partly, but not wholly, turns on the question of the credibility of the government of an independent Scotland and its monetary and fiscal authorities. To put it crudely, a government and country with no track record in fiscal and monetary management is bound to have to pay a risk premium than a more mature state with an established reputation.

So, a 1995 OECD study found that

The most common explanation for these (cross-country) differentials (in borrowing costs) is the existence of financial risk premia which vary across countries. These risk premia can be broadly defined as the additional returns required by savers to compensate for uncertainty with respect to such factors as default risk, market volatility and inflation variability. Several interrelated factors are likely to influence the size of these premia, including the expected sustainability of government fiscal positions and perceived degrees of commitment to monetary discipline. ..... analysis suggests that the rate of return on capital, a country's past history of inflation, current-account balances and government deficits are all important determinants of trend real long-term interest rates - both as a group and relative to one another.

Dollarization removes the monetary discipline/inflation risk, while a fiscal stability pact reassures markets about the sustainability of the government's fiscal position.

It is simply wrong, and also beside the point, for the Scottish government to argue that

Scotland is in a stronger financial position than the UK as a whole, and therefore will have no difficulty adhering to fiscal discipline within a sterling zone as an independent country.

It is wrong because, as I have shown here, the evidence is that Scotland has a fiscal deficit which can be described as 'structural'. This is because even with a geographical share of oil revenues the deficit has averaged above 3 per cent of GDP, when the initial oil production years are excluded. A situation which is worse than the UK. Moreover, oil revenues are strongly predicted to be in decline and are highly volatile, accounting currently for 12 per cent of Scottish government revenue.

It is beside the point, because the fact that the UK may also have run fiscal deficits for some time, or currently has a high debt to GDP ratio, says nothing about the credibility of a Scottish government in fiscal management. In contrast, the credibility of UK government fiscal management is well established going back to Elizabethan times.

But even within a stability pact, it is almost certain that an independent Scotland will be subject to higher borrowing costs than the UK, for three reasons.

First, the stability pact is unlikely to remove completely the credibility problem facing a recently independent Scottish government, with no previous experience of, and reputation for, fiscal management. 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. So, to return to the OECD study cited above:

Some possible explanations for an additional (small country) risk premium could include: domestic and foreign assets not being perfect substitutes, leading to home-country preferences on the part of large country investors; the relative depth of financial markets, with larger countries perhaps offering more variety in terms of the types of assets available; and greater concern over a smaller country's policy stability, given their greater exposure to exogenous external shocks.

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.

A fiscal stability pact plus some agreement with the UK government on the Bank of England acting as a lender of last resort, hence ensuring liquidity to both government and banks, will be a major factor in helping to keep borrowing costs low.

But even then, we should still expect the Scottish government to have to pay a risk premium in its borrowing compared to the UK for the reasons outlined above.

And no amount of political posturing is going to change that.